Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca4-08-02054/USCOURTS-ca4-08-02054-0/pdf.json

Parties Involved:
Marie T. Bergbauer
Appellant
Robert L. Bergbauer
Appellant
United States of America
Appellee

Document Text:

PUBLISHED

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

UNITED STATES OF AMERICA, 

Plaintiff-Appellee,

v.  No. 08-2054

ROBERT L. BERGBAUER; MARIE T.

BERGBAUER,

Defendants-Appellants. 

Appeal from the United States District Court

for the District of Maryland, at Baltimore.

Richard D. Bennett, District Judge.

(1:05-cv-02132-RDB)

Argued: January 28, 2010

Decided: April 16, 2010

Before MOTZ, SHEDD, and AGEE, Circuit Judges.

Affirmed by published opinion. Judge Agee wrote the opinion, in which Judge Motz and Judge Shedd joined.

COUNSEL

ARGUED: Julian Spirer, Bethesda, Maryland, for Appellants.

Francesca Ugolini Tamami, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee. ON

BRIEF: Mark L. Rosenberg, Bethesda, Maryland, for AppelAppeal: 08-2054 Doc: 40 Filed: 04/16/2010 Pg: 1 of 21
lants. John A. DiCicco, Acting Assistant Attorney General,

Kenneth L. Greene, Tax Division, UNITED STATES

DEPARTMENT OF JUSTICE, Washington, D.C.; Rod J.

Rosenstein, United States Attorney, Baltimore, Maryland, for

Appellee.

OPINION

AGEE, Circuit Judge:

Robert and Marie Bergbauer appeal from the grant of summary judgment to the Government establishing their federal

income tax liability. The district court held that Robert Bergbauer’s sale of his interest in a subsidiary of Ernst & Young

LLP ("Ernst & Young") was a fully taxable event in the year

2000. For the reasons set forth below, we affirm the judgment

of the district court. 

I.

A.

In 1999, Ernst & Young LLP ("Ernst & Young") entered

into a letter of intent to sell its consulting business to Cap

Gemini, S.A. ("Cap Gemini"). The parties agreed that Ernst

& Young would transfer the assets of the consulting division

of its business to a newly-formed subsidiary, Cap Gemini

Ernst & Young US LLC ("CGE&Y"), and thereafter distribute membership interests in CGE&Y primarily to those partners in Ernst & Young, like Robert Bergbauer, who worked

in the consulting division ("the consulting partners"). Immediately following the distribution, Ernst & Young and the consulting partners would sell their CGE&Y membership

interests to Cap Gemini in exchange for Cap Gemini common

stock. As a result, Cap Gemini would own all the equity inter2 UNITED STATES v. BERGBAUER

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ests of CGE&Y and operate the former Ernst & Young consulting practice through that entity.1

Ernst & Young distributed a Partner Information Document

("PID") to the consulting partners which described the proposed transaction.2

 The PID indicated that the exchange of

CGE&Y membership interests for Cap Gemini stock would

be structured as a "taxable capital gains transaction," in which

the "partners are treated as though they receive all of the gain

and are taxed on it." J.A. 285. The PID also provided that

"[a]ll partners will vest in their shares immediately upon closing. However, the shares . . . will be subject to forfeiture"

under certain circumstances. J.A. 280. The Cap Gemini shares

received would not be directly distributed to the consulting

partners, but would "be held in an individual account in an

institution such as . . . Merrill Lynch and [would] be subject

to resale restrictions." J.A. 278. 

Twenty-five percent of each consulting partner’s Cap Gemini shares would be released for sale shortly after the transaction closed, so the consulting partner could cover the 2000 tax

liability incurred as a result of recognizing the receipt of all

the Cap Gemini stock as income that year. The remaining

seventy-five percent of a partner’s shares would be held in a

restricted brokerage account for that partner and could be

"monetized," that is sold, in installments of up to fifteen percent of the partners’ shares on each of the next five anniversary dates of the sale. A consulting partner could not "directly

or indirectly, sell, assign, transfer, pledge, [or] grant any

option with respect to or otherwise dispose of any interest" in

non-monetized shares. J.A. 785. While non-monetized shares

1The consulting partners would then sever their relationship with Ernst

& Young by divesting their partnership interests in Ernst & Young, cashing out their capital accounts, and becoming employees of CGE&Y. 

2The PID was not a contract document to be executed by the parties, but

an informational document somewhat akin to a prospectus for security

investments. 

