- 8 -
requirements. Id. The taxpayer argued that exercising his
option was not taxable. Id. In Facq, a general framework was
set forth to assess the rule of taxability of options to
understand the arguments presented by the taxpayer in that case.
Id. This general framework will be applied to the identical
arguments of petitioners in this case.
A. General Rule Regarding Taxation of Stock Options
In general, when an employee receives a nonstatutory stock
option8 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 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); Facq v. Commissioner,
supra; Hilen v. Commissioner, T.C. Memo. 2005-226; sec. 1.83-
3(a), Income Tax Regs. The taxpayer must recognize income in the
8Statutory 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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