*261 Decision will be entered for the respondent.
1. Upon the record the petitioner is held to have realized income upon the exercise of an option to purchase stock, issued to him by his employer, as compensation for services rendered, in the difference between the option price and the market price of the stock on the date the option was exercised.
2. Further held that petitioner is taxable upon the fair market value at the time of receipt of certain stock issued him by his employer corporation as compensation for services.
*651 This proceeding involves deficiencies in income taxes for the calendar years 1945 and 1946 in the amounts of $ 49,418.48 and $ 2,330.08 *262 *652 respectively. The issues are (1) whether, in determining the amount petitioner received as compensation for services rendered by way of a bargain purchase of stock from his employer, respondent erred in selecting the difference between the option price and the market price of the stock on the date the option was exercised, October 3, 1945, rather than the difference on the date the issuance of the option was authorized, July 27, 1944, and (2) whether stock purchased by the corporation and delivered to petitioner in amounts equivalent to dividends declared on the optioned shares after the option authorization but prior to its exercise represents compensation to petitioner in addition to the optioned shares.
FINDINGS OF FACT.
Most of the facts were stipulated and are incorporated herein by reference.
The petitioner is an individual residing in Chicago, Illinois. He filed his returns for the calendar years involved with the collector of internal revenue for the first district of Illinois. He filed his income tax return for the year 1944 on March 15, 1945, and, no waiver having been executed, the time for assessment and collection of additional tax for the year 1944 has expired.
*263 Petitioner was employed by Eversharp, Inc., (hereinafter sometimes referred to as the Company) from September 1942 to February 28, 1946. His employment with the Company from March 1, 1944, to February 28, 1946, was under a written agreement reading as follows:
Mr. John Wahl
Vice President in Charge of Engineering
Eversharp, Inc.,
1800 Roscoe Street
Chicago, Illinois
Dear Sir:
This will confirm the agreement between Eversharp, Inc. and you concerning your employment by the Company for the period beginning March 1, 1944 and ending February 28, 1946:
During the term of your employment you shall devote your entire time and attention to the affairs of Eversharp, Inc. in an engineering and research capacity. In all matters relating to the services to be performed by you, you will, of course, in all instances be subject to the instructions and supervision of the Company's President and/or Vice-President and General Manager in Charge of Operations, and of the Board of Directors.
It is understood that your salary during the above period shall be at the rate of $ 26,000 per year, payable monthly and that you will be placed in Class "B" under the Company's bonus plan, which means that so*264 long as such plan is continued by the Company you will also receive annually, a bonus of 25% of your annual salary. Such bonus payments, so long as the bonus plan is continued, will be made along with other such bonus payments shortly after the close of the fiscal year. It is expressly understood, however, that these provisions *653 relating to your compensation are subject to the approval of the Salary Stabilization Unit of the Treasury Department. The Company either has or will immediately apply for such approval.
This employment arrangement shall continue until February 28, 1946, and from year to year thereafter provided that either you or Eversharp may terminate this agreement at the close of the fiscal year ending February 28, 1946, or at the close of any subsequent fiscal year by serving written notice of such termination upon the other party at least ninety days prior to the close of such fiscal year.
If the foregoing meets with your approval, will you please sign the form of acceptance appended below which will constitute this a valid and binding contract between you and the Company and will confirm the fact that there are no other arrangements or understandings between*265 us relating to your services and the compensation therefor than those herein set forth.
Yours very truly,
EVERSHARP, INC.
By Martin L. Straus
President
ACCEPTED, AGREED TO AND CONFIRMED, this 15 day of June, 1944.
John C. Wahl
In his income tax returns for the years 1944, 1945, and 1946, the petitioner reported receipt of salaries from the company in the amounts of $ 32,499.92, $ 32,500, and $ 10,833.33.
Prior to the taxable years in question the Company appears to have gone through a reorganization. The Company as reorganized had an authorized issue of 75,000 shares of preferred and 200,000 shares of common stock, the latter of the par value of $ 1 per share. Stockholders had preemptive rights to subscribe with respect to any shares of common stock in excess of 150,000 shares issued. Since 117,048 shares had been issued in exchange for old stock pursuant to the reorganization, there were left 32,952 shares of common stock free from preemptive rights.
