                            T.C. Memo. 2005-226



                          UNITED STATES TAX COURT



                       KEITH D. HILEN, Petitioner v.
               COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 21768-03.               Filed September 29, 2005.


        Brian G. Isaacson and Duncan C. Turner, for petitioner.

        Sandra Veliz, for respondent.



                            MEMORANDUM OPINION


        HAINES, Judge:    This case is before the Court on the

parties’ cross-motions for summary judgment pursuant to Rule

121.1       The issue for decision is whether petitioner received



        1
        Unless otherwise indicated, Rule references are to the
Tax Court Rules of Practice and Procedure, and section references
are to the Internal Revenue Code, as amended. Amounts are
rounded to the nearest dollar.
                                - 2 -

gross income from the exercise of nonstatutory stock options in

1999.

                             Background

     At the time of the filing of the petition in this case,

petitioner resided in Santa Rosa, California.

     In May 1995, petitioner commenced work for Strategic

Concepts Corp.    Strategic Concepts Corp. later changed its name

to InsWeb Corp. (InsWeb).

     As part of his compensation package, petitioner received

grants of options to purchase InsWeb common stock.   Each grant

gave petitioner the right to purchase a specified number of

InsWeb shares for a specified price per share at a future date.

To exercise his stock options, petitioner was required to notify

InsWeb in writing and make arrangements to pay InsWeb an amount

sufficient to cover the exercise price and any Federal, State,

and local taxes InsWeb was required to withhold from wages.

     On November 15, 1998, petitioner’s employment with InsWeb

was terminated.   However, petitioner entered into a consulting

relationship with InsWeb and was employed as a consultant under

his separation agreement from November 15, 1998, to September 30,

1999.   Because petitioner’s employment was terminated, under the

terms of his option agreements the last day that he was able to

exercise his stock options was December 31, 1999.
                                 - 3 -

     On July 23, 1999, InsWeb had an initial public offering of

its stock.

     On August 26, 1999, petitioner signed a promissory note and

a security agreement for a $250,000 loan from Comerica Bank-

California (Comerica) to exercise his stock options, pledging the

shares of InsWeb common stock he would receive as collateral.

The security agreement provided that, if petitioner was found to

be in default, Comerica could sell the collateral and apply the

proceeds to the outstanding balance on the indebtedness.   The

security agreement also stated that after such sale the “Debtor

shall remain liable for any deficiency, which it shall pay to

Bank immediately upon demand”.    During 1999 and 2000, petitioner

had a checking account with Comerica.    At all times relevant to

this case, Comerica and InsWeb were separate corporate entities.

     On September 7, 1999, petitioner partially exercised one of

his nonstatutory stock options, option No. 106, to purchase

20,000 shares of InsWeb common stock.    The fair market value of

the stock petitioner received was $572,500.   Petitioner paid an

exercise price to InsWeb of $26,000.

     Petitioner exercised option No. 106 again on December 30,

1999, to purchase 11,250 shares of InsWeb common stock.    The fair

market value of the stock petitioner received was $285,469.    The

exercise price petitioner paid to InsWeb was $14,625.
                                 - 4 -

     On December 30, 1999, petitioner also exercised another of

his nonstatutory stock options, option No. 17, to purchase 23,625

shares of InsWeb common stock.    The fair market value of the

stock petitioner received was $599,484.    The exercise price

petitioner paid to InsWeb was $11,813.

     Petitioner paid InsWeb for the shares of common stock with

checks from his Comerica checking account.

     The stock certificates petitioner received included a

restrictive legend that stated the shares could not be

transferred, sold, or otherwise disposed of before January 18,

2000.   Despite this, petitioner had the right to receive

dividends and exercise his voting rights with respect to the

shares.

     On October 21, 2000, petitioner filed a Form 1040, U.S.

Individual Income Tax Return, for 1999.    Petitioner reported

wages of $1,448,531.   Attached to petitioner’s income tax return

was a Form W-2, Wage and Tax Statement, from InsWeb reporting

wages of $1,435,031, which included the spread between the

exercise prices and the fair market values of the stock he

received when he exercised his nonstatutory stock options on

September 7, 1999, and December 30, 1999.

     Petitioner defaulted on his Comerica loan, and Comerica

issued a notice of private sale of collateral dated December 21,
                               - 5 -

2000, to sell the shares of InsWeb common stock petitioner had

pledged as collateral.

