Gudmundsson v. United States ( 2011 )

09-4869-cv
Gudmundsson v. United States
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
August Term 2010
Argued: September 20, 2010 Decided: February 11, 2011
Docket No. 09-4869-cv
OLAFUR GUDMUNDSSON, SALLY A. RUDRUD,
Plaintiffs-Appellants,
v.
UNITED STATES OF AMERICA,
Defendant-Appellee.
Before: CALABRESI, KATZMANN, and CHIN, Circuit Judges.
Appeal from a judgment of the United States District
Court for the Western District of New York (David G. Larimer, J.)
dismissing plaintiffs-appellants' claim for a tax refund.
Plaintiffs-appellants argued that they prematurely recognized and
significantly overvalued property received in connection with the
performance of services. The district court disagreed and
granted summary judgment to the government.
AFFIRMED.
ARNOLD R. PETRALIA, Petralia, Webb &
O'Connell, P.C., Rochester, New
York (Kenneth L. Greene, on the
brief), for Plaintiffs-Appellants.
ELLEN PAGE DELSOLE, Attorney, United
States Department of Justice, Tax
Division (William J. Hochul, Jr.,
United States Attorney for the
Western District of New York, of
counsel), for John A. DiCicco,
Acting Assistant Attorney General,
for Defendant-Appellee.
CHIN, Circuit Judge
In 2000, plaintiffs-appellants Olafur Gudmundsson
("Gudmundsson") and Sally Rudrud (together, "plaintiffs")1
jointly filed their 1999 federal tax return, reporting income
earned on stock Gudmundsson received as compensation from his
employer, Aurora Foods, Inc. ("Aurora"), on July 1, 1999. The
stock was subject to several contractual and legal restrictions
that impeded its marketability for one year -- by which point the
company's stock value had plummeted. Plaintiffs sought to amend
the tax return and obtain a refund, asserting that they had
prematurely reported the stock and significantly overvalued it as
income under § 83 of the Internal Revenue Code (the "I.R.C.").
After exhausting their administrative remedies, they brought this
1
Plaintiffs were married at all relevant times. They
are now divorced but have pursued this claim together.
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action against the government in the Western District of New
York. In a thoughtful and thorough decision, the district court
(Larimer, J.) granted summary judgment in favor of the
government. We affirm.
STATEMENT OF THE CASE
A. The Facts
The parties stipulated to the following facts before
the district court.
At all relevant times, Gudmundsson was an officer of
Aurora, which marketed food products under brand names such as
Aunt Jemima, Duncan Hines, and Van de Kamp. Shortly after a
corporate reorganization, Aurora made an initial public offering
of 14,500,000 registered shares of common stock on July 1, 1998
(the "IPO"). Gudmundsson became entitled to 73,105 unregistered
shares (the "Stock") by virtue of his participation in Aurora's
incentive compensation plan. The plan provided for the Stock to
be distributed to him one year from the date of the IPO, on July
1, 1999. Gudmundsson received the Stock as planned.
Aurora subsequently provided Gudmundsson a W-2 that
calculated his income from the distribution to be a little less
than $1.3 million. This figure reflected the mean price of
unrestricted shares of Aurora stock trading on the New York Stock
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Exchange (the "Exchange Price") on July 1, 1999: $17.6875.
Gudmundsson reported this amount as income under I.R.C. § 83 --
which governs the taxation of property transferred in connection
with the performance of services -- in the federal tax return he
filed jointly with his then-wife, on or before April 15, 2000.
Gudmundsson held the Stock subject to several
constraints. First, these were "restricted securities" under
Securities and Exchange Commission ("SEC") Rule 144, 17 C.F.R.
§ 230.144(a)(3)(i), meaning they were acquired directly from the
issuer and not in a public offering, id. Under Rule 144, the
Stock could not be sold on a public exchange until the expiration
of a holding period that, in Gudmundsson's case, ended on July 1,
2000. See Berckeley Inv. Grp., Ltd. v. Colkitt, 455 F.3d 195,
213 (3d Cir. 2006) (discussing the operation of Rule 144). The
Stock could, however, be disposed of in a private placement sale
or pledged as security or loan collateral. See McDonald v.
Comm'r, 764 F.2d 322, 323 n.3 (5th Cir. 1985) (citing 17 C.F.R.
§ 230.144(a)(3)).
