Source: https://law.justia.com/cases/federal/appellate-courts/F2/641/287/25566/
Timestamp: 2020-07-09 03:01:27
Document Index: 168766272

Matched Legal Cases: ['§ 83', '§ 1', '§ 1', '§ 4', '§ 77', '§ 203']

Thomas R. Pledger and Phyllis R. Pledger, Petitioners-appellants, v. Commissioner of Internal Revenue, Respondent-appellee, 641 F.2d 287 (5th Cir. 1981) :: Justia
Justia › US Law › Case Law › Federal Courts › Courts of Appeals › Fifth Circuit › 1981 › Thomas R. Pledger and Phyllis R. Pledger, Petitioners-appellants, v. Commissioner of Internal Revenu...
Thomas R. Pledger and Phyllis R. Pledger, Petitioners-appellants, v. Commissioner of Internal Revenue, Respondent-appellee, 641 F.2d 287 (5th Cir. 1981)
U.S. Court of Appeals for the Fifth Circuit - 641 F.2d 287 (5th Cir. 1981)
The first issue raised by the appellant presents the recurring question of what is income. All parties agree that the option to purchase stock was compensation for services and that the purchase of the stock was a taxable event. Taxpayer asserts, however, that the government is utilizing Section 83(a) of the Internal Revenue Code5 to tax a nonexisting value, i. e., the excess of the fair market value of the stock over the discounted value. Section 83(a) provides that the value of compensation in the form of stock or other property for purposes of income taxation is to be determined by reference to the fair market value of the property "without regard to any restriction other than a restriction which by its terms will never lapse." 26 U.S.C. § 83(a). To the degree this statute allows taxation of an amount in excess of the value for which taxpayer could sell the stock during the time of restriction, taxpayer argues that the statute exceeds the powers of Congress to tax under the Sixteenth Amendment and Article 1, Section 8 of the Constitution.6 Relying on the classic definition of income as presented in Eisner v. Macomber,7 252 U.S. 189, 207, 40 S. Ct. 189, 193, 64 L. Ed. 521 (1920), taxpayer argues that the excess value is not realized gain or "something of exchangeable value ... derived from property." Id. With these contentions, we disagree.
First, we note that the Sixteenth Amendment did not limit or expand the power of Congress to tax under Article 1, Section 8 of the Constitution. See Brushaber v. Union Pac. R. R., 240 U.S. 1, 36 S. Ct. 236, 60 L. Ed. 493 (1916). The Sixteenth Amendment simply provided for taxation of income without apportionment. In Eisner v. Macomber, supra, 252 U.S. 189, 40 S. Ct. 189, 64 L. Ed. 521, the Court attempted to define the term "income" used, but left undefined, in the Sixteenth Amendment. In that case, the court struck down a taxing statute on the ground that it attempted to tax stock dividends which were not income within the meaning of the Sixteenth Amendment. The case distinguished between income and capital without focusing particularly on the issue of compensation presented in this case. In defining income as "something of exchangeable value," the Court was stating what was income, not defining the amount of income received. Later developments in the tax law reveal that the definition was not intended as an all-encompassing implication of income. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431, 75 S. Ct. 473, 476, 99 L. Ed. 483 (1955). See generally Note, "Apparent Abandonment of a Definitive Concept of Income," 45 Harv. L. Rev. 1072 (1923). The parties in this case agree that income was received; the only question is whether 65 percent of the fair market value or the full fair market value was received for purposes of taxation. The language of Eisner does not control this case. The taxing scheme does not contravene the language of Eisner defining income under the Sixteenth Amendment, and even if it did, the language of Eisner is not controlling where a different issue of income is presented.
