-39-
financial accounting purposes.15 Accordingly, respondent’s
allocation relating to the grant date value fails to meet the
arm’s-length standard mandated by section 1.482-1(b), Income Tax
Regs.
During the years in issue, petitioners employed the IVM,
which did not treat at-the-money options as expenses. From 1972
until December 15, 1995, the IVM was the only financial
accounting method authorized by FASB for measuring and reporting
the value of options, and thus, the only available method during
the first year of petitioner’s cost-sharing agreement.
Thereafter, the FVM was the preferred method, yet petitioners
were under no affirmative obligation to elect the FVM.16 In
addition, during the years in issue most companies used the IVM
for purposes of valuing ESOs.17 Thus, consistent with the
15 ESOs generally do not have an ascertainable fair market
value on the grant date for purposes of sec. 1.83-7(b)(3), Income
Tax Regs. Thus, the grant date value is not a tax expense
pursuant to sec. 83. During the years in issue, most companies
used the IVM, and thus, were not required, for financial
accounting purposes, to record an expense relating to options
issued at-the-money and certain ESPP purchase rights.
16 In 1996, petitioner employed the IVM to calculate ESO
costs. Respondent, in his Dec. 28, 2000, notice of deficiency,
determined that petitioner’s 1996 cost-sharing pool should be
increased by $14,939,494 relating to stock options and ESPP
purchase rights. The parties subsequently stipulated that this
amount would not be included in the 1996 cost-sharing pool.
17 Although the IVM has been criticized for not measuring
the call premium of an ESO, both parties’ experts acknowledged
that an ESO’s call premium may have some value but cast doubt on
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