Subsequent to its reorganization the Company made changes in its managerial personnel, developed and marketed a new type fountain pen, and through a wholly owned subsidiary organized for that purpose, entered into prime contracts*266 with the United States Navy for the production of certain types of aviation equipment and parts. Its net sales and its net profits before and after taxes increased substantially each year from 1940 to 1946.
At a meeting held October 16, 1942, the board of directors of the Company (hereinafter sometimes referred to as the Board) requested the president of the Company to submit a plan for the optioning of those unissued shares which were free from preemptive rights to its officers and managerial employees. On December 8, 1942, the board of directors unanimously agreed that such options should be granted for a period of from three to five years, and that all such options, whether issued then or at a later date, should be at a price of $ 6 per share. The *654 market price of the common stock of the Company on December 8, 1942, was $ 4.50 per share. The plan agreed upon was formally adopted and embodied in a corporate resolution at the January 27, 1943, meeting of the board of directors and the issuance of 22,000 shares to certain named officers and managerial employees was authorized. With respect to the remaining 10,952 shares the resolution of the Board provided that they *267 should be "reserved, set aside and ear-marked for purchase, on the same terms, under similar options, from time to time in the future, by such other officers and employees of the Company as may be determined from time to time by the executive committee of the board of directors; * * *." The terms and conditions as set forth in the resolution of January 27, 1943, were as follows:
1. The option price shall be $ 6 per share and each of said optionees may exercise his said option in whole or in part at any time on or prior to December 1, 1947, on which date each of said options, to the extent not theretofore exercised, shall automatically terminate and expire.
2. None of said options may be assigned except (1) to another officer or employee of the Company with the consent of the Company, or (2) except in the event of the death of any of said optionees, said options shall pass to the personal representative of said deceased optionee and may be exercised by and on behalf of his estate.
3. Except to the extent permitted by the preceding paragraph, none of said options may be exercised, either in whole or in part, unless at the time of such exercise the particular optionee shall still be in*268 the employ of the Company; provided, however, that this limitation shall not be effective if the particular optionee's employment has been interrupted or terminated solely by reason of incapacitation resulting from accident or ill health. The decision of the Board of Directors as to the applicability of this limitation shall be final and binding.
4. None of said options may be exercised and no stock shall be deliverable upon any exercise or attempted exercise thereof unless and until the shares of common stock of the Company covered by such options shall first have been admitted to the list on the Chicago Stock Exchange and registered under the Securities Exchange Act of 1934, as amended;
* * * *
The 32,952 shares of common stock mentioned above were registered with the Securities and Exchange Commission and with the Chicago Stock Exchange.
Thereafter, at a meeting originating on June 2, 1944, and reconvened on June 7, 1944, the executive committee requested the president to submit recommendations as to additional options for other officers of the Company for action thereon by the board of directors at its next meeting. At its next meeting, on July 27, 1944, the board of directors*269 authorized the optioning of 3,800 shares of the Company's common stock at the option price of $ 6 per share. Of this amount 1,000 shares were voted to the petitioner, 500 to be issued immediately and 500 one year thence. The resolution adopted read:
RESOLVED, that options to purchase common stock of this Company of the kind authorized at the January 27, 1943 meeting of the Board of Directors, *655 be immediately issued to the following officers and employees of the Company covering the number of shares of common stock set opposite each such officer or employee's name:
| Number | |
| Name | of shares |
| N. J. Zaro | 1000 |
| John C. Wahl | 500 |
| R. G. Rech | 100 |
| Marshall Brayman | 125 |
| Larry Robbins | 125 |
| A. T. Harris | 50; and |
FURTHER RESOLVED, that it is in the sense of this Board that approximately one year from the date of this meeting the Board will authorize the issuance at that time of like options to the same officers and employees covering the same number of additional shares of common stock, provided that at such time (i) such officer or employee shall still be associated with the Company; (ii) the services of such officer or employee shall have continued*270 to be satisfactory in the opinion of the Board; and (iii) such officer or employee shall at that time continue to own any and all shares of common stock of the Company which he shall have purchased upon the exercise of the options authorized above to be immediately issued; and provided further that such additional options shall in no event be deemed authorized or shall be issued unless and until, at a meeting to be held approximately one year from the date of this meeting, the Board of Directors shall so order.
On this date, July 27, 1944, the market price of the common stock was $ 36 per share.
Delivery of the options authorized by the Board on July 27, 1944, was delayed because in the opinion of the Company's general counsel such delivery might constitute a violation of the regulations of the Salary Stabilization Unit.
