Court Opinion

ID: 4473038
Source: CourtListenerOpinion
Date Created: 2020-01-14 19:35:03.329685+00
Date Added: 2024-06-11T15:04:15.732457
License: Public Domain

Ruwe, J., dissenting: The issue in this case is whether petitioner is to be denied a deduction for compensation paid in the form of property. The property was not subject to risk of forfeiture. The fair market value of the stock was includible1 in the employees’ income when the transfer occurred. The transfer meets the deductibility requirements of section 162. The only possible impediment to the deduction is section 83 and the regulations thereunder.2  The applicable statutory language is contained in subsections (a) and (h) of section 83. Subsection (a) provides that the value of transferred property: shall be included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture * * * [Emphasis added.] Subsection (h) provides: SEC. 83(h). Deduction by Employer. — In the case of a transfer of property to which this section applies * * * there shall be allowed as a deduction under section 162, to the person for whom were performed the services in connection with which such property was transferred, an amount equal to the amount included under subsection (a), (b), or (d)(2) in the gross income of the person who performed such services. Such deduction shall be allowed for the taxable year of such person in which or with which ends the taxable year in which such amount is included in the gross income of the person who performed such services. [Emphasis added.] The majority interprets the term “included” as used in section 83 as if it means actually reported on each service provider’s income tax return or otherwise used to compute the service provider’s income tax liability.3 The majority simply describes this as the clear, plain, and unambiguous meaning of the statute. No precedent is cited. The word “included” 'is used three times in subsections (a) and (h) of section 83. Section 83(a) provides that the value of the property received as compensation for services “shall be included in the gross income” of the recipient. This means that such property is required to be included in gross income as a matter of law.4  Section 83(h) provides that “there shall be allowed as a deduction under section 162 * * * the amount included under subsection (a)”; i.e., the amount included under subsection (a) as a matter of law. As explained in the Senate Finance Committee report: “The allowable deduction is the amount which the employee is required to recognize as income”. S. Rept. 91-552, at 123 (1969), 1969-3 C.B. 423, 502 (emphasis added). The next sentence of section 83(h) provides that the employer’s deduction “shall be allowed” for the taxable year of the employer that coincides with the taxable year of the person who performed services “in which such amount is included in the gross income” of such person. A natural interpretation of this last phrase, and the one that is consistent with the previous use of the term “included”, is that it refers to included in gross income as a matter of law. The majority makes no argument that these three instances wherein the term “included” was used were intended to convey different meanings of that single word. The majority, however, concludes that when Congress used the word “included” it meant something other than “includible” as a matter of law. I disagree. The Code sections providing that different types of accessions to wealth constitute gross income use various forms of the word “include”. Section 61(a) provides that “gross income means all income from whatever source derived, including (but not limited to) the following items:” and then lists 15 items specifically included in gross income. Section 61(b) provides: “For items specifically included in gross income, see part II (sec. 71 and following). For items specifically excluded from gross income, see part III (sec. 101 and following).” Section 79 uses the same articulation as section 83 in providing that the cost of employees’ group term life insurance “shall be included in the gross income” of employees. The same is true for reimbursed moving expenses under section 82. Other Code sections convey the same meaning by different terms such as providing that “gross income includes” alimony (section 71), annuities (section 72), prizes and awards (section 74), and Social Security benefits (section 86). Section 80(a) provides that the restoration of value of certain securities “shall, except as provided in subsection (b), be included in gross income”. Subsection (b) then provides for reducing “The amount otherwise includible in gross income under subsection (a)” (emphasis added), using the term “includible” to refer to what was previously “included” in gross income. In another variation, section 88 provides that nuclear decommissioning costs that are built into costs of services for ratemaking purposes “shall be includible in the gross income of such taxpayer”.5 (Emphasis added.) Obviously, Congress has used the terms “includes”, “included”, and “includible” interchangeably. The regulations regarding gross income also use variations of the word “include” to describe items that constitute gross income. Section 1.61-l(a), Income Tax Regs., provides that “Gross income includes income realized in any form, whether in money, property, or services.” That regulation goes on to provide: (1) For examples of items specifically included in gross income, see part II (section 71 and following), subchapter B, chapter 1 of the Code. (2) For examples of items specifically excluded from gross income, see part III (section 101 and