Opinion ID: 204635
Heading Depth: 4
Heading Rank: 2

Heading: The Fair Market Value of the Stock

Text: The remaining question is the value of the Stock on July 1, 1999. Section 83(a) recognizes property at its fair market value (determined without regard to any restriction other than a restriction which by its terms will never lapse) . . . over . . . the amount (if any) paid for such property. I.R.C. § 83(a).8 8 As Gudmundsson did not pay for the Stock, the amount of income is only a question of its fair market value. - 18 - Plaintiffs contend that the district court erred in two ways when it determined the fair market value of the Stock. First, they assert that, based on an erroneous reading of § 83(a), the court impermissibly departed from the traditional method of determining fair market value set forth in United States v. Cartwright, 411 U.S. 546 (1973). Second, they contend that restrictions imposed by law, rather than by contract, cannot be considered lapse restrictions within the meaning of § 83(a). We consider these arguments in turn.
In general, the term fair market value is understood to mean the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. Cartwright, 411 U.S. at 551 (quotation mark omitted); accord United States v. Boccagna, 450 F.3d 107, 115 (2d Cir. 2006). Cartwright articulated the general understanding of fair market value used throughout the [I.R.C.] in the absence of a specific statutory rule. Harrison v. United States, 475 F. Supp. 408, 413 (E.D. Pa. 1979). For instance, this definition is used to value a decedent's estate under I.R.C. § 2031, Cartwright, 411 U.S. at 554-56, and to - 19 - assess economic income for minimum tax purposes under I.R.C. §§ 56 and 57, McDonald, 764 F.2d at 322, 329; Estate of Gresham v. Comm'r, 752 F.2d 518, 523 (10th Cir. 1985). Relying on these cases, plaintiffs contend that the fair market value of the Stock -- restricted by the Agreement, unregistered, and not yet publicly marketable -- is determined by the private market, as that is where the willing buyers exist. They argue that nothing in § 83 contains the specific statutory rule that requires using a method of computing fair market value other than Cartwright's. See McDonald, 764 F.2d at 329 (expressing a strong disinclination to disturb the established meaning of the term 'fair market value' as it was enunciated in Cartwright). This is incorrect. Section 83 is, of course, different from I.R.C. § 57 or I.R.C. § 2031, because it calls for fair market value to be determined without regard to any restriction other than [one] which by its terms will never lapse. I.R.C. § 83(a)(1). The methods used to calculate fair market value under other I.R.C. provisions -- and the hypothetical value of the Stock under other I.R.C. provisions -- are irrelevant to its value under § 83(a). It is unsurprising therefore that plaintiffs cite no instances in which Cartwright's definition of fair market value has been used to analyze fair - 20 - market value under § 83: we have discussed before that this language unambiguously breaks from common usage, Sakol, 574 F.2d at 699-701, and every other court to consider the issue has agreed, see, e.g., Roush, 466 F.3d at 386 ([T]he fact that stock is restricted, or even specifically valued for the purposes of private sales at less than the fair market value, does not affect the valuation of the shares for [§ 83] purposes.); McDonald, 764 F.2d at 330, 340-41; Pledger v. Comm'r, 641 F.2d 287, 291, 293 (5th Cir. 1981); see also Kolom v. Comm'r, 454 U.S. 1011, 1016 (1981) (Powell, J., dissenting) ([Section] 83 . . . modifies th[e] phrase [fair market value] with a parenthetical indicating that restrictions that lapse are to be ignored.); Gresham, 752 F.2d at 521-22. We therefore hold that the district court correctly rejected plaintiffs' argument and determined fair market value according to the directives of § 83(a).
