[PUBLIS H] IN THE UN ITED STATES COURT OF APPEALS FOR THE ELE VENTH CIRCUIT

__ __ __ __ __ __ __ __ __ __ __ __ _ No. 1 2- 10 91 6

__ __ __ __ __ __ __ __ __ __ __ __ _ Doc ke t No . CIR-1 :2 43 29 -0 6 ALLEN L. DAVIS, Pet it io ne r-Ap pe ll an t, ve rs us COMM ISSI ONER OF IRS, Res po nd en t-Ap pe ll ee.

__ __ __ __ __ __ __ __ __ __ __ __ No. 1 2- 11 78 6

__ __ __ __ __ __ __ __ __ __ __ __ _ Doc ke t No . CIR-1 :2 75 7- 07 J. DAVID ROSENBERG, DIANE M. ROSENBERG, Pet it io ne rs -Ap pe ll ees , ve rs us COMM ISSI ONER OF IRS, Res po nd en t-Ap pe ll an t.

Case: 12-10916 Date Filed: 05/16/2013 Page: 1 of 29__ __ __ __ __ __ __ __ __ __ __ __ _ No. 1 2- 11 78 7

__ __ __ __ __ __ __ __ __ __ __ __ _ Doc ke t No . CIR-1 :2 75 8- 07 JAR ED A. D AVIS, BRIDGET DAVIS, Pet it io ne rs -Ap pe ll ees , ve rs us COMM ISSI ONER OF IRS, Res po nd en t-Ap pe ll an t.

__ __ __ __ __ __ __ __ __ __ __ __ No. 1 2- 11 78 8

__ __ __ __ __ __ __ __ __ __ __ __ _ Doc ke t No . CIR-1 :2 75 9- 07 A. DAVID D AVIS, TRACY DAVIS, Pet it io ne rs -Ap pe ll ees , ve rs us COMM ISSI ONER OF IRS, Res po nd en t-Ap pe ll an t.

2 Case: 12-10916 Date Filed: 05/16/2013 Page: 2 of 29__ __ __ __ __ __ __ __ __ __ __ __ Pet it io ns forRev ie w of aDeci si on of t he Uni te d S ta te s Tax Co urt

__ __ __ __ __ __ __ __ __ __ __ __ _ (Ma y 16 , 20 13 ) Befo re BARKETT, JORDAN, an d R IPPLE, Cir cu itJu dg es . * RIPP LE, Circu itJu dg e: In20 04 , All enDavi s ex erci se d a n o pt io n t o p ur ch as e ad di ti on al sh ares in CNG Fin an ci al Co rp or at io n (“ CNG”), a cl os el y -h el d c or po rat io n. He d idno t rep ort h is ex erci se of t he op ti on as i nc om e o n h is fed eral in co m e ta x re tu rn , be li ev in g tha t i t h adno tax co ns eque nc es . Howev er, CNG to oka de du ct io n fo r th e v al ue of t he sh ares Mr. Dav is rece iv edth ro ug h t he op ti on ’s exe rci se , st at in g th atitis su edth e o pt io n t o M r. Dav is inco nn ect io n wi thhi s p erfo rm an ce o f se rv ic es . CNG’ s s ha reh ol de rs , othe r th anMr. Dav is , (th e “ CNG tax pa y ers ”), 1 cl ai m edth ei r pr o ra tash ares of t hi s d educ ti on on th ei r 20 04 fed eral in co m e ta x returns . Becau se of t he tra ns act io n’s i nc on si st en t t ax tre atm en t, the Co m m is si on er

Honora ble Kenne th F. Ripple, United States Circuit J udg e for the Seventh Circuit, * sitti ngby designation. The CNG sha

reholde rs other tha

n Mr. Davis a

re J. David Rosenberg , J are d A. Davis 1 and A. Da

vid Davis. Tog ether

with their spouses, bec ause the y filed joint tax returns, the y are the petitioners-a

ppellees in this case . 3 Case: 12-10916 Date Filed: 05/16/2013 Page: 3 of 29of

Int ern al Rev enue (th e “ Co m m is si on er”) is su edde fic ie nc y no ti ces to Mr. Dav is an d the CNG tax pa y ers . Mr. Dav is an d t he CNG tax pa y ers ch al le ng edth ei r res pe ct iv e d efi ci en cy

no ti ces inth e Tax Co urt. The Tax Co urt d et erm in edth at 2 Mr. Dav is sh ou ldhave in cl ud edth e v al ue of t he sh ares he rece iv edfro m th e op ti on ’s exe rci se inhi s 2 00 4 g ro ss in co m e an d s us ta in edth e Co m m is si on er’s de fic ie nc y

no ti ce. The Tax C ou rt uph el d t he CNG tax pa y ers ’ de du ct io ns . Mr. Dav is ha s t im el y

ap pe al ed . To en su re co ns is te nttre atm en t o f th is tra ns act io n,

3 th e Co m m is si on er h as ap pe al edth e Tax Co urt’s d eci si on with re sp ectto th e CNG ta xp ay ers . Thes e ap pe al s h av e b eenco ns ol id at ed . For t he reas on s s etforthinth is op in io n, we af

firm th e jud gm en t o f th e Tax Co urt.

I BACKGRO UND CNG is a subc hapt er S co rp or at io n op erat in g ahi gh ly pro fit ab le pa y -d ay 4 lo anbu si ne ss . CNG is clo se ly hel d; th e sh areh ol de rs are M r. Dav is an d t he CNG ta xp ay ers . Mr. Dav is is act iv el y in vo lv edinCNG’ s o pe rat io ns an d m any of The jurisdiction of the Tax Court was pre dicated on 26 U .S.C. § 7442. 2 The jurisdiction of this court is predic ated on 26 U.S.C. § 7482. 3 26 U.S.C. §§ 1361-1379. 4 4 Case: 12-10916 Date Filed: 05/16/2013 Page: 4 of 29CNG’s ess en ti al cred itag reem en ts are co nt in ge ntup on hi s co nt in ue d i nv ol ve m en t

with C NG’ s m an ag em en t. In20 01 , whenhi s fo rm er wi fe, Jud ith, fi le d fo r di vo rce, M r. Dav is own edtwen ty-th ree p erce ntof C NG, andJu di thown edno in te res t i n C NG. As part o f th e co up le ’s di vo rce p ro pe rty set tl em en t, J ud ith de m an de d h al f of

Mr. Dav is ’s CNG sh ares . Co m pl y in g wi th Ju di th ’s dem an d wo ul d h av e reduc edsi gn ifi can tl y Mr. Dav is ’s own ers hi p o f CNG. Mr. Dav is was o pp os edto an y di lu ti on of h is own ers hi p i nt eres t i n C NG. He freque nt ly thre at en edth e CNG ta xp ay ers an d Ju di th th athe wou ldst op work in g fo r th e co m pa ny sho ul d h is own ers hi p i nt eres t be de crea se d. Mr . Davi s’s d ep artur e fro m CNG wou ldha ve be endi sa st ro us for th e co m pany, becau se itwou ldha ve m ean t the lo ss of h is bu si ne ss ex pe rti se an d i t wou ldha ve pl acedCNG inde fau ltwith re sp ectto ke y cred itag reem en ts . Mr. Dav is pro po se d tha t CNG i ss ue hi m anop ti on to pu rch as e en ou ghsh ares to rep la ce tho se th athe ha d t o g iv e to Ju di th so th athe co ul d m ai nt ai n h is curren t le ve l o f own ers hi p i n C NG. In ex ch an ge forsu chanop ti on , Mr. Dav is pro m is ed th athe wou ldco nt in ue hi s i nv ol ve m en t wi th CNG. In re sp on se to Mr. Dav is ’s th reat s an d t o i nduc e h im to rem ai n a ct iv e in m an ag in g C NG, CNG agre edto gra nt hi m su chanop ti on . Sh ortl y be fo re the op ti on tra ns act io n was co m pl et ed , Mr. Dav is in si st edth at 5 Case: 12-10916 Date Filed: 05/16/2013 Page: 5 of 29he rece iv e anop ti on fro m Ju di th th atwou ldall ow h im to re-p ur ch as e th e sh ares th atwou ldbe trans ferr edto he r. Mr. Dav is co ul d e xe rci se th is op ti on by pay in g si xt eenm il li ondo ll ars to Ju di th . This was the “ Ju di th Opt io n.” Howev er, Mr . Davi s an d the CNG tax pa y ers kn ew th atJu di th ne ve r in te nd edto ke ep an y

