McNamara v. Comm'r of Internal Revenue, Docket No. 29846.

• Decision Date: 05 March 1953
• Docket Number: Docket No. 29846.
• Parties: HARLEY V. McNAMARA, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

19 T.C. 1001

HARLEY V. McNAMARA, PETITIONER,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 29846.

Tax Court of the United States.

Promulgated March 5, 1953.

[19 T.C. 1002]

Herman A. Fischer, Esq., for the petitioner.

David F. Long, Esq., for the respondent.

In 1945, corporation gave one of its officers an option to purchase 12,500 shares of its stock at stated intervals over a two-year period at less than market value. Officer exercised option in 1946 and 1947 when the fair market value of the stock exceeded the option price. Held:

1. Gain derived from the option was intended as compensation.

2. The intended compensation was the difference between the option price and the fair market value of the stock on the dates the option was exercised and the stock acquired. Connolly's Estate v. Commissioner, 135 F.2d 64 (C.A. 6), affirming45 B.T.A. 374, and Commissioner v. Smith, 324 U.S. 177,rehearing denied, 324 U.S. 695, 889, followed.

3. Fair market value of stock on dates the option was exercised determined.

The respondent determined deficiencies in the income tax of petitioner in the amounts of $61,244.87 for the year 1946 and $64,215.93 for the year 1947.

The principal question is whether the petitioner realized taxable income in 1946 and 1947, when he exercised an option to purchase 12,500 shares of the common stock of the National Tea Company, which he had acquired in 1945.

FINDINGS OF FACT.

A stipulation of facts filed by the parties is adopted as part of our findings.

Petitioner is a resident of Hinsdale, Illinois. He filed his income tax returns for the years 1945, 1946, and 1947, on the cash receipts and disbursements basis, with the collector of internal revenue for the first district of Illinois.

Prior to March 1945, the petitioner had been employed by the Kroger Grocery and Baking Company for about 27 years. From 1941 to 1945 he had been the manager of its Chicago branch. He received a fixed salary and a percentage of profits.

National Tea Company (hereinafter referred to as National) operated a chain of 749 stores in eight Middle Western States, selling food products and also engaging in certain related activities. Early in 1944 petitioner and John F. Cuneo discussed the possible acquisition by the later of stock of National, which had been selling at a low price. At that time petitioner told Cuneo that he was convinced that National's trouble was management. In April 1944, Cuneo started to purchase stock of National, and, after he had acquired a substantial amount, he talked to petitioner about leaving Kroger and becoming manager of National. Petitioner, who had been unhappy with Kroger after the death of its president and the appointment of his successor, told Cuneo he would be willing to undertake the management of National.

[19 T.C. 1003]

Petitioner informed Cuneo of the salary, plus percentage of earnings, he was receiving from Kroger and that he would want a slight increase from National, and also would want an opportunity to acquire some of the stock of National because he ‘felt management should have an interest in the company.‘ Cuneo voiced no objection to petitioner's demands, and agreed to take the matter up with the board of directors of National.

Petitioner resigned his position with Kroger Grocery on February 1, 1945, effective February 28, 1945. On February 20, 1945, when the market price of the common stock of National was $15.25 per share, the petitioner received a letter from Cueno in which the latter stated that he had notified the directors of National of his intention to recommend the employment of petitioner as general manager on the terms set forth in a form of contract attached thereto and that he wished to have petitioner's assurance that he would execute the contract when authorization of the board of directors was procured. The proposed contract provided that petitioner should receive for a term of 1 year beginning in April 1945, a stated salary of $27,500 per year, and additional compensation of 2 per cent of the net profits of National in excess of $300,000, the aggregate compensation, however, to be limited to $60,000. It also provided that ‘In consideration of the Employee's acceptance of employment hereunder, the Company agrees to set aside 12,500 shares of its Capital Stock now in its Treasury subject to an option of purchase by the Employee at any time during the term of this contract at the price of $12.00 per share.‘

Prior to the annual meeting of the shareholders of National on March 21, 1945, they received a notice containing a ‘Proxy Statement‘ which stated, in substance, that Cuneo would recommend to the directors the employment of petitioner as executive vice president and general manager at substantially the same salary and percentage of profits mentioned in the proposed contract, and that he would also recommend that National grant options to the petitioner and Robert V. Rasmussen, president, to purchase within 1 year, at $12 per share, the respective amounts of 12,500 and 5,000 shares of its common capital stock held in treasury, the approximate market price of which as of the close of business on March 13, 1945, was $18.75 per share.

At the shareholder's meeting held on March 21, 1945, petitioner was elected a director of National. At a meeting of the board of directors on the same date, the proposed employment contract between petitioner and National was discussed. The directors decided not to take any action with respect to it until approval of the Wage Stabilization Board had been obtained. They meanwhile authorized a monthly drawing account for petitioner at the rate of $27,500 per year.

[19 T.C. 1004]

Petitioner became the executive vice president and manager of National on March 21, 1945, and served in this capacity until he was elected its president on March 21, 1947.

Prior to 1945, and continuously since that year, the common stock of National has been listed and sold on the New York Stock Exchange.

On May 9, 1945, National filed with the Secretary of the State of Illinois an amendment to its certificate of incorporation, the effect of which was to change the par value of its common stock from no par value to a par value of $10 per share.

On August 18, 1945, the President of the United States by Executive Order 9599 authorized the National War Labor Board and other agencies to provide that employers might, be voluntary action, make wage or salary increases without the necessity of obtaining approval therefor. On August 22, 1945, the Bureau of Internal Revenue issued a press release which, among other things, stated that in accordance with the President's executive order it had on that date modified its salary stabilization rules to permit any employer who desired to increase the salary of any employee to do so immediately, and that, if certain specified conditions were met, the employer might proceed to grant the salary increase without any application for approval.

At a meeting held on...