Opinion
Docket No. 52837.
1957-04-22
ESTATE OF JAMES S. OGSBURY, DECEASED, FLORENCE N. OGSBURY, EXECUTRIX, AND FLORENCE N. OGSBURY, SURVIVING WIFE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Harman Hawkins, Esq., for the petitioner. Ellyne E. Strickland, Esq., and A. Jesse Duke, Jr., Esq., for the respondent.
Harman Hawkins, Esq., for the petitioner. Ellyne E. Strickland, Esq., and A. Jesse Duke, Jr., Esq., for the respondent.
As part of his contract of employment, petitioner received an unassignable option to purchase stock of his employer corporation at a bargain price. The option which was to expire December 31, 1945, permitted petitioner to delay payment and passage of title to the stock after exercise for so long as he was still employed by the corporation or for 6 months after his death if he died while in the employ of the corporation. However, upon the exercise of the option, petitioner became unconditionally obligated to pay a certain amount for the stock and, upon payment, the corporation was unconditionally obligated to deliver it to him. Petitioner exercised the option on December 29, 1945, and paid for an received the stock on December 8, 1948. Held, that the exercise of the option on December 29, 1945, bound petitioner and the employer corporation, and that petitioner received the economic benefit of the option as of its exercise in 1945.
The Commissioner determined a deficiency in petitioners' income tax for the year 1948 in the amount of $68,860.56. The issues for decision are (1) whether the employee petitioner received compensation in connection with a stock option in 1948 when he paid for and received title to the stock, or in an earlier taxable year when the option was exercised, and (2) if the petitioner received compensation in 1948, what was the fair market value of the stock so received on December 9, 1948.
In light of the recent decision of the Supreme Court in Commissioner v. LoBue, 351 U.S. 243, petitioners have abandoned the contention that the stock option did not give rise to extra compensation for personal services.
FINDINGS OF FACT.
The stipulation of facts and the exhibits annexed thereto are incorporated herein by this reference.
Petitioner Florence N. Ogsbury is the duly appointed executrix of the Estate of James S. Ogsbury, deceased, who died on February 18, 1950. Florence N. Ogsbury, individually, is made a petitioner herein solely by reason of having filed a joint return with her husband, James S. Ogsbury. Hereinafter James S. Ogsbury shall be referred to as petitioner.
Petitioner was a resident of Garden City, New York. His income tax return for the year 1948 was filed with the then collector of internal revenue for the first district of New York.
On or about September 7, 1937, a contract was entered into between petitioner and Fairchild Aviation Corporation (whose name was subsequently changed to Fairchild Camera and Instrument Corporation, hereinafter referred to as Fairchild), setting forth the terms of his employment as chief executive officer of Fairchild and granting him a nonassignable option to purchase authorized but unissued common stock of Fairchild before December 31, 1941, at the price of $4.50 per share. This option was not exercised.
On or about August 19, 1941, a new contract was entered into between petitioner and Fairchild continuing his employment. This contract extended the option to purchase Fairchild's stock to December 31, 1945, but changed the terms of that option. The pertinent parts of the new option were as follows:
2. As further compensation to James S. Ogsbury for his services heretofore and hereafter to be performed, the Company hereby grants to him, or, in the event of his death, to his estate an unassignable option, upon the terms and conditions and for the period hereinafter specified, to purchase at any time and from time to time during said period not exceeding Ten Thousand (10,000) shares of the authorized but unissued common stock of the Company as it is presently constituted, or the equivalent thereof in case of a recapitalization of the Company involving a split-up or a combination of its common stock at a price equal to Four Dollars and fifty cents ($4.50) per share. The option hereby granted may be exercised by the mailing of a written notice or notices at any time prior to December 31, 1945, except that the option to his estate will expire one year after the date of said James S. Ogsbury's death, or on December 31, 1945, whichever is sooner. The date of the mailing of such notice shall be the effective date for the transfer of title to the stock so acquired on the exercise of such option.
On or about August 7, 1945, petitioner and Fairchild agreed to extend the employment contract dated August 19, 1941. By letter agreement dated August 7, 1945, a change was made in the terms of the option contained in the employment contract. The last sentence of paragraph 2 of the employment contract of August 19, 1941 (reproduced above), referring to the effective date for the transfer of title to stock acquired through exercise of the option, was replaced by the following:
Upon the mailing of such notice said James S. Ogsbury shall be obligated to the Company for the full purchase price of the shares with respect to which the option is thus exercised, but payment therefor and delivery of the stock certificates representing such shares may be postponed to such time or times as said James S. Ogsbury shall elect, but not later than the termination of his employment by the Company or, in the event of his death during such employment, within six months thereafter, subject to his right at any time to make payment for and take delivery of all or part of such shares. Pending payment for and receipt of all or any part of such shares by said James S. Ogsbury, title thereto shall remain in the Company and said James S. Ogsbury shall have no rights as a stockholder (including the right to vote and the right to receive dividends) with respect to such shares.
