Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-3_04-cv-04605/USCOURTS-cand-3_04-cv-04605-1/pdf.json

Parties Involved:
Gamiel C. Gran
Plaintiff
Gail K. Gran
Plaintiff
United States of America
Defendant

Document Text:

United States District Court

For the Northern District of California

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UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

GAMIEL C. GRAN and GAIL K. GRAN,

Plaintiffs,

 v.

UNITED STATES OF AMERICA,

Defendant.

 

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No. 04-4605-SC

ORDER RE: PARTIES'

CROSS-MOTIONS FOR

SUMMARY JUDGMENT 

I. INTRODUCTION

Plaintiffs Gamiel and Gail Gran ("Plaintiffs") filed suit

against Defendant United States of America ("Defendant") following

a dispute with the Internal Revenue Service ("IRS") over the

validity of a claimed tax refund. The dispute centers around the

applicability of a § 83(b) election under the Internal Revenue

Code, 26 U.S.C. § 83. Section 83 is applicable to taxpayers who

receive compensation in the form of property that is subject to a

risk of forfeiture, such as restricted stock options. In the

instant suit, Plaintiffs seek to reverse a § 83(b) election made

by them in 2000. Now before the Court is Plaintiffs' Motion for

Summary Judgment, which seeks a determination that the election

was invalid when made. Also before the Court is Defendant's

Cross-Motion for Summary Judgment, which seeks dismissal of the

suit on the ground that Plaintiffs made a valid election under 26

U.S.C. § 83. For the reasons stated herein, the Court DENIES

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Plaintiffs' Motion and GRANTS Defendant's Motion, except as to the

issue of whether or not a penalty payment is appropriate.

II. BACKGROUND

On February 11, 2000, Gamiel Gran ("Gran") received a grant

of 163,755 unvested incentive stock options ("incentive stock

options") from Asera Inc. ("Asera") in consideration for

employment. Complaint at 2. On April 17, 2000, Gran exercised

all 163,755 options and made a § 83(b) election with respect to

the taxation of the exercise event. Id.

Also on February 11, 2000, Gran received a grant of 68,750

unvested and non-qualified stock options ("non-qualified stock

options") from Asera in consideration for employment. Id. On

April 17, 2000, Gran exercised all 68,750 options and made a

Section 83(b) election with respect to the taxation of the

exercise event. Id. 

Plaintiffs filed their Section 83(b) elections on May 1,

2000. Declaration of Jay R. Weill, Exhibits 2-3. For both the

incentive stock options and the non-qualified stock options,

Plaintiffs stated at the time that 163,755 and 68,750 were

transferred, respectively, on April 17, 2000. Id. Plaintiffs

stated that the amount paid for each of the shares, both incentive

stock options and non-qualified stock options, was $1.3333 per

share, and that the fair market value of each share was $4.00 at

the time. Id. 

Initially, Plaintiffs paid the tax due pursuant to their

section 83(b) election. Then, in September 2002, Plaintiffs

requested a refund which they received, plus interest, in February

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2003. Defendant's Motion at 3. In August 2004, the IRS, having

determined that the refund was in error, sent a notice of

deficiency to Plaintiffs. Id. The notice of deficiency asserted

an amount due of $178,896.00, plus $35,779.20 in penalty payments,

or a total of $214,675.20. Id. 

Plaintiffs paid $210,525.38 to the IRS in September 2004. 

Id. On July 12, 2005, Plaintiffs paid an additional $4,149.82. 

Plaintiffs' Response at 1. Plaintiffs have brought suit under 28

U.S.C. § 1346(a)(1), which requires a taxpayer to have fully paid

a contested tax liability if a federal district court is to have

jurisdiction. Flora v. United States, 362 U.S. 145, 177 (1960)

("§ 1346(a)(1) ... requires full payment of the assessment before

an income tax refund suit can be maintained in Federal District

Court."). The Court finds that the Plaintiffs' two payments for a

total of $214,675.20 satisfy the full payment rule; therefore,

this Court has jurisdiction over the instant matter.