At a meeting of the board of directors on January 11, 1945, a motion to rescind the authorization for the issuance of such options, on the ground that the delay in the delivery of the options was disturbing and upsetting to the key personnel to whom they had been promised, was tabled, for lack of a second. The following resolution was adopted in its stead:
RESOLVED, *271 that it is the consensus of this Board of directors (i) that this Company is obligated, under the circumstances which attended the original employment of the above-named optionees, and as a result of the action taken by this Board at its July 27, 1944 meeting to cause the above-mentioned Management Options to be extended and made available for exercise at the earliest date on which the same may be legally done; and (ii) that when and if this Corporation can legally and properly take such action it will cause said shares of stock to be made available for purchase by said optionees for Management purposes and pursuant to the Company's Management option policy, upon the terms and subject to the conditions and restrictions expressed in and implied by the previous action of this Board with respect to said Management options.
On May 15, 1945, because of a two for one split-up of the Company's common stock the petitioner's authorized option was increased to purchase 2,000 shares of stock and the option price per share was reduced *656 from $ 6 to $ 3. The market price of the common stock on May 15, 1945, before the split-up, was $ 65.25 per share. The resolution of the Board stated*272 that this action was "* * * -- all to the end that such option rights as were authorized to said officers and employees shall remain fixed and unchanged from those authorized at said directors meeting of July 27, 1944, * * *"
On September 26, 1945, the executive committee of the Company, after noting that, in view of recent changes in the regulations and policies of the Salary Stabilization Unit, there was no longer any impediment to the issuance of the options, by resolution authorized the issuance to petitioner of 2,000 shares "upon the terms, prices and conditions heretofore fixed with respect to such management options." Similar action was taken by the board of directors on September 27, 1945. The market price of these shares on September 27, 1945, was $ 30,125 per share.
On October 3, 1945, the petitioner exercised his option and received the stock certificates for the 2,000 shares of the common stock of the Company at the option price of $ 3 per share. On this date the market price of the shares was $ 33.875 per share. The differential between the option price and the market price on this date was compensation to petitioner for services rendered.
On January 5 and January *273 14, 1946, the Company issued and delivered to petitioner stock certificates in the respective amounts of 260 and 100 shares of its common stock. The circumstances in connection with this transaction were that the company, by resolution of its executive committee at a meeting on November 14, 1945, authorized the president of the Company to pay in cash to the petitioner the value of certain cash and stock dividends (the respective amounts of which are not disclosed), which had been paid to owners of the Company's stock prior to the time of the issuance and delivery to petitioner of the stock option here in question. These two dividends to stockholders had been paid subsequent to the original corporate resolution authorizing the issuance to petitioner of the stock option in question. Instead of making the payment to petitioner in cash as authorized, the Company, for some undisclosed reason, purchased the two blocks of stock of 260 and 100 shares in the open market and reissued them to petitioner. The market prices of the common stock on these dates were $ 43 and $ 54.50, respectively. These shares, in their value as of the date of their issue, were additional compensation to petitioner*274 for services rendered to the Company.
OPINION.
The questions presented for decision are (1) whether the amount petitioner received as compensation for services rendered by way of a bargain purchase of his employer's stock should *657 be measured by the difference between the option price and the market price on the day the option was authorized or by such difference on the day the option was exercised; and (2) whether stock purchased by the corporation and delivered to petitioner in amounts equivalent to dividends declared on the optioned shares after the option authorization but prior to its exercise represents compensation to petitioner in addition to the optioned shares. Section 22 (a), Internal Revenue Code, and Regulations 111, section 29.22(a)-1.
With respect to the first issue, petitioner admits that the stock option was by way of compensation for services, but contends in the main that the option was property and as property he received something at the time it was authorized in 1944. Therefore, he contends, the date of authorization is the proper date to use in measuring the difference or spread between the option and the market price.