On December 29, 1945, petitioner notified Fairchild, by mail, of his election to exercise the option as amended, as follows:
Please be advised that I hereby elect to exercise my option to purchase 10,000 shares of the common stock of Fairchild Camera and Instrument Corporation in accordance with our agreement dated August 19, 1941, as amended by letter agreement dated August 7, 1945.
On or about December 8, 1948, petitioner tendered $45,000 to Fairchild in payment for the 10,000 shares of common stock which were issued in his name on December 9, 1948.
In accordance with petitioner's instructions 5,000 shares were delivered to the loan department of the Grace National Bank and 5,000 shares were delivered to the loan department of the Chemical Bank and Trust Company. Each bank held the stock as collateral security for a loan of $25,000 made by it to petitioner which was used to pay for the stock.
As of petitioner's death, in1950, the loans were still unpaid and the stock was still held by the banks as collateral security.
Petitioner did not report either the receipt of the option, the exercise of the option, or the receipt of stock as income in any income tax return.
Fairchild did not claim a deduction in any income tax return for additional compensation paid petitioner either as a result of granting petitioner the option, petitioner's exercise of the option, or the actual transfer of stock. Following the audit of petitioner's income tax return for the year 1948 and in view of the Commissioner's determination that petitioner realized income in 1948 measured by the difference between the fair market value of the stock and the option price on the date of delivery of the stock, Fairchild filed claims for a refund for both 1945 and 1948, each of which incorporated a claim for a deduction for additional compensation paid with respect to petitioner's stock option.
On December 31, 1947, Fairchild had 337,032 shares of common stock outstanding. On December 31, 1948, Fairchild had 347,032 shares of common stock outstanding, including the 10,000 shares issued to petitioner under his option. Approximately 30 per cent of the outstanding shares of the common stock of Fairchild was owned or controlled by the Fairchild family as of March 1, 1948.
In form 10K filed by Fairchild with the Securities and Exchange Commission for the year ended December 31, 1945, the exercise of the option is treated as a footnote under the heading ‘Remuneration of Directors, Officers, and Others' as follows:
9. * * * By written notice dated December 29, 1945, Mr. Ogsbury advised the registrant that he had elected to exercise his option to purchase 10,000 shares of the common stock of the registrant pursuant to the terms of the agreement between Mr. Ogsbury and the registrant. In accordance with this agreement, Mr. Ogsbury may pay for and take delivery of said stock at his election, but not later than the termination of his employment by the registrant, or in the event of his death during such employment, within six months thereafter. Title to said stock to remain in the registrant until such time as payment and delivery of all or any part is made.
In form 10K filed by Fairchild with the Securities and Exchange Commission for the year ended December 31, 1948, the purchase of the stock is set out under the heading ‘Sales of Securities by Registrant’ as follows:
12. * * * (c) On December 29, 1945, Mr. James S. Ogsbury, president of the registrant, exercised his option (originally granted in 1941) to purchase, at $4.50 per share, 10,000 shares of the common stock of the registrant. Under the terms of the agreement granting him such option, as amended, Mr. Ogsbury, upon the exercise of the option, became obligated to the registrant for the full purchase price of the shares, but had the right to pay for and take delivery of the shares at such time as he should elect, but not later than the termination of his employment by the registrant, or, in the event of his death during such employment, within six months thereafter. On December 8, 1948, Mr. Ogsbury paid for and received delivery of such 10,000 shares of common stock.
