Court Opinion

ID: 30745
Source: CourtListenerOpinion
Date Created: 2010-04-25 09:58:30+00
Date Added: 2024-06-11T12:18:21.440685
License: Public Domain

United States Court of Appeals
                                                                         Fifth Circuit
                                                                      F I L E D
                  IN THE UNITED STATES COURT OF APPEALS
                                                                      March 27, 2003
                          FOR THE FIFTH CIRCUIT
                          _____________________                    Charles R. Fulbruge III
                                                                           Clerk
                              No. 02-60463
                          _____________________

PAUL A. TANNER, SR.; BEVERLY N. TANNER,

                                                      Petitioners-Appellants,

                                     versus

COMMISSIONER OF INTERNAL REVENUE,

                                                         Respondent-Appellee.

__________________________________________________________________

     Appeal from the Decision of the United States Tax Court
                           No. 5738-00
_________________________________________________________________

Before REAVLEY, JOLLY and JONES, Circuit Judges.

PER CURIAM:*

           Paul and Beverly Tanner appeal the decision of the Tax

Court holding that they had unreported income of $728,000 in 1994

based on Paul’s exercise of employee nonstatutory stock options for

182,000 shares of Polyphase Corporation.              Paul was, at that time,

the president, chief executive officer, and chairman of the board

of   Polyphase,    and   he   also   held     about   sixty-five   percent     of

Polyphase’s outstanding stock. The Commissioner issued a notice of

deficiency for the unreported income several years later, after

      *
      Pursuant to 5TH CIR. R. 47.5, the Court has determined that
this opinion should not be published and is not precedent except
under the limited circumstances set forth in 5TH CIR. R. 47.5.4.
receiving a Form 1099 from the company.    Finding no error in the

Tax Court’s decision, we affirm.

          The Tanners first argue that the Commissioner’s decision

to issue the notice of deficiency was arbitrary and erroneous

because the Commissioner based its notice solely on a Form 1099

issued by Polyphase and did not conduct any other investigation to

support its issuance of the notice.    Thus, the Tanners argue, the

Tax Court erred in not holding the notice arbitrary and erroneous

under Portillo v. Comm’r, 932 F.2d 1128 (5th Cir. 1991).     Unlike

the situation in Portillo, however, the Tanners did not raise any

factual dispute as to the amount of income.   In fact, the Tanners

stipulated to all of the relevant factual issues in this case. They

argue only that the $728,000 should not be included in gross income

under the Internal Revenue Code, 26 U.S.C. § 83 (2000).   This court

has held that “[t]he Commissioner has no duty to investigate a

third party payment report that is not disputed by the taxpayer.”

Parker v. Comm’r, 117 F.3d 785, 786 (5th Cir. 1997).

          The Tanners next contend that the Tax Court erred in not

placing the burden of proof in this case on the Commissioner,

pursuant to I.R.C.   §§ 6201(d) and 7491(a)(1).    Yet because the

Tanners disputed none of the operative facts, the Tax Court did not

err in not placing the burden of proof on the Commissioner.     See

I.R.C. § 7491(a)(1) (2000) (burden shifts to Commissioner only when

taxpayer introduces evidence with respect to any factual issue

relevant to ascertaining the taxpayer’s liability); Gale v. Comm’r,

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83 T.C.M. (CCH) 1270, 2002 Tax Ct. Memo LEXIS 57, at *21 n.8 (2002)

(stating that admission by taxpayer that income was received is

sufficient to satisfy Commissioner’s burden).            Furthermore, since

the Tanners’ stipulations allowed the Commissioner to satisfy its

burden   of    proof   with   respect   to   the    unreported   income,   the

Commissioner was entitled to take advantage of the six-year statute

of limitations provided for under I.R.C. § 6501(e)(1)(A) (2000).

