*51 Decision will be entered under Rule 155.
*323 Respondent determined deficiencies in petitioners' income taxes as follows:
| Year 1 | Deficiency |
| 1975 | $ 13,234.59 |
| 1976 | 17,916.67 |
The sole issue for decision is the fair market value for purposes of the minimum tax,
*55 FINDINGS OF FACT
The facts are fully stipulated and are found accordingly.
Louis B. Gresham (petitioner) and Margaret S. Gresham are husband and wife. They filed joint Federal income tax returns for the years 1975 and 1976. Mrs. Gresham is a petitioner only by reason of having filed joint income tax returns with her husband. At the time the petition was filed, petitioners resided in Shawnee Mission, Kans.
During the years in question, petitioner was chief executive officer of General Energy Corp. (GEC). GEC common stock was then traded on the over-the-counter market. Effective January 1, 1973, GEC adopted a stock option plan meeting the requirements of
In general, under the rulings of the Securities and Exchange *324 Commission*56 (SEC), the effect of the required investment letter was to prohibit petitioner for a period of 2 years from selling the shares except in a private placement, unless a registration statement was in effect with respect to the shares. No such registration statement was in effect on the dates of issuance of the option shares. In any such private placement, the SEC would require the purchaser to execute a similar investment letter. Certificates for the option stock were required to bear an appropriate legend, and a stop transfer order was placed against the share with GEC's transfer agent.
Petitioner exercised the option to the extent of 5,000 shares in December 1974. During 1975, petitioner purchased in two separate exercises a total of 25,000 shares, and in 1976, petitioner purchased the remaining 20,000 shares of stock. Upon each exercise of the option, petitioner executed the required investment letter.
For purposes of the minimum tax calculation on petitioner's 1974, 3 1975, and the 1976 returns, petitioner determined the bid prices for the GEC common stock traded on the over-the-counter market on the dates of exercise of the option and then discounted the total value of each*57 block of shares purchased by 33 1/3 percent, reporting the discounted value as the fair market value of the option stock so acquired. The amount of tax preference income in each year was determined by deducting from the discounted value of the option stock petitioner's cost for the stock. 4
In determining the deficiencies for these 2 years, respondent valued the option stock at the mean of the bid and asked prices in the over-the-counter market on the dates of exercise of the option, without taking into account the effect of the investment letter restrictions applicable to the stock. In so doing, respondent applied
In this case, the parties have stipulated that if the Court holds that
Pursuant to the stipulation, we find that the mean of the bid and asked prices in the over-the-counter market of GEC common stock on the several*60 dates on which petitioner exercised the option in 1974, 1975, and 1976 were as follows: 7
| Date | Mean price |
| Dec. 11, 1974 | $ 10.9375 |
| Feb. 10, 1975 | 15.3125 |
| July 28, 1975 | 13.6875 |
| Feb. 5, 1976 | 10.750 |
We find that on the respective dates of the transfer of stock to petitioners upon the exercise of this option, the only method by which petitioners could have sold the stock was through a *326 private placement at a price equivalent to 66 2/3 percent of the mean of the bid and asked prices in the over-the-counter market on those dates. We further find that the fair market value of the option stock on the respective dates of acquisition was such discounted value.
OPINION
Section 56 imposes a minimum tax upon the sum of the items of tax preferences with adjustments*61 not here material. The tax preferences are listed in
(6) Stock options. -- With respect to the transfer of a share of stock pursuant to the exercise of a qualified stock option (as defined in
The stock in question was transferred to petitioner upon the exercise of his qualified stock option; thus, we are called upon to determine the amount of this tax preference, that is, the amount, if any, by which the fair market value of the shares exceeded the option price on each date. There is no dispute as to the option price so our inquiry is simply as to the "fair market value" of the shares on each date.
The Code does not define the term "fair market value." However, for many years the universally accepted definition of this term has been the willing buyer, willing seller test under which fair market value is the price at which property would change hands between a willing buyer and a willing *62 seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.