     On February 7, 2001, petitioner filed a Form 1040X, Amended

U.S. Individual Income Tax Return, for 1999 claiming a refund of

$108,488.   In the amended return petitioner reduced the amount of

wage income from InsWeb by the spread between the fair market

value and the exercise price he paid for shares of stock he

received when he exercised his nonstatutory stock options on

December 30, 1999.

     On September 19, 2001, petitioner filed for chapter 7

bankruptcy in the Bankruptcy Court for the Northern District of

California. In his bankruptcy schedules, petitioner listed

Comerica as a creditor.   Petitioner also stated in his schedules

that Comerica had filed suit against him to collect on the

promissory note.

     Petitioner filed a second Form 1040X for 1999 on August 4,

2003, claiming a refund of $404,537.   In the second amended

return petitioner reduced the amount of wage income from InsWeb

by the spread between the fair market value and the exercise

price he paid for shares of stock he received when he exercised

his nonstatutory stock options on September 7 and December 30,

1999.

     On October 1, 2003, respondent sent petitioner a notice of

deficiency in which respondent denied petitioner’s claim for
                               - 6 -

refund and determined petitioner had received additional capital

gains of $6,941 and had a tax deficiency of $1,470 for 1999.

     On December 27, 2004, respondent filed a motion for partial

summary judgment in respondent’s favor upon the issue of whether

petitioner received gross income from the exercise of his

nonstatutory stock options in 1999.2

     On December 30, 2004, petitioner filed a cross-motion for

summary judgment.

                            Discussion

     Summary judgment is intended to expedite litigation and

avoid unnecessary and expensive trials.    Fla. Peach Corp. v.

Commissioner, 90 T.C. 678, 681 (1988).    The Court may grant

summary judgment when there are no genuine issues of material

fact and a decision may be rendered as a matter of law.   Rule

121(b); Sundstrand Corp. v. Commissioner, 98 T.C 518, 520 (1992),

affd. 17 F.3d 965 (7th Cir. 1994); Zaentz v. Commissioner, 90

T.C. 753, 754 (1988).   We conclude that there are no genuine

issues of material fact as to whether petitioner received gross

income from the exercise of nonstatutory stock options in 1999

and that a decision may be rendered as a matter of law.



     2
        Petitioner has since conceded that he received $6,941 of
capital gains in addition to the amount he had reported on his
Federal tax return for 1999, which was the remaining issue not
covered by respondent’s motion for partial summary judgment.
Therefore, respondent’s motion shall be treated as a motion for
summary judgment.
                               - 7 -

     Under section 83, a taxpayer generally must recognize income

when he exercises a compensatory stock option to the extent that

the fair market value of the shares of stock transferred to him

exceeds the exercise price he pays if the taxpayer’s rights in

the shares are transferable or not subject to a substantial risk

of forfeiture.   Sec. 83(a); Tanner v. Commissioner, 117 T.C. 237,

242 (2001), affd. 65 Fed. Appx. 508 (5th Cir. 2003); sec. 1.83-

7(a), Income Tax Regs.

     Section 83(a) provides:

          SEC. 83(a). General Rule.–-If, in connection with
     the performance of services, property is transferred to
     any person other than the person for whom such services
     are performed, the excess of--

               (1) the fair market value of such
          property (determined without regard to any
          restriction other than a restriction which by
          its terms will never lapse) at the first time
          the rights of the person having the
          beneficial interest in such property are
          transferable or are not subject to a
          substantial risk of forfeiture, whichever
          occurs earlier, over

               (2) the amount (if any) paid for such
          property,

     shall be included in the gross income of the person who
     performed such services in the first taxable year in
     which the rights of the person having the beneficial
     interest in such property are transferable or are not
     subject to a substantial risk of forfeiture, whichever
     is applicable. * * *

     Petitioner alleges that, because he exercised his

nonstatutory stock options with “essentially nonrecourse

financing”, the recognition of his gain would be delayed until he
                               - 8 -

made a substantial payment on the debt.    Petitioner argues that

the exercise of his nonstatutory stock options falls under

section 1.83-3(a)(2), Income Tax Regs., which provides:    “The

grant of an option to purchase certain property does not

constitute a transfer of such property.”   While the instant case

concerns whether petitioner recognized income upon exercise of

his nonstatutory stock options, not upon the grant of those

options to him, petitioner’s argument is that because he used a

loan from Comerica to exercise his nonstatutory stock options,

he, in effect, received options to buy the shares of stock.

