Court Opinion

ID: 9457247
Source: CourtListenerOpinion
Date Created: 2023-08-04 20:17:11.370038+00
Date Added: 2024-06-11T17:35:16.946455
License: Public Domain

PELL, Circuit Judge
(dissenting).
In this case, the Tax Court and the majority opinion impose a tax liability in excess of half a million dollars on “paper” income assertedly derived by the taxpayer in the year 1960 by his exercise of stock options. I must respectfully dissent on the basis that the Tax Court’s decision is clearly erroneous on one of two alternative grounds.
Section 1.421-6(c) (3) (i) of the Regulations provides that where an option is not actively traded on an established market, the fair market value of such option is not readily ascertainable unless the value can be measured with reasonable accuracy, which requires that the taxpayer be able to show the existence of certain conditions.
At the time of the hearing before the Tax Court, the parties were in agreement that the first three conditions were satisfied under the facts of the case, to-wit: (a) the option is freely transferable by the optionee; (b) the option is exercisable immediately in full by the optionee; and (c) the option or the property subject to the option is not subject to any restriction or condition (other than a lien or other condition to secure the payment of the purchase price) which has a significant effect on the fair market value of the option as such property.
The fourth condition, and the one on which the Tax Court and majority opinion found against the taxpayer here, is that the fair market value of the option privilege must be readily ascertainable in accordance with further subpara-graphs of the regulation.
While it might be fairly argued that in the “spelling-out” which follows in the regulations, the regulations exceed the Congressional intention of the code, the taxpayer contends it is not necessary to reach this result for the stock options had readily ascertainable market value at the time of issuance. He asserts that the basic test of the regulations is that the fair market value of the option is readily ascertainable if the value of the option privilege can be measured with reasonable accuracy. With this contention I would agree.
The underlying controversy here is whether the stock options were taxable, as the taxpayer contends, as of the date of receipt, September 1958, or, as the Government contends, as of the date of the exercise of the option, September 1960. One needs not to be a student of tax cases to infer that a very substantial appreciation in value of the rights and property involved occurred between the two dates and that the date urged by the Government involves the higher amount.
The regulations upon which the Government relies stem from Commissioner of Internal Revenue v. LoBue, 351 U.S. 243, 76 S.Ct. 800, 100 L.Ed. 1142 (1956). In LoBue (at page 249, 76 S.Ct. at page 804) the Court stated:
“It is of course possible for the recipient of a stock option to realize an immediate taxable gain. See Commissioner of Internal Revenue v. Smith, 324 U.S. 177, 181-182, 65 S.Ct. 591, *559593, 89 L.Ed. 830. The option might have a readily ascertainable market value and the recipient might be free to sell his option.”
In implementing and defining “readily ascertainable market value” in the regulations, the taxing authority, if the regulations are literally and rigidly applied, might well seem to be precluding the ascertainment of market value in all cases where there was not active trading on an exchange. I do not, however, deem such was the intention and indeed the “spelling-out” in the regulations would have been meaningless if ascertainment of market value was confined solely to exchange-traded items.
The Congressional intent is broadly stated in the Internal Revenue Code of 1954 in defining gross income as all income from whatever source derived including compensation for services. 26 U.S.C. § 61. It remained for LoBue to lay down general guidelines for the determination of when the gross income was received in the stock option situation. The possibility of taxation at the receipt rather than the exercise stage, assuming readily ascertainable value, was foreshadowed in Commissioner of Internal Revenue v. Smith, 324 U.S. 177, 182, 65 S.Ct. 591, 593, 89 L.Ed. 830 (1945), where the Court stated, “It of course does not follow that in other circumstances not here present the option itself, rather than the proceeds of its exercise, could not be found to be the only intended compensation.”
The result which, in my opinion, should have been arrived at in the case before us, was reached in Colton v. Williams, 209 F.Supp. 381 (N.D.Ohio 1962). There, as here, the Government contended that the option had no value includa-ble in income in the year of the granting because it did not have a readily ascertainable fair market value. The district judge specifically pointed out that there was no requirement that the stock be actively traded on an established market, indicating that the benefits of this section were not to be limited merely to larger corporations. The court in reaching this decision that within the framework of the regulations there was readily ascertainable market value laid particular stress on the expert testimony of an informed broker.
In the case before us, the taxpayer introduced the testimony of a partner in an investment banking firm. In his testimony this expert, considering various factors involved in this type of situation, placed a specific value on the option as of the issuance date, September 1958. The Government expert witnesses in effect agreed that under normal procedure of brokerage and investment banking houses, values were placed upon items such as this although the Government witnesses did not testify to specific values. Although there was essentially agreement as to the procedures for valuation, the Tax Court rejected the specific valuation testimony basically because the wide disparity of opinion indicated no readily ascertainable market value.
