Pavlosky v. United States , 383 F. App'x 690 ( 2007 )

IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT United States Court of Appeals
Fifth Circuit
FILED
December 4, 2007
No. 06-20896 Charles R. Fulbruge III
Clerk
In The Matter Of: JAMES PAVLOSKY; DEBORAH THUMANN-PAVLOSKY
Debtors
JAMES PAVLOSKY; DEBORAH THUMANN-PAVLOSKY
Appellants
v.
UNITED STATES OF AMERICA, INTERNAL REVENUE SERVICE
Appellee
Appeal from the United States District Court
for the Southern District of Texas, Houston
USDC No. 4:06-CV-2061
Before KING, BARKSDALE, and DENNIS, Circuit Judges.
PER CURIAM:*
Plaintiffs-appellants James Pavlosky and Deborah Thumann-Pavlosky
filed a core adversary proceeding in their Chapter 13 bankruptcy seeking a tax
abatement of $147,538 for taxable year 2000 and a refund of $26,030 for taxable
*
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 R. 47.5, the court has determined that this opinion should not
be published and is not precedent except under the limited circumstances set forth in 5TH CIR.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.
No. 06-20896
year 2001 from defendant-appellee, the United States Internal Revenue Service.
The bankruptcy court granted the Internal Revenue Service’s motion for
summary judgment and dismissed with prejudice the Pavloskys’ complaint. The
bankruptcy court determined that the Pavloskys’ 2001 capital loss from the sale
of certain stock obtained through the exercise of an incentive stock option did not
give rise to a net operating loss for purposes of the regular income tax or the
alternative minimum tax net operating loss deduction. Consequently, the
Pavloskys could not carry that capital loss back to taxable year 2000 to offset the
income realized in that year on the exercise of the stock option or use the capital
loss to offset their ordinary income for taxable year 2001. The Pavloskys appeal
the district court’s judgment affirming the bankruptcy court. We AFFIRM.
I. FACTUAL AND PROCEDURAL BACKGROUND
The case arises from an adversary complaint filed by Chapter 13 debtors
James Pavlosky and Deborah Thumann-Pavlosky (“Taxpayers”) against the
Internal Revenue Service (the “IRS”). Taxpayers asked the bankruptcy court to
determine federal income tax liability relative to their alternative minimum tax
(“AMT”), resulting from the exercise of an incentive stock option (“ISO”).
Taxpayers and the IRS stipulated to the relevant facts of this case.
James Pavlosky (“Pavlosky”) was employed by Network Appliance, Inc.,
during tax years 1999, 2000, and 2001. Network Appliance granted Pavlosky
ISOs that allowed him to acquire shares of Network Appliance stock as part of
his compensation package.
On December 20, 2000, Pavlosky exercised an ISO that allowed him to
acquire 30,000 shares of Network Appliance stock. Pavlosky paid $3.2040 per
share, and each share had a fair market value (“FMV”) of $53.75 on the date of
exercise. Thus, Pavlosky paid $96,120 for stock with a FMV of $1,612,500.
Taxpayers chose not to sell the shares in 2000. Throughout 2001, but within
twelve months of the exercise date of December 20, 2000, Taxpayers sold 28,944
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of the 30,000 shares they had acquired for total sales proceeds of $200,345.95.
The per share sales price in each of these sales ranged from $6.2806 to $9.8217,
representing a loss from the AMT basis, as represented by the FMV of the shares
at the time of exercise.
Taxpayers originally filed a joint tax return for taxable year 2000 that
included, for AMT purposes, income stemming from the exercise of the ISO in
that year. As discussed above, though, the incentive stock was sold at a
substantial loss relative to its AMT basis throughout 2001. Consequently, in
2004, Taxpayers filed an amended 2001 tax return treating the loss realized on
the sale of the stock as a net operating loss (“NOL”) deduction, which eliminated
their tax liability for that year. Taxpayers also filed an amended 2000 return,
in which they attempted to carry back to that year the remainder of their loss
to reduce their AMT liability for 2000. The IRS disallowed the claims for refund
contained in the amended returns.
On January 24, 2005, Taxpayers filed a voluntary petition for Chapter 13
bankruptcy relief in the United States Bankruptcy Court for the Southern
District of Texas. On May 11, 2005, the Taxpayers filed an adversary proceeding
in the bankruptcy court, wherein they requested a determination of their income
taxes for the years 2000 and 2001. After entering a joint stipulation, the parties
filed cross-motions for summary judgment on the issue whether the Internal
Revenue Code (the “Code”) permitted taxpayers to treat their 2001 losses on the
sale of stock as a NOL for purposes of the AMT.
On June 1, 2006, the bankruptcy court ruled for the IRS. The bankruptcy
court rejected Taxpayers’ contention that Congress intended in all situations
that gains and losses from the exercise of an ISO and subsequent sale of the
acquired stock offset each other, concluding that the Code reserved this relief for
transactions occurring within the same taxable year, not any consecutive 12
month period, thus rendering taxpayers ineligible for such relief.
