Court Opinion

ID: 4334764
Source: CourtListenerOpinion
Date Created: 2018-11-14 01:52:21.798633+00
Date Added: 2024-06-11T14:48:07.832923
License: Public Domain

122 T.C. No. 5

                   UNITED STATES TAX COURT

ESTATE OF JOHN W. CLAUSE, DECEASED, THOMAS Y. CLAUSE, PERSONAL
                 REPRESENTATIVE, Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent

   Docket No. 12995-01.               Filed February 9, 2004.

        P, prior to his death, sold all of his shares in C to
   C’s employee stock ownership plan in 1996. P purchased
   qualified replacement property with most of the proceeds
   from the sale within a year of the sale. P’s 1996 original
   Federal tax return was filed timely (i.e., on or before Apr.
   15, 1997) and did not report the transaction. On Nov. 28,
   2000, after R began examining P’s original tax return for
   1996, P filed an amended Federal tax return for 1996
   indicating to R that certain proceeds from the sale had been
   reinvested in qualified replacement property. On Oct. 17,
   2001, R received a second Federal tax return for 1996 from P
   that attached certain statements of election pursuant to
   I.R.C. sec. 1042 regarding the sale in 1996.

        Held: P is not able to defer recognition of the gain
   that resulted from the sale because P failed to elect such
   treatment as required by I.R.C. sec. 1042.
                                - 2 -

     Ronald L. Kahn and Ronald H. Isroff, for petitioner.

     David S. Weiner, for respondent.

     HAINES, Judge:   Respondent determined a deficiency of

$395,279 in John W. Clause’s (Mr. Clause’s) Federal income tax

for 1996.   The issue for decision is whether Mr. Clause duly

elected, under section 1042,1 to defer recognition of a gain that

resulted from a sale of stock to an employee stock ownership plan

(ESOP).

                         FINDINGS OF FACT

     Mr. Clause was 74 years old when he testified at the trial

of this case on June 4, 2003.   Mr. Clause died on November 13,

2003, and his estate was substituted as petitioner by Order of

the Court dated January 30, 2004.   To avoid confusion, the

decedent, Mr. Clause, will be referred to as petitioner herein.

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.   At the time he filed the

petition, petitioner resided in Gainesville, Florida.

     Petitioner retired from W.J. Ruscoe Co. (the company) in

1995 after working for the company since 1956.   The company was a

     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue.
Amounts are rounded to the nearest dollar.
                               - 3 -

domestic C corporation that had no stock outstanding that was

readily tradable on an established securities market.    Petitioner

became the majority shareholder in the company when the company

founder passed away in 1975.   Petitioner owned over 82 percent of

the outstanding shares of the company at retirement.    Petitioner

did not receive these shares in a distribution from a plan

described in section 401(a) or in a transfer pursuant to an

option or other right to acquire stock to which section 83, 422,

or 423 applied.

     At the time of his retirement, petitioner consulted with his

accountant, Ronald C. Midcap, C.P.A. (Mr. Midcap), and an

attorney hired by Mr. Midcap, who Mr. Midcap believed was

familiar with stock sales to ESOPs.    Mr. Midcap had prepared

petitioner’s tax returns since 1978 and was also preparing the

tax returns for the company.   Mr. Midcap prepared petitioner’s

tax returns for 1996 but had never prepared a tax return with a

transaction involving section 1042 before 1996.

     On March 11, 1996, petitioner sold all of his shares in the

company to the W.J. Ruscoe Company Employee Stock Ownership Trust

created pursuant to an ESOP for $1,521,630.    At the time of the

sale, petitioner had a basis in the shares of $115,613 and had

owned the shares for at least 3 years.    On March 12, 1996,

petitioner deposited the $1,521,630 sale proceeds into an account

with South Trust Securities, Inc. (South Trust).
                               - 4 -

     On February 18, 1997, through a sales representative of

South Trust, petitioner made purchases of securities issued by

domestic corporations, totaling $1,399,775, which satisfied the

requirements of section 1042(c)(4) to be “qualified replacement

property”.   All but approximately $120,000 of the proceeds was

thus reinvested in qualified replacement property.

