Lead Opinion
Respondent determined a deficiency in petitioner’s Federal income tax for the year ending March 31, 1982, in the amount of $195,782.54. After concessions, the remaining issue is whether petitioner realized capital
PRELIMINARY MATTER
When the instant case was reached for trial, .the parties had settled all but two of the items raised in the notice of deficiency. Trial then proceeded with respect to the issues involving those two items — the characterization and timing of the income attributable to a warrant for the purchase of stock in Immuno Nuclear Corp., and a warrant for the purchase of stock in FilmTec Corp. The parties then filed simultaneous briefs and simultaneous reply briefs. In his reply brief, respondent stated that he “concedes the portion of the tax deficiency arising from the FilmTec warrant for purposes of this litigation. Respondent makes this concession without waiving its right to pursue the conceded portion through appropriate tax assessment procedures for the [year ending March 31, 1985].”
Although respondent’s reply brief proffered to concede a significant portion of the deficiency for the year before us (ending March 31, 1982), petitioner filed a supplemental reply brief requesting the Court to render a decision on the merits and not to accept respondent’s concession.
Respondent’s shifting positions are prejudicial to the Petitioner. Petitioner has fully liquidated and is in the process of dissolving itself. It has retained only enough assets to pay any judgment in the pending Tax Court matter. It will not have sufficient assets to defend and pay a large judgment based upon the value of the warrant at the time of exercise.
The acceptance or rejection of a proffered concession is a matter within the discretion of the Court, and we should exercise our discretion in accordance with the “interest of justice.” See Jones v. Commissioner,
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.
During all relevant periods, petitioner was a corporation having its principal place of business in Minneapolis, Minnesota. Petitioner is a stock brokerage firm which provided the services usually offered by such firms to their clients. Petitioner’s sole shareholder is Jack W. Pagel.
In September 1977, petitioner served as underwriter for a stock offering by Immuno Nuclear Corp. (Immuno). In the stock offering, 235,000 Immuno shares were sold at $1.50 per share, thus generating total proceeds of $352,500. Of that amount, Immuno received $310,200 and petitioner received $42,300 as commissions for the underwriting.
In connection with the underwriting, petitioner also received a warrant for the purchase of Immuno stock (the warrant). Petitioner paid Immuno a total of $10 for the warrant. Petitioner acquired the warrant pursuant to a clause in an underwriting agreement between Immuno and petitioner which provided that Immuno would sell to petitioner for $10 a warrant for (1) 17,000 Immuno shares, provided that petitioner sold at least 170,000 Immuno shares in the underwriting, or (2) 23,500 shares, in the event that petitioner sold all 235,000 shares made available in the offering.
The warrant provided that petitioner had the right to purchase 23,500 shares of Immuno common stock during the period beginning 13 months after October 5, 1977, the date of the warrant, and ending October 4, 1982, at the following prices per share:
If purchased after October 4, 1978, [2] and on or before October 4, 1979, at $1.605;
If purchased thereafter and on or before October 4, 1980, at $1.710;
If purchased thereafter and on or before October 4, 1981, at $1.815;
If purchased thereafter until expiration at $1.920.
Petitioner’s right under the warrant to purchase the Im-muno stock was not conditioned upon the future performance of any services by petitioner. Petitioner, however, could not assign, transfer, hypothecate, sell, or otherwise dispose of the warrant during the first 13 months after October 5, 1977.
When petitioner received the warrant, there was no active trading of Immuno warrants on any established market. Petitioner held the warrant in a segregated investment account from the time it acquired the warrant (October 1977) until October 1981. On October 2, 1981, petitioner sold the warrant to its sole shareholder, Mr. Pagel, for $314,900. On its Federal corporate income tax return for the year ending March 31, 1982, petitioner reported the sale of the warrant as a capital gain in the amount of $314,890 (proceeds of $314,900 and basis of $10).
