Opinion ID: 703228
Heading Depth: 3
Heading Rank: 1

Heading: The 1978 and 1979 Options

Text: 39 Appellants argue that under Sec. 83(e)(3), the 1978 and 1979 IMED options had a readily ascertainable fair market value at the time of transfer, and that therefore Sec. 83 applied to the transfer of those options. They filed Sec. 83(b) elections with the IRS to include the value of the 1978 Cramer option and the 1979 Boynton and Monaghan options in ordinary income in the year of transfer. 1 While they no longer maintain that those options had zero value upon grant, they argue that, pursuant to Sec. 83(b), the value of those options (determined without regard to any restrictions) was taxable as ordinary income in the year of transfer, and that any subsequent appreciation in value was taxable as capital gain upon sale in 1982. See Boris I. Bittker & Martin J. McMahon, Jr., Federal Income Taxation of Individuals p 37.4, at 37-24 (1988). 40 The Commissioner argues that those options did not have a readily ascertainable fair market value at the time of transfer, and that therefore, under Sec. 83(e)(3), Sec. 83 did not apply at the time of transfer. According to this analysis, the transfer of the options was a nontaxable event, Sec. 83 applied only when appellants sold the options in 1982, see Treas.Reg. Sec. 1.83-7(a), and the proceeds were taxable entirely as ordinary income. See id.; I.R.C. Sec. 83(a). 41 Thus, the issue presented by this case is whether, at the time of the original transfer, the options had a readily ascertainable fair market value, within the meaning of I.R.C. Sec. 83(e)(3). Treasury has issued a regulation defining this standard. That regulation provides that an option that is not traded on an established market, such as the IMED options, 42 does not have a readily ascertainable fair market value when granted unless the taxpayer can show that all of the following conditions exist: 43
44
45 (iii) The option or the property subject to the option is not subject to any restriction or condition ... which has a significant effect upon the fair market value on the option; and 46 (iv) The fair market value of the option privilege is readily ascertainable in accordance with paragraph (b)(3) of this section. 47 Treas.Reg. Sec. 1.83-7(b)(2) (emphasis added). 48 The 1978 and 1979 IMED options clearly did not meet all four of these conditions at the time of transfer, and therefore did not have a readily ascertainable fair market value according to this regulation. Because the options could not be exercised unless the original recipient remained employed at IMED, the options were subject to substantial risk of forfeiture. See I.R.C. Sec. 83(c)(1). The terms of the options also required that if they were transferred, the transferee must take the options subject to this risk. Thus, the options were not transferable within the meaning of the statute. See I.R.C. Sec. 83(c)(2). Moreover, the five year vesting schedule rendered them not exercisable immediately in full upon grant. Finally, appellants do not seriously challenge the Tax Court's factual finding that the transfer and vesting restrictions had a significant effect upon the fair market value on the option[s]. We need not address whether the fourth condition was satisfied, because, even though appellants presented evidence below that the value of each IMED option privilege was ascertainable, these options so clearly failed the first three conditions. Therefore, according to Reg. Sec. 1.83-7(b)(2), the value of the options was not readily ascertainable at the time of transfer, Sec. 83 did not apply to that transfer, and the gain from the 1982 sale of those options was ordinary income, not capital gain. 49 Rather than contest this analysis, appellants argue that Reg. Sec. 1.83-7(b)(2) is simply an invalid interpretation of I.R.C. Sec. 83. They point out that Sec. 83(a) and (b) both require that all lapsing restrictions, such as those listed in Reg. Sec. 1.83-7(b)(2)(i-iii), be disregarded when valuing an option for purposes of calculating the tax. They argue that such restrictions should also be disregarded when determining whether an option has a readily ascertainable fair market value within the meaning of Sec. 83(e)(3). Since, rather than disregarding those restrictions, Reg. Sec. 1.83-7(b)(2) mandates that such restrictions prevent an option from satisfying the Sec. 83(e)(3) test, appellants argue it is invalid. 50 The Tax Court determined that the regulation was valid. That decision depended upon the court's interpretation of the Internal Revenue Code, which we review de novo. Williamson v. Commissioner, 974 F.2d 1525, 1529 (9th Cir.1992). However, we will uphold a Treasury regulation if it implement[s] the congressional mandate in some reasonable manner, National Muffler Dealer's Ass'n v. United States, 440 U.S. 472, 476, 99 S.Ct. 1304, 1306, 59 L.Ed.2d 519 (1979), and is not plainly inconsistent with the Code. Bingler v. Johnson, 394 U.S. 741, 750-51, 89 S.Ct. 1439, 1445, 22 L.Ed.2d 695 (1969). 51 We conclude that Reg. Sec. 1.83-7(b)(2) is neither plainly inconsistent with, nor an unreasonable interpretation of, Sec. 83. The plain meaning of the statute supports Treasury's interpretation. Sec. 83(a) and (b) both contain language requiring that the value of transferred property be determined without regard to any restriction.... This language is conspicuously absent from Sec. 83(e)(3). Adoption of appellants' argument would require us to read that language into Sec. 83(e)(3). It is a fundamental rule of statutory construction that [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. Arizona Elec. Power Co-op., Inc. v. United States, 816 F.2d 1366, 1375 (9th Cir.1987) (citing Russello v. United States, 464 U.S. 16, 23, 104 S.Ct. 296, 300, 78 L.Ed.2d 17 (1983)). 