III. LEGAL STANDARD

Under Rule 56 of the Federal Rules of Civil Procedure,

summary judgment in favor of the movant is proper if "there is no

genuine issue as to any material fact." Celotex Corp. v. Catrett,

477 U.S. 317, 322 (1986). "[T]he movant has the burden of showing

that there is no genuine issue of fact." Anderson v. Liberty

Lobby, Inc., 477 U.S. 242, 256 (1986). Furthermore, "[o]n summary

judgment the inferences to be drawn from the underlying facts ...

must be viewed in the light most favorable to the party opposing

the motion." United States v. Diebold, Inc., 369 U.S. 654, 655

(1962).

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1

 Qualified stock options, which are not of concern in this

matter, are covered by 26 U.S.C. § 422.

4

Now before the Court are competing Motions for Summary

Judgment. Under the above standard, with respect to Defendant's

Motion, this Court must view the facts in the light most favorable

to Plaintiffs, and vice versa. However, notwithstanding the

Court's factual inferences for purposes of the respective Motions,

"[i]n any tax-refund case, the [IRS'] deficiency determination is

presumptively correct and the taxpayer has the burden of proving

that such deficiency is erroneous." Niles v. United States, 710

F.2d 1391, 1393 (9th Cir. 1983). Therefore, the burden is on

Plaintiffs to show that the IRS' deficiency determination is

somehow incorrect.

IV. DISCUSSION

26 U.S.C. § 83 governs the tax implications for employees who

receive compensation in the form of restricted stock plans. The

general rule, pursuant to § 83(a), is that a recipient of

nonqualified1 stock options must include in gross income the

difference between the fair market value of the stock and the

amount paid for the stock in the taxable year in which the stock

becomes alienable or is no longer subject to a substantial risk

of forfeiture. 26 U.S.C. § 83(a). The difference is taxed as

ordinary income. However, § 83(b) provides an exception to the

general rule. Under a § 83(b) election, the employee may include

in his or her gross income the difference between the fair market

value of the stock and the amount paid for it in the year that

the options are granted. Id. at § 83(b). This can be

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2

 The election covered both the incentive stock options and

the non-qualified stock options. Since there is no need to

distinguish between the two for purposes of this Order, the Court

will refer to them without distinction.

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advantageous for the taxpayer since the taxable amount is usually

smaller than the amount as calculated under § 83(a); only when

the stock is sold, potentially years later, is appreciation

taxable, and it is then at probably lower capital gains rates. 

However, if a taxpayer makes a § 83(b) election, the election is

irrevocable unless the IRS agrees otherwise. Id. at § 83(b)(2).

In the instant matter, Plaintiffs made a section 83(b)

election on May 1, 2000.2 Having reviewed the papers submitted by

the parties, the Court finds that the election was valid and

therefore, irrevocable. Plaintiffs have put forth a variety of

reasons alleging that the election was invalid. As described

below, the Court finds that none of these reasons have merit.

First, Plaintiffs assert that "when unvested stock options

are exercised, the income realization event occurs at the time of

vesting, not at the time of exercise." Plaintiffs' Motion at 10. 

Therefore, Plaintiffs assert that the May 1, 2000 election was

invalid since a portion of the shares did not vest until 2001. 

See, e.g., Declaration of Jay R. Weill at Exhibit 8. This is

simply a misreading of the law. Section 83(b) applies precisely

to situations where vesting has not yet occurred. Welsh v.

United States, 2 Cl. Ct. 417, 418 (Cl. Ct. 1983) ("Under section

83(b), one who receives property which is not substantially

vested is allowed 30 days from the date of its transfer to him

nevertheless to elect to recognize income in the year of receipt

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of the property, rather than the year in which the property

becomes substantially vested."). Therefore, the Court holds that

the fact that Plaintiffs' options had not substantially vested at

the time of the § 83(b) election is immaterial.

Second, Plaintiffs assert that their § 83(b) election was

invalid because there was no "transfer" of property as required

by the statute. Plaintiffs' Motion at 10-16. Plaintiffs state,

"At the time of exercise, the unvested shares were subject to the

claims of the creditors of the corporation; therefore, a transfer

within the meaning provided in Treas. Reg. § 1.83-3(a) had not

occurred which would make Plaintiff eligible to make an 83(b)

election." Id. Plaintiffs assert that the property was never

transferred to them because Asera had a "Repurchase Option" for

any unvested shares. Id. at 11; Declaration of Gamiel Gran

Exhibit D at 5. However, the existence of a repurchase option

does not foreclose a § 83(b) election. On the contrary, a

repurchase option raises a "substantial risk of forfeiture" and

§ 83(b) applies precisely when there is such a risk of

forfeiture. Alves v. Comm'r, 734 F.2d 478, 481 (9th Cir. 1984)

