[Federal Register Volume 63, Number 122 (Thursday, June 25, 1998)]
[Proposed Rules]
[Pages 34616-34618]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-16848]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-104641-97]
RIN 1545-AV48
Equity Options Without Standard Terms; Special Rules and
Definitions
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations providing guidance
on the application of the rules governing qualified covered calls. The
new rules address concerns that were created by the introduction of new
financial instruments after the enactment of the qualified covered call
rules. The proposed regulations will provide guidance to taxpayers
holding qualified covered calls. This document also provides notice of
public hearing on these proposed regulations.
DATES: Written comments must be received by September 23, 1998.
Requests to speak (with outlines of oral comments) at the public
hearing scheduled for November 4, 1998, must be submitted by October
14, 1998.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-104641-97), room
5228, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered between the
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-104641-97), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC. Alternatively, taxpayers may submit comments
electronically via the Internet by selecting the ``Tax Regs'' option on
the IRS Home Page, or by submitting comments directly to the IRS
Internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html. The public hearing will be held in room 2615, Internal
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Pamela
Lew, (202) 622-3950; concerning submissions and the hearing, Michael L.
Slaughter, Jr., (202) 622-7190, (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
Section 1092(c) defines a straddle as offsetting positions with
respect to personal property. Under section 1092(d)(3), stock is
personal property if the stock is part of a straddle that involves an
option on that stock or substantially identical stock or securities.
Under section 1092(c)(4), however, writing a qualified covered call
option and owning the optioned stock is not treated as a straddle for
purposes of section 1092.
The special treatment for qualified covered calls was created
because Congress believed that, in certain limited circumstances, a
taxpayer who grants a call option does not substantially reduce his or
her risk of loss with respect to the optioned stock. Congress
established a mechanical test to determine whether a written call
option could substantially reduce a taxpayer s risk of loss and,
therefore, should be subject to treatment as one leg of a straddle. In
order to be classified as a qualified covered call under this test, a
call option must, among other things, be exchange-traded and not be
deep in the money.
Section 1092(c)(4)(C) defines a deep-in-the-money option as an
option whose strike price is lower than an allowed bench mark. Under
section 1092(c)(4)(D), this bench mark is generally the highest
available strike price for an option that is less than the applicable
stock price, as defined in section 1092(c)(4)(G). The Internal Revenue
Code provides other bench marks under specified circumstances.
At the time the qualified covered call definition was written,
listed options were available only at standardized maturity dates and
strike price intervals. This fixed-interval system was a basic
assumption of the Congressional plan for qualified covered calls and,
more specifically, was the foundation for the definition of a deep-in-
the-money option.
Certain options exchanges have begun to trade put and call equity
options with flexible terms. The terms that are flexible include strike
price, expiration date, and exercise style (that is, American,
European, or capped). Except
[[Page 34617]]
as noted below, the strike price is denominated in the smallest
interval available on the options exchanges, which is currently \1/8\
of one dollar. To minimize the market impact of options contract
expirations, equity options with flexible terms may not expire within 2
business days of equity options with standardized terms. Equity options
with flexible terms are generally intended for institutional and other
large investors.
Questions have been raised as to whether the strike prices
established by equity options with flexible terms might establish the
lowest qualified benchmark under section 1092(c)(4)(D) for all equity
options, including those with standardized terms. The following example
illustrates this concern. If a stock is currently selling for $62,
equity options with flexible terms and option periods of not more than
90 days could have a strike price of $61 \7/8\. If the strike prices
from equity options with flexible terms were taken into account in
determining if a 90-day equity option with standardized terms is deep
in the money, any option being sold for less than $61 \7/8\ would be
deep in the money. Because the strike prices for an equity option with
standardized terms are set in $5 intervals, the highest strike price
less than the current selling price for an equity option with
standardized terms would be $60. Thus, any in-the-money equity option
on the stock that had standardized terms would be deep in the money
(for purposes of section 1092(c)(4)).
Explanation of Provisions
The proposed regulations provide that the strike prices established
by equity options with flexible terms are not taken into account in
determining whether equity options that are not equity options with
flexible terms are deep in the money. Thus, the existence of strike
prices established for equity options with flexible terms does not
affect the lowest qualified bench mark, as determined under section
1092(c)(4)(D), for an equity option with standardized terms. The
proposed regulations define equity options with flexible terms as those
equity options described in certain specified SEC releases, including
any changes approved by the SEC to these releases.
The regulations will allow some taxpayers, primarily institutional
and other large investors, to engage in certain exchange-based
transactions that are currently unavailable to them and will permit
other investors to continue doing business under section 1092 without
regard to the existence of the institutional product.