On the authority of
*64 This Court considered this regulation in
Here, in contrast, the effect of the restriction was to make a private placement sale the only market for the stock on the dates in question. Moreover, because the *65 purchaser of such stock was required to execute an investment letter restricting his ability to dispose of the stock, the restriction significantly reduced the value of the stock in that market. See
In Kolom, we carefully avoided deciding on the validity of
Because neither Kolom nor any other case has addressed the *329 overall validity of the regulation, we must now determine whether or not there is any reasonable basis upon which to ignore the apparently plain meaning of
Respondent would have us treat section 83 and sections 56 and 57 in tandem, both reflecting congressional action in 1969 to close existing loopholes and to more equitably apportion the tax burden. However, the fact that both sections were added to the Code in 1969 and were designed to achieve somewhat comparable objectives does not necessarily imply that they must be construed alike. Comparison of these two provisions of the 1969 Act demonstrates that Congress intended different results in the two sections. 11 It is patently clear that Congress had before it the question of the effect of restrictions on sales of property received as compensation for services. In section 83, Congress unequivocally modified the concept of fair market value, whereas, in section 56(a)(6), the modifying language was omitted. We fail to find the necessary ambiguity to allow us to ignore statutory language. Accordingly, we hold that regulation 1.57-1(f)(3) is inconsistent with the statute and is therefore invalid.
*68 Respondent points to language in Kolom in which we recognized (note 12) that Congress intended by section 56 to require payment of tax on "economic income." Respondent argues that in this case the difference between the stock's value on the over-the-counter market and petitioner's cost is economic income because were it not for the deferral of
Respondent calls to our attention the case of
The other court which has examined
We conclude that
Decision will be entered under Rule 155.
Featherston, J., concurring: I agree with the majority's conclusion. As I understand respondent's argument in support of the validity of
The willing buyer, willing seller concept of "fair market value" is nearly as old as the income tax law itself.
I can find nothing written or spoken by the Congress in connection with the 1969 congressional examination of stock restrictions that refutes Justice Powell's statement in
I think it is important that section 56 by clear wording imposes a tax "In addition to the other taxes" imposed under *333 the income tax provisions. This additional tax, the minimum tax, is, in effect, a "flat tax" imposed on specified tax preference items without the ameliorating effects of most deductions, bases adjustments, or carryover and carryback deductions prescribed for the income tax. All the tax preference items except the one here involved are deductions (accelerated depreciation, amortization of various assets, etc.) for which the full tax benefit has been received; the
The assumption underlying the disputed regulation appears to be that Congress intended to prescribe the section 83 valuation method for minimum tax purposes because it measures the amount of income that would be subject to immediate income tax, and therefore the amount subject to preferential deferral, but for
I have a very healthy regard for Treasury regulations. They *334 serve a salutary purpose which is vital to the administration of the income tax laws, and they are entitled to great deference. But the Supreme Court has repeatedly stricken down Treasury regulations which are inconsistent with, or go beyond, the statute they are designed to implement. See, e.g.,
Simpson, J., dissenting: Once again, I must disagree with the majority of this Court over its role in reviewing Treasury regulations. In holding invalid
What our role should be in reviewing regulations was described by the Supreme Court in
we do not *78 sit as a committee of revision to perfect the administration of the tax laws. Congress has delegated to the Commissioner, not to the courts, the task of prescribing "all needful rules and regulations for the enforcement" of the Internal Revenue Code.
See
*335 The Supreme Court, in strong and unequivocal terms, has repeatedly declared that the Treasury regulations should not be struck down lightly (see, e.g.,
it is fundamental, of course, that as "contemporaneous constructions by those charged with administration of" the Code, the Regulations "must be sustained unless unreasonable and plainly inconsistent with the revenue statutes," and "should not be overruled except for weighty reasons."
See Griswold, "A Summary of the Regulations Problem,"
Both section 83 and the minimum tax were enacted as parts of the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 487. In section 83, Congress made clear that the regular income tax is to be imposed on a compensatory bargain sale of property, and it expressly provided that such objective could not be frustrated even though the property was sold subject to restrictions on its transferability. In enacting the minimum tax, Congress decided that*80 a minimum tax should be imposed on certain items of tax preference, including the acquisition of stock pursuant to a qualified stock option under
The tax treatment of compensatory bargain sales has long been a troublesome subject. In
Despite that holding by the Supreme Court, two decisions by this Court made it possible, in many situations, to avoid a tax on a compensatory bargain sale. In
The Treasury refused to accept the consequences of the Lehman and Kuchman decisions and adopted regulations designed to tax compensatory bargain sales.
