Opinion ID: 194881
Heading Depth: 1
Heading Rank: 1

Heading: The Characterization of the 1986 Distribution

Text: 3 The tax provisions at issue are IRC Secs. 83, 104, and 105. Section 83(a) provides for the taxation of property transferred to a person in connection with the performance of services. The person liable for the tax is the person who performed the services, and the amount taxed is the excess of the fair market value of the property over the amount paid for the property. A transfer of property is subject to section 83 if made in respect of past, present, or future services. Treas. Reg. Sec. 1.83-3(f). Section 83 applies at the time a stock option is exercised where, as here, the option does not have a readily ascertainable fair market value at the time the option is granted, provided the stock is transferable or no longer subject to substantial risk of forfeiture at that time (as defined in the regulations). Id. Sec. 1.83-7(a); IRC Sec. 83(a)(1); see Treas. Reg. Sec. 1.83-(c) & (d). 1 In general, section 104(a)(3) excludes from taxable income amounts received through accident or health insurance for personal injuries or sickness.... For section 104 purposes, amounts received under an accident or health plan for employees are treated as amounts received through accident or health insurance. IRC Sec. 105(e)(1). Generally speaking, an accident or health plan is an arrangement for the payment of amounts to employees in the event of personal injuries or sickness. Treas. Reg. Sec. 1.105-5(a). 4 The pertinent facts and our assessment of them in light of this law are as follows. In 1986, John Fisher exercised his option to buy 690 shares of stock as to which the restrictions on transferability had lapsed. The fair market value of the stock was $58,132.55, and Fisher paid $7,406 to exercise his option. Fisher had been granted his stock option rights in 1976 in two stock option agreements, one of which is included in the record. The option agreement in the record makes no reference to Digital's disability plan, but explicitly states that it is subject to Digital's Restricted Stock Purchase Plan (the Restricted Stock Plan), and it incorporates the terms of the Restricted Stock Plan by reference. The option agreement, which was to terminate on July 28, 1986, states that Fisher could exercise the option only while employed by Digital. Similarly, the Restricted Stock Plan states its intent to provide incentives to certain employees who are presently making and are expected to continue to make substantial contributions to the company to ensure that they would continue in the service of the Company ..., thereby advancing [its] interests.... Although the option agreement and the Restricted Stock Plan describe what Fisher's rights to exercise the option would be if Fisher retired with the company's consent, died, or terminated his employment with Digital, neither makes any reference to what Fisher's rights would be if he were unable to work because of sickness or disability. Presumably, however, if he remained employed by Digital, his rights under the option agreement and the Restricted Stock Plan would continue, whereas if he terminated his employment because of disability, his rights would be as provided in the Restricted Stock Plan for employees whose employment with Digital terminates. As a postscript to the option agreement, Fisher signed a pledge affirming his obligations to Digital under the employment agreement he signed when he first joined Digital, and agreeing, among other things, to preserve the confidentiality of Digital's trade secrets, inform Digital of new ideas conceived by him while at Digital, and refrain from inducing others to violate their employment agreements with the company. On the basis of these documents, it is clear that Digital's grant of stock options to its employees was intended to reward present good performance and to encourage future services of like quality. Thus, transferring stock to an employee exercising an option under the option agreement would transfer property in connection with the performance of services as defined in the regulations. See Treas. Reg. Sec. 1.83-3(f) (section 83(a) taxes property transferred in respect of past, present, or future services). Accordingly, such a transfer would subject the performer of the services to taxation with respect to that stock under section 83(a), and the Restricted Stock Plan states, without qualification, that the option holder would receive taxable income under section 83(a) upon exercise of the option with respect to shares as to which the restrictions have lapsed. 