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Taxpayers appealed to the United States District Court for the Southern
District of Texas. The IRS again relied on the Code’s provisions dealing with
capital loss limitations and the AMT, and Taxpayers focused on the alleged
intent of Congress, as well as a number of policy and equitable considerations.
On October 5, 2006, the district court issued its Memorandum and Order ruling
for the IRS. It concluded that 26 U.S.C. (“I.R.C.”) §§ 56 and 1211 governed the
matter, and, consequently, that the capital loss limitations applied for purposes
of the AMT, as well as the regular tax. The district court also rejected the tax
relief intent that taxpayers attempted to ascribe to Congress, determining that
Taxpayers’ conjectures in this regard were unsupported by either the actual
language of the Code or specific legislative history.
Taxpayers filed a timely notice of appeal to our court.
II. DISCUSSION
Taxpayers’ argument that their loss in 2001 constitutes a regular tax NOL
that may be used to offset their ordinary income in the year 2001 and an
alternative tax net operating loss (“ATNOL”) that may be carried back to offset
the income realized in 2000 on Pavlosky’s exercise of the ISO is foreclosed by our
recent opinion in Merlo v. Commissioner of Internal Revenue, 492 F.3d 618 (5th
Cir. 2007). In rejecting the claim of the taxpayer in Merlo that he was entitled
to carry back the loss he incurred when his incentive stock subsequently became
worthless, we explained that once the taxpayer exercised his ISO, he began
holding the stock he acquired as a capital asset. 492 F.3d at 623. As such, the
loss he incurred in the following year was a capital loss. Id. We consequently
held that, under the applicable Code provisions, the capital loss incurred by the
taxpayer in Merlo did not give rise to a NOL or ATNOL that could be carried
back to offset the AMT he realized upon the initial exercise of his ISO. Id. at
623–24. Our holding in Merlo is dispositive of Taxpayers’ similar attempt in the
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instant case to carry back the capital loss they incurred on the sale of their
incentive stock in 2001.
Additionally, Taxpayers’ assertion that their case is distinguishable from
Merlo because, unlike the taxpayer there, they made a disqualifying disposition,
within the meaning of I.R.C. §§ 421 and 422, of the stock they acquired upon
Pavlosky’s exercise of the ISO is meritless. The exercise of an ISO is not a
taxable event for regular tax purposes. Id. § 421. Section 421, however, does not
apply for purposes of the AMT, and, thus, the exercise of an ISO is a taxable
event for AMT purposes.1 I.R.C. § 56(b)(3); Merlo, 492 F.3d at 621. If a taxpayer
makes a disqualifying disposition under I.R.C. § 422 of his incentive stock
because he fails to meet the holding period requirements, he will realize ordinary
income, as opposed to a capital gain, for regular tax purposes, in the year the
disposition occurs. I.R.C. § 421(b). As indicated above, however, section 421
does not apply for purposes of the AMT, and the special rule of I.R.C. § 422(c)(2),
allowing for losses sustained from a disqualifying disposition of incentive stock
1
Sections 56(b) and 56(b)(3) provide:
(b) Adjustments applicable to individuals.—In determining the
amount of the alternative minimum taxable income of any
taxpayer (other than a corporation), the following treatment shall
apply (in lieu of the treatment applicable for purposes of
computing the regular tax):
....
(3) Treatment of incentive stock options.—Section 421
shall not apply to the transfer of stock acquired pursuant
to the exercise of an incentive stock option (as defined in
section 422). Section 422(c)(2) shall apply in any case
where the disposition and the inclusion for purposes of this
part are within the same taxable year and such section
shall not apply in any other case. The adjusted basis of
any stock so acquired shall be determined on the basis of
the treatment prescribed by this paragraph.
I.R.C. §§ 56(b), (b)(3) (emphasis added).
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to offset the gross income includible from the exercise of the ISO, applies in the
AMT context only where the exercise of the ISO and the disqualifying disposition
occur in the same taxable year “and such section shall not apply in any other
case.” Id. § 56(b)(3); see supra n.1.
In the instant case, Pavlosky exercised his ISO in 2000, and Taxpayers
made their claimed disqualifying disposition of the incentive stock in 2001. It
therefore follows that neither I.R.C. § 421 nor I.R.C. § 422 has any application
in this case for purposes of computing Taxpayers’ AMT. Accordingly, Taxpayers’
reference to these provisions provides no basis to distinguish our decision in
Merlo that a capital loss realized with respect to stock acquired pursuant to the
exercise of an ISO does not give rise to a NOL or ATNOL that can be carried
back to offset the AMT realized on the exercise of the option. 492 F.3d at
623–24.
III. CONCLUSION
For the foregoing reasons, we AFFIRM the district court’s judgment.
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