Michael Ferguson and Valene Ferguson v. Commissioner , 108 T.C. No. 14 ( 1997 )

108 T.C. No. 14UNITED STATES TAX COURT
MICHAEL FERGUSON AND VALENE FERGUSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
ROGER N. FERGUSON AND SYBIL FERGUSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 21808-93, 18250-94. Filed April 28, 1997.
Held: Ps donated to various charitable
organizations (the Charities) appreciated stock in C1.
Prior to the gifts, C1 and C2 entered into a merger
agreement, C2 made a tender offer for the shares of C1,
and shares of C1 sufficient to approve the merger were
tendered or guaranteed. The Charities subsequently
sold the stock of C1 received from Ps pursuant to the
tender offer. Ps are taxable on the gain in the stock
transferred to the Charities under the anticipatory
assignment of income doctrine.
David R. Bosse, for petitioners.
Robert First (specially recognized) for petitioners.
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Stephen M. Miller, for respondent.
HALPERN, Judge: These consolidated cases involve the
following determinations by respondent of deficiencies in,
additions to, and penalties on petitioners' Federal income tax:
Docket No. 21808-93 Michael Ferguson and Valene Ferguson
Additions to Tax and Penalties
Sec. Sec. Sec. Sec.
Year Deficiency 6653 6654 6661 6662
1987 $29,115 -- -- -- $5,823
1988 1,249,580 $36,491 $94,384 $182,456 103,951
1989 117,227 -- -- -- 23,445
1990 75,197 -- -- -- 15,039
1991 66,942 -- -- -- 13,388
Docket No. 18250-94 Roger N. Ferguson and Sybil Ferguson
Additions to Tax and Penalties
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(a)(1) 6659 6661 6662(a) 6621(c)
1
1988 $2,017,297 $170,767 $427,524 $163,701 --
1989 160,451 -- -- -- $50,353 --
1991 624,490 -- -- -- 127,120 --
1
120% of interest due on $1,425,079
Certain adjustments having been agreed to and concessions made,
the sole issue remaining for decision is whether petitioners are
taxable on the gain in appreciated stock transferred to various
charitable organizations under the anticipatory assignment of
income doctrine.
Unless otherwise noted, all section references are to the
Internal Revenue Code in effect for the years in issue, and all
Rule references are to the Tax Court Rules of Practice and
Procedure.
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FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of fact and the supplemental stipulation of fact
filed by the parties, both with attached exhibits, are
incorporated herein by this reference. Petitioners Michael and
Valene Ferguson and Roger and Sybil Ferguson resided in Rexburg,
Idaho, at the time their petitions herein were filed.
Background
On January 17, 1972, Four Star, Inc. (Four Star), was
incorporated under the laws of the State of Idaho. All of the
stock of Four Star was owned by Roger and Sybil Ferguson and two
other shareholders. On March 10, 1972, Roger and Sybil Ferguson
purchased all of the stock of Four Star owned by the two other
shareholders. In March 1975, the corporate name of Four Star was
changed to Diet Center, Inc. (Diet Center). From 1975 to
March 31, 1985, Roger Ferguson, Sybil Ferguson, and their son,
Michael Ferguson, were president, secretary/treasurer, and
executive vice-president of Diet Center, respectively, and those
individuals constituted the board of directors of Diet Center.
American Health Companies, Inc. (AHC), was incorporated
under the laws of the State of Delaware on March 8, 1983. On or
about April 1, 1985, AHC acquired, through a series of corporate
transactions, Diet Center, which, theretofore, had been wholly
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owned by petitioners Roger and Sybil Ferguson and their five
children, including petitioner Michael Ferguson.
In June 1986, pursuant to a public offering, AHC and certain
of its shareholders sold 3,000,000 shares of AHC stock.
AHC, through franchises operating under the name of Diet
Center, provided weight loss and diet counseling services and
marketed a variety of vitamins, minerals, and food products.
As of July 28, 1988, there were 6,952,863 issued and
outstanding shares of AHC stock, and members of the Ferguson
family owned approximately 1,309,500 (18.8 percent) of those
shares. Roger and Sybil Ferguson owned approximately 656,000
shares (9.4 percent), and Michael Ferguson owned approximately
520,000 shares (7.5 percent). From April 1, 1985, through at
least September 15, 1988, Roger Ferguson served as consultant for
AHC, Sybil Ferguson was employed as president of Diet Center, and
Michael Ferguson was employed as president of AHC. From
January 1, 1988, through July 28, 1988, the board of directors of
AHC consisted of, among other individuals, Roger Ferguson
(Chairman), Sybil Ferguson (Vice Chairperson), Michael Ferguson,
and C. Stephen Clegg.