     On or before April 15, 1997, petitioner timely filed his

1996 Federal tax return (original tax return) but did not report

the sale of stock, in any manner, on the tax return.   Further,

the original tax return did not include a statement of election

pursuant to section 1042, a statement from the company consenting

to the application of sections 4978 and 4979A, or a statement of

petitioner’s purchase of qualified replacement property with the

proceeds of the stock sale to the ESOP.   Petitioner did not

request an extension of time to file the original tax return.

     On January 12, 1999, after respondent began an examination

of the original tax return with regard to the stock sale,

petitioner signed a Form 2848, Power of Attorney and Declaration

of Representative, appointing Mr. Midcap and certain associates

from Mr. Midcap’s practice as petitioner’s representatives with

regard to the examination.

     On November 28, 2000, respondent received petitioner’s

amended Federal tax return for 1996 (amended tax return).   On the

amended tax return, petitioner reported the portion of the gain
                               - 5 -

from the stock sale to the ESOP attributable to the proceeds that

had not been reinvested in qualified replacement property; i.e.,

$121,807.

     On July 20, 2001, respondent mailed petitioner a notice of

deficiency for 1996.   Respondent determined that petitioner

realized a long-term capital gain of $1,406,017 as a result of

the stock sale to the ESOP.   Further, respondent determined that

the gain must be included in taxable income for 1996 because

petitioner did not make a timely election under section 1042 in

order to defer the gain.   On October 17, 2001, petitioner filed a

petition with the Court with respect to the notice of deficiency.

     Also on October 17, 2001, respondent received a second

Federal tax return for 1996 (second tax return) from petitioner,

which included the undated signature of petitioner and the

signature of Mr. Midcap dated March 4, 1997.   The second tax

return had attached a statement of election pursuant to section

1042 predated to March 4, 1997, a statement of consent from the

company consenting to the application of sections 4978 and 4979A

predated to March 4, 1997, and a statement of petitioner’s

purchase of qualified replacement property predated to March 2,

1998.

     On October 29, 2001, respondent received a second amended

Federal tax return for 1996 (second amended tax return), signed

by petitioner and dated October 27, 2000, and by Mr. Midcap and
                                - 6 -

dated October 11, 2000.   The second amended tax return computed

the same amount of tax owed as the amended tax return but

differed from the amended tax return by the attachment of a

statement of election under section 1042 predated to March 4,

1997, a statement of consent from the company consenting to the

application of sections 4978 and 4979A predated to March 4, 1997,

and a statement of petitioner’s purchase of qualified replacement

property predated to March 2, 1998.

                               OPINION

     Section 1042 provides, generally, that a taxpayer may elect

to defer recognition of the gain from a sale of stock to an ESOP

in certain circumstances.   In relevant part, section 1042

provides:

     SEC. 1042(a). Nonrecognition of Gain.--

            If–-

                 (1) the taxpayer or executor elects in such form
            as the Secretary may prescribe the application of this
            section with respect to any sale of qualified
            securities,

                 (2) the taxpayer purchases qualified replacement
            property within the replacement period, and

                 (3) the requirements of subsection (b) are met
            with respect to such sale,

     then the gain (if any) on such sale which would be
     recognized as long-term capital gain shall be recognized
     only to the extent that the amount realized on such sale
     exceeds the cost to the taxpayer of such qualified
     replacement property.
                    - 7 -

     (b) Requirements To Qualify for Nonrecognition.--A
sale of qualified securities meets the requirements of
this subsection if–

     (1) Sale to employee organizations.--The qualified
securities are sold to–

          (A) an employee stock ownership plan (as
     defined in section 4975(e)(7)), or

          (B) an eligible worker-owned cooperative.

     *    *    *    *       *   *   *

     (3) Written statement required.--

          (A) In general.--The taxpayer files with the
     Secretary the written statement described in
     subparagraph (B).

          (B) Statement.--A statement is described in
     this subparagraph if it is a verified written
     statement of –

               (i) the employer whose employees are
          covered by the plan described in paragraph
          (1), or

               (ii) any authorized officer of the
          cooperative described in paragraph (1),

     consenting to the application of sections 4978 and
     4979A with respect to such employer or
     cooperative.

