Opinion ID: 718808
Heading Depth: 2
Heading Rank: 1

Heading: R.C. 83(a).

Text: 3 Section 83(e)(3) provides that § 83 is inapplicable to the transfer of an option without a readily ascertainable fair market value. I.R.C. § 83(e)(3) 4 The parties rejected this proposal because it required too large a cash outlay for the taxpayer and produced adverse tax consequences for Beegle 5 In June 1986, the taxpayer and Beegle executed various other documents, including unanimous written consent of GSM's directors to adopt a plan of recapitalization and a certificate of amendment of GSM's articles of incorporation 6 The liquidation preference was $9,620 less than GSM's value as of September 30, 1985. The taxpayer promised to pay $10,200, and ultimately paid $10,000, for his stock. There is no explanation in the record for these slight discrepancies in value 7 A recapitalization is tax free, i.e., does not require the recognition of otherwise taxable gain, when it represents merely a new form of the previous participation in an enterprise, involving no change of substance in the rights and relations of the interested parties one to another or to the corporate assets. Bazley v. Commissioner, 331 U.S. 737, 740, 67 S.Ct. 1489, 1491, 91 L.Ed. 1782 (1947) 8 According to the taxpayer, he paid tax on the amounts he received under the settlement agreement for a covenant not to compete and consulting agreement, see Reply Brief for Appellants at 9 n. 5, and GSM deducted the $1.75 million payment it made under the settlement agreement, see Tr. 21 9 From the fair market value of $2,130,200 on September 30, 1985, as found by GSM's board of directors and confirmed by Hood & Strong, GSM's value increased dramatically during 1986. The Newport Group's report, on which the Commissioner relied, valued GSM at roughly $11 million as of December 31, 1986. 67 T.C.M. at 2113. The taxpayer's expert provided the following values for GSM during 1986: $2,944,136 on January 15, $3,357,771 on April 15, $5,311,099 on October 1, and $5,865,267 on December 10. Petitioner's Ex. 38. Even under the taxpayer's view, GSM's value appreciated rapidly during 1986 10 According to the taxpayer, in GSM's claim for a tax deduction, GSM has agreed to be bound by the factual determinations of this case. See Brief for Appellants at 2 n. 4 11 The Commissioner contends the taxpayer failed to make this argument below and thus has waived it. According to the Commissioner, the taxpayer argued to the Tax Court that he obtained only a beneficial interest in GSM in 1985, but now makes a flatly inconsistent argument that he obtained a contractual right to buy GSM's stock in 1985. See Brief for Appellee at 19 We reject the Commissioner's waiver argument. The taxpayer's argument to the Tax Court that he obtained a beneficial interest in GSM in 1985 incorporated an argument that he had a contractual right in 1985 to purchase GSM's stock upon the completion of GSM's recapitalization. Specifically, the taxpayer argued he had an ownership interest in GSM ... based upon the contract, ... the reliance, [and] the economic substance of the transaction. Tr. 19 (emphasis added). Thus, this issue was at least implicitly presented to the Tax Court. In such circumstances, we think it would be unfair to deny the taxpayer his right to appeal on the basis of his contractual right to purchase GSM's stock. See Bolker v. Commissioner, 760 F.2d 1039, 1042 (9th Cir.1985) (allowing review of new argument when the issue presented is purely one of law and ... the pertinent record has been fully developed). 12 See, e.g., Hayden v. Commissioner, 52 T.C. 1112, 1128-29, 1969 WL 1570 (1969); Carpenter v. Commissioner, 20 T.C. 603, 609, 1953 WL 278 (1953), aff'd, 219 F.2d 635 (5th Cir.1955); Scientific Instrument Co. v. Commissioner, 17 T.C. 1253, 1258-59, 1952 WL 351 (1952), aff'd per curiam, 202 F.2d 155 (6th Cir.1953); Armstrong v. Commissioner, 6 T.C. 1166, 1946 WL 299 (1946), aff'd per curiam, 162 F.2d 199 (3d Cir.1947) 13 The cases regarding executory contracts on which the Tax Court relied relate directly to ownership of stock or corporate control, not the broader question of a transfer of property under § 83. See, e.g., Hayden, 52 T.C. at 1128 (addressing when stock is considered issued for purposes of qualifying as a § 1244 plan); Scientific Instrument, 17 T.C. at 1257-58 & n. 1 (addressing whether predecessor corporation or its shareholders had control of successor corporation due to ownership of successor corporation's stock immediately after corporate reorganization for purposes of tax free reorganization); Armstrong, 6 T.C. at 1172 (determining whether taxpayers acquired stock for purposes of capital gains holding period when they agreed to purchase shares of stock or when they paid for shares of stock). In Carpenter, 20 T.C. at 609, the Tax Court ruled the taxpayer-petitioner received income when a cooperative purchased stock on his behalf rather than when he was actually issued the stock certificates. The court