The petitioner relies upon certain*275 language of the Supreme Court in its opinion in Commissioner v. Smith, 324 U.S. 177">324 U.S. 177. In that case the contention by the taxpayer was that an option issued and delivered to the taxpayer constituted "property" and consequently was income realized by him at that time. The Court stated:
In certain aspects an option may be spoken of as "property" in the hands of the option holder. Cf. Helvering v. San Joaquin Fruit & Investment Co., 297 U.S. 496">297 U.S. 496, 498, 56 S. Ct. 569">56 S. Ct. 569, 570, 80 L. Ed. 824">80 L. Ed. 824; Shuster v. Helvering, 2 Cir., 121 F.2d 643">121 F. 2d 643, 645. When the option price is less than the market price of the property for the purchase of which the option is given, it may have present value and may be found to be itself compensation for services rendered. But it is plain that in the circumstances of the present case, the option when given did not operate to transfer any of the shares of stock from the employer to the employee within the meaning of § 22 (a) and Art. 22 (a)-1. Cf. Palmer v. Commissioner, 302 U.S. 63">302 U.S. 63, 71, 58 S. Ct. 67">58 S. Ct. 67, 70, 82 L. Ed. 50">82 L. Ed. 50.*276 And as the option was not found to have any market value when given, it could not itself operate to compensate respondent. * * *
We cannot see where petitioner gains support for his contention from the above-quoted language. Here the petitioner asks that we treat the option as property and hold it to have been received, not when issued and delivered, but when authorized in a prior year by corporate resolution. We do not agree. Even if it could be held that on July 27, 1944, when the directors authorized the issuance of the option, such action vested the petitioner with certain fixed rights to acquire the stock at the option price (and the facts do not justify the conclusion), such rights would necessarily have to be shown to have a definite value when acquired, as pointed out by the Court in Commissioner v. Smith, supra.Moreover, if such showing of value were made that property would constitute income then realized by petitioner in the amount of such value. Petitioner, however, is here contending that the date of authorization be used only for purposes of valuation, the income from the receipt of such property to be determined *658 *277 as realized upon the exercise of the rights in the following year after the issuance and delivery of the option to him.
Petitioner appears to base his contention upon a claim that the corporation was legally obligated to issue him the option by reason of a definite agreement to do so whereby the corporation secured his services. As to this there is not only no evidence of such an agreement but its existence cannot be reconciled with the written contract of employment of petitioner which is set out in our findings.
Upon the question of value of such option on July 27, 1944, the date petitioner contends it should be treated as issued and delivered, the record is silent. Petitioner appears to assume that such value is a mere matter of computation of the difference between the option price and the then market price of the stock. Such is manifestly not the case.
In the first place the resolution of 1944 only authorized the present optioning of one half of the stock here involved, the remaining one half to be covered by an option to be issued one year later and then only when authorized by another corporate resolution. This second option was provided to be issued only if petitioner *278 was then employed by the corporation, his services had been satisfactory, and he still possessed the stock issued him under the prior option. The corporate resolution forbade assignment of any of the options except to another officer or employee of the corporation and then only with the consent of the corporation. These restrictions were made a part of the regular option issued by provision on the face of the printed option form. An option carrying such conditions and restrictions, in our opinion, makes impossible a determination of market value. Harold H. Kuchman, 18 T. C. 154; Burnet v. Logan, 283 U.S. 404">283 U.S. 404; Commissioner v. Carter, 170 F.2d 911">170 F. 2d 911; Westover v. Smith, 173 F.2d 90">173 F. 2d 90.
We think it clear under the facts disclosed that petitioner possessed no option as to the stock here in question until the issuance and delivery to him of such option. The exact date this was done is not shown. We merely know that it was between September 27, 1945, when the secretary-treasurer of the corporation was authorized to issue the option, and October 3, 1945, *279 when the option was exercised by petitioner. For all we are advised, both issuance and delivery may have been on the latter date.
When petitioner exercised the option, the corporation parted with and petitioner received the stock at a price of $ 3 per share which then had a market value of $ 33.875 a share. Petitioner then realized compensation through a bargain purchase measured by the difference between the price paid and the then market value of the stock.
With respect to the second issue, petitioner contends that these 360 shares should be considered as a stock dividend and should be considered as included with the 2,000 shares he was to receive when he exercised the option. Petitioner's counsel has conceded that this position *659 falls on his failure to be sustained on the first issue. It might, however, be noted that these 360 shares were in lieu of an authorized cash payment by way of adjustment for cash and stock dividends in undisclosed proportions to stockholders at a period prior to when petitioner attained that status. Payment in such circumstances compels us to the conclusion that it was additional compensation for services in the amount of the fair market *280 value of the 360 shares of stock when issued to petitioner.
Decision will be entered for the respondent.