In a challenge similar to the one in this case the Second Circuit held in Sakol v. Commissioner, 574 F.2d 694 (2d Cir.), cert. denied 439 U.S. 859, 99 S. Ct. 177, 58 L. Ed. 2d 168 (1978), that Section 83(a) did not violate the Sixteenth Amendment. In that case the taxpayer received as compensation what she claimed to be a lesser value than the fair market value of stock purchased pursuant to a stock option plan and subject to contractually imposed restrictions on the sale. The court considered that the language of Eisner requiring "gain" to be realized for "income" to exist had been modified by subsequent decisions upholding the accrual method of accounting, Burnet v. Sanford & Brooks Co., 282 U.S. 359, 51 S. Ct. 150, 75 L. Ed. 383 (1931), the doctrine of constructive receipt, Corliss v. Bowers, 281 U.S. 376, 50 S. Ct. 336, 74 L. Ed. 916 (1930), and the tax rules prohibiting assignment of income, Helvering v. Horst, 311 U.S. 112, 61 S. Ct. 144, 85 L. Ed. 75 (1940). Id. at 700. The court concluded that the power of Congress to create a realistic and workable tax scheme to prevent tax avoidance was sufficiently broad to permit the taxation scheme of Section 83(a).8
In addition to his argument based on the Sixteenth Amendment, appellant challenges the application of Section 83(a) under the due process clause of the Fifth Amendment. Relying primarily on Heiner v. Donnan, 285 U.S. 312, 52 S. Ct. 358, 76 L. Ed. 772 (1932), and Schlesinger v. Wisconsin, 270 U.S. 230, 46 S. Ct. 260, 70 L. Ed. 557 (1926), two cases which struck down statutes conclusively presuming certain gifts were made in contemplation of death, taxpayer argues that Section 83(a) operates as a conclusive presumption that "lettered" stock received as compensation has the same value as its registered counterpart. Because this value is a fiction, taxpayer argues, the statute deprives the taxpayer of property without due process of law.
The standard of review in the Fifth Circuit governing a due process challenge to a taxing statute is, as taxpayer concedes, whether the taxing statute is so arbitrary and capricious as to amount to a denial of due process. Carr Staley, Inc. v. United States, 496 F.2d 1366, 1375 (5th Cir.), cert. denied, 420 U.S. 963, 95 S. Ct. 1355, 43 L. Ed. 2d 441 (1975). See also Brushaber v. Union Pac. R. R., supra, 240 U.S. at 24-25, 36 S. Ct. at 244. The cases upon which taxpayer primarily relies, Heiner v. Donnan, supra, 285 F.2d 312, and Schlesinger v. Wisconsin, supra, 270 U.S. 230, 46 S. Ct. 260, 70 L. Ed. 557, applied this standard, holding that the creation of an irrebuttable presumption in the legislation in question was arbitrary and capricious. The court in Carr Staley, Inc. v. United States, supra, 496 F.2d at 1374, considered these cases but held in that case that the earlier cases were not controlling and that a "reasonable basis in fact" would justify the statutory scheme. Thus, the irrebuttable presumption doctrine, to the degree it exists in taxing cases, clearly does not require a holding that any irrebuttable presumption is per se unconstitutional as an arbitrary and capricious statutory scheme. This view received further support from the Supreme Court's subsequent pronouncements concerning the irrebuttable presumption doctrine in Weinberger v. Salfi, 422 U.S. 749, 95 S. Ct. 2457, 45 L. Ed. 2d 522 (1975), and Usery v. Turner Elkhorn Mining Co., 428 U.S. 1, 96 S. Ct. 2882, 49 L. Ed. 2d 752 (1976), indicating that in "purely economic matters" the rational relationship test shall apply as the standard of review. At least one commentator12 and one court13 have recognized that these recent irrebuttable presumption cases have probably eroded the validity of Heiner and Schlesinger. Nevertheless, under either the Fifth Circuit or the Supreme Court standard, it is clear that the statutory scheme established by Congress for taxation is entitled to great deference by the courts and shall not be disturbed unless arbitrary and capricious and without a reasonable basis in fact. See Sakol v. Commissioner, supra, 574 F.2d at 698.
First, the plain language of the statute seems to apply to security restrictions as well as contractually imposed restrictions. Secondly, we note that the Treasury Regulations specifically include restrictions under federal and state securities laws as restrictions to be disregarded under Section 83(a). Treas.Reg. § 1.83(h), § 1.83-5(c), Example (3). These regulations must be sustained unless plainly unreasonable or inconsistent with the language of the statute. Fulman v. United States, 434 U.S. 528, 533, 98 S. Ct. 841, 845, 55 L. Ed. 2d 1 (1978). These regulations are both reasonable and comport with the language of the statute referring to "any restriction."