CNG sh ares sh e rec ei ve d fr om Mr. Dav is ; the pl anwas fo r CNG to red eem

im m ed iate ly Jud ith’s s ha res forcas h a ndass um e th e o bl ig at io n un de r th e Ju di th Opt io n t o p erm itMr. Dav is to pu rch as e sh ares fro m CNG. For ex am pl e, he to ldhi s s on s Dav idan d J aredth atCNG wou ldbe is su in g a n o pt io n on ly to h im

an d tha t wh ethe r itwentth ro ug h J ud ith was irr el ev an t. Mr. Dav is 5 al so adm it te d tha t h e so ug htth e o pt io n fo r ta x a vo id an ce p ur po se s b ecau se he be li ev edth atth e ch os enstru ctur e wou ldpre ve nthi m fro m ha vi ng to reco gn iz e in co m e fro m

it s ex erci se . 6 In20 02 , as the pa rti es ha d p lann ed , Mr. Dav is si m ul tane ou sl y

tra ns ferr ed 18 8.8 6 s ha res of C NG st oc k t o J ud ith a ndrece iv edth e Ju di thOpt io n i n re turn , and Ju di th so ldth e 1 88 .86 sh ares to CNG. CNG ass um edJu di th ’s ob li ga ti on s u nd er th e Ju di th Opt io n a ndgra nt edMr. Dav is th e ri gh t t o p ur ch as e 1 88 .86 sh ares fro m CNG. Additional Record Excerpts (“ A.R.E.”) 434. 5 I d. at 859. 6 6 Case: 12-10916 Date Filed: 05/16/2013 Page: 6 of 29Mr. Dav is co nt in ue d h is in vo lv em en t wi th CNG’ s o pe rat io ns .

Subs eque nt ly, CNG an d M r. Dav is ne go ti at edsev eral si gn ifi can t m od ifi cat io ns to th e Ju di th Opt io n. Th e res ul ti ng op ti onwas the “ All enOpt io n.” Firs t, the op ti on was am en de d t o i nc lu de a cas hl es s ex erci se pro vi si on , whi chen ab le d M r. Dav is to gi ve up a nu m

be r of th e 1 88 .86 sh ares equa l t o s ix te enm il li on do ll ars , as de te rm in edby a form

ul a se t fo rth inth e All enOpt io n a gr eem en t, an d re cei ve th e ba lanc e o f th e 1 88 .86 sh ares . Seco nd , th e All enOpt io n re qu ire d tha t M r. Dav is no ti fy CNG inwrit in g i f, aft er ex erci si ng th e o pt io n, h e were t o m ak e a § 83 (b ) el ect io n, wh ic h p erm it s a p ers on rece iv in g p ro pe rty in c on ne ct io n wi th th e pe rfo rm an ce o f se rv ic es to ele ctto tre atth e p ro pe rty as i nc om e in th e y ear i t i s rece iv ed , eve n i f rec og ni ti on us ua ll y wou ldbe de ferr ed . See 2 6 U.S.C. § 83 (b ). Two y ears lat er, i n 2 00 4, M r. Dav is ex erci se d t he All enOpt io n b y us in g the cas hl es s ex erci se pro vi si on . He recei ve d 1 31 .80 55 sh ares . Accor di ng to th e All en Opt io n’s fo rm

ul a, 57 .05 45 sh ares were equi va le ntto si xt eenm il li on do ll ars . CNG de te rm in edth e v al ue of t he sh ares Mr. Dav is rece iv ed , us in g t he ag reed -upo n fo rm ul a, to be $3 6,9 62 ,69 4. Th e CNG ta xp ay ers to okde du ct io ns forth e is su an ce of th es e sh ares un de r 26 U.S.C. § 8 3( h) , whi chpe rm it s a d educ ti on forth e

7 Case: 12-10916 Date Filed: 05/16/2013 Page: 7 of 29pa ym en t o f rea so nabl e co m pe ns at io n fo r se rv ic es ren de red . Mr. Dav is di d n ot 7 rep ort the va lu e o f th e sh ares as i nc om e n ordi d h e ta ke a de du ct io n a s a C NG sh areh ol de r. Bec au se of t he in co ns is te nttax tre atm en t o f Mr. Dav is ’s exe rci se of t he All enOpt io n, the Co m

m is si on er i ss ue d “ whi ps aw” d efi ci en cy no ti ces to Mr. Dav is an d t o the CNG tax pa y ers . Mr. Dav is an d t he CNG tax pa y ers so ug ht rev ie w of the Co m

m is si on er’s d efi ci en cy

no ti ces . In the Tax C ou rt, the Co m m is si on er ar gu edth atMr. Dav is ’s exe rci se of t he All enOpt io n g en erat ed or di na ry in co m e fo r hi m

an d p erm it te d aco rres po nd in g d educ ti on forth e CNG ta xp ay ers . In the alt ern at iv e, th e Co m m is si on er ar gu edth atMr. Dav is ’s exe rci se of th e All enOpt io n g en erat edcap it al ga in s i nc om e an d n o c orres po nd in g de du ct io n fo r th e CNG ta xp ay ers . The CNG t ax pa y ers urg edth atth ei r 8 de du ct io ns were p ro pe r be cau se th e All enOpt io n was gra nt edto Mr. Dav is to in du ce h im

to co nt inue hi s k ey

in vo lv em en t wi th CNG, m ak in g t he All enOpt io n pr op erty tra ns ferr edinco nn ect io n wi th th e p erfo rm an ce o f se rv ic es . Mr. Dav is co nt en de d tha t, b ecau se th e o pt io n was gi ve n t o h im by Jud ith i nc id en t t o the ir

Be causeCNG is an S corpora tion, the deduction flowe d through to CNG’s 7 share holders. Given the Tax Court’s rea soning, the Commi ssioner does not pre ss this alternative 8 char acte rization of the Allen Option’s exercise on a ppeal, a nd we do not addr ess it. 8 Case: 12-10916 Date Filed: 05/16/2013 Page: 8 of 29di vo rce, h is ex erci se of i t was sh ie ld edfro m reco gn it io n a s i nc om e und er 2 6 U.S.C. § 1 04 1. The Tax C ou rt f

oundth atth e All enOpt io n was gra nt edinco nn ect io n wi th th e p erfo rm an ce o f se rv ic es , andit s ex erci se th eref or e cre at edord in ary in co m e fo r Mr. Dav is un de r 26 U.S.C. § 8 3( a). The co urt o bs erv edth atMr. Dav is