In the notice of deficiency, respondent recharacterized the gain from the sale of the warrant as ordinary income, based upon the following explanations:
li. Schedule D (Capital Gains and Losses)
Since you were the underwriter for [Immuno] and were afforded the right to purchase their stock warrants at a bargain purchase price, your sale of these stock warrants should be reported as ordinary income. Therefore, we have not allowed capital gain treatment for the $314,890 gain resulting from the sale of these stock warrants.
lj. Underwriting Income
Ordinary income was increased * * * to reflect the sale of stock warrants of [Immuno] * * * . You were the underwriters * * * , and were afforded the right to purchase their stock warrents [sic] at a bargain purchase price. Therefore, you should recognize ordinary income at the time of exercise or transfer of the option in the amount of the difference between the fair market value and the exercise price.
The issue is whether petitioner’s gain from the sale of the warrant to Mr. Pagel is taxable as ordinary income or as capital gain. Respondent asserts that section 83
Petitioner contends that respondent did not raise the applicability of section 83 until after the completion of trial and, therefore, “All references to section 83 should be stricken on account of the Respondent’s failure to raise the issue.” Petitioner also makes the following alternate arguments to support the proposition that section 83 does not cause the gain from the sale of the warrant to be taxable as ordinary income: (1) There was no compensatory element in petitioner’s receipt of the warrant; (2) any compensation element should be determined only at petitioner’s receipt of the warrant, not at the sale of the warrant, because the warrant was transferrable and had a readily ascertainable fair market value; and (3) section 1.83-7, Income Tax Regs., is either inapplicable to the warrant or is an invalid regulation.
Section 83 Regulations Discussed and Applied to the Warrant
We shall begin our analysis with an exegesis of the general provisions of section 83. We then shall examine those provisions in conjunction with the facts of the instant case so that we may decide whether respondent adequately notified petitioner of the issue of the applicability of section 83. Section 83(a) generally provides that where property is transferred in connection with the performance of past, present, or future services, the excess of the fair market
Section 1.83-7 of the Income Tax Regulations sets forth rules for determining the treatment in the case of a taxpayer who receives a nonqualified stock option
We also have no doubt that petitioner received the warrant in connection with the underwriting services performed by it for Immuno; the parties in fact stipulated to that fact. Immuno certainly would not have issued the warrant to petitioner but for the performance of the underwriting services. The fact that petitioner was not obligated to perform any future services for Immuno is immaterial in determining whether section 83 applies.
Petitioner argues, however, that the fair market value of the warrant at the date of its transfer to petitioner was no greater than the $10 purchase price of the warrant, so the receipt of the warrant involved no compensation element to which section 83 may attach. We cannot agree with that characterization of the facts. Petitioner had an option to purchase 23,500 Immuno shares within the 2 years after the public issuance of the Immuno stock at a price only 7 percent greater than the $1.50 price at which the shares were sold in the fully subscribed offering. The warrant also provided petitioner the opportunity to purchase Immuno stock for 5 years at prices no more than 28 percent greater than the public offering price. On first blush then, it appears to us that the $10 purchase price for the warrant was nominal under any measurement, even taking into account the temporal restrictions placed on petitioner’s exercise of the warrant. See Weigl v. Commissioner,
Extending past our preliminary conclusions, however, we note that several formulae have been developed by economists and other financial authors to value warrants. See Gann, “Taxation of Stock Rights and Other Options: Another Look at the Persistence of Palmer v. Commissioner” 1979 Duke L.J. 911, 945 n. 86. “One of the most accurate [of those formulae] is one developed by Sheen Kassouf,” a simplified version of which may be used to approximate the normal value of a long-lived (more than 3 years), speculative warrant, such as the warrant.
We realize that the Kassouf formula does not take into account the temporal restrictions or the fact that the exercise prices are lower than $1.92 in earlier. years, and we are not satisfied that the warrant necessarily was worth approximately $12,000 at the time of grant.
Mr. Pagel’s use of the 20-percent rule-of-thumb estimate is consistent with regulations of the Minnesota Department of Commerce governing the maximum commissions any underwriter may receive for underwriting services. Those regulations provide that if “no market value exists [for an option or warrant], an option or warrant to acquire common stock shall be valued at 20 percent of the public offering price of such number of shares under option or warrant.”