In explaining the reasons for enacting section 83, the Ways and Means Committee declared:
The present treatment of restricted stock plans is significantly more *337 generous than the treatment specifically provided in the law for similar types of deferred compensation arrangements. Under present law an employee is taxed in full when his employer makes a contribution for his benefit to an employees' pension or profit-sharing trust which does not meet the nondiscrimination and other requirements set forth in the tax law, if his interest in the contribution is nonforfeitable. (A similar rule applies where an employer purchases an annuity for an employee). If an employer transfers stock to such an employees' trust for an employee and the trust provides that the employee will receive the stock at the end of 5 years if he is alive at that time, the employee would be treated as receiving, and would be taxed on, compensation in the amount of the value of the stock at the time of the transfer.
However, if the employer, instead of contributing the stock to the trust, gives the stock directly to the employee subject to the restriction that it cannot be sold for 5 years, then*84 the employee's tax is deferred until the end of the 5-year period. The disparity of treatment between the two situations becomes even more apparent when it is considered that in the situation where the employee has substantially less than full control of the stock (the nonexempt trust situation) he is taxed currently on the full value of the stock, while in the case where the employee actually possesses the stock, can vote the stock, and receives the dividends on the stock (the restricted stock plan), his tax is deferred. [H. Rept. 91-413 (Part 1) (1969),
See also S. Rept. 91-552 (1969),
To prevent the preferential treatment of compensatory sales of restricted stock, section 83 provides that whenever an employee acquires a transferable or vested interest in such stock, he is taxable on the bargain sale at such time, and the bargain is to be measured by the difference between the fair market value of the stock at such time and the price paid for it. For such purposes, section 83 expressly provides that in determining the fair market value, restrictions that will lapse are to be disregarded. *85 H. Rept. 91-413 (Part 1), supra,
Section 83 was included in the Tax Reform Act of 1969 as passed by the House of Representatives, and when the bill was before the Senate Finance Committee, Assistant Secretary of the Treasury for Tax Policy Edwin S. Cohen was asked about the effect of restrictions on the sale of stock to employees and responded:
*338 Restrictions which lapse at some future time serve no essential business purpose but are used principally to affect the tax consequences. They may properly be disregarded for income tax purposes under these conditions. * * * [Hearings before the Senate Comm. on Finance (Part 1), 91st Cong., 1st Sess. 652 (1969).]
The concept of a minimum tax was first proposed by the Senate Finance Committee. In setting forth the reasons *86 for such tax, the committee observed:
Under present law, many individuals and corporations do not pay tax on a substantial part of their economic income as a result of the receipt of various kinds of tax-exempt income or special deductions. * * *
* * * *
The present treatment * * * results in an unfair distribution of the tax burden. * * *
* * * *
The committee has adopted many provisions that are specifically designed to reduce the scope of existing tax preferences. However, the committee believes that an overall minimum tax on tax preferences is also needed to reduce the advantages derived from these preferences and to make sure that those receiving such preferences also pay a share of the tax burden. * * * [S. Rept. 91-552, supra,
It was also the Senate that first proposed that the economic income received by the exercise of a qualified stock option should be treated as an item of tax preference subject to the minimum tax. S. Rept. 91-552, supra,
A review of this legislative history shows that section 83 was enacted in the light of the problems that had arisen in the*87 tax treatment of compensatory bargain sales; it assures that when a compensatory bargain sale of restricted stock is taxable, the tax is to be imposed at the time of the sale, and restrictions that lapse are to be disregarded in measuring the bargain. Although the acquisition of stock pursuant to a qualified stock option is not subject to the regular income tax, the bargain element is considered an item of tax preference and is subjected to the minimum tax. The Treasury regulations take the position that for purposes of imposing the minimum tax, the rules of section 83 are to be applied in determining the amount of the bargain element subject to such tax. In my judgment, it is clear that such rule is necessary to carry out the manifest objective of the legislation.
An employee who acquires stock under a qualified stock option may wholly avoid the minimum tax if the rules of *339 section 83 are not applied to measure the bargain received by him. For example, if he acquires stock having a fair market value of $ 30,000 for a price of $ 20,000, and if the stock is subject to a restriction on transferability which he claims reduces its value to $ 20,000, there is a potential dispute*88 in every case over the effect of the restriction on fair market value -- how much is the fair market value reduced by the restriction? If it is ultimately determined that the restriction does reduce the fair market value by $ 10,000, then the transfer is not subject to the minimum tax, even though the employee has received economic income: after the expiration of the restriction, he owns stock worth considerably more than he paid for it. Moreover, the restriction may have little effect in economic reality since
It has been suggested that sections 83(e) and 422 reflect a legislative policy to treat more favorably acquisitions of stock under a qualified stock option.