Second, the Stock was subject to an agreement among
Aurora's various corporate entities and employee "members,"
including Gudmundsson (the "Agreement"). The Agreement
prohibited, inter alia, the public disposition of the Stock
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before the second anniversary of the IPO, July 1, 2000. Until
then, transfers could be made only to a group of "permitted
transferees," which included family members and relatives.
Permitted transferees were bound by the Agreement and had to
agree in writing to abide by its terms. Aurora would treat any
transfers other than to permitted transferees as null and void,
and in some instances it could intervene to stop a forbidden
transfer. Forfeiture of the Stock, however, was not one of the
penalties contemplated for violations of the Agreement, whether
by Gudmundsson or a permitted transferee.
Finally, Gudmundsson was subject to Aurora's Insider
Trading Policy (the "Policy"). Among other things, the Policy
required compliance with certain waiting periods and consent
procedures prior to trading Aurora stock. Violation of the
Policy could result in disciplinary action, including termination
of employment.
Conditions at Aurora deteriorated in the year between
Gudmundsson's receipt of the Stock and expiration of the
restrictions imposed by the Agreement and Rule 144. Unrestricted
shares of Aurora stock -- which had been worth $17.6875 per share
on July 1, 1999 -- lost a quarter of their value over three days
that November following the company's announcement that it would
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not meet estimated fourth quarter earnings. By December 31,
1999, the Exchange Price had fallen to $9.25.
In February 2000, Aurora's auditors discovered
irregularities in the company's financial statements, and the
board of directors announced the formation of a committee to
investigate Aurora's accounting practices and the possibility of
fraud. Several senior-level executives resigned.2 The Exchange
Price tumbled another fifty percent. That April, Aurora
announced an $81 million downward adjustment in pretax earnings
previously reported for most of 1998 and 1999. By the time the
Stock was freely marketable on July 1, 2000, the Exchange Price
had fallen to $3.8375, a decline of almost $14 in one year.
B. Prior Proceedings
In 2003, plaintiffs filed an amended tax return,
claiming a refund of $301,834 plus interest based on the mean
Exchange price of Aurora stock on December 31, 1999,3 rather than
the price on July 1, as originally reported. The Internal
2
Eventually, the executives responsible for the
wrongdoing were indicted and pled guilty to securities fraud and
related charges. Gudmundsson was not involved, and there is no
evidence that he had knowledge of the misconduct.
3
This amount was based on a mistaken Exchange Price of
$7.5625. The Exchange Price on December 31, 1999 was actually
$9.25.
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Revenue Service (the "IRS") disallowed the claim in 2006. On
March 20, 2008, plaintiffs filed this refund action below,
pursuant to 28 U.S.C. § 1346(a)(1) and 26 U.S.C. § 7422.
In the proceedings before the district court, the
parties agreed that the transaction was governed by I.R.C. § 83
and that the Stock was "transferred" to Gudmundsson within the
meaning of that provision on July 1, 1999. They disagreed as to
when the Stock became taxable income. The government argued that
the original tax return had properly reported the Stock on July
1, 1999, and properly used the Exchange Price that day as the
measure of value. Plaintiffs contended that they had been
premature to treat the Stock as income on July 1, 1999, given the
restrictions still encumbering it at the time. Alternatively,
they argued that if July 1, 1999 was the correct recognition
date, then the Stock should not be treated as if it could be sold
at the same price as Aurora's unrestricted shares.
The parties cross-moved for summary judgment. On
October 27, 2009, the district court (Larimer, J.) entered
summary judgment in favor of the government, holding that the
Stock was reportable as of July 1, 1999 and that the day's
Exchange Price was an appropriate basis for measuring the income
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received. See Gudmundsson v. United States, 665 F. Supp. 2d 227,
236-39 (W.D.N.Y. 2009). This appeal followed.
DISCUSSION
A. Standard of Review
This Court reviews a decision granting summary judgment
de novo. Beth Israel Med. Ctr. v. Horizon Blue Cross & Blue
Shield of N.J., Inc., 448 F.3d 573, 579 (2d Cir. 2006). Summary
judgment is appropriate "if there is no genuine issue as to any
material fact, and if the moving party is entitled to a judgment
as a matter of law." Allianz Ins. Co. v. Lerner, 416 F.3d 109,
113 (2d Cir. 2005) (citing Fed. R. Civ. P. 56(c)). The facts of
this case were stipulated and therefore only questions of law are
presented.