reasoned that the petitioner's right to the stock ripened when the stock purchase was made. Id. (emphasis added). The factual record in Carpenter was unclear as to whether the contract to purchase stock occurred at a separate time than the actual purchase, and neither party argued the taxable event occurred at the time of the contract as opposed to the time of the stock transfer. See id. at 608-09 14 The Commissioner distinguishes Ogsbury on the basis that the taxpayer in Ogsbury actually exercised his option whereas the taxpayer in this case did not exercise his option until December 10, 1986. As we discuss below, however, the taxpayer in this case had a binding contract to purchase GSM's stock, which produced a measurable economic benefit at the time of execution of the contract, rather than an option. Thus, we reject the Commissioner's attempt to distinguish Ogsbury 15 If true, the value of the property the taxpayer received was properly valued by the Tax Court as of that date. Section 83(e)(3) provides that § 83 is inapplicable to the transfer of an option without a readily ascertainable fair market value. I.R.C. § 83(e)(3). Moreover, [a]n indication that no transfer [of property] has occurred [under § 83] is the extent to which the conditions relating to a transfer are similar to an option. Treas.Reg. § 1.83-3(a)(4). For example, if an employee provides a nonrecourse note in exchange for the employer's stock, and makes no payments on the note, the transaction is deemed an option rather than a transfer of property under § 83. Id. § 1.83-3(a)(7) example 2 16 See Moser v. Western Harness Racing Ass'n, 89 Cal.App.2d 1, 200 P.2d 7, 12 (1948) (An offer to purchase stock and to accept and pay for it upon specified conditions becomes binding upon the parties when it is accepted by the corporation, and the subscriber can thereafter withdraw only upon the failure of the corporation to meet the conditions.); see generally Ballatine on Corporations § 193, at 457-58 (1946) (Ordinarily a conditional subscription should be regarded, if possible, as constituting a present contract with conditions precedent to the duty to pay or to deliver a certificate, from which the subscriber cannot withdraw unless the corporation fails in performance of the condition.) 17 Under California law the articles of incorporation must provide for the number and classes of stock which a California corporation is authorized to sell. Cal.Corp.Code § 202 18 The Commissioner also contends that if we accept the taxpayer's theory, we are required to remand the issue of forfeitability for further factual development by the Tax Court. See Brief for Appellee at 20 n. 5. We disagree. The factual record is more than sufficient to determine, under the proper legal standards, whether the taxpayer's right to acquire GSM's stock was subject to a substantial risk of forfeiture We also note the relationship between the substantial risk of forfeiture analysis and the option contract analysis. The risk of forfeiture analysis requires a court to determine the chances the employee will lose his rights in property transferred by his employer. The similar to an option analysis requires a court to determine the chances that an employer will lose its rights in the employee's payment. Some factors--such as whether a contract to purchase stock is enforceable when the articles of incorporation do not provide for such stock--are relevant to both inquiries. 19 The regulations also illustrate what constitutes a substantial risk of forfeiture. If an underwriter receives stock conditioned upon the successful completion of the underwriting, or if an employee receives stock which she must return if the total earnings of the employer do not increase, there is a substantial risk of forfeiture. Id. § 1.83-3(c)(2). If the property [must] be returned to the employer if the employee is discharged for cause or for committing a crime, however, there is no substantial risk of forfeiture. Id 20 Under California law, in order to amend a corporation's articles of incorporation, a corporate officer must certify the wording of the amendment, the approval of the corporation's board of directors, and, if applicable, the approval of the corporation's shareholders. See Cal.Corp.Code § 905. Under its contract with the taxpayer, GSM had a duty to fulfill the condition of amending the articles diligently. See Moser, 200 P.2d at 12. Beegle, the only shareholder, agreed to amend the articles in the April 1986 shareholder agreement. Amending the articles of incorporation is a simple ministerial act. If the state lacks a proper legal basis for refusing to allow the filing of an amendment to the articles, a party may compel such a filing through mandamus. See, e.g., Pratt-Low Preserving Co. v. Jordan, 217 Cal. 292, 18 P.2d 676, 678 (1933); California Tel. & Light, 126 P. at 603; see generally 9 B.E. Witkin, SUMMARY OF CALIFORNIA LAW Corporations § 76, at 579 (9th ed. 1989) (Certificates may be rejected by the Secretary