Lobue v. Comm'r of Internal Revenue

Decision Date28 May 1954
Docket NumberDocket No. 41595.
PartiesPHILIP J. LOBUE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

In 1945, 1946, and 1947, petitioner was granted options to purchase his employer's stock. When petitioner received the stock in 1946 and 1947, its fair market value exceeded the option price. The options were granted to give petitioner a proprietary interest in the corporation, and not as additional compensation.

Held, petitioner received no taxable compensation in 1946 and 1947 upon receipt of the stock. T. D. 5507, 1946–1 C. B. 18, and I. T. 3795, 1946–1 C. B. 15, to the contrary, are not justified by Commissioner v. Smith, 324 U. S. 177 (1945). Richard F. Barrett, Esq., for the petitioner.

John E. Mahoney, Esq., for the respondent.

This proceeding involves deficiencies in income tax as follows:

+----------------+
                ¦Year¦Deficiency ¦
                +----+-----------¦
                ¦1946¦$3,088.63  ¦
                +----+-----------¦
                ¦1947¦464.11     ¦
                +----------------+
                

The issues to be determined are: (1) Whether the exercise of stock options by petitioner resulted in taxable compensation to him in 1946 and 1947; and (2) if so, in what amounts. Other adjustments made in the deficiency notice have not been contested, and will be taken into account under a Rule 50 computation.

Some of the facts were stipulated.

FINDINGS OF FACT.

The stipulated facts are so found and are incorporated herein.

The petitioner is a resident of Leonia, New Jersey, and filed his Federal income tax returns for the years in question with the collector of internal revenue for the fifth district of New Jersey.

The petitioner was employed by the Michigan Chemical Corporation (hereinafter referred to as the corporation) as manager of the New York sales division from September 1941 to February 28, 1947, at which time his employment terminated. There was no written contract covering the terms and conditions of his employment. His salary was $500 per month in 1944 and 1945, and $550 per month in 1946 and 1947. The nature and extent of his duties remained the same throughout his employment.

The corporation was organized in 1935, and was engaged in the business of producing and selling chemical products. One T. C. Davis had been a director and executive vice president of the corporation since 1941. In 1946 he became president, and in 1949 chairman of the board. From 1944 through 1947, he was the company's chief executive officer. Prior to 1944, Davis felt that the corporation should provide some means to give its key employees a proprietary interest in it, because of his longstanding belief that both the company and employees profited from employee stock ownership. Davis discussed his ideas with the directors and officers of the corporation, and proposed at a stockholders' meeting on March 21, 1944, that key employees be given an option to purchase stock. On that date the shareholders of the corporation approved a plan of its board of directors, whereby 10,000 shares of its common stock were to be made available to certain key employees of the corporation over the ensuing 3 years. The option price was $5 per share, and the fair market value of the stock at that time was $4.50. The sale of the stock to the employees was authorized by the Michigan Corporation and Securities Commission on June 15, 1945.

On June 29, 1944, the executive vice president of the corporation addressed a letter to petitioner advising him of the action of the stockholders and board of directors in March of that year. The letter stated:

The purpose of this is to provide an incentive to key employees and especially to permit such men to participate in the success of the Company. This is a method or plan which has been followed by many of the leading American corporations.

* * * * * * *

The letter further stated that petitioner was to be tentatively allotted an option to purchase 10 shares of stock; that the option could not become definite until January 1, 1945, depending upon the company's profitable operations for the remainder of the year 1944. The letter further stated that receipt of the option was contingent upon petitioner's being employed by the company on June 30, 1945.

On January 18, 1945, another letter from the executive vice president of the corporation to petitioner granted him an option to purchase 150 shares of stock on June 30 of that year. The rights to subscribe to the stock were not transferable. The letter also stated:

As you know, we must continue to contribute our every effort toward the success of Michigan Chemical Corporation. There is much yet to be done to bring the Company along towards the attainment of our goal. This will require the most intensive work on the part of all of us during the current year. That we have a great opportunity is, I am sure, well known to you.

* * * * * * *

On May 1, 1945, petitioner gave the corporation his promissory note for $750, covering the purchase price of the 150 shares allotted to him. The corporation had granted similar option rights to 36 other key employees in 1945.

A letter from the executive vice president of the corporation, dated January 1, 1946, granted petitioner an option to purchase an additional 150 shares of stock. The letter stated:

I am sure you recognize that there is much waste in most of our operations. Waste of materials, steam, water and of still greater importance the waste of time and labor. You should make every effort to correct these faults and where you know them to exist in parts of the plant beyond your control, you should not hesitate to point them out to those responsible.