following), subchapter B, chapter 1 of the Code. (3) For general rules as to the taxable year for which an item is to be included in gross income, see section 451 and the regulations thereunder. [Sec. 1.61-l(b), Income Tax Regs.] Section 1.61-2T(a), Temporary Income Tax Regs., 50 Fed. Reg. 52281, 52285 (Dec. 23, 1985), provides that “gross income includes compensation for services”. Section 1.61— 6(a), Income Tax Regs., provides: “Gain realized on the sale or exchange of property is included in gross income, unless excluded by law.” Section 1.61-9(a), Income Tax Regs., provides: Except as otherwise specifically provided, dividends are included in gross income under sections 61 and 301. For the principal rules with respect to dividends includible in gross income, see section 316 and the regulations thereunder. * * * [Emphasis added.] Section 1.61-9(b), Income Tax Regs., provides: Gross income includes dividends in property other than cash, as well as cash dividends. For amounts to be included in gross income when distributions of property are made, see section 301 and the regulations thereunder. The terms “includes”, “included”, and “includible” in reference to gross income are used throughout the Code and regulations and, as the above examples demonstrate, generally refer to the legal status of an item that constitutes gross income. In a Court-reviewed opinion released on February 19, 1998, this Court also used the terms “included” and “includes” in the same sense when we stated: Absent any exclusionary provision, items of income are included in gross income. Sec. 61(a). Section 61(a)(12) includes COD income in gross income. * * * [Nelson v. Commissioner, 110 T.C. 114, 116 (1998).] The majority, relying on the report of the Senate Finance Committee, opines that “included” means “taken into account in determining the tax liability” and is synonymous with the term “recognize”. Majority op. p. 240. In note 3 on page 241 of the majority opinion, the majority argues that because section 83(h) uses the term “included” and section 404(a)(5), which was also added by section 321 of the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 487, 588, uses the term “includible”, Congress intended different meanings.6 However, a close analysis of the Senate Finance Committee report indicates that Congress used the two terms interchangeably. The Senate Finance Committee report refers to the deduction under section 83(h) and states: The allowable deduction is the amount which the employee is required to recognize as income. The deduction is to be allowed in the employer’s accounting period which includes the close of the taxable year in which the employee recognizes the income. * * * [S. Rept. 91-552, supra at 123, 1969-3 C.B. at 502; emphasis added.] Section 404(a)(5), which uses the term “includible”, is then explained by the Senate Finance Committee by using essentially the same terminology: The committee provided with respect to nonexempt trusts that the employer will be allowed a deduction for his contribution at the time that the employee recognizes income * * * [S. Rept. 91-552, supra at 123, 1969-3 C.B. at 502; emphasis added.] The Senate Finance Committee report uses the phrase “required to recognize” to describe the amount of any deduction under section 83(h). Section 83(h) itself describes the amount of the deduction as the “amount included” in the gross income of the employee. The term “recognizes” is used by the committee to describe the period in which property “is included” in an employee’s gross income in section 83(h). The term “recognizes” is also used by the committee to describe the period in which income “is includible” by the employee in section 404(a)(5). Thus, it is reasonable to conclude that the timing provisions of both sections were intended to refer to the year in which income is required to be “included” or is “includible” in the employee’s income. When Congress wants to require actual reporting of gross income, it knows how to say so. For example, section 1367(b)(1) provides that An amount which is required to be included in the gross income of a shareholder and shown on his return shall be taken into account under subpara-graph (A) or (B) of subsection (a)(1) only to the extent such amount is included in the shareholder’s gross income on his return * * * Interpreting the word “included” to mean “reported by” or “actually used in computing the tax liability of” any employee or independent contractor would establish a statutory requirement that would be impractical and in many cases impossible for employers to meet. Deductions are a matter of legislative grace, and a taxpayer is required to meet all of the statutory requirements before taking a deduction. Employers would not be able to take a deduction until they first ascertained that their employees and independent contractors had filed an income tax return and reported the item as gross income. How could employers know that employees and independent contractors had actually filed returns and reported the property transfers as income before taking a deduction? Indeed, in many situations the employer’s return would be due before the due date of the service providers’ returns.7 Even the majority acknowledges that its interpretation sets up an impractical requirement that the majority believes justifies “employer friendly” regulations that are at variance with the majority’s own interpretation of the statutory requirements. When the applicable regulations interpreting section 83(h) were issued in 1978, neither the preamble in the Treasury decision nor the regulations contained