Rev. Rul. 80-300

ISSUE

When is an employee in receipt of income because of the grant to the employee of a stock appreciation right?

FACTS

A corporation adopted a plan under which key employees of the corporation are granted stock appreciation rights (SAR's). An SAR entitles the employee to a cash payment equal to the excess of the fair market value of one share of the common stock of the corporation on the date of the exercise of the SAR over the fair market value of a share on the date the SAR was granted to the employee. An employee need not own any stock of the corporation to receive an SAR, and SAR's are granted without cost to the employee. To exercise an SAR, an employee must notify the corporation in writing. No SAR is exercisable before one year, and if not exercised by the employee within five years, the SAR's will be deemed to have been exercised on the fifth anniversary of the grant. At that time, the amount of the stock appreciation will automatically be paid to the employee. SAR's are not traded on an established market, and are nonassignable and nontransferable by the grantees.

In 1975, the corporation granted 10 SAR's to A, an employee of the corporation. On the date of the grant, the fair market value of the corporation's common stock was 30x dollars a share. In 1980, A exercised the SAR's when the fair market value of a share of the corporation's stock was 80x dollars. A received 500x dollars.

LAW AND ANALYSIS

Section 61 of the Internal Revenue Code provides that, except as otherwise provided, income means all income from whatever source derived.

Section 451(a) of the Code provides that the amount of any item of gross income is includible in gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, the amount is to be properly accounted for as of a different period.

Section 1.451-2(a) of the Income Tax Regulations provides that income, although not actually reduced to a taxpayer's possession, is constructively received in the taxable year during which it is credited to the taxpayer's account, set apart for the taxpayer, or otherwise made available so that the taxpayer may draw upon it at any time, or so that the taxpayer could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions.

The courts and the Internal Revenue Service have recognized that a requirement of surrender or forfeiture of a valuable right is a sufficient restriction to make inapplicable the doctrine of constructive receipt. See Hales v. Commissioner, 40 B.T.A. 1245 (1939), acq., 1940-1 C.B. 2. See also Rev. Rul. 58-230, 1958-1 C.B. 204, which holds that a requirement of a six-month suspension from participation in an employees' profit sharing plan upon an employee's withdrawal of the employer's contributions and earnings thereon, and the employee's consequent loss of the benefit of the employer's contributions that would have been made for the six-month period, is a substantial limitation that precludes constructive receipt of the withdrawable amounts.

The forfeiture of a valuable right is a substantial limitation that precludes constructive receipt of income. The employee's right to benefit from further appreciation of stock, in this case, without risking any capital is a valuable right. However, once the employee exercises the stock appreciation rights, the employee loses all chance of further appreciation with respect to that stock and the amount payable becomes fixed and available without limitation. Accordingly, an employee will be in receipt of income on the date the SAR's are exercised.

HOLDING

An employee who possesses stock appreciation rights is not in constructive receipt of income by virtue of the appreciation of the employer's stock. The cash payment to which the employee is entitled is includible in gross income in the year a stock appreciation right is exercised. Thus, in the example above, the employee must include in gross income 500x dollars in 1980 because the SAR's were exercised in that year.