UNITED STATES v. BERGBAUER 3

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were held in the restricted brokerage accounts, those shares

were subject to forfeiture "for breach of [partners’] individual

Cap Gemini agreements, early departures or termination for

cause." J.A. 280. Upon monetization all restrictions on those

shares lapsed. 

Of particular import for the timing-of-income issue in the

case at bar, the PID stated:

The fair market value of the stock received that

cannot be sold immediately will be calculated at 95

percent of the closing price of Cap Gemini stock on

the day of the exchange for [CGE&Y] shares. This

discount will slightly reduce tax due on the Cap

Gemini shares received at closing. . . . Ernst &

Young, its partners, and Cap Gemini will treat valuation and related issues consistently for [U.S.] federal

income tax purposes. . . .

For all . . . partners . . . [t]he gain on the sale of

the distributed [CGE&Y] shares is reportable on

Schedule D of your U.S. federal income tax return

for 2000.

J.A. 285-86.

The consulting partners, including Robert Bergbauer, had

the opportunity to review the PID before they met on March

7-8, 2000 to discuss and vote on the proposed transaction.

During its presentation of the proposed transaction, Ernst &

Young’s management answered questions regarding the tax

implications of the receipt of Cap Gemini stock, particularly

the decision to structure the sale "as a taxable transaction on

day one" in contrast to "creeping vesting" or "structured vesting." J.A. 495, 500, 501. It was widely anticipated among the

parties that the value of Cap Gemini stock would substantially

appreciate after closing. Management explained that in order

to obtain long-term capital gains treatment on future sales of

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Cap Gemini stock, the consulting partners must recognize the

value of all the shares as taxable income in 2000, thereby setting the shares’ cost basis (Internal Revenue Code ("I.R.C.")

§ 1012) and the required capital gains holding period (I.R.C.

§ 1223).3 Ultimately, ninety-five percent of the consulting

partners, including Robert Bergbauer, voted to approve the

transaction.

After the consulting partners’ vote of approval, Ernst &

Young distributed the necessary contract documents to consummate the transaction. These documents included, inter

alia, the Consulting Partner Transaction Agreement

("CPTA"), the Master Agreement, and a brokerage agreement

as to the non-monetized shares (collectively "the transaction

documents"). 

In executing the CPTA, the consulting partners warranted

their receipt of Cap Gemini shares would "be a taxable transaction for U.S. federal income tax purposes," but the specific

timing language about the year 2000 was not included as it

was in the PID. J.A. 782. Certain provisions of the Master

Agreement (1) reflected that the Cap Gemini shares "not monetized in the Initial Offering [would] be valued for tax purposes at 95% of the otherwise-applicable market price," J.A.

1047, (2) instructed the parties to treat the transaction as a sale

and not to take a contrary position in any tax return without

the written consent of Cap Gemini, and (3) stated that neither

Cap Gemini nor its affiliates were the legal or beneficial

owner of the shares received by the consulting partners. 

The CPTA also contained a liquidated damages clause,

which provided that consulting partners could be terminated

for cause, voluntarily leaving CGE&Y, or breaching the noncompete or confidentiality provisions of their Cap Gemini

employment agreements, and be required to forfeit some or all

3

Internal Revenue Code sections directly correspond to those found in

Title 26 of the United States Code. 

UNITED STATES v. BERGBAUER 5

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of their non-monetized shares. The percentage of Cap Gemini

stock subject to forfeiture depended upon the triggering forfeiture event.4

B.

Robert Bergbauer executed the required transaction documents on May 1, 2000, and received, in exchange for his

CGE&Y membership interest, 10,740 shares of Cap Gemini

stock subject to the limitations and restrictions noted above.5

The Bergbauers timely filed their year 2000 federal income

tax return consistent with the PID and transaction documents.

On Schedule D of their 2000 return, the Bergbauers reported

the value of all the Cap Gemini shares as taxable income.

Twenty-five percent of the shares were valued at the full closing price of $155.30 and the remaining seventy-five percent

at ninety-five percent of that value, $148.52.6

On each successive anniversary date of the closing,

2,013.75 shares were monetized, that is released, from the

restricted brokerage account and made available to Bergbauer

for sale. While the non-monetized shares were held in the

4

If an event occurred triggering the forfeiture provision, partners could

lose: (a) 100% of their stock before December 31, 2000; (b) 75% of their

stock before the first anniversary of the closing; (c) 56.7% of their stock

on or after the first anniversary of the closing and before the second anniversary of the closing; (d) 38.4% of their stock on or after the second anniversary of the closing and before the third anniversary of the closing; (e)

20% of their stock on or after the third anniversary of the closing and

before the fourth anniversary of the closing; and (f) 10% on or after the

fourth anniversary of the closing and prior to the end of the 4-year, 300-

day restricted period. If a consulting partner was terminated for "poor performance," up to fifty percent of the prescribed percentage could be forfeited at the discretion of CGE&Y. J.A. 787. 