Fairchild's stock was traded on the American Stock Exchange (formerly known as the New York Curb Exchange). Between September 1948 and June 1949 Fairchild's stock was in a downswing which took it from a high of 28 1/2 to a low of 12 1/4. The monthly high and low prices and total monthly sales of the stock for 1948 and 1949 were as follows:
+------------------------------------------+ ¦ ¦ ¦Range of prices¦ +--------------+-----------+---------------¦ ¦Month and year¦Shares sold¦ ¦ +--------------+-----------+---------------¦ ¦ ¦ ¦High ¦Low ¦ +--------------+-----------+-------+-------¦ ¦1948 ¦ ¦ ¦ ¦ +--------------+-----------+-------+-------¦ ¦January ¦5,100 ¦12 ¦9 1/2 ¦ +--------------+-----------+-------+-------¦ ¦February ¦5,100 ¦11 3/8 ¦10 1/2 ¦ +--------------+-----------+-------+-------¦ ¦March ¦12,500 ¦13 5/8 ¦11 1/8 ¦ +--------------+-----------+-------+-------¦ ¦April ¦30,200 ¦17 1/2 ¦12 1/8 ¦ +--------------+-----------+-------+-------¦ ¦May ¦54,400 ¦27 1/2 ¦16 1/2 ¦ +--------------+-----------+-------+-------¦ ¦June ¦24,500 ¦28 1/4 ¦21 ¦ +--------------+-----------+-------+-------¦ ¦July ¦36,900 ¦29 ¦23 1/2 ¦ +--------------+-----------+-------+-------¦ ¦August ¦7,500 ¦27 1/2 ¦23 5/8 ¦ +--------------+-----------+-------+-------¦ ¦September ¦14,000 ¦28 1/2 ¦24 ¦ +--------------+-----------+-------+-------¦ ¦October ¦6,800 ¦25 1/2 ¦18 ¦ +--------------+-----------+-------+-------¦ ¦November ¦12,000 ¦19 5/8 ¦14 ¦ +--------------+-----------+-------+-------¦ ¦December ¦7,400 ¦18 3/8 ¦14 1/2 ¦ +--------------+-----------+-------+-------¦ ¦ ¦ ¦ ¦ ¦ +------------------------------------------+
1949 January 3,900 16 3/4 15 1/2 February 3,500 15 5/8 12 1/4 March 8,000 16 5/8 12 3/8 April 2,700 16 1/8 13 1/8 May 3,500 14 3/4 12 1/2 June 16,700 19 3/8 12 1/2 July 5,900 19 17 3/4 August 6,300 21 1/2 18 1/8 September 4,400 19 3/8 17 1/2 October 6,300 21 17 7/8 November 2,800 19 17 1/4 December 26,900 25 3/8 18 1/4
In December 1948 a total of 7,400 shares were traded as follows:
+----------------------------------------+ ¦Day of month¦Sales¦High ¦Low ¦ +------------+-----+----------+----------¦ ¦1 ¦500 ¦15 ¦14 1/2 ¦ +------------+-----+----------+----------¦ ¦2 ¦400 ¦15 1/2 ¦15 1/8 ¦ +------------+-----+----------+----------¦ ¦3 ¦(2) ¦1 15 3/4¦1 14 3/4¦ +------------+-----+----------+----------¦ ¦4 ¦(2) ¦1 15 3/4¦1 14 3/4¦ +------------+-----+----------+----------¦ ¦5 ¦(3) ¦ ¦ ¦ +------------+-----+----------+----------¦ ¦6 ¦100 ¦14 3/4 ¦14 3/4 ¦ +------------+-----+----------+----------¦ ¦7 ¦300 ¦15 1/8 ¦15 ¦ +------------+-----+----------+----------¦ ¦8 ¦200 ¦15 3/8 ¦15 1/4 ¦ +------------+-----+----------+----------¦ ¦9 ¦200 ¦15 3/8 ¦15 1/4 ¦ +------------+-----+----------+----------¦ ¦10 ¦300 ¦15 3/8 ¦15 3/8 ¦ +------------+-----+----------+----------¦ ¦11 ¦400 ¦16 ¦15 1/2 ¦ +------------+-----+----------+----------¦ ¦12 ¦(3) ¦ ¦ ¦ +------------+-----+----------+----------¦ ¦13 ¦500 ¦17 1/8 ¦16 3/8 ¦ +------------+-----+----------+----------¦ ¦14 ¦500 ¦18 ¦17 1/2 ¦ +------------+-----+----------+----------¦ ¦15 ¦600 ¦18 1/8 ¦18 ¦ +------------+-----+----------+----------¦ ¦16 ¦300 ¦18 3/8 ¦18 ¦ +------------+-----+----------+----------¦ ¦17 ¦200 ¦17 3/4 ¦17 3/4 ¦ +------------+-----+----------+----------¦ ¦18 ¦200 ¦17 1/2 ¦17 1/2 ¦ +------------+-----+----------+----------¦ ¦19 ¦(3) ¦ ¦ ¦ +------------+-----+----------+----------¦ ¦20 ¦300 ¦17 3/4 ¦17 1/2 ¦ +------------+-----+----------+----------¦ ¦21 ¦100 ¦17 5/8 ¦17 5/8 ¦ +------------+-----+----------+----------¦ ¦22 ¦100 ¦17 1/2 ¦17 1/2 ¦ +------------+-----+----------+----------¦ ¦23 ¦100 ¦17 1/2 ¦17 1/8 ¦ +------------+-----+----------+----------¦ ¦24 ¦200 ¦17 1/4 ¦17 1/8 ¦ +------------+-----+----------+----------¦ ¦25 ¦(4) ¦ ¦ ¦ +------------+-----+----------+----------¦ ¦26 ¦(3) ¦ ¦ ¦ +------------+-----+----------+----------¦ ¦27 ¦600 ¦17 1/8 ¦17 ¦ +------------+-----+----------+----------¦ ¦28 ¦200 ¦16 3/4 ¦16 5/8 ¦ +------------+-----+----------+----------¦ ¦29 ¦100 ¦16 5/8 ¦16 5/8 ¦ +------------+-----+----------+----------¦ ¦30 ¦400 ¦16 3/4 ¦16 1/2 ¦ +------------+-----+----------+----------¦ ¦31 ¦600 ¦17 1/4 ¦16 3/4 ¦ +------------+-----+----------+----------¦ ¦ ¦ ¦ ¦ ¦ +------------+-----+----------+----------¦ ¦ ¦ ¦ ¦ ¦ +----------------------------------------+ FN1 Denotes bid and asked price. No sales that day.FN2 None.FN3 Sunday.FN4 Holiday.