     *    *    *    *       *   *   *

(c) Definitions; Special Rules. * * *

     *    *    *    *       *   *   *

     (6) Time for filing election.--An election under
subsection (a) shall be filed not later than the last
day prescribed by law (including extensions thereof)
for filing the return of tax imposed by this chapter
for the taxable year in which the sale occurs.
                                - 8 -

Thus, the election to apply section 1042 to a sale of stock

(statement of election) and the verified written statement from

the employer or authorized officer consenting to the application

of sections 4978 and 4979A (statement of consent) are statutory

requirements.   The statute also requires that the taxpayer elect

to be treated under section 1042 by the due date of the tax

return, including extensions.   Sec. 1042(c)(6).

     The Secretary has prescribed a regulation for the form of

the election required under section 1042.   Sec. 1.1042-1T,

Temporary Income Tax Regs., 51 Fed. Reg. 4333 (Feb. 4, 1986);2

see sec. 1042(a).   Our analysis of the regulation is informed by

Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S.
837, 842-843 (1984).   In Chevron, the U.S. Supreme Court stated

the analysis as follows:

          When a court reviews an agency’s construction of the
     statute which it administers, it is confronted with two
     questions. First, always, is the question whether Congress
     has directly spoken to the precise question at issue. If
     the intent of Congress is clear, that is the end of the
     matter; for the court, as well as the agency, must give
     effect to the unambiguously expressed intent of Congress.
     If, however, the court determines Congress has not directly
     addressed the precise question at issue, * * *. * * * the
     question for the court is whether the agency’s answer is
     based on a permissible construction of the statute. [Fn.
     refs. omitted.]

     2
        Temporary regulations are entitled to the same weight as
final regulations. See Peterson Marital Trust v. Commissioner,
102 T.C. 790, 797 (1994), affd. 78 F.3d 795 (2d Cir. 1996); Truck
& Equip. Corp. v. Commissioner, 98 T.C. 141, 149 (1992).
                                - 9 -

Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., supra at

842-843.

        Using the Chevron analysis, we find Congress intended the

Secretary to prescribe the regulation as to the form of the

election.    First, the regulation was prescribed by the Secretary

pursuant to the specific grant of authority stated in section

1042(a) that authorizes him to prescribe the form in which “the

application of this section with respect to any sale of qualified

securities” is to be elected by a taxpayer or executor.     Sec.

1042(a).    Further, the legislative history of section 1042 states

that Congress intended the Secretary to prescribe the form of the

election:    “Under the bill, the seller’s nonrecognition election

is made by filing (as prescribed by the Secretary) an election no

later than the due date of the seller’s income tax return for the

taxable year in which the sale occurs.”   S. Rept. 98-169 (Vol.

I), at 333 (1984).

       With regard to the form of the election, section 1.1042-1T,

Temporary Income Tax Regs., supra, is a legislative regulation

expressly authorized by the statute.    Sec. 1042(a).   A

legislative regulation is given controlling weight unless it is

arbitrary, capricious, or manifestly contrary to the statute.

Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., supra at

844.    We do not find the regulation to be arbitrary, capricious,

or manifestly contrary to section 1042 because the regulation is
                                  - 10 -

consistent with the statute’s prescription; i.e., to prescribe

the form of the election.       All items required by the regulation

to be included in the election serve the purpose of carrying out

the statute.

     The regulation provides the information required in the

statement of election, which includes a notarized statement of

purchase of qualified replacement property, in order to elect

treatment under section 1042.      Sec. 1.1042-1T, Q&A-3(b),

Temporary Income Tax Regs., 51 Fed. Reg. 4334 (Feb. 4, 1986).       In

relevant part, the regulation provides:

          A-2: (a) Under section 1042(b), a sale of qualified
     securities is one under which all of the following
     requirements are met:

               *    *       *      *    *    *    *

               (4) The taxpayer files with the Secretary (as part
          of the required election described in Q&A-3 of this
          section) a verified written statement of the domestic
          corporation (or corporations) whose employees are
          covered by the plan acquiring the qualified securities
          or of any authorized officer of the eligible worker-
          owned cooperative, consenting to the application of
          section 4978(a) with respect to such corporation or
          cooperative.

               *    *       *      *    *    *    *

          Q-3: What is the time and manner for making the
     election under section 1042(a)?

          A-3: (a) The election not to recognize the gain
     realized upon the sale of qualified securities to the extent
     provided under section 1042(a) shall be made in a “statement
     of election” attached to the taxpayer’s income tax return
     filed on or before the due date (including extensions of
     time) for the taxable year in which the sale occurs. If a
     taxpayer does not make a timely election under this section
                        - 11 -

to obtain section 1042(a) nonrecognition treatment with
respect to the sale of qualified securities, it may not
subsequently make an election on an amended return or
otherwise. Also, an election once made is irrevocable.