Section 1.83-7(a), Income Tax Regs., provides that a taxpayer realizes compensation income under the general rule of section 83(a) if the fair market value of the option is readily ascertainable at the time the option is granted. If, however, the option’s fair market value is not readily ascertainable at the time of grant, the taxpayer realizes compensation income only when the option is exercised or otherwise disposed of in an arm’s-length transaction. Sec. 1.83-7(a), Income Tax Regs. The regulation deems an option to have a readily ascertainable fair market value if the option is actively traded on an established market. Sec. 1.83-7(b)(l), Income Tax Regs. If an option is not actively traded on an established market, section 1.83-7(b)(2), Income Tax Regs., provides that the option is not considered to have a readily ascertainable fair market value at time of grant unless four conditions exist:
(i) The option is transferable by the optionee;
(ii) The option is exercisable immediately in full by the optionee;
(iii) The option or the property subject to the option is not subject to any restriction or condition (other than a hen or other condition to secure the payment of the purchase price) which has a significant effect upon the fair market value of the option; and
(iv) The fair market value of the option privilege is readily ascertainable in accordance with [section 1.83-7(b)(3), Income Tax Regs. 9 ]
The terms of the warrant are such that, until 13 months after the grant of the warrant, petitioner could not exercise the right to purchase Immuno stock and could not assign, transfer, hypothecate, sell, or otherwise dispose of the warrant. Nevertheless, petitioner’s reply brief cites to Robinson v. Commissioner,
Petitioner’s reply brief also cites section 83(c)(2) for the proposition that property is transferable if it is “not subject to a substantial risk of forfeiture.” We read section 83(c)(2) only to say that a substantial risk of forfeiture prevents a property interest from being transferable for purposes of section 83; section 83(c)(2) does not provide that a property interest without a substantial risk of forfeiture necessarily is transferable for purposes of section 83. See also sec. 1.83-3(d), Income Tax Regs. Based upon the plain language of the terms of the warrant, we thus hold that the warrant was not transferable when petitioner received it. Pursuant to section 1.83-7(b)(l) and (2)(i) and (ii), Income Tax Regs., the warrant therefore did not have a readily ascertainable
Furthermore, that regulation would require petitioner to recognize compensation income at the time of the warrant’s exercise or other disposition in an arm’s-length transaction. Sec. 1.83-7(a), Income Tax Regs. The price at which petitioner transferred the warrant to Mr, Pagel, $314,900, was selected by petitioner and Mr. Pagel “with some counsel from our attorneys.” Although the transaction was between petitioner and its sole shareholder, neither petitioner nor respondent has suggested that the sales price of $314,900 was other than the fair market value of the warrant or that the sale of the warrant was other than an arm’s-length transaction. We therefore find that petitioner’s sale of the warrant to Mr. Pagel in October 1981 was an arm’s-length transaction executed at the fair market value of the warrant, $314,900. See H.B. Zachary Co. v. Commissioner,
Whether Section 83 Is Properly Before the Court
We now turn to deciding whether section 83 is properly at issue in the instant case. Insofar as we can discern from the record, section 83 was not specifically mentioned in the notice of deficiency, the pleadings, the trial memorEmda, or the trial. Petitioner asserts that the potential applicability of section 83 to the facts of the instant case “was raised for the first time when the Respondent sought an extension of time in which to file its brief.” Indeed, no specific Code
It is web estabbshed that a party may rely upon a theory if the opposing party has been provided with fair warning of the intention to base an argument upon that theory. William Bryen Co. v. Commissioner,
In the instant case, all evidence necessary for a legal determination under the section 83 regulations is contained in the record. Petitioner thus was not prejudiced whatsoever with regard to any evidence; no additional evidence would have changed the status of the warrant under section 1.83-7, Income Tax Regs. We also do not believe that petitioner was unfairly surprised by respondent’s assertion of section 83. Although petitioner’s briefs dispute whether section 83 is properly before the Court, several pages in petitioner’s opening brief and the bulk of its reply brief are devoted to substantive legal analysis regarding section 83. That indicates to us that petitioner had adequate notice of the section 83 issue and adequate opportunity to make its legal arguments on the issue, especially since all facts necessary to determine proper treatment under the section 83 regulations are not reasonably disputable.