("Section 83 [requires] the taxpayer either to elect to include

the 'excess' of the fair market value over the purchase price in

the year the stock was transferred, or to be taxed upon the full

amount of appreciation when the risk of forfeiture was

removed."). As the Alves court noted, "By it's terms, the

statute applies when property is ... subject to a substantial

risk of forfeiture." Id. The statute explicitly assumes that a

§ 83(b) election may result in forfeiture. 26 U.S.C. § 83(b)

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3

 Plaintiffs appear to misunderstand the issue of whether a

restriction on the stock is a lapse or non-lapse restriction. For

example, Plaintiffs assert that Treas. Reg. § 1.83-9(a)(7) Example

3, in which there is no transfer of stock within the meaning of §

83, is analogous to the facts at hand. However, that example is

clearly one of a non-lapse restriction. At issue here is a lapse

restriction. Plaintiffs have spent a great deal of time and space

arguing that Asera's right to repurchase the unvested options upon

Mr. Gran's termination somehow invalidates the § 83(b) election. 

See, e.g., Plaintiff's Reply at 2-5. Again, the Court emphasizes

that it finds that a repurchase option that lapses upon vesting of

shares is a lapse restriction, which is immaterial to the statute.

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("...if such property is subsequently forfeited..."). Therefore,

the Court finds that the fact that Asera maintained a repurchase

option in Plaintiffs' share options does not necessarily mean

that there was no transfer of property as required for a valid §

83(b) election. 

Rather, a repurchase option only affects the validity of a

§ 83(b) election if the option never lapses. 26 U.S.C. §

83(b)(1)(A). The repurchase option at issue here lapsed upon the

full vesting of the shares.3

 Declaration of Gamiel Gran Exhibit D

at 5. Therefore, the Court finds that it does not affect the

validity of the election.

Plaintiffs assert that the Doctrine of Constructive Receipt,

which states that "a taxpayer recognizes income when the taxpayer

has an unqualified, vested right to receive immediate payment,"

Martin v. Comm'r, 96 T.C. 814, 823 (T.C. 1991), dictates that

there was no transfer of property to Plaintiffs that would

trigger § 83. Plaintiffs' Motion at 12. While it is true that

Plaintiffs did not have an unqualified, vested right to the

property at issue here, to apply the Doctrine of Constructive

Receipt would be a misapplication of the law. The fundamental

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4

 Plaintiffs do point to some out-of-circuit cases holding

that a "taxpayer's election to waive the carryback period under

Code Section 172(b)(3)(C) must be unequivocal and unambiguous to be

effective." Miller v. Comm'r, 99 F.3d 1042, 1044 (11th Cir. 1996)

(internal citations and quotations omitted). However, the Court

fails to see a connection between a § 172(b)(3)(C) election and the

§ 83(b) election at issue here.

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basis of a § 83(b) election is that the property has not yet

vested in the taxpayer. Welsh, 2 Cl. Ct. at 418. For Plaintiffs

to take the Doctrine of Constructive Receipt out of context and

attempt to use it to twist the application of § 83(b) is a

frivolous argument. Therefore, for all of the immediately above

reasons, the Court holds that there was a valid transfer of

property from Asera to Plaintiffs.

Third, Plaintiffs allege, "An I.R.C. § 83(b) election is

invalid with respect to the exercise of incentive stock options

if not made unequivocally as an 'AMT I.R.C. § 83(b) election.'" 

Plaintiffs' Motion at 16. Therefore, Plaintiffs assert, their

election was null and void. Id. at 18. Plaintiffs provide no

case law to support their proposition.4 Rather, the Court finds

Plaintiffs' election statement to be a model of what is required

under IRS regulations. For example, Plaintiffs' Declaration is a

series of seven statements numbered 1 through 7. Declaration of

Jay R. Weill, Exhibit 2. Under Treas. Reg. § 1.83-2(e), there

are seven requirements for the content of a § 83(b) election,

numbered 1 through 7. Having examined Plaintiffs' statement of

election, the Court finds that there is a one-to-one match

between what the regulations require and what Plaintiffs provided

in their election statement. Therefore, Plaintiffs have

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unambiguously fulfilled the criteria of the regulations.

