Summary—The IRS issued a complete set of final regulations on incentive stock options (“ISOs”) on August 3, 2004.  The regulations provide guidance under the following Code sections:

• section 422, which authorizes ISOs and spells out the requirements;

• section 421, which governs the income tax treatment of ISOs as
  well as transactions under employee stock purchase plans governed by Code section 423 (“ESPPs”); and

• section 424, which provides special rules for ISOs and ESPP
  options.

The final regulations essentially adopt the proposed regulations issued in June 2003 with limited revisions.  On the same date the final ISO regulations were issued, the IRS issued a Notice requesting comments on possible revisions to the ESPP regulations under Code section 423.

We describe some of the more significant changes the final ISO regulations made to the proposed regulations, and summarize the IRS request for comments on the ESPP regulations.