52 Furthermore, Congress has had opportunity to include such language in Sec. 83(e)(3), or otherwise to amend the statute in order to insure that Sec. 83 applies to options subject to restrictions, but it has failed to do so. Reg. Sec. 1.83-7(b)(2), which became effective in 1978, adopted the definition of readily ascertainable fair market value contained in Treas.Reg. Sec. 1.421-6(c)(3)(i), which became effective in 1961. When Congress enacted Sec. 83 in 1969, it was aware of Treasury's definition of that standard. See Pagel, Inc. v. Commissioner, 91 T.C. 200, 216, 1988 WL 81469 (1988), aff'd, 905 F.2d 1190, 1192 (8th Cir.1990) (concluding that Reg. Sec. 1.83-7(b)(2) is a valid interpretation of the statute). Nonetheless, when Congress included this standard in Sec. 83(e)(3), it did not indicate that restrictions should be disregarded for purposes of that subsection. 53 Since the enactment of Sec. 83, Congress has passed the Tax Reform Act of 1976, which applied Sec. 83 to statutory options previously controlled by I.R.C. Sec. 422. The Senate Finance Committee version of the 1976 bill included an amendment to Sec. 83 that would have allowed taxpayers to elect to include the value of an option in income in the year of grant, even if its fair market value was not readily ascertainable. S.Rep. No. 938, 94th Cong., 2d Sess. 164 (1976), U.S.C.C.A.N.1976, pp. 2897, 3596, reprinted in, 1976-3 Internal Revenue Cumulative Bulletin [C.B.] (vol.3) 49, 202. This proposal would have insured that Sec. 83(b) applied upon grant to restricted options as well as to other difficult to value options. It was not enacted. Therefore, since Congress has failed to require that Sec. 83 applies to restricted options upon grant, we will not do so by implication. 54 Appellants cite legislative history from the 1976 Tax Reform Act to argue that Reg. Sec. 1.83-7(b)(2), which had only been proposed at that time, is invalid. The 1976 Conference Report explaining that Act states: 55 The conferees intend that in applying these rules for the future, the Service will make every reasonable effort to determine a fair market value for an option (i.e., in cases where similar property would be valued for estate tax purposes) where the employee irrevocably elects (by reporting the option as income on his tax return or in some other manner to be specified in regulations) to have the option valued at the time it is granted (particularly in the case of an option granted for a new business venture). The conferees intend that the Service will promulgate regulations and rulings setting forth as specifically as possible the criteria which will be weighed in valuing an option which the employee elects to value at the time it is granted. 56 S.Rep. No. 1236, 94th Cong., 2d Sess. 438-39 (1976), reprinted in 1976-3 C.B. (vol.3) 807, 842-43. See also Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1976, 94th Cong., 2d Sess. 154 (1976), reprinted in 1976-3 C.B. (vol.2) 1, 166 (containing virtually identical language). 57 This legislative history does not demonstrate that the Reg. Sec. 1.83-7(b)(2) interpretation of Sec. 83 is unreasonable. First, an analysis of legislative history is proper only to solve, not to create ambiguity. Arizona Elec. Power, 816 F.2d at 1375 (emphasis in original). As we explained above, the language of Sec. 83 itself ably describes under which subsections restrictions must be disregarded--Sec. 83(a) and (b). This legislative history, on the other hand, provides at best an ambiguous directive regarding Sec. 83(e)(3): It is unclear whether the conferees intended that the Commissioner should henceforth disregard the restrictions listed in then-proposed Reg. Sec. 1.83-7(b)(2)(i-iii), or whether she should relax the rules on valuing the option privilege proposed in Reg. Sec. 1.83-7(b)(3), or neither. See 2 Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates and Gifts p 60.5.2 at 60-51 (2nd ed.1990). Second, the 1976 Tax Reform Act in no way amended the language of Sec. 83, which was enacted in 1969. We hesitate to rely entirely on the views of a later Congress to interpret an earlier enactment. See United States v. Price, 361 U.S. 304, 313, 80 S.Ct. 326, 331-32, 4 L.Ed.2d 334 (1960). Finally, this statement may well have been inserted to assuage members who could not pass the 1976 amendment contained in the Senate Finance Committee bill and discussed above. See Pagel, 91 T.C. at 221. It at most invited, but did not require Treasury to adopt rules that Congress did not enact. Id. 58 Treasury reasonably concluded that Sec. 83(e)(3) allows restrictions to be considered when determining whether an option has a readily ascertainable fair market value. Furthermore, Treasury reasonably concluded that certain restrictions, such as those effecting transfer, exercise, and market value, make an option's value not readily ascertainable, because it is difficult to determine the impact of those restrictions on market value. We therefore reject appellants challenge to Reg. Sec. 1.83-7(b)(2). 59 In sum, because the 1978 and 1979 options clearly did not have a readily ascertainable fair market value upon transfer according to Reg. Sec. 1.83-7, Sec. 83 did not apply until the sale of those options in 1982, see I.R.C. Sec. 83(e)(3); Reg. Sec. 1.83-7(a), and that sale therefore produced only ordinary income. We affirm the Tax Court's decision upholding the deficiency with respect to these options.