* * * * * * *

On January 3, 1946, petitioner gave the corporation his promissory note, in the amount of $750, covering the purchase price of the 150 shares. In 1946 the corporation granted similar option rights to 47 other key employees. On May 24, 1946, petitioner paid his 2 notes in the total amount of $1,500 and received 300 shares of stock.

On January 2, 1947, the president of the corporation advised the petitioner that he had been granted the option to purchase 40 additional shares of the Corporation's stock. The president's letter stated:

Again I wish to call your attention to the fact that these allocations afford you an opportunity to become a stockholder and thus participate in the future earnings of the corporation. The future progress and earnings of the corporation are largely dependent upon the loyal cooperation and efforts of each of its employees. The corporation's plans for 1947 include further expansion which should bring to you greater opportunities for participation in the future of your company both as an employee and stockholder. Incidentally, an employee should feel a certain amount of pride in also being a stockholder.

* * * * * * *

The corporation, in 1947, granted additional option rights to 75 other key employees. On February 3, 1947, petitioner paid the corporation $200 and received a certificate for 40 shares of its stock.

No deduction was taken by the corporation on its income tax return for the year ending December 31, 1945, for the difference in the fair market value and the option price of stock options granted to employees in that year.

On its income tax returns for the years ending December 31, 1946, and December 31, 1947, the corporation deducted an amount described as the excess of market value at exercise date over option price of 3,900 shares of stock sold to employees in 1946 and 5,665 shares sold to employees in 1947.

The fair market value of the corporation's stock at certain times during the 3-year period, 19441947, was as follows:

+-------------------------------+
                ¦Year         ¦Fair market value¦
                +-------------+-----------------¦
                ¦March 1944   ¦$4.50            ¦
                +-------------+-----------------¦
                ¦January 1945 ¦8.69             ¦
                +-------------+-----------------¦
                ¦May 1945     ¦13.25            ¦
                +-------------+-----------------¦
                ¦June 1945    ¦14.38            ¦
                +-------------+-----------------¦
                ¦January 1946 ¦$19.25           ¦
                +-------------+-----------------¦
                ¦April 1946   ¦25.25            ¦
                +-------------+-----------------¦
                ¦May 1946     ¦30.50            ¦
                +-------------+-----------------¦
                ¦February 1947¦19.50            ¦
                +-------------------------------+
                

The number of stockholders, from 1940 to 1947, was as follows:

+----------------------------+
                ¦Year¦Number of stockholders ¦
                +----+-----------------------¦
                ¦1940¦436                    ¦
                +----+-----------------------¦
                ¦1941¦423                    ¦
                +----+-----------------------¦
                ¦1942¦435                    ¦
                +----+-----------------------¦
                ¦1943¦432                    ¦
                +----+-----------------------¦
                ¦1944¦451                    ¦
                +----+-----------------------¦
                ¦1945¦665                    ¦
                +----+-----------------------¦
                ¦1946¦871                    ¦
                +----+-----------------------¦
                ¦1947¦1,132                  ¦
                +----------------------------+
                

In his deficiency notice, the respondent determined that petitioner received additional unreported compensation in the amount of $8,100 from the exercise of the option in 1946 and $580 from the exercise of the option in 1947.

The options granted to petitioner in 1945, 1946, and 1947 were to give him a proprietary interest in the...

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9 cases
  • Gresham v. Comm'r of Internal Revenue
    • United States
    • U.S. Tax Court
    • 16 August 1982
    ...basis for adopting that position. The tax treatment of compensatory bargain sales has long been a troublesome subject. In LoBue v. Commissioner, 22 T.C. 440 (1954), this Court held that when an employee was allowed to purchase the stock of his employer at a bargain, the arrangement was to e......
  • Commissioner of Internal Revenue v. Lo Bue
    • United States
    • U.S. Supreme Court
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    ...granted to give LoBue 'a proprietary interest in the corporation, and not as compensation for services' the Tax Court held for LoBue. 22 T.C. 440, 443. Relying on this finding the Court of Appeals affirmed, saying: 'This was a factual issue which it was the peculiar responsibility of the Ta......
  • Commissioner of Internal Revenue v. Lo Bue
    • United States
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    • 9 June 1955
    ...options granted to him as an employee by that corporation. The facts are set out at length in the opinion of the Tax Court in this case, 22 T.C. 440, and need not be repeated here. Suffice it to say that the Commissioner of Internal Revenue determined a deficiency in income tax against the ......
  • Babbitt v. Comm'r of Internal Revenue
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    ...Treasury Decision shall apply. Accordingly, we are not concerned with the applicability of T.D. 5507 to the facts at hand. Cf. Philip J. LoBue, 22 T.C. 440. Nor are the provisions of section 130A of the 1939 Code, effective for taxable years beginning after 1949, applicable to the instant c......
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