Footnotes
1. The year 1974 is also involved. See note 8 below.↩
2. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as amended.↩
3. Petitioner paid no minimum tax for 1974 as a result of the carryovers allowed by sec. 56(c), as then in effect.↩
4. Inadvertently, in determining the value for this purpose of the option stock acquired in 1976, the discount was applied twice.↩
5.
Sec. 1.57-1(f)(3), Income Tax Regs. , provides:(3) Fair market value. In accordance with the principles of section 83(a)(1), the fair market value of a share of stock received pursuant to the exercise of a qualified or restricted stock option is to be determined without regard to restrictions (other than nonlapse restrictions within the meaning of
§ 1.83-3(h)↩ ). Notwithstanding any valuation date given in section 83(a)(1), for purposes of this section, fair market value is determined as of the date the option is exercised.6. The parties are also in agreement that an adjustment would have to be made in that case to take into account the use by petitioner of a double discount for the year 1976. Other adjustments to the deficiencies will follow automatically from the Court's decision.↩
7. In computing the minimum tax for 1975, respondent reduced the tax carryover from 1974 as a result of revaluing the option stock acquired in 1974 at the mean of the over-the-counter market rather than at the discounted value used by petitioner.↩
8. See also
United States v. Cartwright, 411 U.S. 546↩ (1973) ; sec. 20.2031-2(b), Estate Tax Regs.9. Sec. 83(a) reads as follows:
(a) General Rule. -- If, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of --
(1) the fair market value of such property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over
(2) the amount (if any) paid for such property,↩
shall be included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever is applicable. The preceding sentence shall not apply if such person sells or otherwise disposes of such property in an arm's-length transaction before his rights in such property become transferable or not subject to a substantial risk of forfeiture.10.
Hinton v. Commissioner, T.C. Memo. 1982-221 , is not to the contrary. There we again determined the fair market value of option stock held by an insider subject to sec. 16(b), Securities Exchange Act of 1934,15 U.S.C. sec. 78p(b) . In a brief reference toKolom v. Commissioner, 71 T.C. 235">71 T.C. 235 (1978), we summarized our treatment of the regulation in that case by stating that we upheld its validity, without intending in any way to change our clear reservation of the validity issue as expressed in Kolom↩.11. In his dissent to the denial of the writ of certiorari in
Kolom v. Commissioner, 454 U.S. 1011 (1981) , Justice Powell noted the dissimilarity in the language of these two 1969 Act provisions:"It is this policy of encouraging employee stock ownership that explains why the language of
§ 57 and § 83 differs. Both sections were enacted as part of the Tax Reform Act of 1969. Yet§ 57 , imposing minimum tax on the transfer of qualified stock, uses only the words 'fair market value' whereas § 83, seeking to end tax avoidance through the use of non-qualifying stock and spurious restrictions, modifies that phrase with a parenthetical indicating that restrictions that lapse are to be ignored. Congress's failure to include any similar qualification in§ 57 strongly suggests that it intended to use 'fair market value' in its traditional and well-established sense. Any other understanding of the term would defeat the purpose§§ 57 ,421 and422 were designed to serve.[454 U.S. 1011">454 U.S. 1011 , 1016↩ (1981), 81-2 USTC par. 9741, at 88,487.]"12. The preamble to
T.D. 7564, 2 C.B. 19">1978-2 C.B. 19↩ , reflects that consideration was given to comments received on this part of the proposed regulation urging that restrictions should be taken into account.13. It is interesting to note that Congress has become aware of court decisions such as
Kolom v. Commissioner, supra↩ , and as a part of the Economic Recovery Tax Act of 1981, 95 Stat. 172, 260, has amended sec. 83(c) to provide that, with respect to the sec. 16(b) situation, the taxpayer's ownership of shares of stock would be deemed to be subject to a substantial risk of forfeiture and not transferable, hence not taxable, until after expiration of the 6-month period.