“ th reat en ed , onnu m ero us oc cas io ns , to lea ve CNG if h is own ers hi p i nt eres t was reduc ed .” It al so fou ndth at“ th e CNG st oc k was tra ns ferr edto [Mr. Dav is ] in

9 co nn ect io n wi th hi s p erfo rm an ce o f se rv ic es be cau se CNG gra nt edth e All en Opt io n wi th th e in te nt io n o f se cu rin g [M r. Dav is ’s] pa rti ci pa ti on inth e d ay -to -d ay m an ag em en t o f CNG.” The Tax Co urt cr ed it edJar edDavi s’s t es ti m on y th at“ th e 1 0 All enOpt io n was grant edto in du ce [M r. Dav is ] to st ay .” It al so fou ndth at 1 1

“ [t]he op ti onag reem en t i ts el f pr ov id es ob jecti ve ev id en ce o f CNG’s in te nt , as the ag reem en t co nt ai ns a pr ov is io n tha t re qu ire d [M r. Dav is ] to no ti fy CNG inwrit in g if h e m ad e a s ect io n 8 3( b) ele ct io n.” The co urt the refo re co nc lu de d t ha t 1 2 Mr. Dav is was re qu ire d t o i nc lu de th e v al ue of t he sh ares he rece iv edinhi s g ro ss Davis v. Comm’r, 102 T.C.M. (CCH) 575, 577 (2011). 9 I d. at 578. 1 0 I d. 1 1 I d. 1 2 9 Case: 12-10916 Date Filed: 05/16/2013 Page: 9 of 29in co m e in20 04 , th e y ear h e ex erci se d t he All enOpt io n.

The Tax C ou rt t he n v al ue d t he sh ares to de te rm in e Mr. Dav is ’s tax li ab il ity . It a gr eedwith the Co m

m is si on er an d t he CNG tax pa y ers th atth e sh ares ’ va lu e was es tabl is he d b y

th e All enOpt io n’s ca sh le ss ex erci se pro vi si on ($3 6,9 62 ,69 4) . Mr. Dav is co nt en de d tha t a t hi rty-per cen t d is co un t s ho ul d h av e b eenap pl ie d t o th is va lu at io n t o a cco un t fo r th e fac t tha t the sh ares rep res en te d amin or ity in te res t in a cl os el y -h el d c or

po rat io n. Th e Tax Co urt re jecte d t hi s ar gu m en t, h ol di ng th at su cha di sc ou ntwas i napp li cab le be cau se th e p art ie s h adne go ti at eda fo rm ul a to de te rm in e th e sh ares ’ va lu e. Mr. Dav is ha s t im el y

ap pe al ed ; t o e ns ur e co ns is te nttre atm en t o f th e tra ns act io n, the Co m

m is si on er t im el y

ap pe al edth e d eci si on pe rm it ti ng th e CNG ta xp ay ers ’ de du ct io ns . II DISCUSS IO N Mr. Dav is urg es on ap pe al th atth e Tax Co urt erredinde te rm in in g t ha t the All enOpt io n was grant edto hi m inco nn ect io n wi thhi s p erfo rm an ce o f se rv ic es an d i n v al ui ng th e sh ares he rece iv edup on th e o pt io n’s ex erci se . The res ol ut io n

10 Case: 12-10916 Date Filed: 05/16/2013 Page: 10 of 29of

th e Co m m is si on er’s ap pe al de pe nd s o n the res ol ut io n o f Mr. Dav is ’s app eal . W e th eref

or e fi rs t ad dr es s the ch arac te riz at io n o f Mr. Dav is ’s exe rci se of t he All en Opt io n a ndth enturnto th e is su e o f th e CNG ta xp ay ers ’ de du ct io ns . A. Chara cter iz at io n o f the Al le n Opt io n a nd i ts Ex erci se

“ W e rev ie w th e Tax Co urt’s ap pl ic at io n o f th e ta x c od e d e n ov o a ndit s fin di ng s o f fac t fo r cl ear e rro r.” Cam pb el l v . Comm ’r, 65 8 F .3d12 55 , 12 58 (11 th Ci r. 20 11 ). “ [W] he th er a tran sf er i s m ad e in co nn ect io n wi th th e p erfo rm an ce o f se rv ic es is ess en ti al ly a qu es ti on of f act .” Cen te l Co m

m c’ns Co . v. Co m

m ’r, 92 0 F.2 d 1 33 5, 1 34 1 (7 th Cir . 19 90 ); s ee al so Alv es v. Co m m ’r, 73 4 F .2d47 8, 4 81 (9 th Cir . 19 84 ) (“ The Tax C ou rt c on cl ud edth atAlv es ob ta in edth e st oc k ‘in co nn ect io n wi th th e p erfo rm an ce o f se rv ic es ’ as co m pany vic e-p res id en t. To the ex te ntth atth is co nc lu si on is a fi nd in g o f fac t, i t i s n otcle arl y erro ne ou s.”) . The refo re, the Tax C ou rt’s d et erm in at io n wi ll no t b e d is tu rb edun le ss itis cle arl y erro ne ou s. See Co m

m ’r v. Dub ers te in , 36 3 U.S. 2 78 , 29 1, 8 0 S . Ct. 1 19 0, 1 20 0, 4 L. Ed. 2d12 18 (19 60 ). 1. Appl ic at io n o f Sec tio n 8 3

11 Case: 12-10916 Date Filed: 05/16/2013 Page: 11 of 29The Tax C ou rt d et erm in edth atMr. Dav is was g ran te d t he All enOpt io n “ in

co nn ect io n wi th th e p erfo rm an ce o f se rv ic es ,” 26 U.S.C. § 8 3( a), an d s o h is ex erci se of t he op ti on ge ne rat edord in ary in co m e. Sect io n 8 3( a) o f Tit le 26 pr ov id es th at :

If, in co nn ect io n wi th th e p erfo rm an ce o f se rv ic es , pro pe rty is tra ns ferr edto an y

pe rs on ot he r th anth e p ers on forwho m su ch se rv ic es are p erfo rm ed , th e ex ces s o f– (1 ) th e fai r m ark etva lu e o f su chpro pe rty . . . at the fir stti m e th e ri gh ts of t he pe rs on ha vi ng th e b en efi ci al in te res t i n s uc h p ro pe rty are t ran sf erab le or are n otsubjec t t o asubs tant ia l ri skof f or fei ture, whi ch ev er o ccurs earl ie r, ov er (2 ) th e am ou nt(if

an y ) pa idforsu chpro pe rty, sha ll be in cl ud ed in th e g ro ss in co m e o f th e p ers on who pe rfo rm edsu chservi ces inth e fir sttax ab le y ear i n wh ic h t he rig ht s o f th e p ers on ha vi ng th e be ne fic ia l i nt eres t i n s uc h p ro pe rty are tr an sf erab le or are n otsubjec t to a subs tant ia l ri skof f

or fei tu re, wh ic he ve r is ap pl ic ab le . Inth e cas e o f op ti on s, “ [t]he gra ntof an o pt io n t o p ur ch as e certa inpro pe rty do es no t co ns ti tu te a tr an sf