B. Taxation of Property under I.R.C. § 83
At the heart of this case is I.R.C. § 83, which governs
the taxation of property transferred in connection with the
performance of services.5 Section 83 was enacted as part of the
5
Section 83(a) provides:
If, in connection with the performance of
services, property is transferred to any
person other than the person for whom such
services are performed, the excess of--
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Tax Reform Act of 1969, Pub. L. No. 91-172, 83 Stat. 487 (1969).
It was designed to "curb the use of sales restrictions to defer
taxes on property given in exchange for services," Robinson v.
Comm'r, 805 F.2d 38, 41 (1st Cir. 1986), which had become a
popular practice among corporations and their employees. The
provision's general rule, set forth in § 83(a), has both a timing
element and a valuation element. As a matter of timing, property
received as compensation is to be recognized as income as soon as
the recipient's rights therein are "transferable" or no longer
"subject to a substantial risk of forfeiture," whichever happens
(1) the fair market value of such
property (determined without regard to any
restriction other than a restriction which by
its terms will never lapse) at the first time
the rights of the person having the
beneficial interest in such property are
transferable or are not subject to a
substantial risk of forfeiture, whichever
occurs earlier, over
(2) the amount (if any) paid for such
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,
whichever is applicable.
I.R.C. § 83(a).
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first. I.R.C. § 83(a); see also Treas. Reg. § 1.83-3(b). The
value of the income received is the property's "fair market
value," measured without regard to any restriction, "other than
[a] restriction which by its terms will never lapse," I.R.C.
§ 83(a) -- also known as a "nonlapse" restriction, as
distinguished from one that will "lapse," see Treas. Reg.
§ 1.83-3(h), (i).
Both the timing and valuation components are at issue
in this case, which presents two questions: (1) when was it
appropriate to recognize the Stock as taxable income?, and (2)
what was its fair market value on that date? We address these
issues in turn.
1. The Recognition Date
Plaintiffs argue that the district court erred in
recognizing the Stock as income on July 1, 1999. They contend
that the restrictions still in force on that date rendered it
both non-transferable and subject to a substantial risk of
forfeiture.4 To survive summary judgment, plaintiffs needed to
4
Plaintiffs argue for alternative recognition dates --
e.g., December 31, 1999, July 1, 2000 -- that we need not address
because we agree with the district court that the Stock was
reportable on July 1, 1999. This date was stipulated to be the
date of the Stock transfer, and it was the one reported on
plaintiffs' original tax return. We note, however, that it was
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show the existence of both these conditions, as § 83(a)
recognizes property as soon as either is lifted. The district
court, however, concluded that the Stock was both transferable
and not subject to a substantial risk of forfeiture on July 1,
1999. For the reasons that follow, we agree.
a. Transferability and Substantial Risk of Forfeiture
Section 83(c)(1) provides that property is subject to a
"substantial risk of forfeiture" when the "rights to full
enjoyment of such property are conditioned upon the future
performance of substantial services by any individual." I.R.C.
§ 83(c)(1). The regulations further explain that the existence
of such a risk "depends upon the facts and circumstances" of each
case. Treas. Reg. § 1.83-3(c)(1). It exists where rights "are
conditioned, directly or indirectly, upon the future performance
(or refraining from performance) of substantial services by any
person, or the occurrence of a condition related to a purpose of
the transfer, and the possibility of forfeiture is substantial if
such condition is not satisfied." Id. For example, where the
property is received "subject to a requirement that it be
returned if the total earnings of the employer do not increase,
not necessarily the first day on which the Stock was reportable
under § 83. See Gudmundsson, 665 F. Supp. 2d at 232 n.2.
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such property is subject to a substantial risk of forfeiture."
Id. § 1.83-3(c)(2). On the other hand, circumstances that do not
constitute a substantial risk of forfeiture include the risk that
the property's value will decline, as well as a requirement that
the property be returned if the recipient is discharged for cause
or for committing a crime. Id. § 1.83-3(c)(1), (2).
Substantial risks of forfeiture are also built into the
definition of transferability. Property is "transferable" under
§ 83(c)(2) "only if the rights in such property of any transferee
are not subject to a substantial risk of forfeiture." I.R.C.