              Reaching the merits, the Tanners contend that the Tax

Court erred in applying 26 U.S.C. § 83.            Under section 83(a), when

property (such as stock options) is transferred to a taxpayer in

connection with the taxpayer’s provision of services, the taxpayer

must generally include in gross income the fair market value of the

property at the first time the taxpayer’s interest in the property

becomes “substantially vested,” less the amount paid for the

property.     I.R.C. § 83(a) (2000); Treas. Reg. § 1.83-1(a)(1).           For

the taxpayer’s interest in the options to be substantially vested,

the interest must be transferable or not subject to a substantial

risk of forfeiture.       Treas. Reg. § 1.83-3(b).         Section 83(c)(3)

further provides that a taxpayer’s rights in property are per se

not transferable and subject to a substantial risk of forfeiture

(i.e., not substantially vested) if the sale of the property at a

profit by the taxpayer would subject the taxpayer to suit under

section 16(b) of the Securities Exchange Act of 1934.               I.R.C. §

83(c)(3) (2000).

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          The Tanners initially argue that Paul’s interest in the

Polyphase stock was not substantially vested upon the exercise of

his option because, at the time of the exercise, if he had sold the

stock he would have been subject to liability under section 16(b)

for six more months after the sale.1   The flaw in this argument was

pointed out, however, by the Tax Court’s recognition that although

Section 16(b) liability can extend beyond six months from the

acquisition of the property, Congress did not make the period in

Section 83(c)(3) coterminous with the period of the taxpayer’s

potential Section 16(b) liability. Section 83(c) applies only when

the “sale of property at a profit could subject a person to suit

under section 16(b).”     15 U.S.C. § 78p(b) (2000).       Treasury

Regulation Section 1.83-3(j)(1) incorporates this understanding:

          For purposes of section 83 and the regulations
          thereunder if the sale of property at a profit
          within six months after the purchase of the
          property could subject a person to suit under
          section 16(b) of the Securities Exchange Act
          of 1934, the person's rights in the property
          are treated as subject to a substantial risk
          of forfeiture and as not transferable until
          the earlier of (i) the expiration of such
          six-month period, or (ii) the first day on
          which the sale of such property at a profit

     1
       Under section 16(b), corporate insiders, such as Tanner,
must disgorge to the issuing corporation any profit realized as a
result of a purchase and sale, or sale and purchase, of a covered
equity security within a six month period. Securities Exchange Act
of 1934 § 16(b); 15 U.S.C. § 78p(b) (2000).        For purposes of
section 16(b), the grant of an option is equivalent to a purchase
and the exercise of an option is a nonevent. Magma Power Co. v. Dow
Chem. Co., 136 F.3d 316, 321-22 (2d Cir. 1998) (citing 17 C.F.R. §
240.16b-6(a) (1997)).

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            will not subject the person to suit under
            section 16(b).

Treas. Reg. § 1.83-3(j)(1) (emphasis added).          The tax statute and

regulations protect a recipient of stock options for the first six

months after their grant, consistent with section 16(b), but do not

afford the rolling protection sought by the Tanners based on every

future event of exercise of the options.

            The Tanners finally assert that Paul’s interest in the

options was not substantially vested and the net income realized

upon exercise of the options was not includible in his taxable

income   under   section    83(a)   because   a   lockup   agreement   with

Polyphase prohibited Paul from selling his Polyphase stock for a

period of two years.       While the lockup agreement did prevent Paul

Tanner from selling his Polyphase stock, it did not prohibit him

from assigning his Polyphase stock to another (he gave some of his

stock to relatives) or pledging it as collateral for a loan.           Under

the regulations, Paul’s interest was plainly transferable and thus

substantially    vested.      Treas.   Reg.   §   1.83-3(d)   (property   is

transferable and not subject to a substantial risk of forfeiture if

it can be sold, assigned, or pledged).

            Because the Tax Court did not err with respect to its

procedural rulings or in holding the $728,000 to be properly

included as income to the Tanners, the decision of the Tax Court is

AFFIRMED.

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