er o f su chpro pe rty.” 26 C.F.R. § 1.8 3- 3( a)(2 ). Rathe r, th e tra ns fer o ccu rs when th e o pt io n i s ex erci se d. Se e id . § 1 .83 -3 (g ). Sect io n 1 .83 -3 (f) o f th e reg ul at io ns de fin es “pr op erty tra ns ferr edin co nn ect io n wi th th e p erfo rm an ce o f se rv ic es ” as “ [p ]rop erty tra ns ferr edto an em pl oyee oranin de pe nd en t co nt ract or(orbe ne fic iary th ereo f) i n re co gn it io n o f th e p erfo rm an ce o f, orth e ref rai ni ng fro m

pe rfo rm an ce o f, se rv ic es .” Id . 12 Case: 12-10916 Date Filed: 05/16/2013 Page: 12 of 29§ 1 .83 -3 (f). The reci pi en t o f pr op erty tra ns ferr edinco nn ect io n wi th th e pe rfo rm an ce o f se rv ic es do es no t n eedto be an“ em pl oyee” o f th e co m

pany tra ns ferr in g the pro pe rty. T he op ti on ee al so canbe anoff ic er. See Alv es , 73 4 F.2 d a t 4 80 (in vo lv in g a n o pt io ne e who was avi ce-p res id en t). Furth erm or e, “ [t]he tra ns fer o f pr op erty

is subjec t t o [2 6 U.S.C. § 83 ] whe th er s uc h t ran sf er i s i n res pe ctof p as t, p res en t, o r futu re s erv ic es .” 26 C.F.R. § 1.8 3- 3( f). W e ag ree wi th ou r si st er ci rcu it s tha t the lan gu ag e o f § 8 3- -“ in co nn ect io n with the pe rfo rm an ce o f se rv ic es ”--e nc om pa ss es m or e tr an sf

ers th anjus t tho se m ad e as co m

pe ns at io n. Se e Ma cNau gh to n v . Uni te d S ta te s, 8 88 F.2d41 8, 4 21 (6 th Cir . 19 89 ) (h ol di ng th atsh ares ina ho sp it al rece iv edby a phy si ci anup on hi s em pl oym en t b y

th e h os pi ta l wer e tr an sf

erre d i n c on ne ct io n wi th th e p erfo rm an ce of servi ces ev enth ou gh th e “ st oc k was no t co m pe ns at io n fo r se rv ic es he ren de red atth e Cl in ic ”); Alv es , 73 4 F .2dat 4 80 -8 2 (f in di ng th at§ 8 3 app li edto anop ti on gr an te d t o ra is e cap it al an d “pr ov id [e] th e Em pl oyee with a n a dd it io na l i nt eres t i n th e Co m pa ny” (in te rn al qu ot at io n m ark s o m it te d) ). Ind eed , th e Tax Co urt h as reco gn iz edth at , inm os t ca se s g ov ern edby § 83 , “ th e em pl oyers’ in te ntingra nt in g th e st oc k o pt io ns was t o e ns ur e th atth e em pl oyers re ta in edth e em

pl oym en t se rv ic es of the ir k ey

em pl oyees.” Cen te l Co m

m c’ns Co . v. Co m

m ’r, 92 T.C. 61 2,

13 Case: 12-10916 Date Filed: 05/16/2013 Page: 13 of 2963 2 (1 98 9) , aff’d 9 20 F.3d13 35 (7t h C ir. 1 99 0) .

Gran ti ng anem

pl oyee, off

ic er o r in de pe nd en t co nt ract oranop ti onas a n in cen ti ve to co nt in ue hi s i nv ol ve m en t wi th th e co m pa ny is a t ran sf

er o f pr op erty

in co nn ect io n wi th th e p erfo rm an ce o f se rv ic es . For e xa m pl e, inBag le y

v. Co m m is si on er, 8 5 T.C. 6 63 , 66 4 (1 98 5) , aff’d 8 06 F.2d16 9 (8 th Cir . 19 86 ), th e ta xp ay er ag reedto workforhi s emplo y er fo r fi ve y ears as avi ce-p res id en t, an d h e was grant eda st oc k o pt io n a ll owi ng hi m to pu rch as e sh ares inth e em pl oyer-co m

pa ny. The Tax C ou rt f

ou ndth atth e o pt io n was pro pe rty tran sf erre d in co nn ect io n wi th th e p erfo rm an ce o f se rv ic es un de r § 8 3. Th e Tax Co urt’s de ci si on was b as edonsev eral im po rtantfact s, i nc lu di ng th atth e ta xp ay er was refe rredto as a“ ‘key

em pl oyee,’ ” th athe ga ve no co ns id erat io n fo r th e o pt io n ot he r th anhi s p ro m is e to be anem pl oyee an d t ha t the co m

pa ny’ s i nt en t was to ret ai n h is servi ces whi le in cen ti vi zi ng hi m to workha rdfor

th e b us in es s. Id . at 66 9- 70 ; s ee al so Alv es , 73 4 F .2dat 4 81 (no ti ng th atth e p art ie s s ti pu la te d t ha t the pu rp os e o f gr an ti ng th e o pt io n “ was to en su re tha t k ey pe rs on ne l wo ul d re m ai n with the co m

pa ny”). Here, the Tax C ou rt f

ou ndth atth e All enOpt io n was grant edto Mr. Dav is

14 Case: 12-10916 Date Filed: 05/16/2013 Page: 14 of 29“ in co nn ect io n wi th hi s p erfo rm an ce o f se rv ic es ” fo r CNG. Mr. Dav is arrang ed 1 3 fo r th e cre at io n o f th e Ju di th Opt io n wi th ou t J ud ith’s i nv ol ve m en t, an d a ll of t he 1 4 pa rti es kn ew th atCNG wou ldimm ed ia te ly cash -o utJu di th ’s CNG sh ares an d gr an t M r. Dav is anop ti on to pu rch as e sh ares di rect ly from th e co m pany. Des pi te th e fo rm of t he tra ns act io n, M r. Dav is ne ve r in te nd edto ex erci se th e Ju di th Opt io n to pu rch as e sh ares fro m

Ju di th ; h e in te nd edto pu rch as e sh ares fro m CNG. In real ity , CNG, no t J ud ith, al way s b or e th e b ur de n o f pr ov id in g M r. Dav is with ad di ti on al sh ares when he ex erci se d t he op ti on . The Tax C ou rt’s fi nd in g tha t CNG g ran te d M r. Dav is th e All enOpt io n i n co nn ect io n wi th hi s p erfo rm an ce o f se rv ic es is no t cl earl y erro ne ou s. Th e rec or d am pl y supp orts th e Tax Co urt’s d et erm in at io n. Th e Tax Co urt fo un d t ha t CNG gr an te d M r. Dav is th e All enOpt io n t o e ns ur e h is co nt in ue d i nv ol ve m en t wi th th e co m pa ny. Mr. Dav is ha d c on di ti on edhi s co nt in ue d i nv ol ve m en t i n C NG’ s m an ag em en t o n the rece ip t o f anop ti on to pu rch as e sh ares to rep la ce tho se he ha d to gi ve to Ju di th . CNG, bel ie vi ng hi s thr eat s, g ran te d t he All enOpt io n i n o rd er t o ret ai n h is servi ces . The re i s ample e vi de nc e inth e rec or d t o s up po rt t hi s fi nd in g. Se ve ral CNG Davis, 102 T.C.M. (CCH) at 578. 1 3 A.R.E. 2045. 1 4 15 Case: 12-10916 Date Filed: 05/16/2013 Page: 15 of 29ta xp ay ers tes ti fie d, an d e vi de nc e d em on strat es , th atMr. Dav is rep eat ed ly

