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TITLE 26-INTERNAL REVENUE CODE or the laws of descent and distribution, and is exercisable, dturing his lifetime, only by him; and (7) such individual, immediately after such option is granted, does not own stock possess- Ing more than 5 percent of the total com- bined voting power or value of all classes of stock of the employer corporation or of its parent or subsidiary corporation; except that if the equity capital of such corporation or corporations (determined at the time the option is granted) is less than $2,000,000, then, for purposes of applying the limitation of this paragraph, there shall be added to such 5 percent the percentage (not higher than 5 percent) which bears the same ratio to 5 percent as the difference between such equity capital and $2,000,000 bears to $i,000,000. (c) Special rules (1) Exercise of option when price is less than value of stock If a share of stock is transferred pursuant to the exercise by an individual of an option which fails to qualify as a qualified stock option under subsection (b) because there was a failure in an attempt, made in good faith, to meet the requirement of subsection (b)(4), the requirement of subsection (b)(4) shall be considered to have been met, but there shall be included as compensation (and not as gain upon the sale or exchange of a capital asset) in his gross income for the taxable year in which such option is exercised, an amount equal to the lesser of- (A) 150 percent of the difference between the option price and the fair market value of the share at the time the option was granted, or (B) the difference between the option price and the fair market value of the share at the time of such exercise. The basis of the share acquired shall be in- creased by an amount equal to the amount in- cluded in his gross income under this para- graph in the taxable year in which the exer- cise occurred. (2) Certain options treated as outstanding For purposes of subsection (b)(5)- (A) any restricted stock option which is not terminated before January 1, 1965, and (B) any qualified stock option granted after December 31, 1963, shall be treated as outstanding until such option is exercised in full or expires by reason of the lapse of time. For purposes of the pre- ceding sentence, a restricted stock option granted before January 1, 1964, shall not be treated as outstanding for any period before the first day on which (under the terms of such option) it may be exercised. (3) Options granted to certain shareholders For purposes of subsection (b)(7)- (A) the term "equity capital" means- (1) in the case of one corporation, the sum of its money and other property (in an amount equal to the adjusted basis of such property for determining gain), less the amount of its indebtedness (other than indebtedness to shareholders), and (i) in the case of a group of corpora- tions consisting of a parent and Its subsid- iary corporations, the sum of the equity capital of each of such corporations ad- justed, under regulations prescribed by the Secretary, to eliminate the effect of intercorporate ownership and transac- tions among such corporations; (B) the rules of section 425(d) shall apply in determining the stock ownership of the individual: and (C) stock which the individual may pur- chase under outstanding options shall be treated as stock owned by such individual. If an individual is granted an option which permits him to purchase stock in excess of the limitation of subsection (b)(7) (deter- mined by applying the rules of this para- graph), such option shall be treated as meet- Ing the requirement of subsection (b)(7) to the extent that such individual could, if the option were fully exercised at the time of grant, purchase stock under such option with- out exceeding such limitation. The portion of such option which is treated as meeting tle requirement of subsection (b)(7) shall be deemed to be that portion of the option which is first exercised. (4) Certain disqualifying dispositions where amount realized is less than value at exercise If-- (A) an individual who has acquired a, share of stock by the exercise of a qualified stock option makes a disposition of such share within the 3-year period described in subsection (a)(1), and (B) such disposition is a sale or exchange with respect to which a loss (if s~istained) would be recognized to such individual, then the amount which is includible in the gross income of such individual, and i.he amount which is deductible from the income of his employer corporation, as compensation attributable to the exercise of such option shall not exceed the excess (if any) of the amount realized on such sale or exchange over the adjusted basis of such share. (5) Certain transiers by insolvent individuals If an insolvent individual holds a share of stock acquired pursuant to his exercise of a qualified stock option, and if such share is transferred to a trustee, receiver, or other similar fiduciary, in any proceeding under the Bankruptcy Act or any other similar insolven- cy proceeding, neither such transfer, nor any other transfer of such share for the benefit of his creditors in such proceeding, shall consti- tute a "disposition of such share" for pur- poses of subsecion (a)(1). (6) Application of subsection (b)(5) whele options are for stock of same class in same corporation The requirement of subsection (b)(5) shall be considered to have been met in the case of any option (referred to in this paragraph as "new option") granted to an individual if- (A) the new option and all outstanding options referred to in subsection (b)(5) are to purchase stock of the same class in the same corporation, and Page 347 § 422