United States Court of Appeals
Fifth Circuit
F I L E D
UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT January 9, 2007
_______________________ Charles R. Fulbruge III
Clerk
No. 05-51372
_______________________
RICARDO CIDALE; LESLIE CIDALE,
Plaintiffs-Appellants,
v.
UNITED STATES OF AMERICA,
Defendant-Appellee.
Appeal from the United States District Court
for the Western District of Texas
Before JONES, Chief Judge, and DAVIS and GARZA, Circuit Judges.
EDITH H. JONES, Chief Judge:
Ricardo and Leslie Cidale appeal the district court’s
grant of summary judgment to the United States on their claim to
recover income taxes erroneously assessed. The issue in this
appeal is whether a taxable transfer occurred on the date the
taxpayers’ non-statutory employee stock options were exercised,
when they financed the purchase with margin debt, or on the date
the shares were sold. Relying on the district court’s analysis and
a growing body of caselaw, we hold that the exercise date is
controlling and thus AFFIRM.
I. BACKGROUND
On January 31, 2000, Cidale exercised stock options
granted by his employer, RealNetworks, by borrowing funds from his
broker, Salomon Smith Barney (“Smith Barney”). He paid $356,256 to
purchase 24,000 shares of stock, which then had a fair market value
exceeding $3 million. Because an employee who exercises stock
options must pay withholding tax on the difference between the
exercise price and the fair market value of the stock on the date
the options are exercised, the $3,416,256 difference created a tax
liability of $1,010,811.79. Cidale’s tax liability plus the stock
purchase price meant he had to pay RealNetworks $1,367,067.79 to
exercise his stock options. Pursuant to the margin loan agreement
between Cidale and Smith Barney, the broker paid this fee to
RealNetworks with a check drawn on Cidale’s margin account.
The margin agreement stated that Cidale maintained all
incidents of ownership of the shares, including the right to sell,
vote, and pledge the shares, and to receive dividends, subject to
the broker’s security interest in all of Cidale’s accounts. Under
the agreement, Smith Barney could sell the stock as collateral to
pay off Cidale’s loan, but the Cidales remained personally liable
for any deficiency in the event that proceeds for the shares did
not repay the loan.
The Cidales reported the stock options as income for the
2000 tax year. In July 2002, they filed a Form 1040X and an
amended tax return, seeking a refund of federal income taxes paid
in the final amount of $274,941 plus interest. They claimed that
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the taxes should have been assessed when the loan was repaid by
liquidation of Cidale’s interest in his RealNetworks stock in
September 2000, rather than on the date he exercised his stock
options in January 2000. They argued that no taxable income arose
at the date of exercise of the stock options because he borrowed
the purchase money from Smith Barney. Needless to say, the stock
was worth less, and the resulting tax was less, if the taxable
transfer date was in September rather than January. The IRS
rejected the refund claim.
The Cidales sued the United States to recover a refund
based on their theory about the exercise date for the stock
options. After the district court’s adverse decision, they timely
appealed.
II. DISCUSSION
This court reviews the district court’s grant of summary
judgment de novo, applying the same legal standards as the district
court. Mayo v. Hartford Life Ins. Co., 354 F.3d 400, 403 (5th Cir.
2004). Summary judgment is proper when “the pleadings,
depositions, answers to interrogatories, and admissions on file,
together with the affidavits, if any, show that there is no genuine
issue as to any material fact and that the moving party is entitled
to a judgment as a matter of law.” FED. R. CIV. P. 56(c); see also
Celotex Corp. v. Catrett, 477 U.S. 317, 325, 106 S. Ct. 2548, 2554
(1986).
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Under I.R.C. § 83, in general terms, an employee is taxed
when he exercises nonqualified stock options if the shares (1) have
been transferred to and (2) have substantially vested in the
employee. See TREAS. REG. § 1.83-3(a); Racine v. Comm’r, 92 T.C.M.
100, 102 (2006). The tax equals the amount by which the fair
market value of the shares exceeds the exercise price. “[A]
transfer of property occurs when a person acquires a beneficial
ownership interest in such property.” TREAS. REG. § 1.83-3(a)(1).