5Shortly after the closing, Robert Bergbauer sold twenty-five percent of

his Cap Gemini stock and the proceeds were distributed to him. 

6The Bergbauers’ 2000 return reported total capital gain income of

$1,515,814, total taxable income of $2,473,832, and a federal income tax

liability of $676,493. 

6 UNITED STATES v. BERGBAUER

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restricted brokerage account, Bergbauer received the dividend

income attributable to those shares.

In December 2002, CGE&Y terminated Robert Bergbauer’s employment as part of a reduction in force following

the "dot com bubble burst." J.A. 81. Bergbauer, however, did

not forfeit any of his Cap Gemini shares and received a cash

severance payment. He later found employment at KPMG

where he became a full equity partner.

By 2003, in contrast to the consulting partners’ expectations, the Cap Gemini share price had dropped precipitously.7

Bergbauer and other former Ernst & Young colleagues discussed the prospect of filing amended year 2000 tax returns

based on "what had happened to the value of the Cap [Gemini] stock." J.A. 92. 

The Bergbauers filed an amended year 2000 federal income

tax return in 2003, taking the position that only the twentyfive percent of Cap Gemini shares, those which were monetized and then sold in 2000, were taxable income for that year.

Citing the "lack of control over the remaining Seventy-Five

(75%) of the stock in the trust," the Bergbauers contended

those shares were not taxable in 2000 because Robert Bergbauer "did not receive the stock," but should have been recognized as income only in the years of monetization and valued

at the much lower market rates. J.A. 914. The amended return

correspondingly reduced the amount of 2000 taxable income,

resulting in a claim for a refund of $253,490 plus accrued

interest. 

7The drop in share price was reflected by Bergbauer’s sale of his monetized Cap Gemini shares: (1) 555 shares at $76.77 in April 2002, netting

proceeds of $42,607.06; (2) 4,278 shares at $33.09 in May 2003, netting

proceeds of $141,569.00; (3) 2,148 shares at $46.45 in September 2003,

netting proceeds of $99,792.51; and (4) 1,074 shares at $24.68 in October

2004, netting proceeds of $26,505.67. 

UNITED STATES v. BERGBAUER 7

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The Internal Revenue Service ("IRS") reviewed the

amended return and agreed to abate the Bergbauers’ year

2000 tax liability by the requested $253,490. The IRS applied

$100,000 as a credit to the Bergbauers’ 2001 tax liability and

cut a check to them for the remainder plus accrued interest.

Upon further examination, the IRS later determined that the

abatement and refund had been made in error. As a result, a

civil action was brought against the Bergbauers under I.R.C.

§ 7405, seeking payment to the Government of the erroneous

tax refund. After the parties conducted discovery, the Government filed a motion for summary judgment contending the

undisputed facts proved the value of all the Cap Gemini stock

was taxable income in 2000 and the tax refund was in error.

The Bergbauers responded with a cross-motion for summary

judgment, arguing the abatement and refund were not erroneous because only twenty-five percent of the stock was taxable

income in 2000.8

The district court observed that, when determining the tax

treatment of a transaction, the Fourth Circuit "applies a twopronged test which examines (1) the intent of the parties; and

(2) the economic substance of the transaction," United States

v. Bergbauer, No. 05-2132, 2008 WL 3906784, at *8 (D. Md.

Aug. 18, 2008) (citing Gen. Ins. Agency, Inc. v. Comm’r, 401

F.2d 324, 327 (4th Cir. 1968)), commonly termed the "economic reality" test. The court determined that the intent prong

of the economic reality test showed an intent to recognize the

value of all the Cap Gemini stock as taxable income in 2000.

Id. at *10. The district court also concluded that the parties

8The district court initially postponed a decision until other district

courts considering the same question concerning former Ernst & Young

consulting partners had an opportunity to rule. See United States v. Bergbauer, No. 05-2132, 2008 WL 3906784, at *4 (D. Md. Aug. 18, 2008). To

date, there are more than 200 cases pending in the lower courts or administratively with the IRS in which former Ernst & Young consulting partners have sought to defer their recognition of income from the sale of their

CGE&Y interests to Cap Gemini in 2000. 

