Compliance December 1, 2004

Court: Microsoft Employee who Exercised Options Not Entitled to Tax Refund

December 1, 2004 (PLANSPONSOR.com) - A federal district court has ruled that an employee who exercised his stock options by placing them in a margin account and then pledging them as collateral for the loan is not eligible for a refund on the taxes paid for the options.

Reported by

Kip McDaniel

>In granting a summary judgment for the government in the case, US District Court Judge Jeffrey White of the US District Court for the District of Northern California rejected Miller’s claim that the options were not taxable in 2000 because no taxable event occurred when the options were exercised.

>Microsoft employee Kent Miller was granted stock options to acquire company stock which could be exercised through a program that allowed him to post the options as collateral for the loan needed to purchase them. Under the program, employees who opted to exercise the options were required to purchase the shares at the strike price and withhold taxes on the date that they chose to exercise the options.

>Miller exercised the options in 2000 through a loan from Paine Webber worth over $900,000. The shares were subsequently held in a margin account and pledged as collateral, as per the company program. After exercising the shares, they declined in value and were liquidated in expectation of the Paine Webber margin calls.

>Miller reported the options on his 2000 tax filing, and in 2003 he filed two amended tax returns requesting refunds of $229,387 and $221,770. The Internal Revenue Service (IRS) denied the claim, and Miller filed suit in federal court.

>Citing Section 83(a) of the Tax Code, White ruled that the options were taxable when exercised because property is taxable if it is transferred in connection with performance on services. Since the options had been substantially vested in the taxpayer, and Miller could receive dividends from the shares, White rejected his claim.

>White also rejected the plaintiff’s claim that the structure of the Paine Webber loan was essentially a “stop loss agreement”, which would result in Miller being not at risk regarding the options and therefore not personally liable. He shares were also transferable when Miller exercised them, showing that they were substantially vested, White ruled.

>The case is Miller v. United States, N.D. Cal., No. C 04-00511.