Gordon v. Commissioner , 53 T.C.M. 1331 ( 1987 )

RUTH GORDON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Gordon v. Commissioner

Docket No. 13039-84.

United States Tax Court

T.C. Memo 1987-344; 1987 Tax Ct. Memo LEXIS 344; 53 T.C.M. (CCH) 1331; T.C.M. (RIA) 87344;

July 13, 1987

---

From 1973 until 1979, petitioner was a vice-president of Medfield Corporation. In 1976 and 1977, petitioner was granted options to purchase Medfield stock. Petitioner exercised these options in 1979 after Medfield's merger with National Medical Enterprises, Inc., but prior to termination of her employment. Held: The options were not exercised in a timely manner under sec. 251(c) of the Economic Recovery Tax Act of 1981, Pub. L. 97-34, 95 Stat. 259. Therefore the options do not qualify as incentive stock options under sec. 422A and ordinary income must be recognized in 1979.

Ruth Gordon, pro se.

Max K. Boyer and John S. Winkler, for the respondent.

---

WHITAKER

MEMORANDUM FINDINGS OF FACT AND OPINION

WHITAKER, Judge: Respondent determined a deficiency in petitioner's 1979 Federal income tax in the amount of $ 13,729. The issue for decision is whether gain realized from the exercise of certain stock options granted by petitioner's employer should be recognized as ordinary income.

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference.

At the time of filing the petition, petitioner resided in Tampa, Florida. From 1973 through 1979 petitioner was employed as a vice president of the Medfield Corporation (Medfield). On June 23, 1976, petitioner was granted an option to purchase 900 shares of Medfield common stock at a price of $ 4.25 per share. The option price reflected the highest quoted value of such stock for that date on the Pacific and Boston Stock Exchanges. ^{*346 On November 1, 1977, petitioner was granted an option to purchase 2,600 shares of Medfield stock at a price of $ 10.125 per share. Pursuant to each of these stock option agreements, the options could only be exercised while petitioner was actually employed by Medfield, or within 3 months after termination of such employment, unless termination was due to petitioner's death, in which case the 3 months would be extended to 1 year.}

On February 28, 1979, Medfield and National Medical Enterprises, Inc. (NME), were merged, with NME as the surviving corporation. While the Medfield options stated that they would terminate if the company became a party to a merger in which it was not the surviving company, NME's proposal for acquisition granted each Medfield option holder a substitute option to purchase NME stock. As a result, petitioner's options to purchase Medfield shares were converted to options to purchase NME shares. The conversion formula reflected the disparity in fair market values between Medfield common stock and NME common and preferred stock. Petitioner exercised her options to purchase shares of NME stock on May 23, 1979. Her employment with NME was terminated as June 23, 1979.

OPINION

The first issue for decision is whether section 422A *348 by the merger of Medfield into NME.

Because petitioner's options were exercised prior to January 1, 1981, they fall outside the scope of section 422A.Donigan v. Commissioner,68 T.C. 632, 636 (1977).

Once any stock option granted an employee is stripped of its preferential treatment, the employee is left with compensation, pure and simple, which in the vast majority of cases is taxed as ordinary income upon receipt. When nonqualified stock options are exercised, thereby becoming transferrable, section 83 requires that the excess of the fair market value over the amount paid for such property shall be included in the gross income of the employee. Consequently, we decide this issue for respondent.

Decision will be entered for the respondent.

---

Footnotes

• 1. Prior to May 23, 1979, Medfield increased the number of shares subject to this option to 1,089 to avoid dilution through the declaration of stock dividends, and petitioner partially exercised this option to the extent of 726 shares. This partial exercise is not at issue here. ↩

• 2. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. ↩

• 3. It should also be noted that the requirements of ERTA section 251(c)(1)(B) have not been complied with in that Medfield did not file an election to have section 422A apply. See sec. 14a.422A-1, Q-4 and A-4, Temp. Income Tax Regs., 46 Fed. Reg. 61839 (Dec. 21, 1981), 1982-1 C.B. 70↩.