Before considering the specific statute in question, a review of certain fundamental truisms of tax law might be helpful in properly focusing the issues. To begin with it is accepted that the power of Congress to levy taxes is not without limit. Prior to the adoption of the Sixteenth Amendment, a time which though so close is so very far away, the imposition of an income tax was unconstitutional. Subsequent to its adoption, Congress was authorized to institute a progressive tax, but only to the extent that the tax applied to income. Income is, as it was classically defined in Eisner v. Macomber, 252 U.S. 189, 40 S. Ct. 189, 64 L. Ed. 521 (1920), the "gain derived from capital, from labor, or from both combined..." 252 U.S. at 207, 40 S. Ct. at 193. It is "something of exchangeable value proceeding from, the property ... and coming in, being 'derived ' that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit, and disposal that is income derived from property. Nothing else answers the descriptions." 252 U.S. at 207, 40 S. Ct. at 103. I think it significant to remember that, although the definition of income has become more complex in response to the intricate tax laws and tax problems resulting therefrom, when the government seeks to tax something as income, it may do so only to the extent that "something of exchangeable value" was derived from labor or capital. By way of simple example, it is clear that if A, attorney, agrees to draft P, painter's, will in exchange for a painting worth $200, and at the end of the transaction P gives A a painting that would be worth $200 but for a hole in the canvas, that fact making it worth only $100, A may only be taxed to the extent of $100. A may only be taxed on the value of what he actually received, not on the value that the property would have had but for a condition affecting such value.
This action was taken in order for the transaction to qualify as a private offering, exempted from registration requirements under the Securities Act of 1933 by § 4(2) of that act. 15 U.S.C. § 77d(2). Stock issued in these private offerings is commonly referred to as "lettered" stock, and is subject to certain restrictions regarding sale under the rules and regulations of the securities laws. This stock may be sold after a two year holding period without regard to restrictions if other conditions are met. Rule 144(d) (1), 17 C.F.R. § 203.144 (1980)
Value of Stock on Dates of Exercise (per appraisals) .. $395,363 Amount Paid for Stock on Dates of Exercise ........... 200,000 -------- Amount Determined to be Compensation (excess of value over amount paid) .... $195,363 4 The Commissioner calculated the amount of compensation as follows: Value of Stock on Dates of Exercise (per market value) .. $634,500 Amount Paid for Stock on Dates of Exercise ............. 200,000 -------- Amount Determined to be Compensation ................. $434,500 Amount Reported on 1970 Form 1040 .................... $195,363 -------- Deficiency .................... $239,137
The government argues that the taxpayer concedes that even if the tax is not appropriate under the Sixteenth Amendment, the tax could be upheld under the general taxing provisions of Article 1, Section 8 if the tax is uniform. The government is correct in arguing that the progressive taxation scheme of the income tax does not affect the finding that the tax imposed in this case is uniform. See Knowlton v. Moore, 178 U.S. 41, 20 S. Ct. 747, 44 L. Ed. 969 (1900); Penn Mutual Indem. Co. v. Commissioner, 32 T.C. 653 (1959), aff'd 277 F.2d 16 (3d Cir. 1960). However, because the real arguments in this case center on the issue of income, we base our decision on an analysis under the Sixteenth Amendment
This is the standard measure of recognizable gain. Prior to adoption of section 83, the amount actually taxed would have been less than this standard measure. This was the result of the operation of regulations adopted in 1959, 1.421-6(d) (2), Income Tax Regs., providing that the tax on bargain purchases of stock subject to restrictions having a significant effect on value would be imposed only when the restrictions lapsed or the property was sold in an arm's-length transaction. The measure of income as ordinary gain income at that point was the lesser of the fair market value of the stock at the time of its acquisition, determined without regard to any restrictions, or the fair market value at the time the restrictions lapsed, over the cost of the stock