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Subject:   exercise date
Date:   2 Oct 2008
From:   Charles

Dear Michael Gray,

You wrote the exercise date is the date the optionee chooses to exercise, not the settlement date when the stock is issued.

Our attorney disagrees. He states the exercise date is considered to be the settlement date.

Can you substantiate your position?

Answer

Date:   7 Oct 2008

Hello Charles,

According to Treasury Regulations Section 1.83-7, the income is taxable "at the time the option is exercised or otherwise disposed of." "If the option is exercised, Sections 83(a) and 83(b) apply to the transfer of property pursuant to such exercise, and the employee or independent contractor realizes compensation upon such transfer at the time and in the amount determined under section 83(a) and 83(b)."

In Walter v. Commissioner, TC Memo 2007-2, January 3, 2007, the Tax Court ruled that income was taxable when the employee/option holder faxed his notice of exercise and not when he later paid for the shares or when the shares were physically issued. (Since he faxed the notice after business hours, it was considered effective the next business day.) The Tax Court held the Mr. Walter had beneficial ownership of the shares when he exercised the option according to the terms of the plan by giving notice to his employer.

The Tax Court cited Treasury Regulations Section 1.83-3(a)(1), which states, "a transfer of property occurs when a person acquires a beneficial ownership interest in such property." Under the terms of the option agreement, Mr. Walter received the beneficial ownership of the stock when he exercised the option, not when he later paid the option price or when the stock was physically issued.

Good luck!

Mike Gray

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IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this answer was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.