X. (A) : Margin Account Agreements:
1986 WL 370319 (I.R.S.)
Internal Revenue Service (I.R.S.)
Private Letter Ruling
June 10, 1986
Dear * * *
This is in reference to your April 21, 1986 letter, and prior correspondence, that you submitted on behalf of the Corporation and two of its wholly owned subsidiaries. You seek rulings concerning the federal income tax consequences of the transfer of certain stock to a Broker under the Margin Account Agreements described below.
The Corporation has extended qualified incentive stock options, described in section 422A of the Internal Revenue Code, to its employees. In addition, the Corporation has assumed the qualified incentive stock options of its two subsidiaries as part of two corporate mergers described in section 368(a)(1)(A) of the Code.
Following the exercise by an employee of an option, the employee may enter into a Margin Account Agreement with either Broker A or Broker B. Under either Margin Account Agreement, the employee would transfer legal title to the optioned stock to the Broker as collateral for a margin account. The Broker would become the holder-of-record for the stock, but the stock would be held in an account for the employee. The employee would remain the beneficial owner of the stock, thereby retaining voting rights and dividend rights. The Broker would have the power to dispose of the employee's stock; but upon doing so would be obligated to replace the employee's optioned stock with stock of the same kind and amount.
The Margin Account Agreements will afford the employees the opportunity to use qualified option stock as collateral on a margin account. In some cases, the proceeds from such a margin account could pay for all or a portion of the exercise price for a subsequently exercised option, or to pay, in whole or in part, any outstanding balance on a loan incurred by the employee to acquire the qualified optioned stock deposited in the margin account. Moreover, the Margin Account Agreements will enable the employee and Broker to facilitate a possible transfer of the optioned stock by eliminating the need to execute and deliver the stock at the time of transfer.
Section 425(c) of the Code states that the term 'disposition' includes a sale, exchange, gift, or transfer of legal title, but does not include an exchange to which section 1036 applies. Section 1036(a) provides that no gain or loss shall be recognized if common stock in a corporation is exchanged solely for common stock in the same corporation, or if preferred stock in a corporation is exchanged solely for preferred stock in the same corporation.
Section 425(c)(1)(C) of the Code, and section 1.425-1(c)(1)(iii) of the Income Tax Regulations provide that a 'disposition' does not include a mere pledge or hypothecation of stock. However, a disposition of the stock pursuant to a pledge or hypothecation is a 'disposition' for purposes of section 425(c) of the Code.
Rev. Rul. 57-451, 1957-2 C.B. 295, illustrates three situations involving the issue of whether a shareholder has made a disposition of stock. In the second situation, which is relevant here, a shareholder endorses stock certificates and deposits them with a broker in a 'safekeeping' account. The shareholder authorized the broker to 'lend' such certificates to the broker's other customers in the ordinary course of business. The broker has the certificates cancelled and has new certificates issued in the broker's name. All incidents of ownership pass to the broker, and then to the 'borrowing customer'. The Revenue Ruling concludes that a disposition has occurred UNLESS the broker replaces the original certificates with new certificates representing shares of the same kind and amount as contemplated under section 1036 of the Code.
Based solely on the facts submitted and assuming that the Brokers will, in fact, replace the employee's optioned stock with the Corporation's stock of the same kind and amount, we conclude that the transfer of stock to a Broker pursuant to the above described Margin Account Agreements will not result in a 'disposition' of such stock under section 425(c) of the Code. In addition, such a transfer of optioned stock to be used as collateral on a margin account, the proceeds of which margin account are to be used by the employee to pay all or a portion of the exercise price for a subsequently exercised option or to pay in full or reduce any loan incurred by the employee to acquire the optioned stock, will not result in a disposition of such stock under section 425(c).
No opinion is expressed regarding whether options granted or assumed by the Corporation qualify as incentive stock options as defined in section 422(A) of the Code. Except as specifically ruled upon above, no opinion is expressed as to the federal income tax consequences of the transaction described above under any other provision of the Code.
This ruling is directed only to the taxpayer who requested Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.
A copy of this ruling should be attached to the Corporation's tax return for the next taxable year in which the Corporation files. We are enclosing a copy for that purpose.
Sincerely yours,
Richard H. Manfreda
Chief
Individual Income Tax Branch
This document may not be used or cited as precedent. Section 6110(j)(3) of the Internal Revenue Code.
PLR 8636055, 1986 WL 370319 (I.R.S.)
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