C. A. 9th Cir. Reported below: 644 F.2d 1282.
JUSTICE POWELL, dissenting.
In the decision below, "fair market value" of a share of stock for minimum-tax purposes was determined solely by reference to the New York Stock Exchange (NYSE) price at the time of purchase even though § 16(b) of the Securities Exchange Act of 1934, 48 Stat. 896, 15 U. S. C. § 78p(b), effectively prohibited the taxpayer's sale of the security for six months thereafter. The case presents an important question of fairness to taxpayers, who, under this ruling, must recognize a "gain" that does not yet exist and may never materialize. Because the decision below is not supported by either the statutory language or its legislative history and because it tends to frustrate the congressional policy favoring employee stock ownership, I would grant certiorari and set the case for argument.
In 1968, 1970, and 1971, petitioner Aaron L. Kolom received options to acquire stock in Tool Research and Engineering Corp. (TRE) pursuant to a plan that qualified under § 421 and § 422 of the Internal Revenue Code of 1954 (IRC), as amended, 26 U. S. C. § 421 and § 422. Kolom exercised the options in September and October 1972 when he was an officer and director of TRE. He bought a total of 12,427 shares in three blocks at an average of 13 1/4, 12, and 19 5/8, per share. On the dates of exercise, the mean prices of the stock on the NYSE were, respectively, 52, 45 1/4, and 45 1/4.
Because Kolom was a TRE director, he was not free to take this "gain." Under § 16(b) of the Securities Exchange Act, 15 U. S. C. § 78p(b), Kolom would have been liable to the company for any profits realized from the sale of these shares during the 6-month period following exercise of his option.
And by the time Kolom was able to sell, the situation had altered dramatically. Six months after the date of exercise of the first block, the NYSE price dropped over 50% to 23 5/8. Six months after the date of exercise of the other two blocks, the NYSE price also dropped over 50% to 20 7/8. Kolom eventually sold 5,000 of the shares for an average price of $9.27 per share, realizing a substantial loss on the transaction.
Under the IRC provisions in effect at that time, the exercise of the options did not result in any recognized compensation for purposes of calculating income because the TRE Employee Stock Option Plan (Plan) qualified under § 421 and § 422. Tax on stock transferred under a qualified plan is deferred until the stock is sold, and any gain is then taxed at capital-gains rates provided certain other requirements are met.
Stock received pursuant to a qualified plan can, however, result in tax liability under the minimum-tax provisions. Title 26 U. S. C. § 56 and § 57 (1976 ed. and Supp. III) impose a tax on certain "preference" items, including stock received under plans that qualify under § 421 and § 422. The Commissioner audited Kolom's 1972 return and assessed a deficiency on the ground that, for purposes of calculating his minimum tax, Kolom should have included as a "preference" item the difference between the option price and the NYSE price at the time each option was exercised. The Commissioner argued that Kolom should have included his "gain" of $424,888 as a preference item even though Kolom could not have realized the gain and even though the gain evaporated in the course of the six months following exercise of the option. This fictional gain resulted in a deficiency assessment of $43,792. The Tax Court affirmed the Commissioner, as did the Court of Appeals for the Ninth Circuit.
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