26 USC 421 - General rules

(a) Effect of qualifying transfer 
If a share of stock is transferred to an individual in a transfer in respect of which the requirements of section 422 (a) or 423 (a) are met
(1) no income shall result at the time of the transfer of such share to the individual upon his exercise of the option with respect to such share;
(2) no deduction under section 162 (relating to trade or business expenses) shall be allowable at any time to the employer corporation, a parent or subsidiary corporation of such corporation, or a corporation issuing or assuming a stock option in a transaction to which section 424 (a) applies, with respect to the share so transferred; and
(3) no amount other than the price paid under the option shall be considered as received by any of such corporations for the share so transferred.
(b) Effect of disqualifying disposition 
If the transfer of a share of stock to an individual pursuant to his exercise of an option would otherwise meet the requirements of section 422 (a) or 423 (a) except that there is a failure to meet any of the holding period requirements of section 422 (a)(1) or 423 (a)(1), then any increase in the income of such individual or deduction from the income of his employer corporation for the taxable year in which such exercise occurred attributable to such disposition, shall be treated as an increase in income or a deduction from income in the taxable year of such individual or of such employer corporation in which such disposition occurred. No amount shall be required to be deducted and withheld under chapter 24 with respect to any increase in income attributable to a disposition described in the preceding sentence.
(c) Exercise by estate 

(1) In general 
If an option to which this part applies is exercised after the death of the employee by the estate of the decedent, or by a person who acquired the right to exercise such option by bequest or inheritance or by reason of the death of the decedent, the provisions of subsection (a) shall apply to the same extent as if the option had been exercised by the decedent, except that
(A) the holding period and employment requirements of sections 422 (a) and 423 (a) shall not apply, and
(B) any transfer by the estate of stock acquired shall be considered a disposition of such stock for purposes of section 423 (c).
(2) Deduction for estate tax 
If an amount is required to be included under section 423 (c) in gross income of the estate of the deceased employee or of a person described in paragraph (1), there shall be allowed to the estate or such person a deduction with respect to the estate tax attributable to the inclusion in the taxable estate of the deceased employee of the net value for estate tax purposes of the option. For this purpose, the deduction shall be determined under section 691 (c) as if the option acquired from the deceased employee were an item of gross income in respect of the decedent under section 691 and as if the amount includible in gross income under section 423 (c) were an amount included in gross income under section 691 in respect of such item of gross income.
(3) Basis of shares acquired 
In the case of a share of stock acquired by the exercise of an option to which paragraph (1) applies
(A) the basis of such share shall include so much of the basis of the option as is attributable to such share; except that the basis of such share shall be reduced by the excess (if any) of
(i)  the amount which would have been includible in gross income under section 423 (c) if the employee had exercised the option on the date of his death and had held the share acquired pursuant to such exercise at the time of his death, over
(ii)  the amount which is includible in gross income under such section; and
(B) the last sentence of section 423 (c) shall apply only to the extent that the amount includible in gross income under such section exceeds so much of the basis of the option as is attributable to such share.
(d) Certain sales to comply with conflict-of-interest requirements 
If
(1) a share of stock is transferred to an eligible person (as defined in section 1043 (b)(1)) pursuant to such persons exercise of an option to which this part applies, and
(2) such share is disposed of by such person pursuant to a certificate of divestiture (as defined in section 1043 (b)(2)),

such disposition shall be treated as meeting the requirements of section 422 (a)(1) or 423 (a)(1), whichever is applicable.