1 Unless otherwise indicated, all section references are

to the Internal Revenue Code in effect for the taxable year in

issue. All Rule references are to the Tax Court Rules of

Practice and Procedure.

T.C. Memo. 1998-247

UNITED STATES TAX COURT

HERMAN E. AND SHERI L. VILLARROEL, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 12618-97. Filed July 6, 1998.

Herman E. Villarroel and Sheri L. Villarroel, pro se.

Matthew J. Fritz, for respondent. 

MEMORANDUM OPINION

DINAN, Special Trial Judge: This case was heard pursuant

to the provisions of section 7443A(b)(3) and Rules 180, 181, and

182.1
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Respondent determined a deficiency in petitioners' Federal

income tax for 1994 in the amount of $2,327.

The issues for decision are: (1) Whether petitioners are

required to include in their gross income any amount of a

distribution from a qualified stock bonus plan; (2) whether the

amount of the distribution which must be included in their gross

income, if any, is subject to the section 72(t) additional tax;

and (3) the amount and character of the gain that petitioners are

required to include in their gross income from the subsequent

sale of a portion of the distributed stock. 

Some of the facts have been stipulated and are so found. 

The stipulations of fact and attached exhibits are incorporated

herein by this reference. Petitioners resided in Terrace Park,

Ohio, on the date the petition was filed in this case. All

references to petitioner in the singular are to Sheri L.

Villarroel.

Petitioner worked as an employee of Oral B Laboratories

(Oral B), a subsidiary of the Gillette Company (Gillette), for at

least 5 years as of October 1994. By reason of her length of

employment, petitioner was eligible to participate in Gillette's

employee stock ownership plan (ESOP) when it was established in

1990. Gillette made automatic contributions to the ESOP on her

behalf. She was not permitted to make any contributions to the

ESOP on her own behalf. The contributions and the earnings on

the contributions were invested in a special class of Gillette
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2 Respondent allowed petitioners a withholding credit in

the amount of $217 in the statutory notice of deficiency.

stock called Series C ESOP Convertible Preferred Stock (ESOP

stock). Petitioner's account balance vested when she completed 5

years of service.

Petitioner decided to terminate her employment with Oral B

in October 1994. On a distribution request form dated October

27, 1994, petitioner elected to receive payment of her entire

account balance in the form of Gillette common stock plus the

cash value of any fractional shares of such stock. As of

September 30, 1994, the account had 15.1473 shares of ESOP stock

which were convertible into 302.946 shares of Gillette common

stock.

On or about December 12, 1994, the plan distributed to

petitioner 302 shares of Gillette common stock with a fair market

value of $73.19 per share at the time of distribution for a total

fair market value of $22,105.71. The distribution also included

cash in the amount of $217.39, representing the cash value of her

fractional share of Gillette common stock plus the cash value of

the dividends accumulated in her account between October 1, 1994,

and the date of the distribution. Petitioner did not receive the

cash because an equal amount was withheld for Federal income tax

purposes.2

Petitioner sold a number of shares of Gillette common stock

for $6,114.79 on December 20, 1994. On their 1994 return,
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petitioners reported the entire proceeds from this sale as

capital gain. They did not report the distribution from the ESOP

on their 1994 return. In the statutory notice of deficiency,

respondent determined that petitioner had received a taxable

distribution in the amount of $9,320 which was subject to the

section 72(t) 10-percent additional tax on qualified retirement

plan distributions.

The first issue for decision is whether petitioners are

required to include in their gross income any amount of the

distribution of petitioner's ESOP account.

In general, an ESOP is defined as a stock bonus plan which

meets the requirements of section 401(a). Sec. 4975(e)(7).

Petitioners argue that petitioner's Gillette ESOP account was not

a "retirement account" because it was "set up without her

knowledge or consent", and she had "no choice in participating"

in the plan. However, they introduced no documentary evidence

which supports their position. To the contrary, letters received

by petitioner as an ESOP participant from the plan as well as

other documents submitted as evidence of her account balance

convince us that the Gillette ESOP was a qualified stock bonus

plan, and we so conclude.

Section 402(a) generally provides that any amount actually

distributed from a section 401(a) qualified stock bonus plan

shall be taxable to the distributee as provided in section 72. 
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Under section 72(e), the amount included in gross income equals

the amount distributed to the distributee less the amount of any

investment (i.e., contributions) made by the distributee. Since

petitioner made no contributions to her account, the amount

includable under section 72, in the absence of any exceptions,

would be equal to the total amount of the distribution.

However, section 402(e)(4) provides:

(4) Net Unrealized Appreciation.--

(A) Amounts attributable to employee

contributions.-- * * *

(B) Amounts attributable to employer

contributions.--For purposes of * * * [section 402(a)]

and section 72, in the case of any lump sum

distribution, which includes securities of the employer

corporation, there shall be excluded from gross income

the net unrealized appreciation attributable to that

part of the distribution which consists of securities

of the employer corporation. * * *

(C) Determination of amounts and adjustments.--For

purposes of * * * [section 402(e)(4)(A) and (B)], net

unrealized appreciation and the resulting adjustments

to basis shall be determined in accordance with

regulations prescribed by the Secretary.

(D) Lump sum distribution.--For purposes of * * *

[section 402(e)(4)], the term "lump sum distribution"

has the meaning given such term by * * * [section

402(d)(4)(A)] (without regard to * * * [section

402(d)(4)(F)]).