§ 83(c)(2). The regulations explain that "transferable" property
can be sold, assigned, or pledged "to any person other than the
transferor" without that person also incurring a substantial risk
of forfeiture. Treas. Reg. § 1.83-3(d). Transferability is not
a demanding standard, as the ability to transfer to even one
transferee free of that substantial risk is presumed to
constitute "transferability," even though it may not also mean
full marketability. See Horwith v. Comm'r, 71 T.C. 932, 939-40
(1979).
Finally, § 83 contains a "[s]pecial rule[]" for
"[s]ales which may give rise to suit under section 16(b) of the
Securities Exchange Act of 1934," providing that if the sale of
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property given as compensation at a profit could subject a person
to suit under § 16(b), that person's rights in the property are
deemed to be subject to a substantial risk of forfeiture and not
transferable. I.R.C. § 83(c)(3).5
b. Application to the Stock
(1) Substantial Risk of Forfeiture
We are not persuaded by plaintiffs' arguments that the
Stock was subject to a substantial risk of forfeiture on July 1,
1999. Plaintiffs first argue that under the circumstances, the
risk of termination Gudmundsson faced if he failed to comply with
the Policy constituted a substantial risk of forfeiture. Section
83 is concerned with the forfeiture of interests in property,
however, not in employment, and a substantial risk of forfeiture
requires that those property interests be capable of being lost.
5
The parties agree that at all relevant times
Gudmundsson was an "insider" within the meaning of § 16(b). See
Morales v. Quintel Entm't, Inc., 249 F.3d 115, 121 (2d Cir. 2001)
("An 'insider' is . . . a beneficial owner of more than ten
percent of any class of the company's non-exempt, registered
equity securities, or a director or officer of the company
issuing the stock." (citing 15 U.S.C. § 78p(a), (b)). In the
district court, plaintiffs asserted that the Stock came within
§ 83(c)(3) on July 1, 1999 because Gudmundsson could have been
subject to a § 16(b) suit at that time. The district court
disagreed. See Gudmundsson, 665 F. Supp. 2d at 230, 234-35.
Because plaintiffs do not appeal this aspect of the decision, we
do not address it.
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See Merlo v. Comm'r, 492 F.3d 618, 622 (5th Cir. 2007);
Theophilos v. Comm'r, 85 F.3d 440, 447 n.18 (9th Cir. 1996)
(inquiring into "the chances [that] the employee will lose his
rights in property transferred by his employer" to determine
substantial risk of forfeiture (emphasis omitted)). Therefore,
the risk of termination of employment is relevant under § 83 only
if it has a causal connection to the loss or potential loss of
rights in the property given as compensation. See Merlo, 492
F.3d at 622 (termination for violating insider trading policy
"was not enough to cause [taxpayer] to forfeit the shares"). No
such connection exists here. The Agreement did not provide that
termination for violation of the Policy -- or termination for any
reason at all -- would or could result in the forfeiture of the
Stock. We therefore reject plaintiffs' argument.
Second, plaintiffs argue that Gudmundsson would be
exposed to a suit under § 10(b) of the Securities Exchange Act of
1934, 15 U.S.C. § 78j(b),6 if he transferred the Stock on July 1,
6
Under § 10(b), it is unlawful to "use or employ, in
connection with the purchase or sale of any security . . . , any
manipulative or deceptive device or contrivance" in violation of
SEC rules, including rules against insider trading and fraud. 15
U.S.C. § 78j(b); see 17 C.F.R. § 240.10b-5. Because we hold that
liability under this provision does not create a substantial risk
of forfeiture under § 83, we need not decide whether Gudmundsson
could have been the subject of such a suit.
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1999, and that this created "facts and circumstances" evidencing
a substantial risk of forfeiture, Treas. Reg. § 1.83-3(c),
analogous to the risk of suit under § 16(b), see I.R.C.
§ 83(c)(3).
We hold that the district court correctly rejected the
argument, as we conclude that Congress has already indicated that
§ 10(b) does not create a substantial risk of forfeiture under
§ 83. See Merlo, 492 F.3d at 622 ("For civil suits such as
[§ 10(b)] to be considered within the definition of a substantial
risk of forfeiture, Congress would have to amend § 83."); United
States v. Tuff, 469 F.3d 1249, 1256 (9th Cir. 2006). Congress
inserted directly into the statutory text a "[s]pecial rule[]"
using language that refers only to suits under § 16(b), and by
doing so it indicated "that civil suits are not generically
covered by I.R.C. § 83." Tuff, 469 F.3d at 1256; see I.R.C.