co nd it io ne d h is co nt in ue d i nv ol ve m en t wi thCNG onhi s re cei ptof a n o pt io n t o pr es erv e o r rec on st itut e h is own ers hi p i nt eres t p erce nt ag e. Fo r ex am pl e, he wrot e to Ju di th : “ I can tel l you wi th ou t an y res erv at io n t ha t I wi ll no t s tay at C NG if m

y st oc k o wne rs hi p fa ll s b el ow tha t wh ic h I c urren tl y own . . . . I wil l n otworkth e res t o f m y li fe t o m ak e ev eryone inm y ‘ fam il y ’ ric h i n re tu rnfora sm al l pe rcen ta ge .” Mr. Dav is ’s so n, J ared , tes ti fie d t ha t M r. Dav is to ldhi m th athe 1 5 wan te d t o p res erv e h is curren t l ev el of o wne rs hi p a nd , if tha t was no t d on e, th en he wou ld“ fin d a no th er job .” 1 6 Furth erm or e, th e rec or d m ak es cle ar tha t, i f Mr. Dav is carr ie d o uthi s thr eat s an d s to pp edhi s i nv ol ve m en t wi th CNG, th e co m pany’ s s urvi va l wo ul d b e th reat en ed . W

he n a sk edwhet he r itwas i m po rta ntin20 02 to CNG th atMr. Dav is m ai nt ai n h is day -to -d ay

m an ag em en t o f th e co m

pany, Jaredan swe red : “ W el l, witho ut[Mr. Dav is ], we ha d n o b an k c red itfaci li ty. W ith n o b an k c red itfaci li ty,

I d. Ex .44-P at 2. 1 5 I d. at 369; see a lso id. at 371 (J are d Davis’s testimony , noting that Mr. D avis told him, 1 6 “I ’m staying when I

g et the option. I f I

don’t g et the option, then I am not g oing to be full time and we ’re in defa

ult.”); id. at 583-84 (D avid Davis’s te stimony that CNG g ave Mr . Davis the option because Mr. Davis “ asked f or it and then he demande d it” and that the c ompany felt the option was “the be st way

to incent [sic] him to st ay .”).

16 Case: 12-10916 Date Filed: 05/16/2013 Page: 16 of 29we ha d n o c om pa ny.” One o f CNG’s len de rs tes ti fie d t ha t i ts cred itag reem en t

1 7 with C NG “ ne ed ed[Mr. Dav is ] to be th ere s te eri ng th e co m pa ny as a l ead er.” 1 8 The len de r no te d tha t, were Mr. Dav is to lea ve hi s l ead ers hi p ro le at C NG, th en th e le nd er wo ul d h av e se rio us do ub ts ab ou t an y co nt in ue d i nv ol ve m en t wi th CNG be cau se itlac ke d c on fid en ce i n the ot he r CNG m an ag ers an d was “ larg el y un de rwri ti ng [Mr. Dav is ] an d h is cap aci ty to l ead ” CNG. 1 9 The reco rdsupp orts th e co nc lu si on th atCNG gra nt edMr. Dav is th e All en Opt io n fo r th e p ur

po se of r et ai ni ng hi s s erv ic es . Mr. Dav is ’s so ns , Jar edan d Dav id , were CNG o ffi cers an d a ct iv el y in vo lv edinth e co m

pa ny’ s m an ag em en t. Ja redtes ti fie d tha t M r. Dav is to ldhi m th at , if CNG g ran te d h im th e o pt io n, “ he [wo ul d h av e] hada hu ge in cen ti ve to st ay , th athe wou ldst ay aro un d a ndwork ” fo r CNG. He als o t es ti fie d tha t the pu rp os e o f th e All enOpt io n was to in du ce

2 0 Mr. Dav is “ to co nt in ue work in g” at C NG. Add it io na ll y , Davi d t es ti fie d t ha t h e 2 1 ag reedto gra ntMr. Dav is th e o pt io n b ecau se “ we th ou gh t i t was th e b es t way to

I d. at 375. 1 7 I d. at 1915. 1 8 I d. at 1916. 1 9 I d. at 370. 2 0 I d. at 386. 2 1 17 Case: 12-10916 Date Filed: 05/16/2013 Page: 17 of 29in cen t [s ic ] hi m to st ay an d t o wo rkan d h el p u s g ro w th e co m pa ny.” 2 2 Mr. Dav is do es no t d is pu te th atCNG gra nt edth e o pt io n t o h im to en su re h is co nt in ue d i nv ol ve m en t wi th th e co m pa ny. Rathe r, he ass ert s tha t the Ju di th Opt io n, wh ic h, af

te r am en dm en t, b ecame the All enOpt io n, s erv edad di ti on al pu rp os es , su chas s tabi li zi ng co nt ro l o f CNG an d re so lv in g fa mil y strif e. Und oubt ed ly the All enOpt io n a ls o p ro vi de d t he se be ne fit s. Ho wev er, the pr es en ce o f ad di ti on al be ne fit s o r m ot iv at in g fa ct or s d oe s n otalt er the na tu re o f th e o pt io n g ran t. See Alv es , 73 4 F .2dat 4 80 , 48 3 (f in di ng th at§ 8 3 app li edto an op ti on gra ntin te nd edto sec ur e Mr. Al ve s’s co nt in ue d p art ic ip at io n a s vi ce-p res id en t, as well as t o “ rai se cap it al forth e Co m pa ny’ s i ni ti al op erat io ns ” (in te rn al qu ot at io n m ark s o mitte d) ). Seco nd , th e Tax Co urt fo un d d is po si ti ve th e All enOpt io n’s re qu ire m en t th atMr. Dav is no ti fy

CNG inwrit in g i f he ch os e to m ak e a § 83 (b ) el ect io n. Itis un di sp ut edth atth e All enOpt io n a gr eem en t was ne go ti at edwith t he advi ce o f co un se l, wh ic h s ug ge st s tha t the pa rti es were awar e o f th e si gn ifi can ce o f a § 83 (b ) el ect io n. Th e Tax Co urt fo un d the ag reem en t’s ex pr es s co nt em pl at io n o f a § 83 (b ) el ect io n s ig ni fic an t b ecau se § 8 3( b) on ly app li es to in co m e fro m pro pe rty

I d. at 584. 2 2 18 Case: 12-10916 Date Filed: 05/16/2013 Page: 18 of 29tra ns ferr edinco nn ect io n wi th th e p erfo rm an ce o f se rv ic es .