On December 8 and 9, 1948, the average quoted price of Fairchild stock was $15.3125 per share. Two hundred shares were traded each day.
OPINION.
KERN, Judge:
The major issue presented for decision herein is whether petitioner received compensation by means of a stock option granted to him by his employer, Fairchild, in the year in which the option was exercised (1945) or in the year in which payment and transfer of stock was made (1948). If we should determine that petitioner received compensation in 1948, when payment and transfer of the stock was accomplished, then we must determine the fair market value of the stock as of the date of the transfer, December 8, 1948.
The petitioner's position is that he received extra compensation upon the exercise of the option in 1945. He contends that the transfer of the stock and payment therefor in 1948 was merely the completion of a fixed contractual obligation entered into in 1945, and that any economic benefit resulting from this transaction must be calculated as of the time at which the obligations and duties under the contract became definite and certain. Respondent, on the other hand, contends that the exercise of the option in 1945 did not bind the parties thereto. He argues that petitioner's notice of exercise of the option contained in his letter to Fairchild dated December 29, 1945, was not an exercise of the option but merely notice that petitioner ‘intended to exercise the option and would purchase the stock at some future date to be chosen by him during the course of his employment.’ Respondent also argues that no economic benefit and, therefore, no income was realized until the transaction was completed in 1948 and petitioner had received title to the stock and the benefits and burdens appertaining thereto. Commissioner v. Smith, 324 U.S. 177; Lucas v. North Texas Lumber Co., 281 U.S. 11; Commissioner v. Segall, 114 F.2d 706, certiorari denied 313 U.S. 562, reversing 38 B.T.A. 43; Fred C. Hall, 15 T.C. 195; J. T. Wurtsbaugh, 8 T.C. 183. Of these cases, only the Smith case involved a stock option.
We cannot agree with respondent's interpretation of the option contract. It should be noted, at the outset, that the option was to expire, on its terms, as of December 31, 1945. Nowhere in the record is there any evidence that the option could be extended by a statement of intention. Rather, from petitioner's course of action and Fairchild's statements to the Securities and Exchange Commission, it is clear that both petitioner and Fairchild intended to be and were bound by their amended contract.
The terms of the contract are clear and unambiguous. It provides that: ‘Upon the mailing of such notice (petitioner) shall be obligated to the Company for the full purchase price of the shares * * * , but payment therefor and delivery of the stock certificates * * * may be postponed to such time or times as (petitioner) shall elect, but not later than the termination of his employment by the Company * * * .’ Petitioner could delay payment while he was still employed by Fairchild, or his estate could delay payment for a maximum period of 6 months after his death if he was employed by Fairchild at the time of his death. However, the contract affords no opportunity for cancellation by or on behalf of the petitioner. The language used in the contract is subject to only one interpretation— that petitioner and Fairchild entered into a binding agreement whereby petitioner's obligation to pay for and right to receive the stock became absolute and unconditional upon the mailing to Fairchild of the notice of petitioner's election to exercise the option. Petitioner could postpone payment within the limits set forth above, but could not rescind the contract thus made, nor refuse to pay for the stock when the limits of the postponement period had been reached. See Blau v. Ogsbury, 210 F.2d 426.