§ 83(c)(3). We therefore reject plaintiffs' effort to use the
regulations' "facts and circumstances" analysis to bootstrap
§ 10(b) liability into § 83.
(2) Transferability
The Stock was not subject to a substantial risk of
forfeiture on July 1, 1999, and although this is enough for
income recognition under § 83, we briefly address plaintiffs'
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arguments regarding the transferability of the Stock, as well.
As a preliminary matter, plaintiffs stipulated -- and the
Agreement was clear -- that Gudmundsson could transfer the Stock
to "permitted transferees," which included his family members and
relatives, any of whom were "person[s] other than [Aurora,] the
transferor," see Treas. Reg. § 1.83-3(d). Plaintiffs assert,
however, that the Stock was not transferable because "in reality,
. . . [t]he various restrictions imposed by law and agreement
made [the Stock] impossible to sell." Pls.' Br. 24. Regardless
of whether this is true, the argument misunderstands what § 83
requires. Transferability is not just a question of
marketability. In fact, even if sales are prohibited for a
period of time, property may be transferable if it can be pledged
or assigned. See Tanner v. Comm'r, No. 02-60463, 2003 WL
21310275, at *2 (5th Cir. Mar. 26, 2003); see also Treas. Reg.
§ 1.83-3(d).
We also reject plaintiffs' effort to analogize the
Agreement's transfer restrictions to those in Robinson v.
Commissioner, 805 F.2d 38 (1st Cir. 1986). In Robinson, the
First Circuit concluded that the stock at issue was not
transferable because it had been received subject to an agreement
that contained a mandatory sell back provision prohibiting any
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disposal of the shares other than to the employer for one year.
Id. at 39. In short, for Robinson to transfer the stock "to any
person other than the transferor," Treas. Reg. § 1.83-3(d), he
would be forced to breach the agreement, Robinson, 805 F.2d at
42. By contrast, here the Agreement permitted at least some
transfers during the restricted period. Further -- as plaintiffs
stipulated below -- the Agreement did not provide for the Stock
to be forfeited if Gudmundsson or a transferee violated its
terms. The agreement in Robinson, however, gave the employer the
power to recoup the stock after an event of noncompliance. Id.
at 39-40; see Hernandez v. United States, 450 F. Supp. 2d 1112,
1119 (C.D. Cal. 2006) (rejecting analogy to Robinson where
agreement did not contain mandatory sell back provision).7
Robinson does not help plaintiffs' case and is not a reasonable
analogue: individuals saddled by more complete transfer
restrictions than was Gudmundsson have been held to have
transferable interests under § 83. See Tanner, 2003 WL 1922926,
at *2 (deeming stock to be transferable despite two-year
7
In concluding that Robinson's stock could not be
recognized under § 83(a) until these restrictions expired, the
First Circuit held that transferability could not depend on "a
hypothetical, back-door transfer in breach of the option
agreement." Robinson, 805 F.2d at 42. Rather, it must operate
"on standard practices" and the "observance of contracts." Id.- 17 -
moratorium on sales where taxpayer could and did give the stock
to a relative).
To summarize, the district court was correct to
recognize the Stock as income on July 1, 1999, as the Stock was
transferable and not subject to a substantial risk of forfeiture
on that day. This conclusion was correct under § 83(a) and in
general, as income in whatever form is taxable in the year in
which it is received, Wolder v. Comm'r, 493 F.2d 608, 612-13 (2d
Cir. 1974); see also Sakol v. Comm'r, 574 F.2d 694, 700 (2d Cir.
1978), and stock is usually valued on the day it is issued,
United States v. Roush, 466 F.3d 380, 385 (5th Cir. 2006); cf.
Wolder, 493 F.2d at 612-13.
2. The Fair Market Value of the Stock
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.
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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.
a. The Calculation of Fair Market Value under § 83
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
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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
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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).
b. Lapse and Nonlapse Restrictions
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
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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).
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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
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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.
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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 ready-
made, 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
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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
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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
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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.
CONCLUSION
We have considered plaintiffs' other arguments and
conclude that they are without merit. The judgment of the
district court is AFFIRMED.
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