Fourth, Plaintiffs assert that they "should be granted

consent to revoke [the] election under I.R.C. § 83(b) because the

election was predicated on a mistake of fact." Plaintiffs'

Motion at 18. Plaintiffs' explanation of this mistake of fact is

as follows:

 Plaintiff was operating under the 'mistakes of fact'

(1) that the right to repurchase the shares at cost

was assignably to the [sic] any party, including

creditors of Asera, and (2) that Asera that [sic]

could only repurchase the shares if Gran terminated

the employment services. In reality, the shares

could be repurchased at cost if Asera terminated the

employment agreement, Asera could for any reason

terminate the employment agreement, and Asera would

had [sic] a fiduciary duty to its shareholders to

repurchase the shares at cost if it did terminate

Grans' [sic] employment if the repurchase was in the

shareholders [sic] best interest. If Plaintiff had

known of these facts, he would not have made the

83(b) election at the time of the exercise of the

unvested shares. He would have waited until the

share [sic] had vested.

Plaintiffs' Motion at 18-19 (internal citations omitted). These

facts, which Plaintiff Gamiel Gran alleges he was unaware of,

were plainly written in the Stock Option Exercise and Repurchase

Agreement ("Agreement"). For example, with respect to the issue

of Asera's right to repurchase the unvested shares at cost, the

Agreement stated, "The Company ... shall have the option to

repurchase Purchaser's Unvested Shares ... if Purchaser is

Terminated (as defined in the Plan) for any reason, or no

reason." Declaration of Gamiel Gran, Exhibit D at 5. This

sentence appeared under a section titled in underlined bold

letters, "Company's Repurchase Option for Unvested Shares." Id.

Then, in the same section of the Agreement, but under a

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subsection with the underlined title, "Calculation of Repurchase

Price," the Agreement stated, "The Company or its assignee(s)

shall have the option to repurchase from Purchaser ... the

Purchaser's Unvested Shares at the Purchaser's original Price Per

Share." Id. at 9. On page 12 of the Agreement appears Mr.

Gran's signature. Under California contract law, "a unilateral

mistake not encouraged or fostered by the other party is not

reasonable when plaintiff could have ascertained the truth

through the exercise of reasonable diligence." Brookwood v. Bank

of America, 53 Cal. Rptr. 2d 515, 520 (Cal. Ct. App. 1996)

(internal citations and quotations omitted). Furthermore,

"[r]easonable diligence requires the reading of a contract before

signing it." Id. (internal citations and quotations omitted). 

Plaintiffs have not alleged any facts to suggest that Asera

encouraged or fostered the alleged mistake. The Court therefore

holds that given the plain language of the Agreement as stated

above, Plaintiffs did not make a mistake of fact which would void

their § 83(b) election. As Defendant notes, the opposite

conclusion would be absurd. "If the plaintiffs have their way,

taxpayers could sign documents without reading them, and then

revoke their elections if subsequent events are unfavorable,

claiming that they were under mistakes of fact as to the contents

of the agreement." Defendant's Opposition at 11. The Court

declines Plaintiffs' invitation to reach such a conclusion.

Fifth, Plaintiffs request that even if this Court holds that

the § 83(b) election was valid, as this Court does hold, that

they be allowed to adjust the declared value of the shares on

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their election statement by reapportioning the value between

vested and unvested shares. Plaintiffs' Motion at 22-24. 

However, the statute unambiguously states that the fair market

value of the property at time of transfer is to be "determined

without regard to any restriction other than a restriction which

by its terms will never lapse." 26 U.S.C. § 83(b)(1)(A). Since

the vesting conditions were conditions which would lapse, the

Court finds that they are immaterial to the fair market value of

the share options at the time of Mr. Gran's election. Therefore,

the Court declines to allow Plaintiffs to reapportion the value

of the vested and unvested shares.

Finally, Plaintiffs assert that they should not be subject to

penalty for underpayment because they submitted a Form 8275

attached to their Form 1040X for the 2000 tax year. Plaintiffs'

Motion at 24. Plaintiffs state that the Form 8275 is included in

the exhibits attached to the Declaration of Gamiel Gran. The

Court has reviewed the exhibits and the Form does not appear to

be attached. Therefore, at this time, the Court finds that the

penalty imposed under 26 U.S.C. § 6662 was not in error. 

