Cramer v. Comm'r of Internal Revenue
| Decision Date | 22 September 1993 |
| Docket Number | 27684–90,29100–90.,Nos. 27682–90,s. 27682–90 |
| Citation | 101 T.C. 225,101 T.C. No. 16 |
| Parties | Richard A. and Alice D. CRAMER, et al.,1 Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
William P. Shannahan, Robert K. Smith, Robert F. Dailey, Seth Throop Karpinski, and Brookes D. Billman, Jr., for petitioners in all cases.
Michael Ira Saltzman, for petitioners in docket Nos. 27682–90 and 27684–90.
William H. Quealy, Jr., Alice M. Harbutte, Thomas A. Dombrowski, and Valerie N. Larson, for respondent.COHEN, Judge:
In these consolidated cases, respondent determined deficiencies in and additions to petitioners' Federal income taxes as follows:
50 percent of the interest due on $619,317.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
The issues presented for decision are:
(1) Whether proceeds received by petitioners in 1982 from the sale of certain options granted in 1978, 1979, and 1981 constituted ordinary income or long-term capital gains;
(2) whether Richard A. and Alice D. Cramer (the Cramers) are entitled to exclude $1.3 million of the proceeds received by them from the sale of such options from their income for 1982;
(3) whether petitioners are liable for additions to tax under 6653(a) for 1982 for underpayments resulting from characterizing the proceeds from the sale of such options as long-term capital gains instead of as ordinary income;
(4) whether petitioners are liable for additions to tax under section 6661 for 1982; and
(5) whether additions to tax under section 6653(a) may be cumulatively assessed with additions to tax under section 6661.
Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference.
At the time of the filing of the petitions, petitioners resided in California.
Petitioner Richard A. Cramer (Cramer) founded IMED Corporation (IMED), a company engaged in the design, manufacture, and sale of electronic medical instruments, primarily a device known as an “infusion pump” and related disposable devices. From 1972 through August 1982, Cramer was a shareholder, the president, and chief executive officer of IMED.
From 1972 through August 1982, petitioner Warren K. Boynton (Boynton) was vice president of IMED. Boynton was on the board from 1972 through October 1973 and from December 1974 through August 1982.
Petitioner Kevin P. Monaghan (Monaghan) served as outside general counsel to IMED from its inception in 1972 until August 1982. From August 1975 through August 1982, Monaghan was assistant secretary of the board of directors of IMED (the board). Monaghan, an attorney admitted to practice in California, was a member of the firm of Hahn, Cazier & Leff from 1979 through 1982. Petitioners Cramer, Boynton, and Monaghan were close friends as well as business associates.
From 1978 through 1981, the stock of IMED was neither publicly traded on an established stock market exchange nor registered with the Securities and Exchange Commission. As of July 7, 1978, there were 571,045 issued and outstanding shares of IMED common stock and 10,000 issued and outstanding voting shares of IMED preferred stock. On September 26, 1978, IMED effected a 3–for–1 stock split (the stock split) of its outstanding common and preferred stock. As of October 18, 1979, there were 2,061,884 issued and outstanding shares of IMED common stock. According to the shareholder lists of IMED, from 1978 to 1981, the stock of IMED was held by no less than approximately 150 shareholders and no more than approximately 255 shareholders.
On September 26, 1977, the board authorized the grant to Cramer of an option (the Cramer 1978 option) for the purchase of 50,000 shares of IMED common stock at $50 per share.
On May 24, 1978, IMED filed a permit application, prepared by Monaghan, with the California Department of Corporations (the Department of Corporations) with respect to the proposed issuance of the Cramer 1978 option. In the application, IMED represented that the option contained “special vesting provisions under which the option ‘vests' in Mr. Cramer at the rate of 20% (10,000 shares) per year, so that it is not fully vested for five years, with the vesting subject to termination in the event that Mr. Cramer voluntarily resigns as an officer of Applicant.” In a letter dated June 7, 1978, to the Department of Corporations regarding the above application, Monaghan represented that the proposed option contained a 5–year vesting provision. In a letter dated June 19, 1978, Monaghan represented to the Department of Corporations regarding the Cramer 1978 option that
A Notice of Annual Meeting of Shareholders, dated June 14, 1978, that was sent to the shareholders of IMED stated that one of the purposes of the July 7, 1978, shareholders meeting was to authorize the issuance to Cramer of the Cramer 1978 option. A proxy solicitation dated June 14, 1978, was sent to the IMED shareholders in connection with the July 7, 1978, shareholders meeting soliciting votes in favor of the issuance of the Cramer 1978 option. The proxy statement stated that the board had approved a special stock option to be issued to Cramer “In recognition of the foregoing and other services rendered to the Company by Mr. Cramer, and as an incentive for Mr. Cramer's continued involvement with the Company.” It further represented that “The option would ‘vest’ in Mr. Cramer at the rate of 20% (10,000 shares) per year for five years, so long as he had not voluntarily resigned as an officer of the Company prior to the end of each such ‘vesting’ year.”
The Cramer 1978 option was delivered to Cramer on or about September 1, 1978. The Cramer 1978 option was increased to 150,000 shares as a result of the stock split.
The Cramer 1978 option stated: “Cramer may exercise this Option in 20% increments through the fifth year-end anniversary hereof, so long as he is, at such anniversary date, still an employee of IMED.” The Cramer 1978 option contained the following vesting schedule:
The option stated that “The intent of the vesting provisions and restrictions * * * is to provide an inducement to Cramer to remain as an employee of IMED for a period of five years and to not voluntarily resign within that period.” The Cramer 1978 option also provided that its transferability was subject to the vesting provisions and limited the persons to whom Cramer could transfer or assign all or a portion of the option to persons approved by the board as “qualified offerees”. The approval of the board was stated to be contingent on the receipt of a favorable opinion of counsel and could be refused if the transfer would require registration under section 5 of the Securities Act of 1933, 48 Stat. 74, as amended, 15 U.S.C. sec. 77a (1988).
Cramer was also granted an option dated August 30, 1979, to purchase 4,390 shares of IMED common stock at $8 per share (the Cramer 1979 option). The Cramer 1979 option, like the Cramer 1978 option, provided that the optionee could exercise the option “in 20% increments through the fifth year-end anniversary hereof, so long as he is, at such anniversary date, still an employee or consultant to IMED”. The Cramer 1979 option contained the following vesting schedule:
The Cramer 1979 option contained the same transfer restrictions as the Cramer 1978 option.
Boynton was granted an option dated August 17, 1979, for the purchase of 30,000 shares of IMED stock at $13 per share (the Boynton 1979...
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