Opinion
No. 05-11561.
September 5, 2006
Memorandum on Motion for Summary Judgment
Ordinarily, when a stock option is exercised an employee realizes taxable income on the difference between the fair market value of the stock and the exercise price the employee pays. However, where there is a legal restriction on the employee's ability to sell the stock and the restriction serves a significant business purpose then there is no taxable income until the restriction is lifted. Robinson v. C.I.R., 805 F.2d 38, 41 (1st Cir. 1986).
In this case, the debtors do not allege a specific legal restriction on their sale of stock after November 5, 1999. However, they argue that as a practical matter they were never able to sell their stock because of Herman Bluestein's status as an insider and strong company policy against insider trading. They state that the company had a stringent "preclearance" process and only allowed trading during a narrow trading window each quarter. Further, they allege that there were "at least four insurmountable hurdles" to his sale of stock "that would have involved several parties violating agreements."
The employer's IPO was May 5, 1999. Bluestein was required to sign a "lock-out" agreement precluding him from any stock transactions for six months thereafter. He exercised 180,000 stock options on September 16, 1999.
Where the employee is an insider, there is no taxable event until the first time there was an open trading window, regardless of whether or not the employee took advantage of it; once the failure to sell the stock is the result of an investment decision and not a legal impediment, the event is taxable. U.S. v. Tuff, 359 F.Supp.2d 1129, 1137 (W.D. Wash. 2005). The IRS does not consider potential liability for insider trading, by itself, as a legal impediment. IRS Rev. Rul. 2005-48.
Each case involving a dispute when income is realized on the exercise of a stock option must be individually considered according to its facts and circumstances. Miller v. U.S., 345 F.Supp. 1046, 1049 (N.D.Cal. 2004). In this case, Bluestein has submitted a declaration that there were "at least four insurmountable hurdles" to his sale of stock "that would have involved several parties violating agreements." While the court is skeptical of this allegation, it is enough to create a triable issue of fact. Accordingly, the court cannot grant claimant's motion for summary judgment.
It does appear that there is no triable issue that the 2001 and 2003 tax year claims are priority claims. The court will defer any decision as to subordination of any portion of any claim until confirmation of a plan of reorganization is before the court or the case has been converted to Chapter 7.
For the above reasons, claimant's motion for summary judgment will be denied. However, it will be deemed without substantial controversy in further proceedings that the 2001 and 2003 tax year claims are priority claims. Counsel for claimant shall submit an appropriate form of order which counsel for the debtors has approved as to form.