-10-
We begin with the general rule of taxability of options to
best understand petitioners’ arguments.
A. General Framework
When an employee receives a nonstatutory stock option7 that
does not have a readily ascertainable fair market value, the
employee is not taxed on the receipt of the option at that time,
although it is part of his or her compensation. Sec. 83(e)(3).
Instead, the employee is generally taxed when he or she exercises
the option and receives shares, if the shares have been
transferred to, and are substantially vested in, the employee.
Sec. 83(a); Tanner v. Commissioner, 117 T.C. 237, 242 (2001),
affd. 65 Fed. Appx. 508 (5th Cir. 2003); Hilen v. Commissioner,
supra; sec. 1.83-3(a), Income Tax Regs. The taxpayer must
recognize income in the amount that the fair market value of the
shares he or she receives exceeds the exercise price that he or
she pays. Sec. 83(a).
For the taxpayer to be taxed at the time he or she exercises
the option and receives the shares, the shares must be
transferred to and substantially vested in the employee. Sec.
1.83-3(a), Income Tax Regs. A transfer to the employee occurs
when the employee acquires a beneficial ownership interest in the
property. Miller v. United States, supra at 1049; sec. 1.83-
3(a), Income Tax Regs. The shares are substantially vested in
7Statutory stock options are compensatory options that meet
certain criteria and are treated differently under the Code. See
sec. 422. Stock options that do not meet the requirements of
statutory stock options are nonstatutory stock options.
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