Moreover, as we noted above, the language in the notice of deficiency set forth the underlying rationale for attachment of the principles of section 83 to the gain from the sale of the warrant. Nothing in respondent’s notice of deficiency, answer, trial memorandum, or trial presentation set forth any position inconsistent with taxation of the gain from the sale of the warrant under section 83. This is not a situation where respondent issued a narrowly drawn notice of deficiency and subsequently advanced new grounds not directly or implicitly within the ambit of the determination in the notice of deficiency. See Sorin v. Commissioner,
We note also that in circumstances such as those herein, there is often an assertion that respondent has the burden of proof because he has alleged a “new matter.” In the instant case, however, petitioner has not suggested that respondent should have the burden of proof with respect to section 83. Even if petitioner had made such an assertion, we feel that the burden of proof herein is a moot issue. As we stated above, all facts relevant to any determination under the provisions of the section 83 regulations are in our mind unambiguous; the only question is the appropriate law to apply to those facts.
Retroactivity of Section 1.83-7, Income Tax Regs.
Having determined that section 83 is properly at issue in the instant case and that section 1.83-7, Income Tax Regs., supports respondent’s position herein, we turn to petitioner’s remaining arguments.
Petitioner argues that section 1.83-7, Income Tax Regs., is inapplicable to the gain from the sale of the warrant because that regulation was not issued in final form until July 21, 1978, several months after the grant of the warrant to petitioner. See T.D. 7554, 1978-
We see no abuse of that discretion in the retroactive application of the section 83 regulations to property transferred after June 30, 1969. Indeed, the effective date of the section 83 regulations comports with the effective date of section 83, which applies to taxable years ending after June 30, 1969. See Pub. L. 91-172, sec. 321(a), 83 Stat. 487, 591. We note also that in 1971, well before the grant of the warrant, proposed regulations under section 83 were released which included provisions substantially identical to the relevant provisions of section 1.83-7 in final form. See 36 Fed. Reg. 10794 (1971). There thus was public notice of the proposed administrative position well before petitioner received the warrant, and petitioner certainly cannot argue that it relied upon that proposed position to its detriment. Under such circumstances, the retroactive application of section 1.83-7, Income Tax Regs., to the warrant is not an abuse of authority. Peach v. Commissioner,
Validity of Section 1.83-7, Income Tax Regs.
We turn finally to what, in our view, is the only genuine issue in the instant case. We view petitioner’s remaining contentions as being intertwined and, thus, we shall discuss the validity of regulation section 1.83-7 in conjunction with whether the warrant had a readily ascertainable fair market value for purposes of section 83. Before we begin our analysis of the regulation’s validity, we pause to note that petitioner has not asserted that the regulation is invalid
Petitioner’s final contention basically is that if any ordinary income must be recognized on account of the warrant, that ordinary income is recognizable upon the grant of the warrant in 1977, not upon the sale of the warrant to Mr. Pagel in 1981. In support of its case, petitioner notes that the amount which respondent proposes to tax to petitioner as ordinary income from the sale of the warrant — $314,890—is greater than the $310,200 received by Immuno from the 1977 stock offering. Petitioner argues that it is an “absurd and illegal proposition” for it to be taxed on compensation income
Section 1.83-7, Income Tax Regs., was promulgated to provide guidance in determining which options have a readily ascertainable fair market value and, thus, are subject to section 83. Transfers of options without a readily ascertainable fair market value are, by the terms of Code section. 83(e)(3), not subject to section 83. The phrase “readily ascertainable fair market value,” as applied to options, finds its genesis in a 1956 Supreme Court case, Commissioner v. LoBue,
In 1961, the Treasury Department embraced the “readily ascertainable” standard with the promulgation of section 1.421-6(c), Income Tax Regs.
