Commissioner of Internal Revenue v. Lo Bue/Concurrence Frankfurter

by Felix Frankfurter

United States Supreme Court

351 U.S. 243

Commissioner of Internal Revenue  v.  Lo Bue

 Argued: March 6, 1956. --- Decided: May 28, 1956

Mr. Justice FRANKFURTER and Mr. Justice CLARK, concurring.

We join in the judgment of the Court and in its opinion on the main issue. However, the time when LoBue acquired the interest on which he is taxed was not in issue either before the Tax Court or the Court of Appeals. In the circumstances of this case, there certainly is no reason for departing fron the general rule whereby this Court abstains from passing on such an issue in a tax case when raised here for the first time. See Helvering v. Minnesota Tea Co., 296 U.S. 378, 380, 56 S.Ct. 269, 270, 80 L.Ed. 284; Helvering v. Tex-Penn Co., 300 U.S. 481, 498, 57 S.Ct. 569, 577, 81 L.Ed. 755.

Mr. Justice HARLAN, who Mr. Justice BURTON joins, concurring in part and dissenting in part.

In my view, the taxable event was the grant of each option, not its exercise. When the respondent received an unconditional option to buy stock at less than the market price, he received an asset of substantial and immediately realizable value, at least equal to the then-existing spread between the option price and the market price. It was at that time that the corporation conferred a benefit upon him. At the exercise of the option, the corporation 'gave' the respondent nothing; it simply satisfied a previously-created legal obligation. That transaction, by which the respondent merely converted his asset from an option into stock, should be of no consequence for tax purposes. The option should be taxable as income when given, and any subsequent gain through appreciation of the stock, whether realized by sale of the option. if transferable, or by sale of the stock acquired by its exercise, is attributable to the sale of a capital asset and, if the other requirements are satisfied, sould be taxed as a capital gain. ^[1] Any other result makes the division of the total gains between ordinary income (compensation) and capital gain (sale of an asset) dependent solely upon the fortuitous circumstance of when the employee exercises his option. ^[2]

The last two options granted to respondent were unconditional and immediately exercisable, and thus present no further problems. The first option, however, was granted under somewhat different circumstances. Respondent was notified in January 1945 that 150 shares had been 'allotted' to him, but he was given no right to purchase them until June 30, 1945, and his right to do so then was expressly made contingent upon his still being employed at that date. His right to purchase the first allotment of stock was thus not vested until he satisfied the stated condition, and it was not until then that he could be said to have received income, the measure of which should be the value of the option on that date.

Accordingly, while I concur in the reversal of the judgment below and in the remand to the Tax Court, I would hold the granting of the options to be the taxable events and would measure the income by the value of the options when granted.

Notes

1. Commissioner of Internal Revenue v. Smith, 324 U.S. 177, 65 S.Ct. 591, 89 L.Ed. 830; Id., 324 U.S. 695, 65 S.Ct. 891, 89 L.Ed. 1295, does not require an opposite result. In that case Smith's employer, Western, had undertaken the management of a reorganized corporation, Hawley, under a contract by which Western was to receive as compensation for its managerial services a specified amount of stock in Hawley if it was successful in reducing Hawley's indebtedness by a stated amount. Western, in turn, gave Smith, who was active in the Hawley reorganization, an option to buy, at the then-existing market price, a fixed share of any Hawley stock received under the management contract. The management contract was successfully performed, and a part of the Hawley stock received by Western-the value of which was of course substantially enhanced by the performance of the contract-was sold to Smith at the option price. Under the peculiar facts of that case-more analogous to an assignment to an employee of a share in the anticipated proceeds of a contract than to the usual employee stock option plan-the Tax Court's finding that the gain that would accrue to Smith upon the successful performance of the management contract was intended as 'compensation' to him for his services was no doubt amply justified. But as the Court expressly stated in upholding that finding: 'It of course does not follow that in other circumstances not here present the option itself, rather than the proceeds of its exercise, could not be found to be the only intended compensation.' Id., 324 U.S. at page 182, 65 S.Ct. at page 593.
2. Suppose two employees are given unconditional options to buy stock at $5, the current market value. The first exercises the option immediately and sells the stock a year later at $15. The second holds the option for a year, exercises it, and sells the stock immediately at $15. Admittedly the $10 gain would be taxed to the first as capital gain; under the Court's view, it would be taxed to the second as ordinary income because it is 'compensation' for services. I fail to see how the gain can be any more 'compensation' to one than it is to the other.