     Petitioner relies on the further clarification provided by

the regulation:

     if the amount paid for the transfer of property is an
     indebtedness secured by the transferred property, on
     which there is no personal liability to pay all or a
     substantial part of such indebtedness, such
     transaction may be in substance the same as the grant
     of an option. * * * [Sec. 1.83-3(a)(2), Income Tax
     Regs.]

The regulation also suggests that “the extent to which the risk

that the property will decline in value has been transferred, and

the likelihood that the purchase price will, in fact, be paid”

should be taken into consideration in determining whether a

transfer has occurred.   Id.

     In addition, petitioner cites section 1.83-3(a)(7), Example

(2), Income Tax Regs., and argues that when an employee exercises

stock options using nonrecourse debt, he does not bear the risk
                                - 9 -

of decline in value except to the extent he or she makes payments

toward the principal of the debt.

     Section 1.83-3(a)(7), Example (2), Income Tax Regs., is

distinguishable from the present case.    In the example, the

employee received shares of stock from his employer in exchange

for a nonrecourse note.   In this case, the indebtedness was not

owed to the employer, InsWeb, but to an unrelated third party.

Also contrary to the example, petitioner was personally liable to

Comerica.

     The facts do not support petitioner’s assertion that when he

received his shares of InsWeb common stock, he in effect received

only options to purchase InsWeb common stock at a future date.

The amount petitioner paid InsWeb was not indebtedness of any

nature.   Rather, petitioner paid InsWeb in full by checks for the

exercise prices as well as the required withholding amounts for

taxes.    In addition, the type of property transferred was shares

of stock which he actually received.    After exercising his

nonstatutory stock options, petitioner had the right to receive

dividends and the right to vote with respect to the shares of

stock he purchased.   Thus, petitioner did not receive another

option but instead received shares of stock.

     Furthermore, petitioner incurred personal liability to pay

all of the debt secured by the shares.    There was no provision in

the promissory note or security agreement which limited
                              - 10 -

petitioner’s liability to repay Comerica.   In fact, Comerica

filed suit to collect on its note, forcing petitioner into

chapter 7 bankruptcy.

     Therefore, the shares of InsWeb common stock were

“transferred” to petitioner, within the meaning of section 1.83-

3(a), Income Tax Regs., when petitioner exercised his

nonstatutory stock options.

     Petitioner next alleges the proper date of transfer for

determination of tax is January 18, 2000, instead of September 7

and December 30, 1999.   Petitioner argues his rights to the

shares of InsWeb common stock he acquired through exercising his

nonstatutory stock options were nontransferable and subject to a

substantial risk of forfeiture under section 1.83-3(c), Income

Tax Regs., because of the restrictive legend on the stock

certificates.   In his brief, petitioner relies on Robinson v.

Commissioner, 805 F.2d 38 (1st Cir. 1986), revg. 82 T.C. 444

(1984).

     In Robinson v. Commissioner, supra at 40-41, the Court of

Appeals for the First Circuit held that a taxpayer’s shares of

stock were subject to a substantial risk of forfeiture until a

1-year sellback provision lapsed.   The employer in Robinson could

have compelled its employee to sell the shares of stock back to

it at the price the employee paid at the time he exercised his
                              - 11 -

stock option if the employee had attempted to sell the shares of

stock within a year of exercising his stock option.

     Robinson is distinguishable from the instant case on its

facts.   Petitioner was not subject to a sellback provision that

required him to return the shares of stock to InsWeb in the event

he attempted to sell the stock before January 18, 2000.

     For a taxpayer to be allowed to defer recognition of income,

section 83(a) requires that shares of stock be both

nontransferable and subject to a substantial risk of forfeiture.

Petitioner was not prohibited from pledging his shares of InsWeb

common stock as collateral.   This may be taken as an indicium

that petitioner’s shares of InsWeb common stock, upon receipt,

were transferable within the meaning of section 1.83-3(d), Income

Tax Regs.   See Tanner v. Commissioner, 117 T.C. 237, 242 (2001),

affd. 65 Fed. Appx. 508 (5th Cir. 2003).