Thus, when Congress enacted section 83 in 1969, the regulatory treatment of stock options received by independent contractors for the performance of underwriting services was identical to that of current regulations section 1.83-7, at least insofar as the facts of the instant case are concerned. In fact, the regulatory scheme is such that the provisions of sections 1.61-15 and 1.421-6, Income Tax Regs., govern property transferred on or before June 30, 1969, and the identical rules of section 1,83-7, Income Tax Regs., apply if the property was transferred after June 30, 1969.
We upheld the validity of sections 1.61-15 and 1.421-6, Income Tax Regs., as applied to pre-1969 grants of warrants to underwriters in Weigl v. Commissioner,
We begin by noting that we easily might have concluded that the warrant had a readily ascertainable fair market value at the date it was granted, and we might have made a finding of the warrant’s value. We already have discussed the Kassouf formula, a generally well-respected method for approximating the normal value of a warrant without regard to whether the warrant is publicly traded. We have cited to a law review ■ footnote which referred to several authors who have developed models for the valuation of stock options and warrants. See Gann, supra at 945 n. 86. We even noted a State regulatory provision that provided a deemed value for an option or warrant. We would not think it too unwieldy for one or more of those methods to be adopted as constructs whereby nonpublicly traded options and warrants could be found to have readily ascertainable values.
Our'role in the constitutional scheme, however, is not to draft the law; it is "solely to interpret it. Indeed, we are constrained to uphold a regulation if it has a reasonable basis in the statutory history, even though a taxpayer’s challenge to the policy behind the regulation has logical force. National Muffler Dealers Association, Inc. v. United States,
The Code states only that section 83 “shall not apply to * * * the transfer of an option without a readily ascertainable fair market value.” Sec. 83(e)(3). The legislative histories that accompany the enactment of section 83 provide no elaboration whatsoever on that provision. See H. Rept. 91-413, 1969-
Congress did not specify any changes from the regulations’ treatment of whether an option transferred in connection with the performance of services had a “readily ascertainable fair market value,” when it had a clear opportunity to do so. Arguably, Congress’ silence in that regard may amount to a legislative enactment of the regulation provisions regarding whether options have a readily ascertainable fair market value. See Helvering v. R.J. Reynolds Tobacco Co.,
The conferees intend that in applying these rules for the future, the Service will make every reasonable effort to determine a fair market value for an option (i.e., in cases where similar property would be valued for estate tax purposes) where the employee irrevocably elects (by reporting the option as income on his tax return or in some other manner to be specified in regulations) to have the option valued at the time it is granted (particularly in the case of an option granted for a new business venture). The conferees intend that the Service will promulgate regulations and rulings setting forth as specifically as possible the criteria which will be weighed in valuing an option which the employee elects to value at the time it is granted.
Commentators have suggested that Congress’ statement in 1976 indicates disapproval with the regulation provisions specifying when the value of an option is “readily ascertainable.” See, e.g., Billman, “Nonstatutory Stock Options,” 383 Tax Management A-8 (1984); Diamond & Salles, “The Receipt of Property for Services After the TRA,” Tax Advisor 325, 334 (May 1988); Nolan, “Deferred Compensation and Employee Options Under the New Section 83 Regulations,” 56 Taxes 790, 795-796 (1979). We, however, do not interpret that statement to express Congress’ disapproval of the regulation provisions. As embodied in the regulations under sections 61 and 421 and the proposed regulations under section 83, the Treasury position has been consistent since 1961 on the issue of when an option has a readily ascertainable value. If Congress in 1976 truly disapproved of the Treasury position, it could have enacted statutory provisions and superseded the Treasury’s ability to take such a position.