In the alternative, respondent contends that where, as in the instant case, the exercise of the option and payment for and receipt of the stock take place in different taxable years, the year of transfer and payment is the one in which there was ‘effectual conveyance to Ogsbury of the benefits and burden of ownership of the stock’ and, consequently the one in which there was a realization of income. In support of this contention, respondent relies heavily on Commissioner v. Smith, supra, Lucas v. North Texas Lumber Co., supra, and Commissioner v. Segall, supra.
The last two cases cited by respondent have to do with tax liabilities resulting from the sales of property and the precise question considered was when the sales took place. The opinion of the Supreme Court in the Smith case indicates that it considered the problem there to be a different one. There, as in the instant case, the tax liability resulted not from a sale of property but from the receipt by the taxpayer of ‘economic or financial benefit,’ resulting from an option given to him, as compensation, to purchase the stock of the employer corporation at bargain prices. The precise question was whether income was derived in the year the option was given or the year in which it was exercised. See, also, Commissioner v. LoBue, 351 U.S. 243.
With regard to stock options, certain rules now appear to be clear from the decided case.
An assignable option with a readily ascertainable market value may constitute extra compensation and, therefore, taxable income in the year in which the option is granted. Commissioner v. LoBue, supra; Commissioner v. Smith, supra. An unassignable option, however, or one which does not have a readily ascertainable value at the time when the option is granted, may constitute extra compensation and, therefore, taxable income in the year in which the option is exercised. Commissioner v. LoBue, supra; Commissioner v. Smith, supra; Estate of Connolly v. Commissioner, 135 F2d. 64, affirming 45 B.T.A. 374; I.T. 3795, 1946-1 C.B. 15; Regs. 111, sec. 29.22(a)-1.
However, the instant case involves a factual situation which presents a question not present in any of the cited cases except the LoBue case. Here, the option was exercised and the rights and obligations of the parties were fixed in one year, but the payment for the transfer of the stock did not take place until a later year. The question is: In what year did the taxpayer realize income stemming from the stock option?
This question was not answered in the LoBue case. There, as here, the taxpayer was definitely obligated to pay for the stock covered by the option (in that case the obligation was evidenced by notes), and the employer corporation was obligated to deliver the stock to the taxpayer upon payment, these reciprocal obligations being incurred in a year prior to the taxable year. In the latter year the taxpayer paid for the stock and it was delivered to him. The Supreme Court held that taxable gain to the taxpayer should be measured as of the time the options were exercised, and not the time they were granted, and then added:
It is possible that a bona fide delivery of a binding promissory note could mark the completion of the stock purchase and that gain should be measured as of that date. * * *
Since that question had not been passed on by the lower courts, the case was remanded. See, also, concurring and dissenting opinions in the LoBue case.
Nor was this question answered in the Smith case, although in that case also the Supreme Court posed the problem. On petition for rehearing in that case, 324 U.S. 695, the Court said:
We do not have before us a case where by the exercise of an option in one year the taxpayer acquires an unconditional right to receive the stock in a later year. We express no opinion upon the question whether, in such a case, compensation would be received and would be taxable in the earlier or the later year.
It is now our duty in deciding the instant case to resolve the questions left unanswered by the Supreme Court in the Smith and LoBue cases.
In our opinion, the taxable economic benefit of the unassignable option held by petitioner was realized by him upon his exercise of the option in 1945. At that time he acquired ‘an unconditional right to receive the stock’ even though it might be, and was, received ‘in a later year.’ For all practical purposes, he was then in receipt of the value represented by the stock option. By his own act, that of payment, he could take delivery of the stock at any time and utilize the rights to receive dividends, vote the stock, or sell it at a profit. His right to the stock was conditioned only on his personal decision as to when to make payment, not on the happening of any event beyond his control.
It is our conclusion and we so hold that petitioner received the economic benefit of the stock option granted by Fairchild when he exercised the option in 1945 and obligated himself to pay for and accept the stock unconditionally within a limited period of time. The physical acts of payment and transfer of title to the stock, occurring in a later taxable year, did not add to the economic benefit already received. Cf. Hawke v. Commissioner, 109 F.2d 946, remanding 35 B.T.A. 784; Omaha National Bank v. Commissioner, 75 F.2d 434, reversing 29 B.T.A. 817; Gardner-Denver Co. v. Commissioner, 75 F.2d 38, certiorari denied 295 U.S. 763, affirming 27 B.T.A. 1171. In view of our holding on this issue and the fact that the year 1945 is not before the Court, it is unnecessary to determine the fair market value of the Fairchild stock received under the option.
Reviewed by the Court.
Decision will be entered for the petitioners.