Hann v. United States
133 Fed. Cl. 559
| Fed. Cl. | 2017Background
- In 2009 Wesco granted Gregory Hann nonqualified stock options (65,574, later increased by a 9-for-1 split) that vested over time; fair market value was not readily ascertainable at grant so income was deferred until exercise.
- For Wesco's July 28, 2011 IPO, employees could participate by automatically exercising vested options and selling the resulting shares proportionally alongside primary shareholders (lock-up prevented other sales for 180 days).
- Hann executed documents (power of attorney, exercise notice, custody and lock-up agreements) allowing attorneys to exercise 89,139 options on his behalf and immediately sell the shares to underwriters in a cashless exercise.
- Underwriters paid $15/share to the public, paid selling stockholders $14.1375/share (charging $0.8625/share underwriting commission); Hann received proceeds net of exercise price and commission; Wesco reported $776,103.56 as ordinary income on Hann’s 2011 W-2.
- Plaintiffs amended their 2011 return to treat the $76,882.39 underwriting commission as a reduction of ordinary income (seeking a refund); IRS denied the claim and plaintiffs sued in the Court of Federal Claims.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Tax treatment of underwriters' commission | Hann argues the commission is a cost of exercising options and should reduce ordinary income (or be an ordinary business expense) | U.S. argues commission is a selling cost of a capital asset and reduces amount realized on sale (capital loss) | Commission is a capital expense that reduces amount realized on the sale; treated as capital loss |
| Whether the transaction is a single-step (exercise+cash) or two-step | Hann: simultaneous cashless exercise + sale is effectively one step, so commission offsets ordinary income | U.S.: exercise (taxable ordinary income) and sale (separate capital transaction) are distinct taxable steps | Two taxable steps exist; immediacy of resale does not collapse steps; separate tax treatment applies |
| Whether commission counts as "amount paid" under §83 or should be added to basis under §1012 | Hann: commission was required to effect exercise, so it should reduce §83 income or increase basis under §1012 | U.S.: commission was not required to exercise options and is payment to sell shares (establish market), not part of exercise cost | Commission is not an "amount paid" to exercise; it is not capitalized into basis for offsetting §83 ordinary income |
| Whether commission is deductible as a business expense under §162 | Hann: as CFO/employee, expense is ordinary/necessary business expense tied to generating ordinary income | U.S.: Hann was acting as shareholder when selling shares; commissions for disposition of securities by non-dealers are capital in nature | Commission is not a trade-or-business deduction for Hann; it is a selling expense against sale proceeds (capital) |
Key Cases Cited
- Comm'r v. LoBue, 351 U.S. 243 (employee compensation in stock/options is taxable as ordinary income)
- Spreckels Sugar Co. v. Comm'r, 315 U.S. 626 (selling commissions are offsets to amount realized on disposition)
- Woodward v. Comm'r, 397 U.S. 572 (costs of acquiring or disposing of capital assets are capital expenditures)
- Ark. Best Corp. v. Comm'r, 485 U.S. 212 (definition and treatment of capital assets)
- Davis v. Comm'r, 151 F.2d 441 (8th Cir.) (underwriting commissions in an IPO are capital expenses)
- United States v. Generes, 405 U.S. 93 (dual status as employee and shareholder yields different tax consequences)
- Mitchell v. United States, 408 F.2d 435 (Ct. Cl.) (being a corporate officer can be a trade or business for §162 purposes)