7554 / What is the tax effect of modification, renewal, or extension of an incentive stock option?

The modification, renewal or extension of an incentive stock option is, for tax purposes, the equivalent of the granting of a new option; therefore, the requirements explained in Q 7545 will apply.¹ Thus a new option price is required if the fair market value of the stock is greater than the price of the original option, since the option price must equal at least 100 percent of the fair market value of the stock at the time the option is granted.

“Modification” generally means any change in the terms of the option that gives the employee additional benefits under the option. For example, a change that shortens the period during which the option is exercisable is not a modification. However, a change that provides more favorable terms for the payment for the stock purchased under the option is a modification. A change in the number of shares subject to the option will not be considered a modification of the existing option, but it will constitute the grant of a new option with respect to the additional shares. A change in the number or price of shares of stock subject to an option merely to reflect a stock dividend or stock split-up is not a modification of the option.²

The IRC states that the following changes in the terms of an option will not be considered a “modification”: (i) changes attributable to certain corporate reorganizations and liquidations; and (ii) in the case of an option not immediately exercisable in full, changes that accelerate the time at which the option may be exercised.³ For examples of reorganizations that did not result in modifications of options, see Letter Rulings 9810024 and 9849002.