     Caselaw establishes that a restriction on the

transferability of property does not affect the timing of income

inclusion or the amount of income required to be included under

section 83 if the property is not subject to a substantial risk

of forfeiture.   See Pledger v. Commissioner, 71 T.C. 618 (1979),

affd. 641 F.2d 287 (5th Cir. 1981); Sakol v. Commissioner, 67

T.C. 986 (1977), affd. 574 F.2d 694 (2d Cir. 1978); Koss v.

Commissioner, T.C. Memo. 1989-330, affd. without published

opinion 908 F.2d 962 (3d Cir. 1990).
                              - 12 -

     A taxpayer’s right to his shares of stock may be subject to

a substantial risk of forfeiture if his right to full enjoyment

of the shares of stock is conditioned upon the future performance

of substantial services.   Sec. 83(c)(1).    The record is devoid of

any facts showing that petitioner’s right to full enjoyment of

his shares of InsWeb common stock was conditioned upon the future

performance of substantial services.

     Petitioner also alleges a substantial risk of forfeiture

existed because he was prohibited from transferring his shares as

their fair market value declined.    Section 1.83-3(c)(1), Income

Tax Regs., however, specifically provides that the risk that the

value of property will decline during a certain period does not

constitute a substantial risk of forfeiture.

     The Court of Appeals for the Ninth Circuit, citing section

1.83-3(c)(1), Income Tax Regs., has noted:     “The risk of

forfeiture analysis requires a court to determine the chances the

employee will lose his rights in property transferred by his

employer.”   Theophilos v. Commissioner, 85 F.3d 440, 447 n.18

(9th Cir. 1996), revg. on another issue T.C. Memo. 1994-45.

     Although petitioner was restricted from transferring his

shares of stock until after January 18, 2000, the evidence shows

that petitioner had no substantial risk of losing the rights to

his shares of InsWeb common stock.     There is no evidence that

InsWeb could have compelled him to return his shares of stock; no
                              - 13 -

sellback provision is present; nor is there any evidence that

InsWeb could have compelled petitioner to forfeit his shares of

stock.3

     Finally, petitioner alleges that his inability to sell his

shares of InsWeb common stock as their fair market value declined

resulted in his beneficial interests in the shares having been

“constructively forfeited” under section 1.83-1(e), Income Tax

Regs.

     Section 1.83-1(e), Income Tax Regs., provides:

     If a person is taxable under section 83(a) when the
     property transferred becomes substantially vested and
     thereafter the person’s beneficial interest in such
     property is nevertheless forfeited pursuant to a lapse
     restriction, any loss incurred by such person * * *
     upon such forfeiture shall be an ordinary loss to the
     extent the basis in such property has been increased as
     a result of the recognition of income by such person
     under section 83(a) with respect to such property.

Section 1.83-1(e), Income Tax Regs., is not applicable to

petitioner’s case.   There is no evidence of forfeiture pursuant

to a lapse restriction, nor was petitioner’s right to the shares


        3
        Under sec. 83(c)(3), if a taxpayer selling his shares of
stock at a profit could be subject to a suit under the Securities
Exchange Act of 1934, ch. 404, sec. 16(b), 48 Stat. 896 (current
version at 15 U.S.C. sec. 78p(b)(2000)), “such person’s rights in
such property are (A) subject to a substantial risk of
forfeiture, and (B) not transferable.” Sec. 83(c)(3) does not
apply beyond the initial 6-month period provided in sec. 16(b) of
the Securities Exchange Act of 1934. Tanner v. Commissioner, 117
T.C. 237, 245-256 (2001), affd. 65 Fed. Appx. 508 (5th Cir.
2003).
     Petitioner does not claim that he would have been subject to
liability under sec. 16(b) of the Securities Exchange Act of 1934
upon sale of his shares of InsWeb common stock at a profit.
                              - 14 -

of InsWeb common stock subject to a substantial risk of

forfeiture.   Petitioner’s shares of stock were not forfeited but

were sold to pay Comerica when he filed for bankruptcy.

     In consequence of the foregoing, we hold petitioner received

gross income from the exercise of his nonstatutory stock options

in 1999.

     In reaching our holdings herein, we have considered all

arguments made, and to the extent not mentioned above, we

conclude that they are moot, irrelevant, or without merit.

     To reflect the foregoing,




                                               An appropriate order

                                       and decision will be entered.