8 UNITED STATES v. BERGBAUER

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bargained at arms-length for, and received, real economic

benefit from treating all the Cap Gemini stock as received for

income tax purposes in 2000. Id. Accordingly, the district

court awarded summary judgment to the Government and

denied the Bergbauers’ motion. Id. at *11.

The Bergbauers noted a timely appeal, and we have jurisdiction pursuant to 28 U.S.C. § 1291. 

II.

We review an award of summary judgment de novo. Desmond v. PNGI Charles Town Gaming, L.L.C., 564 F.3d 688,

691 (4th Cir. 2009). Summary judgment is appropriate only

"if the pleadings, the discovery and disclosure materials on

file, and any affidavits show that there is no genuine issue as

to any material fact and that the movant is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(c)(2); Erwin v.

United States, 591 F.3d 313, 327 (4th Cir. 2010). Because the

Bergbauers’ claims were rejected on summary judgment, we

view the factual evidence in the light most favorable to them.

See Walker v. Prince George’s County, 575 F.3d 426, 427

(4th Cir. 2009) (citing Anderson v. Liberty Lobby, Inc., 477

U.S. 242, 255 (1986)). 

III.

This case presents the issue of the timing of the receipt of

income: Were the Bergbauers the taxable recipients of all the

Cap Gemini shares in 2000 or only the twenty-five percent

monetized and available for sale? The Bergbauers do not contest the valuation of the shares, the adequacy of consideration,

or challenge the validity of the transaction. They simply contend that the 8,055 non-monetized Cap Gemini shares were

not "received," for income tax purposes, in 2000 and therefore

should not be "recognized" as income in that year. Citing

I.R.C. § 451(a), the Bergbauers argue that cash method taxpayers, like them, should report income in the tax year in

UNITED STATES v. BERGBAUER 9

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which they actually or constructively receive it. See I.R.C.

§ 451(a) ("The amount of any item of gross income shall be

included in the gross income for the taxable year in which

received by the taxpayer . . . ."). 

The Bergbauers posit that Robert was not in actual receipt

of the non-monetized shares in 2000 because those shares

were held in a restricted account and subject to transfer prohibitions. Citing the regulations under § 451 in 26 C.F.R.

§ 1.451-2(a), the Bergbauers also argue there was no "constructive receipt" of the non-monetized shares in 2000

because of both the restrictions on transfer and the risk of forfeiture.9

 Br. of Appellant at 20. As further support, the Bergbauers reference I.R.C. § 83(a)(2), which they claim sets the

timing of recognition of income as "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." Br. of Appellant at 28. 

Thus, if Robert Bergbauer did not "receive" the nonmonetized shares in 2000, the Bergbauers argue they were not

required to recognize and report the value of those shares as

taxable income that year. Br. of Appellant at 23. Instead, the

Bergbauers contend that the non-monetized shares were

received, for income tax purposes, seriatim in each year after

2000 when the forfeiture restrictions lapsed and the shares

were released and available for transfer. Br. of Appellant at

14-15. The Bergbauers conclude that their intention, and that

of the other parties, that the "shares be deemed to have been

9

26 C.F.R. § 1.451-2(a) provides in relevant part: 

Income although not actually reduced to a taxpayer’s possession

is constructively received by him in the taxable year during

which it is credited to his account, set apart for him, or otherwise

made available so that he may draw upon it at any time, . . . .

However, income is not constructively received if the taxpayer’s

control of its receipt is subject to substantial limitations or restrictions. . . . 

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received sooner for tax purposes could not hasten the taxability of the shares" because § 451 or § 83 foreclose that result.

Br. of Appellant at 23. 

The Government responds by citing the unanimous decisions from courts in other circuits addressing the claims of

similarly situated former Ernst & Young consulting partners,

all of which have determined that the value of all the Cap

Gemini shares was fully taxable in 2000. See, e.g., United

States v. Fletcher, 562 F.3d 839 (7th Cir. 2009). Recognizing

that decisions from outside this Circuit use different standards

in evaluating the recharacterization of a taxable transaction,

the Government also argues the district court correctly applied

our Court’s economic reality test and that the Bergbauers’

statutory argument is misplaced. Br. of Appellee at 26-27. 