The Tax C ou rt’s fi nd in g tha t CNG g ran te d t he op ti on to in du ce M r. Dav is to rem ai n a t CNG i s b as edon subs tant ia l ev id en ce an d t he refo re n otcle arl y erro ne ou s. Mr. Dav is co nt en ds th at , bec au se he rece iv edth e Ju di th Opt io n fr om Ju di th , itco ul d n otha ve be eninco nn ect io n wi th th e p erfo rm an ce o f se rv ic es . Thatcla im is un av ai li ng . CNG was the de fact o c ou nt er-p arty un de r th e Ju di th Opt io n. Mo re im po rta nt ly, CNG gr an te d M r. Dav is th e All enOpt io n. Th e Supr em e Co urt co ns is te nt ly has he ldth atinan al yzi ng tax cas es , subs tanc e, no t fo rm , go ve rn s. See, e.g ., Diedric h v . Comm ’r, 45 7 U.S. 1 91 , 19 6, 1 02 S. Ct. 2 41 4, 2 41 8, 7 2 L. Ed. 2d77 7 (1 98 2) (di sc us si ng cas es inwhi ch“ itwas the ‘ real ity ,’ no t the form , of the tra ns act io n tha t g ov ern ed ”). The All enOpt io n, wi th it s p ack ag e o f subs tant ia ll y di ffer en t ri gh ts th anth os e g ran te d b y th e Ju di thOpt io n, i s es se nt ia ll y a di ffer en t op ti on , des pi te be in g t erm edan“ am en dm en t” of the Ju di th Opt io n. As M r. Dav is adm it te d a ndth e rec or d m ak es cle ar, CNG was alwa y s the pa rty actu al ly gran ti ng Mr. Dav is anop ti on : J ud ith n ev er i nt en de d t o k eep an y CNG sh ares , so Mr. Dav is ne ve r co ul d h av e ex erci se d t he Ju di th Opt io n and

19 Case: 12-10916 Date Filed: 05/16/2013 Page: 19 of 29pu rch as edsh ares fro m Ju di th . Mr. Dav is an d C NG always in te nd edth atCNG

2 3 wou ldred eem

Ju di th ’s sh ares imm ed iate ly andth atMr. Dav is ul ti m at el y wou ld ex erci se anop ti on to rece iv e sh ares di rect ly from CNG. The rec or d d em on st rat es th atMr. Dav is in te nt io na ll y stru ctur edth is tra ns act io n t o try to av oi d a n o pt io n be in g g ran te d d ire ct ly by CNG. He dem an de d t ha t CNG p as s the op ti on th ro ug h Ju di th . He to ldCNG th atth is pa ss -th ro ug h a rran ge m en t “ do es n’t m eanan yth in g to th e co m

pa ny. The co m

pa ny is s ti ll gra nt in g m e anop ti on . I am st il l s ti ck in g aro un d. So itdo es n’t m atte r if itflo ws thr ou gh Ju dy. It i s i rrel ev an t t o t he co m pa ny.” Mr. Dav is als o t es ti fie d t ha t h e wan te d t he op ti on to pa ss th ro ug h

2 4 Ju di th “ [s ]o itco ul d n ev er b e d eem edto be co m pe ns at ory .” 2 5 Des pi te Mr. Dav is ’s effo rts , th e rec or d am pl y supp orts th e Tax Co urt’s co nc lu si on : Al th ou gh th e o pt io n p as se d t hr ou gh Ju di th , th e fac t re m ai ns th atCNG A.R.E. 435 (Testimony

of Jared Davis) (The Judith Opti on “couldn’ t be [ex erc ised] 2 3 beca use therewas a

simult aneous c losing. [Mr. Davis] gave the sha res to Judy . J udy

sold the share s to us. And then we g ave a n option to my

dad.”) ; id. at 864 (Testimony of Mr. Da

vis) (statingthat J udith owned no share s befor e he tr ansfe rre d his to her and that whe n she had sha res she held them for

“a minute” and then sold them bec ause “ she wa nted them re deeme d from the company”); id. at 2043-45 ( Testimony of Judi th’s attorney

) (“ [W ]e never w orried a

bout the option. Any

thing a bout him gettingan option was fr om the company to him. . . . [ T]he terms and conditions of our option we re to be deter mined not by

us but by , it say s here by Allen and CNG bec ause w e we ren’ t parties to it. It was all for m over substanc e.”) . I d. at 434. 2 4 I d. at 859. 2 5 20 Case: 12-10916 Date Filed: 05/16/2013 Page: 20 of 29gr an te d the All enOpt io n t o M r. Dav is inco nn ect io n wi th hi s p erfo rm an ce o f

se rv ic es . 2. Se cti on 10 41 an d the Al le n Opt io n Mr. Dav is als o u rg es th at , bec au se he co nv in cedCNG fir stto ha ve Ju di th gr an t h im anop ti on th atCNG wou ldlat er as su m e v ia‘ am en dm en t,’ hi s ex erci se of th e o pt io n i s s hi el de d b y

26 U.S.C. § 1 04 1’s n on -rec og ni ti on pro vi si on an d, th eref or e, th e tr an sa ct io n h adno tax co ns eque nc es . W e can no t ag ree. Sect io n 1 04 1( a) p ro vi de s i n re le va ntpa rt t ha t “ [n ]o ga in or l os s s ha ll be reco gn iz edon a tr an sf

er o f pr op erty

fro m anin di vi du al to . . . (1 ) a s po us e, or (2) a fo rm er s po us e, bu t o nl y

if the tra ns fer i s i nc id en t t o the di vo rce.” 26 U.S.C. § 1 04 1( a). Pro pe rty is tran sf erre d i nc id en t t o d iv or ce i f th e tr an sf er “ oc cu rs withi n 1 year aft er the da te on whi chth e m arri ag e cea se s” or “ is rel at edto th e ces sa ti on of th e m arri ag e.” Id . § 1 04 1( c). Itis un di sp ut edth atop ti on s ar e p ro pe rty with in th e m ean in g o f § 1 04 1 a ndth atth e tr an sf er o f th e Ju di th Opt io n fr om Ju di th to Mr. Dav is was i nc id en t t o the ir d iv or ce. Howe ve r, by its ownterm s, § 10 41 ap pl ie s o nl y

to tra ns fers of p ro pe rty betweensp ou se s o r fo rm er s po us es in ci de ntto di vo rce p ro ceed in gs , no t t o the subs eque ntdi sp os it io n o f th atpro pe rty by th e

21 Case: 12-10916 Date Filed: 05/16/2013 Page: 21 of 29reci pi en t s po us e o r fo rm er s po us e. The tran sf er o f anop ti on be twee n s po us es or fo rm er s po us es in ci de ntto di vo rce i s s hi el de d b y § 1 04 1. Se e I.R.S. Pri v. Ltr. Ru l. 20 10 16 03 1 (Ap r. 23 , 20 10 ) (s ta ti ng th at“ se ct io n 1 04 1 c on fers no nr eco gn it io n tre atm en t o n a ny gai n tha t A [tran sf ero r-s po us e] m ay

ot he rwis e rea li ze wh enA tra ns fers th e o pt io ns to B [tran sf eree -s po us e]” (cit in g R ev . Rul . 20 02 -2 2, 2 00 2- 1 C.B. 8 49 )). Thu s, wh enJu di thtra ns ferr edth e o pt io n t o M r. Dav is pu rs ua ntto

2 6 th ei r di vo rce s et tl em en t, n ei th er h adto reco gn iz e an y ga in or l os s. Ho wev er, o nc e th is tra ns fer was co m

pl et e, § 1 04 1 n o l on ge r ap pl ie d. The tra ns fer o f anop ti on is di st in ctfro m it s ex erci se . Mr. Dav is ask s thi s co urt t o e xt en d § 10 41 ’s pro te ct io ns to hi s ex erci se of t he All enOpt io n. Ho wev er, § 1 04 1 d oe s n otap pl y

to di sp os it io ns of a ss et s, wh ethe r orno t the y were pr ev io us ly tran sf

erre d b etweensp ou se s i nc id en t t o d iv or ce. See , e.g., i d. (s ta ti ng th atwhi le th e tr an sf

er o f st oc k o pt io ns was s hi el de d b y § 1 04 1, the ir s ub se qu en t ex erci se wil l cr eat e ta x c on se qu en ces forth e rec ei vi ng sp ou se ); I .R.S. Pri v. Ltr. Ru l. 2 00 64 60 03 (Nov . 17 , 20 06 ) (s am e); see als o B erg er v . Comm ’r, 71 T.C.M. (CCH) 21 60 , 21 62 (19 96 ) (h ol di ng th at , wher e hus bandtra ns ferr edhi s i nt eres t i n Although the I RS’s private letter r ulings a re not bidingprec edent, see 26 U .S.C. 2 6 § 6110(k)( 3), we are entitled to givethem persua sive authority beca use they “do re veal the interpre tation put upon the statute by the ag ency

charg ed with the re sponsibili ty of administering the re venue la

ws.” Ha nover B ank v. Comm’r, 369 U.S. 672, 687, 82 S. Ct. 1080, 1088 (1962).