     (b) The statement of election shall provide that the
taxpayer elects to treat the sale of securities as a sale of
qualified securities under section 1042(a), and shall
contain the following information:

          (1) A description of the qualified securities
     sold, including the type and number of shares;

          (2) The date of the sale of the qualified
     securities;

          (3) The adjusted basis of the qualified
     securities;

          (4) The amount realized upon the sale of the
     qualified securities;

          (5) The identity of the employee stock ownership
     plan or eligible worker-owned cooperative to which the
     qualified securities were sold; and

          (6) If the sale was part of a single, interrelated
     transaction under a prearranged agreement between
     taxpayers involving other sales of qualified
     securities, the names and taxpayer identification
     numbers of the other taxpayers under the agreement and
     the number of shares sold by the other taxpayers. See
     Q&A-2 of this section.

If the taxpayer has purchased qualified replacement property
at the time of the election, the taxpayer must attach as
part of the statement of election a “statement of purchase”
describing the qualified replacement property, the date of
the purchase, and the cost of the property, and declaring
such property to be the qualified replacement property with
respect to the sale of qualified securities. Such statement
of purchase must be notarized by the later of thirty days
after the purchase or March 6, 1986. In addition, the
statement of election must be accompanied by the verified
written statement of consent required under Q&A-2 of this
section with respect to the qualified securities sold.
                             - 12 -

          (c) If the taxpayer has not purchased qualified
     replacement property at the time of the filing of the
     statement of election, a timely election under this Q&A
     shall not be considered to have been made unless the
     taxpayer attaches the notarized statement of purchase
     described above to the taxpayer’s income tax return filed
     for the taxable year following the year for which the
     election under section 1042(a) was made. Such notarized
     statement of purchase shall be filed with the district
     director or the director of the regional service center with
     whom such election was originally filed, if the return is
     not filed with such director.

Sec. 1.1042-1T, A-2, Q&A-3, 51 Fed. Reg. 4334 (Feb. 4, 1986).

     Having not literally complied with the election requirements

in the statute and the regulation, petitioner argues that he

substantially complied with the requirements of section 1042 and

should, therefore, receive the benefits of the section because

the failure to file the elections was “purely administrative in

nature”.   We disagree.

     Section 1042 requires that an election, in the form

prescribed by the Secretary, be made by the due date (including

extensions) for filing the return for the year of the sale.3

     3
        We note that, in certain circumstances, the Commissioner
may grant an extension of time to make an election. If the
taxpayer has not filed a request for an extension, an automatic
extension of 6 months from the due date of the original tax
return may be granted if the taxpayer has taken corrective action
within the 6-month extension period. Sec. 301.9100-2T(b),
Temporary Proced. & Admin. Regs., 61 Fed. Reg. 33368 (June 27,
1996). As relevant here, “corrective action” is defined as
“filing an original or an amended return for the year the
regulatory or statutory election should have been made and
attaching the appropriate form or statement for making the
election.” Sec. 301.9100-2T(c), Temporary Proced. & Admin.
Regs., 61 Fed. Reg. 33368 (June 27, 1996). Petitioner timely
                                                   (continued...)
                               - 13 -

According to the regulation, the election is to be made in the

form of statements attached to the return.   Not only did

petitioner’s return for the year of sale fail to include such

statements, it reported none of the information required to be

provided in such statements.   Indeed, the return made no mention

of the sale at all.

     The Commissioner must be notified in some manner of a

taxpayer’s intentions to elect the benefit of section 1042 in

order to facilitate the Commissioner’s duty to ensure compliance

with the tax laws and minimize disputes between taxpayers and the

Internal Revenue Service.   Knight-Ridder Newspapers, Inc. v.

United States, 743 F.2d 781, 795 (11th Cir. 1984); Young v.

Commissioner, 83 T.C. 831, 841 (1984), affd. 783 F.2d 1201 (5th

Cir. 1986).   As we stated in Dunavant v. Commissioner, 63 T.C.
316, 320 (1974):   “We are not at liberty to infer that an

election existed when the unequivocal proof required by Congress

does not exist.”   Petitioner did not alert respondent to the

intended “election” under section 1042 until respondent received

the amended tax return on November 28, 2000, over 3 years after

the due date of the original tax return.