We note that the Bergbauers do not contend the economic

reality test is invalid. Instead, the bottom line of their position

is that the provisions of § 451 and § 83 supersede any application of that test and mandate their proposed tax treatment of

the Cap Gemini stock. We disagree and find the district court

properly applied our precedent and committed no error in

awarding summary judgment to the Government.

In Commissioner v. National Alfalfa Dehydrating and Milling Co., 417 U.S. 134 (1974), the Supreme Court stated:

[W]hile a taxpayer is free to organize his affairs as

he chooses, nevertheless, once having done so, he

must accept the tax consequences of his choice

whether contemplated or not, and may not enjoy the

benefit of some other route he might have chosen to

follow but did not.

417 U.S. at 149 (internal citations omitted); Signet Banking

Corp. v. Comm’r, 118 F.3d 239, 241 (4th Cir. 1997) (same);

see also Frank Lyon Co. v. United States, 435 U.S. 561,

583-84 (1978) (holding that "the Government should honor

UNITED STATES v. BERGBAUER 11

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the allocation of rights and duties effectuated by the parties"

when "there is a genuine multiple-party transaction with economic substance . . . compelled or encouraged by business or

regulatory realities, . . . imbued with tax-independent considerations, and . . . not shaped solely by tax-avoidance features

that have meaningless labels attached"); id. at 584

("Expressed another way, . . . the form of the transaction

adopted by the parties governs for tax purposes."); accord

Gray v. Powell, 314 U.S. 402, 414 (1941) ("The choice of disregarding a deliberately chosen arrangement for conducting

business affairs does not lie with the creator of the plan."). 

In embracing National Alfalfa’s principle, "courts have

established very strict standards," Furman v. United States,

602 F. Supp. 444, 456 (D.S.C. 1984), for a taxpayer who

elects "a specific course of action and then when finding himself in an adverse situation [seeks to] extricate himself by

applying the age-old theory of substance over form." Cornelius v. Comm’r, 494 F.2d 465, 471 (5th Cir. 1974) (quotation

omitted). We have recognized that "[g]enerally, taxpayers are

liable for the tax consequences of the transaction they actually

execute and may not reap the benefit of recasting the transaction into another one substantially different in economic effect

that they might have made." Estate of Leavitt v. Comm’r, 875

F.2d 420, 423 (4th Cir. 1989); see also Signet, 118 F.3d at

242 ("[T]he bank simply cannot structure the terms of the

cardholder agreement to its advantage and then rely on an

indeterminate question of Virginia law to evade the federal

tax implications thereof."); Snowa v. Comm’r, 123 F.3d 190,

198 n.11 (4th Cir. 1997) (observing that § 1034(g) of the

Internal Revenue Code "provide[d] a legislative exception to

the general rule that a taxpayer cannot recharacterize a transaction to avoid the tax consequences of the form of the transaction actually chosen"). 

To put it plainly, we have bound taxpayers to "the ‘form’

of their transaction" when they attempt to recharacterize an

otherwise valid agreement bargained for in good faith. Estate

12 UNITED STATES v. BERGBAUER

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of Leavitt, 875 F.2d at 423. We have also refused to entertain

arguments "that the ‘substance’ of their transaction triggers

different tax consequences." Id. This precept not only maintains the vital public policy of enforcing otherwise valid contracts, but also assures the reliability of agreed tax

consequences to the public fisc. 

"[A]llowing the government to adopt as conclusive a result

agreed to by the parties . . . provide[s] a more efficient system

that . . . greatly reduce[s] the possibility of litigation . . .

aimed at revising the parties’ bargained agreement." Sullivan

v. United States, 618 F.2d 1001, 1004 (3d Cir. 1980); see also

Furman, 602 F. Supp. at 455 ("To allow a taxpayer to unilaterally reform one end of a bargain could encourage taxpayers

to ignore agreements as written in the hope that the courts will

give them more advantageous tax treatment."). To do otherwise would allow situations to be created where the alteration

of tax benefits, as a result of inconsistent reporting, "whipsaws" the Government and results in disastrous and unfair

effects on our tax system. Sullivan, 618 F.2d at 1004 (recounting the previous practice of parties "advocat[ing] mutually

conflicting tax characterizations of their agreement[s]," which

"frequently" would compel the Commissioner "to assess

inconsistent deficiencies" and to pursue litigation against both

parties "in separate suit[s]," wherein the Commissioner was

forced to take "divergent positions so as to avoid two adverse

judgments"). 

