Commissioner v. LoBue

1956-05-28

Headline: Employee bargain stock options are taxable compensation, Court reverses lower rulings and allows taxing the difference between option price and market value when options are exercised.

Holding: The Court held that employer-granted stock options given to reward services are taxable compensation and that taxable gain is generally measured when the options are exercised.

Real World Impact:

Treats employee bargain stock options as taxable compensation.
Measures taxable gain at option exercise, affecting tax timing for employees.
Remands to lower courts to determine exact taxable dates and amounts.

Topics: employee stock options, income tax, compensation, tax timing

Summary

Background

LoBue was a sales manager for a chemical company that adopted a stock option plan for key employees. The plan let employees buy shares at $5 per share over three years. LoBue received nontransferable options and eventually bought 340 shares by paying $1,700 while the stock’s market value was $9,930, a benefit of $8,230. The company deducted the cost, but LoBue did not report the benefit as income. The tax commissioner assessed a deficiency, the Tax Court found the options gave LoBue a proprietary interest (not compensation), and the Court of Appeals affirmed.

Reasoning

The Supreme Court rejected the idea that an employer’s intention to make an employee a part-owner removes tax liability. The Court explained that the tax law’s broad definition of income covers gains given to secure better services. These stock transfers were not gifts. Because the options were compensation for services, LoBue realized taxable gain. The Court also addressed timing: the options were nontransferable and contingent on employment, and the Treasury’s long-standing practice measures such compensation when the options are exercised. The Court reversed and remanded for further proceedings to resolve questions about the exact date the purchases were completed.

Real world impact

Employees who get bargain stock options as rewards for work may have to report the bargain as income. Employers who grant such options cannot avoid income tax treatment merely by calling the award a proprietary interest. The Court left one timing question open and sent the case back for the lower courts to decide the precise taxable dates and amounts.

Dissents or concurrances

Justices Frankfurter and Clark agreed with the judgment but declined to decide the timing issue. Justice Harlan (joined by Justice Burton) disagreed on timing and would have taxed the grant of an unconditional option when it was given.