The phrase "securities of the employer corporation" includes

shares of stock of a parent or subsidiary corporation of the

employer corporation. Sec. 402(e)(4)(E). The net unrealized

appreciation (NUA) in the securities is the excess of the fair

market value of such securities at the time of distribution over
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3 This amount equals the sum of the cash distributed in

the amount of $217.39 and $9,103.41. The later figure is the

excess of the fair market value of the stock at the time of the

distribution over the NUA in the stock in the amount of

$9,103.41. Petitioner's basis in the stock, for purposes of her

subsequent sale of the stock, is equal to the amount of such

excess. See sec. 1.402(a)-1(b)(1)(i), Income Tax Regs. 

the cost or other basis of such securities to the plan. Sec.

1.402(a)-1(b)(2)(i), Income Tax Regs.

Petitioner's distribution constitutes a lump sum

distribution because her entire account balance was distributed

to her during her 1994 taxable year on account of her separation

from service. Sec. 402(d)(4)(A)(iii). Petitioners are therefore

entitled to exclude from their gross income an amount equal to

the NUA in the 302 shares of Gillette common stock which were

distributed to petitioner. This amount was determined by

respondent, from information reported by the distributor, to be

$13,002.30. We find respondent's determination on this point to

be correct and reject petitioners' arguments to the contrary.

Based on the record, we find that petitioners failed to

report a distribution from the Gillette ESOP in the amount of

$22,323.10, of which $13,002.30 is attributable to the NUA in the

Gillette common stock. Accordingly, we hold that they are

required to include in their gross income the portion of the

distribution, $9,320.80,3 which is not attributable to the NUA.
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The second issue for decision is whether the amount of the

distribution which must be included in petitioners' gross income

is subject to the section 72(t) additional tax.

Section 72(t)(1) provides:

(1) Imposition of additional tax.--If any taxpayer

receives any amount from a qualified retirement plan

(as defined in section 4974(c)), the taxpayer's tax

under this chapter for the taxable year in which such

amount is received shall be increased by an amount

equal to 10 percent of the portion of such amount which

is includible in gross income.

The term "qualified retirement plan" includes any plan

described in section 401(a), which includes qualified stock bonus

plans such as the Gillette ESOP. Sec. 4974(c)(1). Section

72(t)(2) provides exceptions to the imposition of the additional

tax with respect to certain distributions. Petitioners, however,

have not proved that any exception applies in their case. We

therefore hold that the portion of the distribution which we held

must be included in their gross income is subject to the section

72(t) additional tax.

The third issue for decision is the amount and character of

the gain petitioner must recognize from her sale of a portion of

the Gillette common stock.

Section 61(a)(3) includes as gross income gains derived from

dealings in property such as the sale of stock. The amount of

the gain is the excess of the amount realized from the sale over

the adjusted basis of the property at the time of the sale. Sec.

1001(a). The entire amount of the gain determined under section
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4 This amount is calculated by dividing petitioner's

aggregate basis in the Gillette common stock ($9,103.41) by the

total number of shares (302).

1001(a) is recognized in the year of the sale with certain

exceptions not applicable in this case. Sec. 1001(c).

The amount realized from the sale is the sum of any money

received plus the fair market value of any property received. 

Sec. 1001(b). In this case, the amount realized by petitioner

from the December 20, 1994, sale of Gillette common stock is

$6,114.79. In order to calculate the gain on the sale, we must

first determine petitioner's adjusted basis in the shares which

were sold on December 20, 1994.

Petitioner's adjusted basis in each share was $30.14.4

Although the precise number of shares that were sold on December

20, 1994, is not revealed in the record, petitioner testified

that the fair market value of the shares at the time they were

sold was approximately $75 per share. Based on her credible

testimony and the fact that the shares were sold only 1 week

after the distribution, at which time (i.e., the time of

distribution) the fair market value was $73.19 per share, we

accept her estimate of the fair market value of Gillette common

stock on December 20, 1994. After dividing the proceeds of the

sale ($6,114.79) by the fair market value of the stock

(approximately $75), we find that petitioner sold 82 shares on

December 20, 1994. Therefore, the adjusted basis in the 82
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5 This amount is calculated by subtracting the adjusted

basis of the 82 shares sold ($2,471.48) from the amount realized

from the sale ($6,114.79).

shares equals $2,471.48 and the amount of gain realized from the

sale equals $3,643.31.5

Finally, we must decide the character of the gain which must

be recognized from the December 20, 1994, sale. The amount of

the gain attributable to the NUA in the 82 shares of stock at the

time of the distribution is treated as gain from a capital asset

held for more than 1 year. Sec. 1.402(a)-1(b)(1)(i), Income Tax

Regs.; see Rev. Rul. 81-122, 1981-1 C.B. 202; see also Notice 98-

24, 1998-17 I.R.B. 5. The amount of the gain which exceeds the

NUA at the time of distribution constitutes short-term capital

gain, since petitioner's post-distribution holding period was not

more than 1 year. Sec. 1.402(a)-1(b)(1)(i), Income Tax Regs.;

see Rev. Rul. 81-122, supra; see also Notice 98-24, supra.

Accordingly, we hold that petitioners must recognize long-term

capital gain in the amount of $3,530.10 and short-term capital

gain in the amount of $113.21 from petitioner's December 20,

1994, sale of Gillette common.

To reflect the foregoing,

Decision will be entered

under Rule 155.