anything indicating that deductibility under section 83(h) depends on an employee or independent contractor’s actually reporting the compensation. On July 11, 1978, final regulations were issued dealing with section 83(h). T.D. 7554, 1978-2 C.B. 71. The general rule for deductions under section 83(h) was stated as follows: (1) General rule. In the case of a transfer of property in connection with the performance of services, or a compensatory cancellation of a nonlapse restriction described in section 83(d) and §1.83-5, a deduction is allowable under sections 162 or 212, to the person for whom such services were performed. The amount of the deduction is equal to the amount includible as compensation in the gross income of the service provider, under section 83(a), (b), or (d)(2), but only to the extent such amount meets the requirements of section 162 or 212 and the regulations thereunder. Such deduction shall be allowed only for the taxable year of such person in which or with which ends the taxable year of the service provider in which such amount is includible as compensation. For purposes of this paragraph, any amount excluded from gross income under section 79 or section 101(b) or subchapter N shall be considered to have been includible in gross income. [Sec. 1.83-6(a)(l), Income Tax Regs.; emphasis added.] The explanation of the difference between these final regulations and those previously proposed in 1971 was as follows: Subject to the requirements of sections 162 and 212, a deduction is allowed to the person for whom services were performed, in an amount equal to the amount of compensation includible in the gross income of the person who provided the services, at the time the compensation becomes includible in the gross income of the person who performed the services. This timing rule is a change from the regulations as proposed in 1971, which allowed a deduction at the time an amount was actually included in gross income. This change was suggested by public comments to the regulations as proposed in 1971. [T.D. 7554, supra, 1978-2 C.B. at 72-73; emphasis added.] There is nothing in T.D. 7554, supra, to indicate that these regulatory provisions allowing the deduction “at the time the compensation becomes includible” were intended to be anything other than a proper interpretation of the statutory language of section 83(h). Nothing in T.D. 7554, supra, describes the use of the word “includible” as a “safe harbor” or an “employer-friendly” variance from the statutory requirement. Indeed, T.D. 7554, supra, states that the U.S. Treasury Department rejected any suggested regulatory language that conflicted with the express statutory language. Many comments suggested changes that either conflicted with the express statutory language or would have made the regulations unreasonably long and complex. Those suggestions were rejected. [Id., 1978-2 C.B. at 73.] It is clear that use of the word “includible” in the regulations is used in the sense that the law requires inclusion. Those regulations remained in effect for 17 years and apply to the years in issue. I believe that section 1.83-6(a)(l), Income Tax Regs., is a proper interpretation of the requirements of section 83(h). This interpretation is supported by Duncan Indus., Inc. v. Commissioner, 73 T.C. 266, 285 (1979), where we stated: Section 83(h) expressly allows the person for whom the services were performed to deduct an amount equal to the amount includable in the service performer’s income under section 83(a). * * * [Emphasis added.] The majority’s interpretation of section 83 conflicts with the interpretation contained in section 1.83-6(a)(l), Income Tax Regs. The majority attempts to reconcile this conflict by describing the regulations as being an “employer-friendly” “safe harbor”. But such rationalization is only necessary because of the majority’s strained interpretation of the term “included”. If given a choice between two possible interpretations, we should choose the one that is reasonable and practical rather than assume that Congress intended to set standards for deductions that are impractical, if not impossible, to meet.8 See United States v. American Trucking Associations, Inc., 310 U.S. 534, 543 (1940). The more reasonable and practical interpretation, and the one contained in the applicable interpretative regulations, is that a deduction under section 83(h) is allowed for the employer’s taxable year that coincides with the taxable year in which the compensation is “includible” in the service provider’s income. Section 1.83-6(a)(2), Income Tax Regs., provides a “Special rule” for compensatory transfers of property by “employers” to “employees”. It allows a deduction in the employer’s taxable year that coincides with the year in which the compensation is “includible” in the employee’s income, but “only if the employer deducts and withholds upon such amount in accordance with section 3402.” Id. This regulatory requirement that there be withholding has no basis in the statutory language or the legislative history of section 83(h). The majority nevertheless upholds the validity of this withholding requirement by treating it as a relaxation of what it believes to be the more explicit and onerous requirements in the Code. The only basis for this is the majority’s restrictive and erroneous interpretation of the word “included”.9  Finally, even if section 1.83 — 6(a)(2), Income Tax Regs., is considered valid, section 1.83 — 6(a)(3), Income Tax Regs., provides an exception to the requirements of section 1.83-6(a)(2), Income Tax Regs. Despite the statutory timing provisions of section 