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S stock call options as a second class of stock.

Publication: The Tax Adviser
Publication Date: 01-OCT-07
Format: Online
Delivery: Immediate Online Access

Article Excerpt
An S corporation can have only one class of stock; if a second class of stock exists, a corporation's S election will terminate. The second-class-of-stock requirements are governed by the regulations under Sec. 1361, which states that generally call options, warrants, or similar instruments (collectively, "call options") are treated as a second class of stock if the call options are substantially certain to be exercised and have a strike price substantially below the FMV of the underlying stock on the date that the call options are issued or transferred by an eligible shareholder to a person who is not an eligible shareholder. The regulations require retesting if and when the call options are first transferred to an ineligible shareholder. A call option is not considered to have a strike price substantially below FMV if the price at the time of exercise, under terms of instrument, cannot be substantially below the FMV of the underlying stock at the time of the exercise. It is...

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