On July 1, 1999, the Stock was subject to two transfer restrictions: one imposed by contract (the Agreement) and one imposed by law (Rule 144). The question is whether these restrictions will never lapse under § 83; only in that event would they be considered in determining value. See I.R.C. § 83(a)(1). The regulations define a nonlapse restriction as a - 21 - permanent limitation on the transferability of property that will (1) require the property to be sold at a price determined under a formula, and (2) that will apply to all subsequent transferees. Treas. Reg. § 1.83-3(h).9 The regulations also provide that [l]imitations imposed by registration requirements of State or Federal security laws or similar laws imposed with respect to sales or other dispositions of stock or securities are not nonlapse restrictions. Id. Applying these rules, the district court determined that the Agreement and Rule 144 both 9 We note that § 83 is different from but not inconsistent with Cartwright's core principle. There, the Court rejected a regulation that taxed the decedent's mutual fund shares at the asked price -- the price used by the [mutual] fund when selling its shares to the public -- because, [a]s a matter of statutory law [under the Investment Company Act of 1940], holders of mutual fund shares cannot obtain the 'asked' price from the fund. Cartwright, 411 U.S. at 552. In other words, the regulation purport[ed] to assign a value to mutual fund shares that the estate could not hope to obtain and that the fund could not offer. Id. at 553. The more reasonable value was the redemption price, the only price that a shareholder may realize and that the fund -- the only buyer -- will pay, which was, also as a matter of statutory law, somewhat less than the asked price. Id. at 552-53. If the same issue had been considered under § 83(a), the result likely would have been the same. Section 83(a) adjusts its method of calculating fair market value when property is subject to permanent pricing or transfer limitations that negatively affect its value -- nonlapse restrictions. See I.R.C. § 83(a). A statutorily-set price that will run to all potential transferees is such a restriction. See Treas. Reg. § 1.83-3(h). - 22 - imposed restrictions that lapsed, and so disregarded them in calculating the fair market value of the Stock on July 1, 1999. Plaintiffs argue that this was error. They argue that because § 83 does not explicitly say that securities laws lapse, these laws do not lapse, and that Treasury Regulation § 1.83-3(h) therefore unreasonably includes them in the statute's scope. The regulation contravenes what they claim was Congress's intention for lapse restrictions to include only contractually imposed restrictions, and not those imposed by law. We disagree. The plain text of the statute broadly requires that any restriction be disregarded in valuing the property, limited only by the permanence of a particular restriction. Nothing in the statute indicates that Congress meant to further differentiate a restriction on the basis of its source. Nor do we see any legitimate reason to infer such a distinction. Targeting restrictions was the point of § 83. For context, before the provision was enacted in 1969, restricted stock received preferential treatment in the I.R.C.10 It was 10 Under earlier law, the restrictions were cooperatively imposed, allowing the employee to defer the payment of taxes until the restrictions lapsed while, at the same time, enjoying the voting and dividend benefits of shareholding. Sakol, 574 F.2d at 698-99. The corporate employer, meanwhile, could pay the - 23 - taxed either when the restrictions lapsed or when the stock was sold, and the tax was levied upon the difference between the purchase price and the fair market value at the time of transfer or when the restrictions lapsed, whichever was less. Alves v. Comm'r, 734 F.2d 478, 481 (9th Cir. 1984). At the same time, and by contrast, contributions to employee pension plans and profit sharing trusts were immediately taxable in the year of receipt. Id. Thus, Congress's primary intention in enacting § 83 was to address the disparity created by the favorable treatment of restricted stock plans vis-a-vis other mechanisms for providing deferred compensation. Theophilos, 85 F.3d at 444; see also Grant v. United States, 15 Cl. Ct. 38, 41 (1988). The problem was essentially one of timing, and therefore Congress drafted a blanket rule, Sakol, 574 F.2d at 699, that ignor[ed] any value-depressing effect of [temporary] transfer restrictions in computing income, id. at 698 n.14. We previously addressed § 83 and its purpose