5 We see nothing in Digital's personnel or disability policies or in the way in which John Fisher was treated while on leave that would alter that result with respect to Digital's transfer of stock to Fisher in 1986. At the time Fisher was granted his option, he was performing services for Digital. In 1978, before he went on a leave of absence, an internal company memorandum explained that, for employees on a leave of absence, [stock] options continue to lapse as though [the] employees were not on leaves of absence. This memorandum made explicit the inference to be drawn from the proviso in Fisher's option agreement that the option was exercisable only as long as he was employed by Digital-that is, that employees on leave are still employed by Digital and have full rights under their option agreements and under the Restricted Stock Plan. 6 Digital's leave of absence policy, stated in Section 4.23 of its Personnel Policies and Procedures, is consistent with the 1987 memorandum. The benefits subsection of the policy describes the extent to which benefits continue for employees on a leave of absence. The entry Qualified and Restricted Stock Plans provides that [i]f the employee is a participant in either the Qualified or Restricted Stock Plan, restrictions on these options continue to lapse while the employee is on a leave of absence. A separate entry Medical, Dental, Life and Disability Insurance states that employees on a leave of absence can continue their disability income protection by paying their premiums in advance. Thus, Personnel Policy 4.23 makes clear that some benefits continue for employees on leave; it also treats an absent employee's rights under the Restricted Stock Plan and under a long-term disability plan separately, and does not make the exercise of stock options a component of the disability benefits provided employees on a disability leave of absence. 7 Nor do Digital's disability policies do this. In Section 5 of its benefits booklet, Digital discusses its disability plans. 2 The preface explains that Digital offers one sickness and three disability plans to help provide you with all or a portion of your income if you are sick or disabled and unable to work. (Emphasis in original.) Although Digital automatically enrolls all employees in its short-term disability plan, employees must purchase their long-term disability plan from an insurance company, as Fisher did. In the event of long-term disability, the insurance company sends monthly checks for as long as you are totally disabled.... The checks amount to two-thirds of an employee's base salary, and the amounts received are not taxed. 3 Nowhere does Section 5 of the benefits booklet state that disability payments may be made by way of distribution of Digital's stock under the Restricted Stock Plan or an option agreement. Although Section 5 includes a subsection entitled What happens to your other Digital benefits if you're disabled, that subsection does not refer to the Restricted Stock Plan or employee option agreements either. 4 8 John Fisher was on disability leave from Digital from 1982-87. At no point during his leave did Fisher or Digital terminate Fisher's employment with Digital. Although he performed no services for Digital during that time, he presumably continued to observe his employment agreement (reaffirmed in the option agreement), which was a matter of clear importance to Digital. In addition, Digital carried him on its employee rolls, extended certain benefits to him, and undoubtedly anticipated his performance of future services when his disability ended. (Fisher did return at the end of his leave and as of the time of trial was still performing services for Digital.) Consistent with Personnel Policy 4.23, the restrictions on Fisher's option stock continued to lapse during his leave, and before his option agreement expired in July 1986, he exercised his option to purchase the then remaining shares of stock on which restrictions had lapsed. As the facts show, that exercise could only have been pursuant to the option agreement, which was fully effective at that time since Fisher's employment with Digital had not terminated, the Restricted Stock Plan and Personnel Policy 4.23. The option could not have been exercised pursuant to his rights under the long-term disability insurance policy he had purchased. That policy provided only for the receipt of monthly checks from Fisher's disability insurance company during his disability, which Fisher testified he had received and excluded from taxable income. 9 On these facts, we have no hesitation affirming the Tax Court's decision that the distribution of stock to Fisher was taxable under section 83(a). The purpose of the Restricted Stock Plan was to encourage the continued services of certain employees by distributing stock which became more valuable to those employees as their service to the company continued. Through its leave of absence policy and the specific provisions of the option agreement, which required only that an optionee remain employed in order to exercise his option, Digital ensured that employees whose employment had not terminated, but who were temporarily unable to perform services because on a leave of absence, were entitled to take advantage of the benefits of the Restricted Stock Plan, thus receiving the same incentive to continue their employment as employees not on leave. The Restricted Stock Plan was not intended to provide stock to sick or disabled employees, and, being entirely silent on the subject, cannot conceivably be thought to have done so. Likewise, the disability policy made no mention of distributing stock to sick or disabled employees, but spoke only of distributing monthly checks to disabled employees, and so cannot conceivably be thought to have authorized stock distributions to disabled employees. Consequently, the Restricted Stock Plan was not accident or health insurance under IRC Sec. 104 or an accident or health plan under IRC Sec. 105, nor was the 1986 distribution of stock a disability payment to Fisher under Fisher's long-term disability insurance.