In short, Congress’ silence indicates to us that it did not perceive the regulatory provisions to be unreasonable or plainly contrary to'congressional intent. Indeed, the regulations further a policy under which there is reasonable accuracy in the valuation of nonpublicly traded options. As we have stated in regard to the valuation rules of regulations section 1.421-6:
Surely, it cannot be considered unreasonable to require reasonable accuracy in the valuation of stock options. To hold otherwise would be to encourage estimates of fair market value of such rights on the basis of pure speculation and surmise.
Weigl v. Commissioner,
Besides upsetting a regulatory scheme which has been the Treasury position for 25 years, a contrary finding would run counter to numerous cases, e.g., Bagley v. Commissioner,
To reflect the parties’ concessions,
Decision will be entered under Rule 155.
Notes
The parties’ reply and supplemental briefs indicate that respondent’s position with respect to the FilmTec warrant is that any income from the receipt or disposition of that warrant should be recognized in petitioner’s tax year ending in 1985, not in the 1982 year herein in issue.
2Although the warrant sets an exercise price as of Oct. 5, 1978, other provisions in the warrant preclude petitioner from exercising the warrant until Nov. 5, 1978, 13 months after the date of the warrant.
Unless otherwise indicated, all Code and section references are to the Internal Revenue Code of 1954 as amended and in effect during the relevant year. All Rule references are to the Tax Court Rules of Practice and Procedure.
See also Cassetta v. Commissioner,
A “nonqualified stock option” is defined as one to which sec. 421 does not apply. Sec. 1.83-7(a), Income Tax Regs. Neither party has suggested that petitioner’s warrant is an option to which sec. 421 applies, and we find that sec. 421 is inapplicable to the warrant.
The obligation of a taxpayer to perform future services may affect when, not whether, sec. 83 applies to a transfer of property. See sec. 1.83-3(a), (b), and (f), Income Tax Regs.
Respondent’s expert witness applied the complex Kassouf formula, as well as one known as the “Black-Scholes model,” and took an average of the two results to determine a value for the FilmTec warrant.
We used an exercise price of $1.92, instead of the lower potential exercise prices, in order to give petitioner the benefit of the doubt and a lower valuation.
Using the complex Kassouf formula, set forth in Levine, supra at 470, we also performed several calculations based upon the minimum exercise price ($1.605) and the maximum exercise price ($1.92), as well as upon several assumptions we made about the dividend rate and previous 11 months’ stock prices for Immuno stock. Based upon those different assumptions, the values we calculated for the warrant ranged from approximately $8,900 to approximately $15,200.
Sec. 1.83-7(b)(3), Income Tax Regs., provides that in the determination of whether the value of an option is readily ascertainable, one must consider whether the value of the option may be measured with reasonable accuracy. That paragraph also provides that if an option has a readily ascertainable value, the amount of that value is to be determined by considering:
(i) Whether the value of the property subject to the option can be ascertained;
(ii) The possibility of any ascertainable value of such property increasing or decreasing; and
(iii) The length of the period during which the option can be exercised.
By virtue of our holdings below, we need not further analyze sec. l,83-7(b){3), Income Tax Regs.
As in effect during the year in issue, sec. 1236 provided as follows:
SEC. 1236. DEALERS IN SECURITIES.
(a) Capital Gains. — Gain by a dealer in securities from the sale or exchange of any security shall in no event be considered as gain from the sale or exchange of a capital asset unless—
(1) the security was, before the close of the day on which it was acquired (before the close of the following day in the case of an acquisition before January 1, 1982), clearly identified in the dealer’s records as a security held for investment or if acquired before October 20, 1951, was so identified before November 20, 1951; and
(2) the security was not, at any time after the close of such day, held by such dealer primarily for sale to customers in the ordinary course of his trade or business.
* * * * * * *
(c) Definition of Security. — For purposes of this section, the term “security” means any share of stock in any corporation, certificate of stock or interest in any corporation, note, bond, debenture, or evidence of indebtedness, or any evidence of an interest in or right to subscribe to or purchase any of the foregoing.