for noncompliance with the law.... But this duty is ... subject to control by mandamus.). Such a slim possibility of GSM's failure, in good faith, to amend the articles of incorporation cannot constitute a substantial risk of forfeiture of the taxpayer's property right after his contract with GSM became binding 21 In California, a contract for sale of securities is not enforceable unless (1) there is a writing signed by the party against whom the contract is being enforced, (2) delivery of a certified security or payment for the security has been made without objection, or (3) the person against whom the contract is being enforced received, without objection, a written confirmation of the sale from the adverse party. See Cal.Comm.Code § 8319(1) 22 The Tax Court's finding that there was a meeting of the minds in June 1986 is consistent with our holding that the taxpayer had a binding contract to acquire GSM's stock as of April 1986, because the Tax Court's finding addressed the details of recapitalization, not the timing of the contract. To the extent the Tax Court's finding varies from ours, we find it to be clearly erroneous. We also note the written shareholder agreement between Beegle and the taxpayer provides the type of clear evidentiary basis needed to facilitate the enforcement of the tax laws and preclude the possibility of tax fraud by parties falsely claiming the existence of an oral agreement after the fact in order to shift the tax burden from one party in favor of another 23 An election under § 83(b) eliminates the need for a taxpayer to include a transfer under § 83(a) in a later tax year 24 We note that an election under § 83(b) is not cost-free: if a taxpayer elects to include property as gross income, even though the property is forfeitable and is subsequently forfeited, the taxpayer may not claim a deduction for the loss. I.R.C. § 83(b). In this case, of course, the risk to the taxpayer was small ($10,000) and it would have been sensible to elect to report his contractual right in 1985 or 1986 under § 83(b) 25 It is true that the taxpayer, as GSM's president and chief executive officer, could have declined to claim a deduction for GSM because of his financial self-interest in avoiding the disclosure of taxable income for himself. There is no factual basis in the record to support such a theory, however, and it is clear that GSM and the taxpayer conducted arm's length negotiations over how to structure the taxpayer's purchase of GSM's stock 26 GSM argued in its amicus brief to the Tax Court that the taxpayer could have secured more favorable tax treatment by paying GSM the $10,000 he promised to pay before December 10, 1986. See Amicus Brief of GSM at 29. Undoubtedly, there could be cases in which payment would help demonstrate in an objective manner a party's intention to be bound, but in the circumstances of this case we find that payment was not required to establish that the taxpayer had a binding contract to acquire stock 27 Consistent with the Tax Court's finding that the shareholder agreement was executed at some time in April 1986, the record reveals that the shareholder agreement was executed a short time before an April 30, 1986 letter transmitting Beegle's wife's consent to the shareholder agreement. See Joint Ex. 16-P; Tr. 223-24; see also Tr. 231, 369, 903-04; Joint Ex. 25-Y (letter dated April 10, 1986, supplementing taxpayer's employment agreement); Tr. 368 (taxpayer discussing signing of employment agreement in the first two weeks of April). The taxpayer testified the wives ... sign[ed] the consents to the share-holder agreement ... [a]nd I know there's correspondence exchanging those [documents] dated mid-April. That's how I'm putting the chronology together.... Tr. 369-70 On remand, we request that the taxpayer and the Commissioner attempt to stipulate to the effective date of the shareholder agreement in April of 1986. If they cannot, the Tax Court should determine the date of the execution of the shareholder agreement on the basis of the record as a whole. In this regard, we note the Tax Court dismissed the fact that the April 1986 shareholder agreement was back-dated to January 15, 1986, as not controlling the timing of the transaction. We agree. See, e.g., Hensel Phelps Const. Co. v. Commissioner, 74 T.C. 939, 950-51, 1980 WL 4480 (1980), aff'd, 703 F.2d 485 (10th Cir.1983). 28 The Commissioner's expert witness testified he based this assessment on conversations with three or four different people in the investment banking wor[ld]. I had a couple friends at Solomon Brothers. That was one place. I had a buddy at Paine Webber. That was another. When I described the attributes of this particular class B, it was pretty much a uniform response I got back. Not only is that not a discount, it might be a premium. Tr. 625. On cross-examination, however, the expert witness acknowledged he did not tell the investment bankers whom he called that the company was a closely-held corporation. Tr. 643-44.