     3
      (...continued)
filed the original tax return on or before Apr. 15, 1997.
Petitioner’s first amended tax return was not received by
respondent until Nov. 28, 2000. We conclude that petitioner did
not take the appropriate corrective action in order to receive an
automatic extension of time for filing the election under sec.
1042.
                                - 14 -

     There is no defense of substantial compliance for failure to

comply with the essential requirements of the governing statute.

See Tipps v. Commissioner, 74 T.C. 458, 468 (1980); Penn-Dixie

Steel Corp. v. Commissioner, 69 T.C. 837, 846 (1978).    As the

plain language of section 1042 indicates, the “essence” of the

statute is to demand evidence of a binding election to accept the

tax consequences imposed by the section.    See Dunavant v.

Commissioner, supra at 320.    Inasmuch as there was nothing on

petitioner’s return to inform the IRS that an election was made

and nothing on the return indicating that the sale had even

occurred, the essence of a valid election was missing, and the

use of the substantial compliance doctrine is insufficient to

secure the benefits of section 1042.     Knight-Ridder Newspapers,

Inc. v. United States, supra.

     Petitioner argues that we have held that a taxpayer

substantially complied with the requirements for an election even

though the taxpayer failed to meet the literal requirements for

an election.    See Bond v. Commissioner, 100 T.C. 32 (1993);

Taylor v. Commissioner, 67 T.C. 1071, 1080 (1977); Hewlett-

Packard Co. v. Commissioner, 67 T.C. 736, 748 (1977); Columbia

Iron & Metal Co. v. Commissioner, 61 T.C. 5 (1973); Sperapani v.

Commissioner, 42 T.C. 308 (1964); Cary v. Commissioner, 41 T.C.
214 (1963).    The cases that petitioner cites are inapplicable

because, as discussed above, the substantial compliance doctrine
                               - 15 -

may not be used as a defense in the instant case.   Even if we

assume, arguendo, that the cases apply, in each of those cases

the taxpayer’s attempt to make the election was evident on the

original tax return, the taxpayers had provided most of the

information required, and the information missing was not

significant.   See Bond v. Commissioner, supra at 41-42; Taylor v.

Commissioner, supra at 1080; Hewlett-Packard Co. v. Commissioner,

supra at 747-750; Columbia Iron & Metal Co. v. Commissioner,

supra at 9; Sperapani v. Commissioner, supra at 329-332; Cary v.

Commissioner, supra at 218; cf. Hewitt v. Commissioner, 109 T.C.
258, 264 (1997) (holding that the taxpayers were not entitled to

deduct amounts in excess of those allowed by the Commissioner for

stock contributions because the taxpayers provided “practically

none of the information required by either the statute or the

regulations”), affd. without published opinion 166 F.3d 332 (4th

Cir. 1998).    In the instant case, petitioner provided none of the

information required by either the statute or the regulation

regarding the transaction with the ESOP on his original tax

return.   Respondent, therefore, had no indication from the

original tax return that the sale had even occurred.

     It is clear to the Court that petitioner relied upon Mr.

Midcap’s knowledge in filing his tax returns for 1996.   While we

are sympathetic to petitioner regarding Mr. Midcap’s failure to

file a proper election under section 1042 on petitioner’s behalf,
                              - 16 -

the general rule is that the duty of filing an accurate tax

return cannot be avoided by placing responsibility on an agent,

and taxpayers bear responsibility for the failure of their

agents.   Pritchett v. Commissioner, 63 T.C. 149, 174 (1974); Am.

Props. Inc. v. Commissioner, 28 T.C. 1100, 1116 (1957), affd. 262
F.2d 150 (9th Cir. 1958).   Therefore, petitioner must bear

responsibility for the failure to file a timely election pursuant

to section 1042.

     We hold that petitioner is not able to defer recognition of

a gain that resulted from a sale of stock to the ESOP because he

failed to elect such treatment as required by section 1042.

     We have considered all of petitioner’s contentions,

arguments, and requests that are not discussed herein, and we

conclude that they are without merit or irrelevant.

     To reflect the foregoing,

                                              Decision will be

                                         entered for respondent.