83(h), which are also contained in section 1.83-6(a)(l) and (2), Income Tax Regs., section 1.83-6(a)(3), Income Tax Regs, (hereinafter subparagraph (3)), provides: (3) Exceptions. Where property is substantially vested upon transfer, the deduction shall be allowed to such person in accordance with his method of accounting (in conformity with sections 446 and 461). * * * Pursuant to this exception, when the compensatory transfer consists of property that is substantially vested upon transfer (which is true in the instant case), the explicit timing provisions of section 83(h) and the regulations are not applicable.10 Petitioner’s transfers come within the exception in subparagraph (3). The majority suggests that the exception in subparagraph (3) overrides the explicit statutory timing requirements in section 83(h) but does not override the withholding requirements in section 1.83-6(a)(2), Income Tax Regs. This is a non sequitur. Section 1.83-6(a)(2), Income Tax Regs., imposes a withholding requirement, but only in connection with the application of its specific timing provisions. Thus, in the only-sentence that has any application to this case, the regulation provides: If the service provider is an employee of the person for whom services were performed, such deduction is allowed for the taxable year of the employer in which or with which ends the taxable year of the employee in which such amount is includible as compensation, but only if the employer deducts and withholds upon such amount in accordance with section 3402. * * * [Sec. 1.83 — 6(a)(2), Income Tax Regs.] The literal terms of the withholding requirement in the above-quoted regulation apply only where the deduction is allowed for the employer’s taxable year in which or with which ends the taxable year in which the compensation is includible in the employees’ income; i.e., where the timing rules of section 83(h) apply. The withholding requirement does not purport to apply to other situations, such as where the deduction is allowed in accordance with the employer’s own accounting method pursuant to subparagraph (3). The majority states that the regulations under section 83(h) implement the following three requirements for deduct-ibility: (1) The requirements of sections 162 or 212; (2) the requirements of section 83(h) regarding the amount of the deduction; and (3) the requirements of section 83(h) regarding the timing of the deduction. There is no question in this case that the transfer of property qualifies for deduction under section 162. Deductions under section 162 are not conditioned on withholding. There is also no question in this case regarding the amount of any potential deduction pursuant to the formula in the statute.11 As stated in the Senate Finance Committee report: “The allowable deduction is the amount which the employee is required to recognize as income.” S. Rept. 91-552, supra at 123, 1969-3 C.B. at 502 (emphasis added). As we stated in Duncan Indus., Inc. v. Commissioner, 73 T.C. at 285: Section 83(h) expressly allows the person for whom the services were performed to deduct an amount equal to the amount includable in the service performer’s income under section 83(a). * * * [Emphasis added.] The only other requirement concerns timing.12 The majority argues that subparagraph (3) is only an exception to the statutory timing provision. But that is the only statutory requirement that is conceivably in issue. We recently addressed the exception contained in subpara-graph (3). In Schmidt Baking Co. v. Commissioner, 107 T.C. 271 (1996), the taxpayer-employer’s taxable year ended on December 28. The taxpayer deducted vacation and severance pay that it had accrued as of December 28, 1991, on its return for the year ended December 28, 1991. The taxpayer’s employees received unrestricted property representing the accrued vacation and severance pay on March 13, 1992, which was during the employees’ calendar year ended December 31, 1992. If the explicit timing provisions of section 83(h) and section 1.83-6(a)(2), Income Tax Regs., applied, the taxpayer would not have been entitled to take the deduction until its taxable year ended December 28, 1993; i.e., the taxpayer’s taxable year in which or with which ends the employee’s taxable year in which the amount was includible in the employee’s income. Nevertheless, based on the exception in subparagraph (3), we allowed the deduction irf the year ended December 28, 1991, in accordance with the taxpayer’s accrual method of accounting.13  The instant case turns on an interpretation of section 83 and the regulations. Legal interpretations should not be driven by the facts of a particular case. While I disagree with the majority’s interpretation, I recognize that the operative facts of this particular case raise questions about the “equity” of allowing a corporate deduction for compensation paid to its controlling shareholders and principal officers, who failed to report the same items as income. However, neither respondent nor the majority relies on equitable arguments. In any event, such considerations should play no part in how we interpret statutory and regulatory language. Cohen, Wells, Beghe, Chiechi, and Gale, JJ., agree with this dissent.   The words “includible” and “includable” are used interchangeably. I will use “includible” because that spelling is used consistently by Congress throughout the Code.    Unless otherwise stated, references to the regulations under sec. 83 are to those in-effect from 1978 through 1995 and which are applicable to the years in issue. The current regulations promulgated in 1995 are effective for taxable years ending after Jan. 1, 1995, although they may be used by employers who so choose for any taxable year not closed by the statute of limitations.    