The proposed regulations do not address whether an equity option
with flexible terms is eligible for qualified covered call treatment
under section 1092(c)(4). Comments are requested on the following
issues: (1) whether equity options with flexible terms should be
eligible for qualified covered call treatment under section 1092(c)(4);
(2) whether there should be uniform rules governing the bench marks for
equity options with flexible terms and standardized options; and (3) if
uniform rules are not appropriate, what bench marks should apply to
equity options with flexible terms.
Proposed Effective Date
These regulations apply to equity options with flexible terms
entered into on or after the date that the Treasury Decision adopting
these rules as final regulations is published in the Federal Register.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations, and because the
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this
notice of proposed rulemaking will be submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on its
impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (preferably a
signed original and eight (8) copies) that are submitted timely to the
IRS. All comments will be available for public inspection and copying.
A public hearing has been scheduled for Wednesday, November 4,
1998, beginning at 10:00 a.m. The hearing will be held in Room 2615,
Internal Revenue Building, 1111 Constitution Avenue NW., Washington DC.
Because of access restrictions, visitors will not be admitted beyond
the Internal Revenue Building lobby more than 15 minutes before the
hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons who wish to present oral comments at the hearing must
submit written comments by September 23, 1998 and submit an outline of
topics to be discussed and the time to be devoted to each topic (signed
original and eight (8) copies) by October 14, 1998.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal author of these regulations is Pamela Lew, Office of
Assistant Chief Counsel (Financial Institutions and Products). However,
other personnel from the IRS and Treasury Department participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1092(c)-1 also issued under 26 U.S.C. 1092(c)(4)(H). *
* *
Par. 2. Section 1.1092(c)-1 is added to read as follows:
Sec. 1.1092(c)-1 Equity options with flexible terms.
(a) Effect on lowest qualified bench mark for other options.
The existence of strike prices established by equity options with
flexible terms does not affect the determination of the lowest
qualified bench mark, as defined in section 1092(c)(4)(D), for any
option that is not an equity option with flexible terms.
(b) Definitions. For purposes of this section:
(1) Equity option with flexible terms means an equity option--
(i) That is described in the following Securities Exchange Act
Releases--
(A) Self-Regulatory Organizations; Order Approving Proposed Rule
Changes and Notice of Filing and Order Granting Accelerated Approval of
Amendments by the Chicago Board Options Exchange, Inc. and the Pacific
Stock Exchange, Inc., Relating to the Listing of Flexible Equity
Options on Specified Equity Securities, Securities
[[Page 34618]]
Exchange Act Release No. 34-36841 (Feb. 21, 1996); or
(B) Self-Regulatory Organizations; Order Approving Proposed Rule
Changes and Notice of Filing and Order Granting Accelerated Approval of
Amendment Nos. 2 and 3 to the Proposed Rule Change by the American
Stock Exchange, Inc., Relating to the Listing of Flexible Equity
Options on Specified Equity Securities, Securities Exchange Act Release
No. 34-37336 (June 27, 1996); or
(C) Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment Nos. 2, 4 and 5 to the Proposed Rule Change by the
Philadelphia Stock Exchange, Inc., Relating to the Listing of Flexible
Exchange Traded Equity and Index Options, Securities Exchange Act
Release No. 34-39549 (Jan. 23, 1998); or
(D) Any changes to the SEC releases described in paragraphs
(b)(1)(i)(A) through (C) of this section that are approved by the
Securities and Exchange Commission; or
(ii) That is traded on any national securities exchange which is
registered with the Securities and Exchange Commission (other than
those described in the SEC Releases set forth in paragraph (b)(1)(i) of
this section) or other market which the Secretary determines has rules
adequate to carry out the purposes of section 1092 and is--
(A) Substantially identical to the equity options described in
paragraph (b)(1)(i) of this section; and
(B) Approved by the Securities and Exchange Commission in a
Securities Exchange Act Release.
(2) Securities Exchange Act Release means a release issued by the
Securities and Exchange Commission. To determine identifying
information for releases referenced in paragraph (b)(1) of this
section, including release titles, identification numbers, and issue
dates, contact the Office of the Secretary, Securities and Exchange
Commission, 450 5th Street, NW., Washington, DC 20549. To obtain a copy
of a Securities Exchange Act Release, submit a written request,
including the specific release identification number, title, and issue
date, to Securities and Exchange Commission, Attention Public
Reference, 450 5th Street, NW., Washington, DC 20549.
(c) Effective date. These regulations apply to equity options with
flexible terms entered into on or after the date that the Treasury
Decision adopting these regulations is published in the Federal
Register.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
[FR Doc. 98-16848 Filed 6-24-98; 8:45 am]
BILLING CODE 4830-01-U