There is no "disparity" in allowing "the Commissioner

alone to pierce formal" agreements as "taxpayers have it

within their own control to choose in the first place whatever

arrangements they care to make." Comm’r v. Danielson, 378

F.2d 771, 775 (3d Cir. 1967) (en banc). The Government’s

interest lies "in having the transaction reported consistently

by" the parties to the sale. Throndson v. Comm’r, 457 F.2d

1022, 1024 n.2 (9th Cir. 1972). In this case, the Government

never challenged the Bergbauers’ recognition of the value of

all 10,740 Cap Gemini shares as taxable income in 2000. All

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the other parties to the transaction, including Cap Gemini,

reported the stock transfer consistent with the Bergabuers’

treatment on the 2000 return and the Commissioner has not

challenged those actions.

With the foregoing in mind, our Circuit has applied a twopronged "economic reality" test when reviewing a taxpayer’s

attempt to recharacterize the tax consequences of a transaction.10

Gen. Ins. Agency, Inc., 401 F.2d at 329-30; see also Volvo

Cars of N. Am., LLC v. United States, 571 F.3d 373, 379 (4th

10Other circuits have fashioned their own standards for determining

whether a taxpayer may challenge his prior treatment of the tax consequences of a transaction. As these standards do not apply in the Fourth

Circuit, we mention them only for informational purposes. Two such standards are the Danielson rule and the "strong proof" rule. In Commissioner

v. Danielson, 378 F.2d 771 (3d Cir. 1967) (en banc), the Third Circuit held

that a taxpayer could recharacterize the terms of a transaction only if those

terms were unenforceable due to "mistake, undue influence, fraud, [or]

duress, etc." Danielson, 378 F.2d at 775; see also Bradley v. United States,

730 F.2d 718, 720 (11th Cir. 1984) ("A party can challenge the tax consequences of his agreement as construed by the Commissioner only by

adducing proof which in an action between the parties would be admissible to alter that construction or to show its unenforceability because of

mistake, undue influence, fraud, duress, et cetera.") (quotations omitted)

(emphasis in original); Smith v. Comm’r, 65 F.3d 37, 40 (5th Cir. 1995)

("[A] taxpayer may argue substance over form when necessary to prevent

unjust results, and when proof is offered which in an action between the

parties would be admissible to alter that construction or to show its unenforceability because of mistake, undue influence, fraud, duress, etc.")

(quotations and internal citation omitted). 

The "strong proof" rule requires a party to adduce "strong proof" that

the parties intended an allocation different than that included in the contract. See N. Am. Rayon Corp. v. Comm’r, 12 F.3d 583, 588 n.6 (6th Cir.

1993) ("The ‘strong proof’ rule requires a party seeking to disregard the

express price allocations in an agreement to adduce strong proof that the

parties actually intended to attribute different values than those stated in

the agreement."); Rogers’ Estate v. Comm’r, 445 F.2d 1020, 1021 (2d Cir.

1971) ("In this Circuit, the rule is, that when the parties to a transaction

. . . have specifically set out the covenants in the contract and have there

given them an assigned value, strong proof must be adduced by them in

order to overcome that declaration.") (quotation omitted). 

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Cir. 2009) ("[W]e have long held that the parties’ intent and

the relevant facts are critical in construing contracts for federal tax purposes."); Thomas v. Comm’r, 83 T.C.M. (CCH)

1576 (2002) (recognizing and applying the "economic reality"

test). The economic reality test examines (1) the intent of the

parties, and (2) the economic substance of the transaction.

The determination of the parties’ intent and the economic substance of the transaction are questions of fact, with the taxpayer bearing the burden of proof. Gen. Ins. Agency, Inc., 401

F.2d at 329. 

The district court concluded that the provisions in the transaction documents, particularly the CPTA and Master Agreement, "strongly demonstrate[d]" that it was the parties’

understanding that all Cap Gemini shares would be immediately taxable at the transaction’s closing. Bergbauer, 2008

WL 3906784, at *5. However, the court recognized that other

sections of the transaction documents, namely the forfeiture

and stock transfer restriction provisions, could be in conflict

with immediate taxation of the non-monetized shares. Id. at

*8-9. 

Without a definitive answer from the plain language of the

transaction documents, the district court turned its analysis to

the extrinsic evidence, particularly the PID, and found that

this evidence "shed[ ] light on the terms of the transaction

documents," and demonstrated that "the parties’ original

intent was for the [c]onsulting [p]artners to be immediately

taxed on the entirety of the shares they received at the transaction’s closing on May 23, 2000." Id. at *10.