However, if Plaintiffs can show the existence of a Form 8275 that

was filed with their previously filed Form 1040X for the 2000 tax

year, the Court grants Plaintiffs 30 days from the date of this

Order to file a renewed motion with respect to this issue.

 In sum, the Court emphasizes that § 83 "is a comprehensive

and complex arrangement of the rights, responsibilities and risks

of transferees, as well as transferors, of property in connection

with the performance of services." Welsh, 2 Cl. Ct. at 418. It

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applies to unvested stock options used to compensate employees,

such as the options at issue. See, e.g., Robinson v. United

States, 335 F.3d 1365 (Fed. Cir. 2003). An employee recipient of

stock options may choose to pay tax on the difference between

cost and fair market value in the year of the option grant or in

the year of vesting. 26 U.S.C. § 83. The former is governed by

§ 83(b), the latter by § 83(a). If a § 83(b) election is made,

"subsection (a) shall not apply with respect to the transfer of

such property." Id. at § 83(b)(1); Cramer, 64 F.3d at 1411. In

other words, it is an either/or choice. Furthermore, when there

is a substantial risk of forfeiture, such as a repurchase option

held by the transferor or its creditors, while § 83(a) cannot

apply until the risk of forfeiture is removed, there is no such

requirement mentioned in § 83(b). "[W]hen Congress includes a

specific term in one section of a statute but omits it in another

section of the same Act, it should not be implied where it is

excluded." Cramer, 64 F.3d at 1412 (internal citations and

quotations omitted). Therefore, the fact that there was a

repurchase option, which lapsed upon vesting as described above,

is of no consequence here. See, e.g., Alves, 734 F.2d at 480.

Based on this case law, Plaintiffs made a valid § 83(b)

election. The statute was written precisely to cover the sorts

of transactions as the one at issue here. Section 83 provides

taxpayers with flexibility in deciding when they pay tax on

unvested property that may appreciate significantly in value--

electing § 83(b) "enables the employee to treat as a capital gain

any appreciation in the value of the property between the time of

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5 This inability to deduct a loss for taxes paid is distinct

from the deduction suggested by Defendant, which would be a

deduction for the basis loss.

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the transfer and the time the restrictions lapse." Robinson, 335

F.3d at 1367. The flip side is that should the property fail to

appreciate, become worthless as here, or be forfeited, the

election cannot be undone--"an election under § 83(b) is not

cost-free: if a taxpayer elects to include property as gross

income, even though the property is forfeitable and is

subsequently forfeited, the taxpayer may not claim a deduction

for the loss."5 Theophilos v. Comm'r, 85 F.3d 440, 449 (9th Cir.

1996). Therefore, while the Court sympathizes with Plaintiffs,

who gambled that their Asera options would result in significant

capital gain when it in fact did not, their § 83(b) election is

valid and irrevocable.

V. CONCLUSION

For the reasons stated above, the Court holds that Plaintiffs

have not carried the burden of showing the IRS' deficiency

determination was in error. Rather, the Court holds that

Plaintiffs made a valid 26 U.S.C. § 83 election. The Court also

holds that Plaintiffs did not make a mistake of fact or law which

would allow rescission. Furthermore, the Court declines to allow

Plaintiffs to reapportion the previously stated value of the

vested and unvested shares. Therefore, the Court hereby DENIES

Plaintiffs' Motion for Summary Judgment, except as to the issue of

the penalty payment, as hereinafter set forth. With respect to

Defendant's Motion for Summary Judgment, the Court hereby GRANTS

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the Motion but stays issuance of a judgment dismissing the case

pending resolution of the issue of whether or not a penalty

payment is appropriate. Solely with respect to that issue and the

disputed Form 8275, the Court GRANTS Plaintiffs 30 days from the

date of this Order to renew their Motion. Should Plaintiffs

choose not to file anything within 30 days, then the Court will

grant Defendant's Motion in its entirety and dismiss the action

with prejudice.

IT IS SO ORDERED.

Dated: August 26 , 2005

 

UNITED STATES DISTRICT JUDGE

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