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sharing agreement, to share with XI the costs of certain ESOs.
Respondent determined that the cost required to be taken into
account equaled the spread (i.e., the stock’s market price on the
exercise date over the exercise price) relating to ESOs exercised
by petitioner’s employees (spread theory). Respondent defined
the spread as the amount of petitioners’ section 83 deduction
relating to the exercise of NSOs and disqualifying dispositions
of ISOs and ESPP purchase rights.10 Respondent’s determination
resulted in the following deficiencies and penalties:11
Penalty
Year Deficiency Sec. 6662(a)
1996 $24,653,660 $4,935,813
1997 25,930,531 5,189,389
1998 27,857,516 5,573,412
1999 27,243,975 5,448,795
On March 26, 2001, and January 14, 2003, respectively,
petitioners timely filed their petitions with the Court seeking a
redetermination of the deficiencies set forth in the December 28,
2000, and October 17, 2002, notices. Petitioner’s principal
place of business was San Jose, California, at the time the
10 ISOs and ESPP purchase rights meeting the requirements
of secs. 422 and 423, however, were not included in respondent’s
definition because they are not subject to tax under sec. 83 (see
supra note 5).
11 Respondent’s reallocation of petitioner’s expenses, in
turn, reduced petitioner’s deductible business expenses and
increased petitioner’s taxable income.
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