Commissioner of Internal Revenue v. Straus

• Decision Date: 10 November 1953
• Docket Number: No. 10849.,10849.
• Citation: 208 F.2d 325
• Parties: COMMISSIONER OF INTERNAL REVENUE. v. STRAUS.
• Court: U.S. Court of Appeals — Seventh Circuit

208 F.2d 325 (1953)

COMMISSIONER OF INTERNAL REVENUE. v. STRAUS.

No. 10849.

United States Court of Appeals, Seventh Circuit.

November 10, 1953.

H. Brian Holland, Asst. Atty. Gen., Joseph F. Goetten, Ellis N. Slack, Hilbert P. Zarky, Sp. Assts. to the Atty. Gen., for petitioner.

Roswell Magill, New York City (Allen H. Merrill and Albert Rosenblum, New York City, of counsel), for respondent.

Before DUFFY, FINNEGAN and LINDLEY, Circuit Judges.

FINNEGAN, Circuit Judge.

This is a petition by the Commissioner of Internal Revenue for review of a decision of the Tax Court entered on July 31, 1952, which decided that there was no deficiency in income tax for the year 1944 due from taxpayer Martin L. Straus, II.

The facts as found by the Tax Court may be summarized as follows:

In 1938, the taxpayer, Martin L. Straus, II, acquired certain stock of a corporation, then known as the Wahl Company, and hereinafter referred to as Eversharp, or as the Company. The corporation was engaged in the manufacture of writing implements and other products. In 1940, Straus owned more than 5000 shares of common stock and a considerable amount of the preferred stock of Wahl.

The taxpayer, Straus, had by that time become a director, and in December of 1940 was chosen as chairman of the executive committee of the board of directors. In the spring of 1941, he was elected president of the Company, and he continued to hold such offices for about ten years.

At the beginning of 1940 the Company, then known as Wahl, was in a very unsatisfactory condition. It had incurred losses in all but two of the sixteen years in which it had done business, and had paid no dividends on its common stock during most of the time. It was also heavily in arrears on dividends on its cumulative preferred stock. In 1940, the Company, under the direction of Straus, was reorganized by the merger into itself of one of its wholly owned subsidiaries. Its name was then changed to Eversharp, Inc.

Within a few months after the reorganization, the Company, under the direction of the taxpayer Straus, began the marketing of a new product and adopted a national advertising news program. It also made changes in its managerial personnel.

Upon the reorganization of 1940, the Company was authorized to issue 200,000 shares of preferred stock, together with common stock. Stockholders had preemptive rights to subscribe to new shares of common stock issued in excess of 150,000 shares. Since 117,048 shares of common stock had been issued in the reorganization of the outstanding stock of the Wahl Company, there were left 32,952 shares of unissued common stock free from stockholders' preemptive rights.

During the year 1941, the taxpayer Straus, and the executive committee of the Company discussed for the first time the adoption of the stock option plan which would reserve those shares for option at a future time at a fixed price to the executive and supervisory officials of the Company.

In October, 1942, Straus was asked by the Company's Board of Directors to formulate a plan respecting the issuance of the 32,952 shares. On December 8 of that year, the Board unanimously agreed that such shares would be so issued over a period of three to five years and that all shares, whether issued then or later, should be sold to employees at a price of $6 per share. The market price of Eversharp's common stock on December 8, 1942, was $4.50 per share, or $1.50 less than the price fixed by the Board.

The plan agreed upon at the December 8, 1942 meeting was formally adopted and embodied in a corporate resolution at the January 27, 1943, meeting of Eversharp's Board. As set forth in the minutes of December 8th the stock option plan was adopted:

"* * * as a means of making it possible for the Company\'s principal officers and supervisory employees to increase their equity holdings in the Company and thereby insure the permanence of their association with the Company * * *"

The plan included the following terms of purchase, among others:

(1) the option price for all shares was fixed at $6 per share;

(2) the options were not assignable (except that in the event of the optionee's death they passed to his personal representative); and

(3) the optionee was required still to be in the Company's employ at the time the option was excercised (unless his employment had been terminated solely because of incapacity resulting from accident or ill health).

Under the resolution adopted at the January 27, 1943, meeting, 22,000 of the 32,952 shares reserved under the plan were then allotted to named individuals, including 10,000 shares to Straus. The balance of 10,952 shares not so allotted was reserved, earmarked and set aside 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 * * *."

On January 27, 1943, when the option plan was formally adopted by the Board, the market price of Eversharp's common stock was $6.87 per share. On May 29, 1943, when the market price of the stock had increased to $17.25 per share, a written option agreement in respect of the 10,000 shares allotted to Straus on January 27, 1943, was issued to him. In a letter to the Company dated October 2, 1947, the Commissioner ruled that the purchase of 10,000 shares allotted to Straus and the 12,000 shares allotted to various other individuals on January 27, 1943, did not result in taxable income to them.

At a meeting originating on June 2, 1944, and reconvened on June 7, 1944, 2,500 additional shares were allotted to Straus under the Company's stock option plan. These are the shares with which we are concerned in this case. A written option agreement with respect to those 2,500 additional shares was delivered to Straus on June 27, 1944. The terms of that agreement, including the price of $6 per share, were in accordance with the resolution of January 27, 1943, wherein, as stated above, the Board of Directors provided that the balance of the 10,952 unallotted shares was reserved, earmarked and set aside for purchase...