The alternative to reporting as gross income on the employee’s or independent contractor’s return would be an adjustment to gross income in a deficiency determination.    In Adair v. Commissioner, T.C. Memo. 1985-392, we stated: Section 83(a) provides that property transferred “in connection with the performance of services” is included in the gross income of the transferee in an amount equal to the excess of the fair market value over the amount paid for the property transferred.* * * [Fn. ref. omitted; emphasis added.]    Congress has used the phrase “shall be includible in gross income” as a legal mandate in the following Code sections: 101(fX3)(B)(ii); 415(b)(10)(C)(ii); 454(c); 457(a), (g); 468A(c)(l); 529(c)(3)(A); 530(d)(1); 704(e)(2); 7702(f)(1)(C); 7702A(e)(l)(C); and 7702B(b)(2)(C), (d)(1). Further, Congress has used the phrase "is includible in the gross income” as a legal mandate in sec. 72(m)(3)(B), and Congress has used the phrase “are includible in gross income” as a legal mandate in sec. 803(a)(3).    Sec. 404(a)(5) provides that contributions to nonexempt plans are deductible in the taxable year in which an amount attributable to the contribution is “includible in the gross income of employees”. Sec. 402(b)(1) provides that employer contributions to a nonexempt trust “shall be included in the gross income of the employee in accordance with section 83”.    Most individual employees file returns on a calendar year basis, in which case their returns are due on Apr. 15. Employers are often corporations filing returns on the basis of a fiscal year. Even those corporations filing returns on a calendar year basis are, absent extensions, required to file returns on Mar. 15. See sec. 6072.    Indeed, were we to interpret “included” as meaning "reported”, an employer could arguably take the deduction in any amount for any year that matches the employee’s reporting position.    The withholding requirement in sec. 1.83-6(a)(2), Income Tax Regs., is fatally flawed even if one were to accept respondent’s definition of “included”. Under this regulation, deductibility is totally dependent on whether the employer withheld tax upon the compensatory transfer of property. An obvious example in which the withholding requirement is unworkable involves its application to situations where there are significant restrictions on the employee’s rights to the property at the time of transfer, such as a substantial risk of forfeiture. In that case, the employee generally receives no includible gross income under sec. 83(a) until those restrictions are lifted. Therefore, there would be no withholding requirement at the time of the initial transfer. Indeed, the amount of any reportable compensation would not be known at the time of transfer. But any withholding that might be required when the restrictions are lifted, possibly years later, may be physically or legally impossible if the employee earned no other compensation in the later year or was no longer an employee. Withholding would also be inappropriate if the employee’s Form W-4 indicates no withholding was required. Sec. 1.83-6(a)(2), Income Tax Kegs., would also disallow a deduction for a compensatory transfer of property to an employee where there was no withholding, even where the employee reported the income and paid the tax. Respondent has acknowledged that “employers that failed to deduct and withhold income tax were denied a deduction even where the employee reported the income and paid the tax .” T.D. 8599, 1995-2 C.B. 12, 12 (emphasis added). Thus, this part of the regulation was in conflict with respondent’s current position that actual reporting is exactly what sec. 83(h) requires.    Sec. 83(h) requires that any deduction by the service recipient be allowed “for the taxable year of such person [the service recipient or employer] in which or with which ends the taxable year in which such amount is included in the gross income of the person who performed such services.” In light of the explicit timing provisions of sec. 83(h), how can the exception in subpar. (3) be justified? The original version of sec. 83 introduced in the House of Representatives contained no provision regarding deductions for property transferred in return for services. What is now sec. 83(h) was first introduced by the Senate Finance Committee. The Senate report states: The committee provided rules for the employer’s deduction for restricted property given to employees as compensation. The allowable deduction is the amount which the employee is required to recognize as income. * * * [S. Rept. 91-552, at 123 (1969), 1969-3 C.B. 423, 502; emphasis added.] It is therefore possible that the U.S. Treasury Department concluded that sec. 83(h) was not intended to affect deductions based on the transfers of unrestricted property.    The majority makes no attempt to link the regulatory withholding requirement to the statutory provisions regarding the amount of any deduction, and, indeed, there is no linkage.    As stated in Duncan Indus., Inc. v. Commissioner, 73 T.C. 266, 285 (1979): Section 83(h) is a modification of section 162 which only affects the time and amount of deductions otherwise allowable, when property is transferred in connection with services. * * * [Emphasis added.]    In Schmidt Baking Co. v. Commissioner, 107 T.C. 271 (1996), the parties had stipulated that the taxpayer-employer had not withheld taxes when it transferred the property on Mar. 13, 1992.