22 Case: 12-10916 Date Filed: 05/16/2013 Page: 22 of 29th e co up le ’s bu si ne ss to wife an d wi fe s ub se qu en tl y so ldth e b us in es s, “ th e g ai n o n th e sa le of [ th e b us in es s] is att rib ut ab le init s en ti rety ” to wife ). Mo reo ve r, Mr. Dav is ’s arg um en t d oe s n otserve th e g oa ls of § 10 41 . “ [T]he rat io na le be hi ndth e ad op ti onof § 10 41 [was ] to faci li ta te [] the di vi si on of a m ari ta l es ta te in ci de ntto di vo rce wi th ou t t ax at io n t o t he sp ou se who is withd rawi ng ass et s fr om

th e m ari ta l es ta te .” Crav env. Un it edSta te s, 2 15 F.3d 12 01 , 12 07 (11 th Cir . 20 00 ) (i nt ern al qu ot at io n m ark s o m it te d) . Here, Mr. Dav is ex erci se d the op ti on to rev ers e th e co ns eque nc es of h is di vo rce wi th res pe ctto hi s own ers hi p i n C NG. HadMr. Dav is ex erci se d t he Ju di th Opt io n, h e st il l wo ul d h av e h adto reco gn iz e as ord in ary in co m e th e d iff eren ce, i f an y , betweenth e fai r m ark etva lu e of th e sh ares an d the op ti on pri ce, s ee IR S Pub. 5 25 (20 12 ), 20 12 W L 67 37 13 0, be cau se ex erci se , as d is ti nc t fr om tra ns fer, i s n otsh ie ld edby § 10 41 . Howev er, Mr. Dav is di d n ot(an d c ou ldno t) e xe rci se th e Ju di th Opt io n. In st ead , CNG gr an te d h im

th e All enOpt io n, wh ic h h e d idex erci se . The n ew ri gh ts co nt ai ne d i n th e All enOpt io n a re wh athe ul ti m at el y ex erci se d; he rece iv edsh ares fro m CNG an d d idso by usi ng th e cas hl es s ex erci se pro vi si on . Thes e ri gh ts were n ot tra ns ferr edto hi m

by Jud ith o r in ci de ntto di vo rce.

23 Case: 12-10916 Date Filed: 05/16/2013 Page: 23 of 29B. Val ua tio n o f the CNG S ha res Mr. Dav is Recei ve d

W e rev ie w th e Tax Co urt’s v al ua ti on m etho d d e n ov o a ndfactua l de te rm in at io ns ab ou t v al ue forcle ar erro r. See Es tate of J el ke v. Co m m ’r, 50 7 F.3 d 1 31 7, 1 32 1 (1 1t h C ir. 2 00 7) . Sect io n 8 3( a) re qu ire s tha t the “ fai r m ark et va lu e” o f th e p ro pe rty tran sf erre d b e d et erm in edinass es si ng tax li ab il ity . The Tax Co urt was requi redto de te rm in e th e sh ares ’ fai r m ark etva lu e o n the da te Mr. Dav is ex erci se d the All enOpt io n. Th e Supr em e Co urt h as no te d t ha t “ [t]he wil li ng bu y er-wi ll in g s el le r te stof f ai r m ark etva lu e is ne arl y as o ldas t he fed eral in co m e, es ta te , andgi fts tax es th em se lv es .” Uni te d S ta te s v . Cartwrig ht , 41 1 U.S. 54 6, 5 51 , 93 S. Ct. 1 71 3, 1 71 6, 3 6 L. Ed. 2 d 5 28 (19 73 ). “ The fai r m ark etva lu e is th e p ric e atwhi chth e p ro pe rty woul d c ha ng e h an ds be twee n awil li ng bu y er an d a wil li ng sel le r, ne ithe r be in g u nd er an y co m pu ls io n t o b uy or to sel l an d b oth ha vi ng reas on ab le kn owl ed ge of r el ev an t fa ct s.” 2 6 C .F.R. § 2 0.2 03 1- 1( b) . Sect io n 8 3( a) re qu ire s the in cl us io n i n i nc om e o f th e d iff eren ce b etween(1) th e p ro pe rty’ s fa ir m ark etva lu e atth e ti m e th e rec ip ie nt ’s rig ht s v es t, i n t hi s ca se whe n the op ti onrig ht s wer e n otsubjec t t o asubs tant ia l ri skof f or fei ture, an d (2 ) th e rec ip ie nt ’s bas is inth e sh ares rece iv ed . It i s u nd is pu te d t ha t M r. Dav is ha d a

24 Case: 12-10916 Date Filed: 05/16/2013 Page: 24 of 29zero ba si s i n the sh ares be cau se he pa idno th in g fo r th e All enOpt io n. Th eref or e, th e en ti re “ fai r m ark etva lu e” o f th e sh ares he rece iv edis in cl ud ab le inMr. Dav is ’s 20 04 ord in ary in co m e. The Tax Co urt v al ue d M r. Dav is ’s sh ares by usi ng th e fo rm ul a co nt ai ne d i n the All enOpt io n a gr eem en t, wh ic h a ls o was em pl oyed t o de te rm in e h ow m an y

sh ares Mr. Dav is ha d t o fo reg o i n o rd er t o u se th e cas hl es s ex erci se pro vi si on . W e fi ndno erro r in th e Tax Co urt’s ap pr oa chor v al ua ti on . The All enOpt io n p erm it te d M r. Dav is eit he r to pay CNG si xt eenmil li on do ll ars to acqui re 1 88 .86 sh ares of s to ckto rep la ce wh athe ga ve to Ju di th in20 02 orto acce ptfewer s ha res inex ch an ge forpa y in g n ot hi ng . By us in g t he cas hl es s 2 7 ex erci se pro vi si on , Mr. Dav is rel in qu is he d h is rig htto as m an y sh ares as we re worthsi xt eenm il li on do ll ars an d re cei ve d t he rem ai nd er o f th e 1 88 .86 sh ares or ig in al ly tran sf

erre d. Up on ex erci se , he r ecei ve d 1 31 .80 55 sh ares . This arra ng em en t p erm it te d M r. Dav is to cap ture the sh ares ’ ap pr eci at io n e ve n i f he la ck edth e cas h t o e xe rci se th e o pt io n. Usi ng th e fi gu res fro m

th e o pt io n a gr eem en t, the Tax C ou rt c on cl ud edth at each CNG sh are was worth $ 28 0,4 33 .62 on th e ex erci se da te . There fo re the 2 8

A.R.E. 1450. 2 7 The Tax Court rea ched this figure by dividing six teen million dollars by the 57.0545 2 8 share s that Mr. Davis did not rec eive. 25