Rights “are transferable only if the rights in such property of any
transferee are not subject to a substantial risk of forfeiture,”
and if the transferee can sell, assign and pledge his interest in
the property. I.R.C. § 83(c)(2); see also Racine, 92 T.C.M. at
102. “Property is substantially vested for such purposes when it
is either transferable or not subject to a substantial risk of
forfeiture.” TREAS. REG. § 1.83-3(b). Rights are subject to a
substantial risk of forfeiture “if such person’s rights to full
enjoyment of such property are conditioned upon the future
performance of substantial services by any individual.” I.R.C.
§ 83(c)(1).
The Cidales argue that no taxable transfer occurred when
Ricardo Cidale exercised stock options with margin debt because his
own capital was not at risk. They assert that he did not have
“beneficial ownership” of the shares until the margin loan was
repaid because he did not bear any risk of loss. Citing Example 2
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in Treasury Regulation § 1.83-3(a)(7),1 they contend that Ricardo
Cidale’s use of margin debt is treated as the grant of another
option to buy shares and is not a taxable event. Accordingly, he
should have been taxed when the shares were sold to repay the
margin debt.
The United States Tax Court recently rejected all of the
arguments that the Cidales now assert. See Racine v. Comm’r,
92 T.C.M. 100, 102 (2006); Facq v. Comm’r, 91 T.C.M. 1201 (2006).
In Racine, the court held that a taxable transfer occurred under
I.R.C. § 83 when the taxpayer exercised her stock options because
the shares were transferred and she acquired beneficial ownership
of the shares, even though she purchased the shares through a
margin loan. 92 T.C.M. at 104. When she exercised the options,
the taxpayer had legal title to the shares and was entitled to all
the incidents of ownership, including the right to receive
dividends and to pledge the shares as collateral. Id. at 102-03.
1
Example 2 states:
On November 17, 1972, W sells to E 100 shares of stock in W
corporation with a fair market value of $10,000 in exchange for a
$10,000 note without personal liability. The note requires E to
make yearly payments of $2,000 commencing in 1973. E collects the
dividends, votes the stock and pays the interest on the note.
However, he makes no payments toward the face amount of the note.
Because E has no personal liability on the note, and since E is
making no payments towards the face amount of the note, the
likelihood of E paying the full purchase price is in substantial
doubt. As a result E has not incurred the risks of a beneficial
owner that the value of the stock will decline. Therefore, no
transfer of the stock has occurred on November 17, 1972, but an
option to purchase the stock has been granted to E.
TREAS. REG. § 1.83-3(a)(7) (Example (2)).
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The court rejected the taxpayer’s argument, founded on Example 2 to
Treasury Regulation § 1.83-3(a)(7), that she received an option
when she used her margin account to exercise the options. Id. at
103-04. There is no material difference between Racine and this
case, and while Racine does not bind this court, we find its
analysis compelling. The taxpayers’ arguments fail to perceive the
distinction between the employer’s receipt of full payment for the
options, which creates the taxable event, and the employee’s
separate obligation to a third party for the loan of the purchase
price.
Every other court to have addressed this issue has
rejected the Cidales’ arguments. See United States v. Tuff,
469 F.3d 1249 (9th Cir. 2006), aff’g 359 F. Supp. 2d 1129 (W.D.
Wash. 2005); Miller v. United States, No. 04-17470, 2006 WL 3487016
(9th Cir. Dec. 4, 2006) (mem.), aff’g 345 F. Supp. 2d 1046 (N.D.
Cal. 2004); Facq v. United States, 363 F. Supp. 2d 1288, 1292 (W.D.
Wash. 2005); see also Palahnuk v. United States, 70 Fed. Cl. 87
(Fed. Cl. 2006).
The district court properly determined that the Cidales
owed taxes on Ricardo Cidale’s stock options on the date the
options were exercised, not the date on which he repaid the margin
loan. The RealNetworks shares were transferred and substantially
vested in Cidale on the date of exercise, because he then acquired
beneficial ownership of the shares and had the right to receive any
dividends and vote the stock. His capital was at risk under the
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terms of the margin agreement. Accordingly, a taxable event
occurred when Ricardo Cidale exercised his stock options with
margin debt.
AFFIRMED.
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