We conclude that the district court did not clearly err in this

finding. Indeed, the Bergbauers conceded the intent prong of

the economic reality test on appeal, i.e., that the parties

intended the value of all the Cap Gemini shares exchanged for

the CGE&Y membership interests be fully taxed in 2000.

Even without such a concession, the district court’s determiUNITED STATES v. BERGBAUER 15

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nation of intent was strongly supported by the record evidence. 

Several provisions of the PID demonstrate that the parties

plainly intended for Robert Bergbauer to be immediately

taxed on all 10,740 Cap Gemini shares in 2000. Not only did

the PID provide that the transaction would be structured as a

"taxable capital gains transaction," J.A. 285, but it also stated

that "Ernst & Young, its partners, and Cap Gemini [would]

treat valuation and related issues consistently." J.A. 285-86.

But, most importantly, the PID unequivocally stated that "[a]ll

partners [would] vest in their shares immediately upon closing," J.A. 280, and "[t]he gain on the sale of the [CGE&Y

interests] [would be] reportable on Schedule D of [their] U.S.

federal income tax return for 2000." J.A. 286. 

Further, Arthur Gordon, Ernst & Young’s director of tax in

2000, testified that the consulting partners knew the intent of

the parties was to close the transaction so they would own all

the Cap Gemini shares outright that year, thus establishing a

cost basis and holding period for long-term capital gain treatment of future sales of the stock. As the district court

observed, "even if Robert Bergbauer did not immediately

appreciate the operative tax language contained within the

PID, after attending the March 7-8, 2000 meeting he was well

aware that all parties to the agreement" intended for the consulting partners to be "immediately taxed" on all their Cap

Gemini shares in 2000. Bergbauer, 2008 WL 3906784, at *9.

Finally, the Bergbauers’ initial 2000 tax return, wherein they

reported as income the value of all 10,740 Cap Gemini shares,

demonstrates that the Bergbauers understood the intention to

be taxed on the entirety of those shares in 2000. 

While the parties intended immediate taxation on all the

Cap Gemini shares in 2000, the "economic reality" test

requires that there be economic substance to that decision. See

Halle v. Comm’r, 83 F.3d 649, 655 (4th Cir. 1996) (explaining that "we must look beyond the parties’ terminology to the

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‘substance and economic realities’ of the [transaction],

gleaned from the totality of the circumstances surrounding the

transaction"). In other words, the "economic realities surrounding the transaction in this case [must] confirm" that the

parties’ agreement to treat the shares as immediately taxable

"accurately portrayed their intentions." Id.; see also Wrangler

Apparel Corp. v. United States, 931 F. Supp. 420, 426

(M.D.N.C. 1996) ("The second prong of the General Insurance test requires that the covenant bargained for have some

independent value grounded in economic reality."). 

All parties to the transaction, bargaining at arms-length,

had economic reasons to subject the entirety of the consulting

partners’ Cap Gemini stock to full and immediate taxation in

2000. For consulting partners, like Robert Bergbauer, immediate taxation in 2000 was the means to both start the holding

period for capital gains treatment under I.R.C. § 1223, and at

the same time establish a high cost basis under I.R.C. § 1012.

Both elements were key for Bergbauer and his colleagues to

achieve their goal of minimizing tax when they later disposed

of the Cap Gemini stock after its anticipated high rise in

value. 

Cap Gemini, on the other hand, sought to fix its cost basis

for the acquired assets in CGE&Y, and, in turn, its amortization deductions under I.R.C. § 197. This course of action also

enabled all of the parties to avoid future litigation over conflicting opinions of value if anything other than the agreed

value of the Cap Gemini stock was used for tax reporting purposes.

While the stock transfer restrictions and forfeiture provisions presented a potential risk to the consulting partners during the non-monetization period, these provisions were

mutually beneficial, in part, to all parties’ economic interests.

The forfeiture provision clearly benefitted Cap Gemini as a

retention mechanism to preserve the consulting partners’ client relationships, goodwill, and expertise. But other economic

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benefits accrued to Cap Gemini and the consulting partners as

well. As Arthur Gordon testified:

The purpose of the restricted account was to protect the value of the stock. In one moment of time we

doubled the number of issued and outstanding shares

of Capgemini, the public company. The feeling was

if everybody was allowed to go to the market at

once, the stock would plummet because you had too

many shares without enough buyers. So in order to

protect everybody’s value, the partners agreed that

they would voluntarily restrict their shares with the

consideration being that everybody else will restrict

their shares. . . .