Case: 12-10916 Date Filed: 05/16/2013 Page: 25 of 29va lu e o f th e 1 31 .80 55 sh ares he rece iv edis $3 6,9 62 ,69 4. Mr . Davi s i nt ro du cedan

ex pe rt’s v al ua ti on of t he sh ares . Howev er, the Tax C ourt d ecl in edto ad op t i t, de te rm in in g tha t the form ul a th atth e p art ie s ac tu al ly use d a t M r. Dav is ’s exe rci se of th e All enOpt io n was a be tt er s tarti ng po in t fo r de te rm in in g v al ue . Mr. Dav is so ug htto ha ve a th irty -p erce ntlac k- of -m ark et ab il ity

di sc ou ntap pl ie d t o t he sh ares ’ va lu e. The Tax Co urt d en ie d t hi s re du ct io n a s i napp ro pr ia te , gi ve n the ex is te nc e o f anag reed -upo n fo rm ul a fo r de te rm in in g s ha re v al ue at e xe rci se . Mr. Dav is di sa gr ees . In h is vi ew, th e Tax Co urt erredas am at te r of law b y fai li ng to reduc e th e v al ue of t he sh ares fro m th ei r ne go ti at edpri ce i n t he All en Opt io n a gr eem en t. Thi s ar gu m en t i s wi th ou t m eri t; th ere i s n o aut ho rit y forth e pr op os it io n tha t a l ack -o f-m ark et ab il ity di sc ou ntis ne ces sa ril y

requi red . “ Whe n de te rm in in g the va lu e o f un li st edst oc k b y refe ren ce t o the va lu e o f li st edst oc k, a di sc ou ntfro m

th e li st edva lu e is typic al ly w arra nt edinord er t o re fle ctth e la ckof m ark et ab il ity

of t he un li st edst oc k.” Est at e o f Cl ou ti er v . Comm ’r, 71 T.C.M. (CCH) 20 01 , 20 03 (19 96 ). Here, h owe ve r, CNG sh ares were n otva lu edwith refe ren ce t o l is te d s ecu rit ie s. Ra th er, the Tax C ou rt v al ue d t he sh ares by usi ng Mr. Dav is ’s pu rch as e o f th em th ro ug h t he All enOpt io n a s the be stin di cat or of th ei r va lu e. Fo ll owi ng th is co ur se was i n a cco rd an ce wi th th e Tax Co urt’s

26 Case: 12-10916 Date Filed: 05/16/2013 Page: 26 of 29pr eced en t tha t “ [i]n d et erm in in g t he va lu e o f un li st edst oc ks , actua l s al es m ad e in

reas on ab le am ou nt s atarm ’s len gt h, i n t he no rm al co ur se of b us in es s wi th in a reas on ab le ti m e b efo re o r aft er the va lu at io n d at e are th e b es t cr it eri a o f m ark et va lu e.” Dun canIndus ., Inc . v. Co m m ’r, 73 T.C. 26 6, 2 76 (19 79 ). Dete rm in in g th e sh are p ric e b y

refe ren ce t o the nu m

be r of sh ares th atth e p art ie s d eem edva lu ed atsi xt eenm il li on do ll ars when th e o pt io n was ex erci se d g av e th e Tax Co urt a so li d, re al -wo rldba si s fo r it s v al ua ti on of t he sh ares pu rch as ed . The All enOpt io n a gr eem en t was anarm ’s len gt h t ran sa ct io n a ndem pl oyed a fo rm ul a to cal cu la te sh are v al ue at any giv enti m e b as edon CNG’ s pe rfo rm an ce. At b ot to m , th e Tax Co urt cr ed it edth e p art ie s’ ownva lu at io n.

2 9 The Tax C ou rt a ls o fo un d i m pl au si bl e Mr. Dav is ’s su gg es ti on th ata di sc ou ntwas warran te d. Itst at ed :

If, as [Mr. Dav is ] co nt en ds , th e cas hl es s ex erci se pro vi si on es tabl is he s o nl y

a no min al free ly trad edva lu e fo r th e sh ares by fail in g to acco un t fo r th e st oc k’s l ackof m ark et ab il ity , th enth atwou ldm ean CNG acce pt edst oc k wi th a real fai r m ark etva lu e o f $1 1.2 m il li on ($ 16 m il li on di sc ou nt edby 30 p erce nt ) as pa ym en t o f th e $ 16 mil li on ex erci se pri ce. Inothe r wor ds , CNG wou ldha ve acce pt edpay m en t o f 70 cen ts on th e d ol lar. [ 3 0 ] Whe n C NG andMr. Dav is ne go ti at edth e cas hl es s ex erci se pro vi si on , th ey were A.R.E. Ex .98-P at 2 (tying sha re va lue to CNG’s twelve -month trailing E BI TDA). 2 9 Davis, 102 T.C.M. (CCH) at 579. 3 0 27 Case: 12-10916 Date Filed: 05/16/2013 Page: 27 of 29aware th atCNG was a c lo se ly-hel d c or po rat io n wh os e st oc k i s n ottra de d o n a n ex ch an ge an d tha t the nu m be r of sh ares Mr. Dav is co ul d p ur ch as e wit h t he op ti on rep res en te d am in or ity

st ak e in th e co m

pa ny (in de ed , all st ak es inCNG are m in or ity). Ther e is no ba si s t o c on cl ud e th atth es e k ey m eas ur es of v al ue were ig no red . The Tax C ou rt d idno t err in it s v al ua ti on m etho do lo gy. The co urt was ta sk edwith v al ui ng th e sh ares Mr. Dav is rece iv edinth ei r cas hl es s s al e. It i s reas on ab le to us e th e p art ie s’ ownva lu at io n o f th e sh ares on th e ex erci se da te in as se ss in g fa ir m ark etva lu e. Ther efo re, the Tax C ou rt’s v al ua ti on is no t cl earl y erro ne ou s an d M r. Dav is sh ou ldha ve in cl ud ed$3 6,9 62 ,69 4 i n o rd in ary in co m e in 20 04 . C. The CNG Ta xp ay ers ’ Deduc tio ns Bec au se we ho ldth atCNG gra nt edMr. Dav is th e All enOpt io n i n co nn ect io n wi th th e p erfo rm an ce o f se rv ic es an d t ha t h e sh ou ldha ve in cl ud edth e va lu e o f th e sh ares he rece iv edas o rd in ary in co m e und er § 83 (a), we al so up ho ld th e CNG ta xp ay ers ’ de du ct io ns . Und er § 83 (h ), th e p ers on or e nt ity th attrans ferr edth e p ro pe rty in

28 Case: 12-10916 Date Filed: 05/16/2013 Page: 28 of 29co nn ect io n wi th servi ces pe rfo rm edis en ti tl edto a de du ct io n i n t he am ountequa l

to th e am ou ntth e rec ip ie ntis requi redto reco gn iz e und er § 83 (a), t o t he ex te ntit refl ect s re as on ab le co m

pe ns at io n. Se e 2 6 U.S.C. § 83 (h ). The C omm is si on er do es no t ch al le ng e th e rea so nabl en es s o f th e sh ares as c om pe ns at io n andso th e is su e o f rea so nabl en es s i s n otbe fo re u s. Th eref or e, we co nc lu de th atth e CNG ta xp ay ers ’ de du ct io ns were p ro pe r un de r § 8 3( h) an d a ffi rm th e jud gm en t o f th e Tax Co urt.

Con cl us io n Fo r th e rea so ns setforthinth is op in io n, the jud gm en t o f th e Tax Co urt i s affi rm ed . AFFIRMED .

29 Case: 12-10916 Date Filed: 05/16/2013 Page: 29 of 29