The business world utilizes the stock option for employees. The investment world appears to be able to cope in most cases with the matter of placing valuation on these options as of the date of issuance. Of course, there must be some value at the date of issuance but that was not controverted here. In the case of unlisted securities in which there is not heavy trading, experts may frequently disagree but that does not prevent a trier of fact from determining with ready facility a market value. I am not dealing here with policy aspects of stock options. If Congress had chosen to prohibit their utilization or to lay down specific rules as to their taxability it could do so. It has not chosen, however, to do either.
Businessmen who have stock options should have some guidelines to determine the time of taxability of these options rather than discovering many years later, as in the case before us, that a staggering amount of tax with interest thereon was owing on a transaction which realized only “paper” income. As stated by Mr. Justice Harlan in dissent*560ing in Commissioner of Internal Revenue v. LoBue, supra, 351 U.S. at p. 251, 76 S.Ct. 800, any other result makes the division of the total gains between ordinary income and capital gain dependent solely upon the fortuitous circumstance of when the employee exercises his option. I recognize, of course, that the taxpayer will always have the burden of demonstrating, in addition to the other conditions such as immediate exercisability and free transferability, that at the date of issuance there was a readily ascertainable market value. Here it appears to me that the taxpayer has discharged his burden.
The result reached by the Tax Court puts the matter on a pick and choose basis with the Internal Revenue Service where small companies are involved. I dare say that if the value of the stock of the company here involved had depreciated between 1958 and 1960 because of bankruptcy or other economic factors, the Government would have contended that there was readily ascertainable market value as of the date of the granting of the option.
Thus, in an earlier case from this court, Fesler v. Commissioner of Internal Revenue, 38 F.2d 155 (1930), the position was reversed and the taxpayer was contending in a different factual situation that as of the date of a transfer of certain securities they did not have a readily realizable market value.
This court rejected the taxpayer’s contention that the lack of an active market should be equated with readily realizable market value stating, at p. 158: “The word ‘readily’ does not mean immediately, but easily or promptly. It is a relative and not an absolute term, and must be interpreted by the circumstances which are related to the transactions in question.”
Even though the securities in Fesler involved large blocks and assertedly would have had to have been sold over a period of time, this court affirmed the Board of Tax Appeals in finding that there was a readily realizable market value on the date of the transfer. Also, in McNamara v. Commissioner of Internal Revenue, 210 F.2d 505 (1954), this court in a case decided before the promulgation of the Treasury Regulation with which we are here dealing reversed the Tax Court holding that a stock option was intended as additional compensation for services for the year in which the option was granted and that it was not taxable in the year of exercise. In LoBue, supra, 351 U.S. at p. 246, 76 S.Ct. 800, the court in referring to cases where there might be a readily ascertainable market value and an immediate taxable gain cited in a footnote the McNamara case.
In summary, it appears to me that the Tax Court in disregarding the practice of the market and specific testimony on value reached a clearly erroneous result and that even under the regulations the taxable date was that of the issuance of the options.
In the majority opinion, there is outlined the alternative contention of the taxpayer which, of course, is inconsistent with his first contention, that if the option had no readily ascertainable market value at grant there were sufficient restrictions upon his sale of the stock resulting from the exercise of the option as to prevent taxability at the date of the exercise of the option.
The various claimed restrictions are outlined in the majority opinion and need not be repeated here.
The pertinent subsection of the Treasury Regulation provides in part as follows:
“If the option is exercised by the person to whom it was granted but, at the time an unconditional right to receive the property subject to the option is acquired by such person, such property is subject to a restriction which has a significant effect on its value, the employee realizes compensation at the time such restriction lapses or at the time the property is sold or exchanged, in an arm’s length transac*561tion, whichever occurs earlier. * * *” Treasury Regulations, § 1.-421-6(d) (2) (i) (Emphasis supplied.)
The Tax Court attempted to distinguish the ease of Ira Hirsch, 51 T.C. 121 (1968), urged by the taxpayer as supporting his position. I take this as some indication the Tax Court felt that if Hirsch had been factually applicable that the law stated in Hirsch was still viable, to-wit, that restrictions on the transfer of stock deriving from the operation of the Securities Act of 1933 constitute restrictions having a significant effect on the value of stock within the intendment of the regulations.
The majority opinion agrees with the taxpayer that Ira Hirsch is indistinguishable but holds against the taxpayer on the ground that Hirsch was incorrectly decided.
Assuming that Hirsch is factually indistinguishable I find no support for the majority’s opinion that it is not good law.
The essence of the majority’s holding is that the restrictions contemplated in the regulations are of a contractual nature preventing the sale of the stock at its fair market value. Primarily, this conclusion is arrived at on the basis of the various examples utilized in the regulation, all of which pertain to contractual restrictions. However, it appears to me that a restriction which has a significant effect on its value is not limited as to source and if the Securities Act of 1933 in its operation restricts the ready sale of a security then it is squarely a restriction within the meaning of the regulation.1 Examples are merely illustrative and are not controlling where the language is clear and explicit as it is here.
I would, therefore, for either of the reasons discussed herein reverse the Tax Court.

. To paraphrase an oft-quoted aphorism, a restriction is a restriction is a restriction.