LoBue v. Commissioner
351 U.S. 243 (1956)

  • LoBue received options to buy his employer's stock $5 a share.
    • A few years later, LoBue exercised his options to buy 340 shares. It cost him $1700 to buy the shares, and at the time he bought them 340 shares were selling for $9900 on the open market.
  • When he filed his taxes LoBue did not report any of the stock as income. The IRS disagreed and assessed a deficiency.
    • The IRS argued that the full $9900 was compensation for services rendered and so was a classic example of gross income under the tax code (then 26 U.S.C. 22(a), now 61(a)).
    • The IRS also argued that LoBue should be taxed on the amount he gained when the options were exercised ($9900 - $1700 = $8200) as ordinary income on the date he exercised the options.
    • LoBue argued that where a company gives options to an employee in order to elicit the employee's loyalty, that this was a "proprietary interest" that should not be considered compensation.
      • Basically, LoBue was arguing that the company wanted LoBue to have an interest in how well the company did, so they gave him the ability to buy some stock and become a co-owner.
    • LoBue also argued that even if the money was taxable, then he should be taxed on the value of the options when they were received ($1700) as ordinary income, and that the rest (the $8200) should only be taxed as long-term capital gain.
  • The Tax Court found for LoBue. The IRS appealed.
    • The Tax Court found that the stock options had been provided to give LoBue "a proprietary interest in the corporation, and not as compensation for services."
  • The Appellate Court affirmed. The IRS appealed.
  • The US Supreme Court reversed.
    • The US Supreme Court found that all income is taxable unless there is a specific exemption.
    • The Court noted that the only possible exemption this could fit under was gift, but it wasn't a gift. Since there was no other exemption it might fit under, it must be compensation and therefore taxable as ordinary income.
      • "Since the employer's transfer of stock to its employee LoBue for much less than the stock's value was not a gift, it seems impossible to say that it was not compensation."
    • The Court found that compensation is received at the earliest possible time when the fair market value of the compensation can be known.
      • Therefore, the taxable gain to LoBue should be measured as of the time the options were exercised, and not the time they were granted. So the entire $8200 was ordinary income.