. . . And it was an agreement that we would all

lose certain rights for the benefit of the whole and

for us individually. 

J.A. 431-32. Thus, it was in each consulting partner’s economic interest to agree to restrict every other consulting partner’s transfer and sale of shares. Flooding the market with

Cap Gemini shares would only depress the price of the stock,

thereby damaging every party’s economic interest in the

transaction.

We therefore conclude that the district court did not err in

its conclusion that the terms of the transaction contained

"some economic substance beyond the parties’ subjective

intent." Bergbauer, 2008 WL 3906784, at *10. The district

court properly determined that the second prong of the economic reality test was met because the terms of the transaction were grounded in "business reality such that reasonable

men, genuinely concerned with their economic future, might

bargain for such an agreement." Gen. Ins. Agency, Inc., 401

F.2d at 330. 

Thus, the value of all the Cap Gemini shares should have

been recognized as taxable income in 2000, as agreed to and

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reported by all parties, unless the Bergbauers’ statutory arguments mandate a different result. We conclude those arguments are without merit. 

The Bergbauers’ argument as to § 83 is readily rejected.

The restrictions under that statute on the recognition of

income for property not "transferable" or "subject to a substantial risk of forfeiture" applies only if the property is transferred "in connection with the performance of services."

I.R.C. § 83(a). The CGE&Y for Cap Gemini equity interest

exchange was clearly not related to the performance of services and the Bergbauers do not contend to the contrary.

Thus, the plain terms of § 83 verify that statute has no application to this case. 

The argument as to I.R.C. § 451 is similarly unavailing. If

Robert Bergbauer had received the Cap Gemini stock in the

absence of an agreement, but subject to the forfeiture and

restricted transfer provisions, his timing argument for the year

of income recognition might have more credence. Of course,

he did not receive the Cap Gemini stock in the abstract or in

a vacuum. Neither are the tax consequences to be adjudicated

in that context, but upon the totality of the circumstances. As

the legion of caselaw set forth above clearly illustrates, a taxpayer’s choice of tax treatment under a binding contract is not

an optional commitment. "[T]axpayers are liable for the tax

consequences of the transaction they actually execute and

may not reap the benefit of recasting the transaction into

another one substantially different in economic effect that

they might have made." Estate of Leavitt, 875 F.2d at 423. 

In this case, the parties bargained for mutually beneficial

tax consequences with the consulting partners receiving a

high basis for future capital gains treatment in exchange for

immediate taxation in 2000. At the same time, Cap Gemini

received a set amortization basis in exchange for foregoing

the opportunity (or risk) of a different basis if a structured

stock-distribution schedule were used. This allocation fixed

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the tax consequences for both parties and enabled the Government to receive the benefit of higher taxable income from the

consulting partners in 2000, offset over time by Cap Gemini’s

higher-based amortization deductions in later years, as well as

the potential reduced tax when the consulting partners sold

Cap Gemini stock at long-term capital gains rates. 

The Bergbauers point to no statute or caselaw which would

permit them to unilaterally change the agreed upon tax treatment of the transaction, years after the fact, because their

prior choices no longer serve their economic interests. Nothing in § 451 or any other provision of the Internal Revenue

Code permits a taxpayer to whipsaw the Government and the

other parties to the transaction by unilaterally altering the

agreed tax treatment, which has economic substance and

reflects his intent, after the fact when the winds of change

foment delayed seller’s remorse. The principle established in

National Alfalfa is as valid now as when pronounced nearly

four decades ago and settles the issue raised by the Bergbauers:

[W]hile a taxpayer is free to organize his affairs as

he chooses, nevertheless, once having done so, he

must accept the tax consequences of his choice,

whether contemplated or not, and may not enjoy the

benefit of some other route he might have chosen to

follow but did not.

417 U.S. at 149 (internal citations omitted); Signet Banking

Corp., 118 F.3d at 241 (same).

We therefore reject the Bergbauers’ contention that § 451

grants them the authority to rewrite the tax treatment of the

Cap Gemini stock which they agreed upon, and did, treat as

fully taxable income in 2000 and for which there were reasons

of bona fide economic substance. 

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IV.

As the record reflects, both prongs of the "economic reality" test have been satisfied and the district court did not err

in so finding. Accordingly, we affirm the district court’s grant

of summary judgment to the Government and the court’s

denial of summary judgment to the Bergbauers. 

AFFIRMED

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