Cramer v. Commissioner

64 F.3d 1406 (9th Cir. 1995)

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Nature of the Case

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Facts

In 1978, IMED issued to Cramer (P) an option to purchase 50,000 shares at $50 per share with vesting to occur 20% each year over the next five years so long as P was an employee of IMED and P could only transfer the option to persons approved by the board subject to vesting restrictions. In 1979, IMED issued to P an option to purchase 4,390 shares of IMED stock at $8 per share, to Boynton (P1) an option for 30,000 shares at $13 per share, and to Monaghan (P2) an option for 4,500 shares at $13 per share. All of the options were vested over 5 years and subject to the same 1978 restrictions on P. The vesting was intended to induce continued employment. P never exercised any part of the options. The corporate controller consulted with Arthur Young over the tax treatment of the options. There was never a review of the options but they informed the controller that as a general matter 83(b) elections could be filed to include the value of nonstatutory options in ordinary income at the time of the grant even if the company were not publicly traded and that would cause the options to get capital gains treatment upon later disposition. D and the others were told that they must file 83(b) elections with the IRS to include the value of their grant in their ordinary income if they wanted capital gains status. P was also told that the value of the grant could not be readily ascertained and that 83(b) may not apply at all. P filed the 83(b) election stating that the fair market value of the options was zero. D reported no taxable income in the year of the grant. P believed that the options have a value greater than zero. In 1981, P inquired over the statute of limitations issue regarding the 83(b) filing and the accountant determined that 83(b) was contingent upon a readily ascertainable fair market value. In 1982, Warner-Lambert purchased all of the IMED stock at $163 per share. Warner agreed to buy all the outstanding and vested and nonvested options of IMED stock. Warner paid P $163 per share less the exercise price of each option. P got $25,945,506, Boynton got $7,714,800 and Monaghan got $2,274,895. P prepared 1982 taxes and tried for capital gains status. None of the returns disclosed that the options were subject to transfer and vesting restrictions, that 83(b) elections had been filed with respect to some of the options and that the options were not traded on an established market or on what authority they based their treatment on. The IRS assessed them as ordinary income and assessed penalties. P challenged these determinations. The Tax Court agreed with the IRS and under regulations, held that at the time the options did not have a readily ascertainable fair market value under 83(e)(3) and that 83(a) and (b) did not apply. The court also found that P had intentionally disregarded regulation 1.83-7(b)(2) and upheld the penalties assessed. This appeal resulted.