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“Where [as in the instant case], the option itself is
transferred or canceled prior to exercise, section 421 is not
applicable, and the gain realized on such cancellation or
transfer is compensation.” Mitchell v. Commissioner, 65 T.C.
1099, 1110 (1976), affd. 590 F.2d 312 (9th Cir. 1979). We
further held in Bagley v. Commissioner, 85 T.C. 663 (1985), affd.
806 F.2d 169 (8th Cir. 1986), that a payment received by the
taxpayer from an employer in exchange for the cancellation of
stock options was includable in gross income as compensation
pursuant to section 83.
Petitioner has provided no evidence to support his
contention that the $4,650 payment received to cancel Mrs.
Buckley’s Systems stock options was taxable as a capital gain.
Mrs. Buckley received her stock options as part of her employment
with Systems. In exchange for canceling Mrs. Buckley’s stock
options, Systems paid her $4,650. Thus, since Mrs. Buckley’s
stock options were received in connection with her employment
with Systems and canceled prior to being exercised, section 83(a)
applies. Sec. 1.83-7(a), Income Tax Regs.
Under section 83(a), Mrs. Buckley realized ordinary income
at the time she received the $4,650 payment from Systems to
cancel the stock options. Bagley v. Commissioner, supra; sec.
1.83-7(a), Income Tax Regs. Since Mrs. Buckley paid nothing upon
the grant or the cancellation of the Systems stock options, her
amount paid is zero. Accordingly, we sustain respondent’s
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