See also Big “D” Development Corp. v. Commissioner,
Sec. 1.83-8{b)(3), Income Tax Begs., provides that sec. 83 shall not apply to property received upon the exercise of an option granted before Apr. 22, 1969. That paragraph apparently is inapplicable to the warrant because petitioner never exercised the warrant (but see secs. 1.83-7(a) and 1.83-8(b)(3), Income Tax Regs.). In any event, the difference between the two effective dates is immaterial to the resolution of the instant case.
Petitioner notes that respondent’s position in this case would result in petitioner’s recognizing $357,190 of ordinary compensation income on account of the underwriting ($314,890 net gain on the warrant plus $42,300 cash received at the time of the underwriting).
(c) Options with a readily ascertainable fair market value. — (1} If there is granted an option to which this section applies and which has a readily ascertainable fair market value (determined in accordance with subparagraphs (2) and (3) of this paragraph) at the time the option is granted, the employee in connection with whose employment such option is granted realizes compensation at such time in an amount equal to the excess, if any, of such fair market value over any amount paid for the option. If an option to which this section applies does not have a readily ascertainable fair market value at the time the option is granted, the time when the compensation is realized and the amount of such compensation shall be determined under paragraph (d) of this section.
(2) Although options may have a value at the time they are granted, that value is ordinarily not readily ascertainable unless the option is actively traded on an established market. If an option is actively traded on an established market, the fair market value of such option is readily ascertainable for purposes of this section by applying the rules of valuation set forth in section 20.2031-2 of this chapter (the Estate Tax Regulations).
(3)(i) When an option is not actively traded on an established market, the fair market value of the option is not readily ascertainable unless the fair market value of the option can be measured with reasonable accuracy. For purposes of this section, if an option is not actively traded on an established market, the option does not have a readily ascertainable fair market value when granted unless the taxpayer can show that all of the following conditions exist:
(a) The option is freely transferable by the optionee;
(b) The option is exercisable immediately in full by the optionee;
(c) The option or the property subject to the option is not subject to any restriction or condition (other than a lien or other condition to secure the payment of the purchase price) which has a significant effect upon the fair market value of the option or such property; and
(d) The fair market value of the option privilege is readily ascertainable in accordance with subdivision (ii) of the subparagraph.
The unmistakable intention of the regulatory scheme is that sec. 1.83-7, Income Tax Regs., applies to post-1969 nonqualified options such as the warrant; however, it appears to us that a technical reading of the regulations would result in the facts of the instant case not being subject to any regulation provision. The terms of sec. 83(e)(3) state that sec. 83 does not apply to the transfer of an option without a readily ascertainable value, and sec. 83(a), by its terms, applies only to a transfer of property in connection with the performance of services. It thus appears to us that an option without a readily ascertainable value at the time it was transferred by the recipient of services is not subject to taxation under sec. 83 and, thus, the sec. 83 regulations do not appear to provide the authority to tax the performer of the services. By default, sec. 61 therefore should control taxation of the property. Secs. 1.61-15(a) and 1.61-2(d)(l) and (6), Income Tax Regs., provide several exceptions and cross-references to the sec. 83 regulations; however, we are unable to find any provision in the sec. 61 regulations that applies to a post-1969 option without a readily ascertainable value to make it taxable under the sec. 61 regulations or any incorporation by reference of the scheme of sec. 1.83-7, Income Tax Regs.
We nevertheless believe that the regulatory scheme is intended to apply to options taxable under both sec. 83 and sec. 61. We thus shall apply the scheme of the sec. 83 regulations as if it technically applied to options which fell out of the provisions of sec. 83 into those of sec. 61. Even lacking such a regulatory scheme, we would reach the same conclusion as provided by that scheme pursuant to the relevant case law that otherwise exists. See p. 221, infra.
We also note that although this issue may not have been squarely before the Court, the Eighth Circuit, the Court to which the instant case is appealable, affirmed the application of this regulatory scheme to a post-June 30, 1969, year in Bagley v. Commissioner,
A holding that the regulation is invalid would upset a regulatory scheme for the taxation of options that has been in effect for 25 years, since the release of T.D. 6696 in late 1963.