in Sakol. At issue there was stock that was held subject to a temporary transfer restriction imposed by the plaintiff's stock purchase plan. Id. at 696. The IRS had taxed the stock, under § 83, employee with dollars that, because they may be tax-free or tax-favored, may be fewer. Id. at 699. - 24 - without taking into account any temporary loss of value that might be caused by the transfer restriction. The plaintiff sued. We agreed with the Tax Court that the IRS's approach was constitutionally acceptable and held that restrictions other than permanent, nonlapsing restrictions[] may not be considered in determining fair market value. Id. Because nonqualified plans have been the vehicles of tax avoidance, we concluded, Congress may clothe the tax incidental to them with a readymade, rather than a custom-tailored, suit. Id. at 701. The decision was addressed to the contract restrictions as well as the constitutional questions presented, but we did not hold, as plaintiffs now imply, that contract restrictions constitute the universe of lapsable restrictions under § 83. Nor was our holding interpreted that way, as Sakol's reasoning was extended to legal restrictions shortly thereafter. See, e.g., Pledger, 641 F.2d at 293; Grant, 15 Cl. Ct. at 41. Plaintiffs are correct that contracts were the primary source of the problem the statute was designed to solve, but its plain language is not limited to contractual restrictions. Again, § 83 differentiates only on the basis of a restriction's permanence, not on its type or source. See Grant, 15 Cl. Ct. at 41. The statute's legislative history reveals that this was - 25 - deliberate. In its proposal for what became § 83, the Treasury Department recommended that certain securities law restrictions be given the same treatment as those that never lapse. Koss v. Comm'r, 57 T.C.M. (CCH) 882, n.14 (Tax Ct. 1989). The proposal fared poorly: Both the House Ways and Means Committee and the Senate Finance Committee ignored the Treasury's recommendation and in their respective versions of section 83 provided that only a nonlapse restriction will affect a stock's fair market value for the purpose of income realization. The Treasury, having no choice but to comply with the wishes of Congress, provided in the proposed regulations to section 83 that registration requirements imposed by federal or state securities laws do not qualify as either nonlapse or substantial risk of forfeiture restrictions . . . . Ronald Hindin, Internal Revenue Code Section 83 Restricted Stock Plans, 59 Cornell L. Rev. 298, 332 (1974) (footnotes omitted). It is clear that the regulation plaintiffs challenge effectuates Congress's intent, as the regulation provides that [l]imitations imposed by registration requirements of State or Federal security laws or similar laws imposed with respect to sales or other dispositions of stock or securities are not nonlapse restrictions. Treas. Reg. § 1.83-3(h). In sum, we hold that all lapse restrictions -- whether imposed by contract or by law -- must be disregarded in - 26 - calculating income under § 83. The district court was correct to disregard Rule 144, which was a restriction on the Stock's marketability that by its terms lapsed on July 1, 2000. See I.R.C. § 83(a)(1); accord Grant, 15 Cl. Ct. at 41 (holding that because Rule 144's restrictions will eventually expire, there can be no merit to the argument that the shares are burdened by a nonlapsing restriction). Stripped of restrictions, the Stock was like Aurora's unrestricted shares trading on the New York Stock Exchange on July 1, 1999, and the district court correctly used the Exchange Price to determine fair market value, which is how stock is typically valued under § 83(a), see, e.g., Roush, 466 F.3d at 385-86; Sakol, 574 F.2d at 696, as well as in general, see Boyce v. Soundview Tech. Grp., Inc., 464 F.3d 376, 385 (2d Cir. 2006); E. Serv. Corp. v. Comm'r, 650 F.2d 379, 384 (2d Cir. 1981); Maxim Grp. LLC v. Life Partners Holdings, Inc., 690 F. Supp. 2d 293, 301 (S.D.N.Y. 2010). Finally, we acknowledge, as we have before, that in the course of addressing restricted stock arrangements, Congress employed a rule that is reasonably well tailored, but that can operate unfairly in an individual case. Sakol, 574 F.2d at 699. This may be such a case, but this is the result § 83(a) contemplates. As we have previously noted, taxpayers participate - 27 - in stock-based compensation plans voluntarily and presumably aware of Section 83(a)'s tax consequences, id., or at least that the risk of loss is part of any stock acquisition, McDonald, 764 F.2d at 339 n.29; Pledger, 641 F.2d at 291.