Merger Agreement and Tender Offer
In December 1987, after informal discussions among the
members of the board of directors of AHC, C. Stephen Clegg
contacted Goldman, Sachs & Co. (Goldman, Sachs) in connection
with a possible sale of AHC. A letter agreement was executed on
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March 4, 1988, authorizing Goldman, Sachs, among other things, to
search for a purchaser of AHC and to assist in the sale
negotiations. By July 22, 1988, Goldman, Sachs received four
proposals.
On July 28, 1988, AHC, CDI Holding, Inc. (CDI), which was a
corporation owned by Thomas H. Lee Co. and ML-Lee Acquisition
Fund, L.P., and DC Acquisition Corp. (DC Acquisition), which was
a wholly owned subsidiary of CDI, entered into an agreement and
plan of merger (the merger agreement). The merger agreement
provided that, as soon as practicable after DC Acquisition had
purchased the stock of AHC by means of a tender offer of $22.50 a
share, DC Acquisition would be merged into AHC, and AHC would
thereupon become a wholly owned subsidiary of CDI. According to
the merger agreement, each outstanding share of AHC stock would
be converted into the right to receive $22.50 in cash.
It was expected that, upon consummation of the merger, Roger
and Sybil Ferguson would become members of the executive
committee of AHC and the board of directors of CDI, and Sybil
Ferguson would become president of AHC. In addition, Roger and
Sybil Ferguson and their children, including Michael Ferguson,
were offered the opportunity to make an equity investment in CDI
by means of an exchange of AHC stock or options for securities of
CDI.
The board of directors of AHC, with Roger Ferguson, Sybil
Ferguson, and Michael Ferguson abstaining, unanimously authorized
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and approved of the merger agreement, determined that $22.50 a
share was a fair price, and recommended acceptance of the offer
to the shareholders of AHC. The obligation of AHC to effect the
merger was subject to various conditions, including approval of
the merger agreement by shareholders owning a majority of AHC
stock. The authority of AHC shareholders to withhold approval of
the merger was limited by the right of DC Acquisition and CDI to
proceed with the merger upon acquisition of a majority of the
outstanding shares. The terms of the tender offer provided:
Pursuant to the Certificate of Incorporation, as
amended, of the Company [AHC] and the Delaware Law, if
the Purchaser [DC Acquisition] acquires pursuant to the
Offer a majority of the outstanding Shares, then the
Purchaser will be able to assure that the requisite
number of affirmative votes in favor of the Merger will
be received even if no other stockholder votes in favor
of the Merger. Pursuant to the short form merger
provisions of the Delaware law, if the Purchaser holds
90% or more of the outstanding Shares, the Merger can
be effected, and the Purchaser intends to effect the
Merger, without a meeting or vote of the stockholders
of the Company.
The obligation of DC Acquisition and CDI to effect the
merger was also subject to various conditions. On August 3,
1988, pursuant to a tender offer, DC Acquisition offered to
purchase all of the issued and outstanding AHC stock for $22.50 a
share. The tender offer was conditioned on DC Acquisition’s
acquiring and owning at least 85 percent of the AHC stock upon
consummation of the tender offer (minimum tender condition). The
minimum tender condition could be waived by DC Acquisition in its
sole discretion. DC Acquisition and CDI also had the right to
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terminate or amend the tender offer upon the occurrence of
material adverse changes affecting AHC. The original expiration
date for the tender offer was August 30, 1988, but the expiration
date was extended to September 9, 1988, as a result of a fire
that totally destroyed the AHC product manufacturing plant on
August 25, 1988.
On August 3, 1988, a letter, signed by Roger and Sybil
Ferguson as co-chairpersons of AHC, was sent to all shareholders
of record. That letter stated, among other things:
Your Board of Directors has determined that each of the
DC Acquisition offer and merger is fair to the
shareholders of American Health and recommends that all
shareholders accept the offer and tender their shares
to DC Acquisition.
The supplement to the offer to purchase, dated August 22,
1988, filed with the Securities and Exchange Commission (SEC) as
an exhibit to schedule 14D-9, and signed by Michael Ferguson,
states:
The Fergusons have advised the Parent [CDI], subject to
applicable securities laws, that they will purchase the
stock in Parent by means of an exchange of Shares they
hold in the Company [AHC], valued at $22.50 per share,
for an amount of stock in Parent of equivalent value.
Subject to applicable securities laws, Sybil and Roger
Ferguson and Michael D. Ferguson have advised the
Parent and the Company that they will tender all of
their Shares not exchanged for stock in the Parent.
Sybil Ferguson is expected to become President of the
Company following the consummation of the Offer. It is
anticipated that she will enter into a three year
employment agreement with the Company pursuant to which
she will receive an annual salary of $200,000.
Pursuant to the agreement, she will be a full time
employee and will be eligible to participate in an
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executive incentive plan and a long term incentive plan
which are expected to be developed by the Board of
Directors for participation by key members of senior
management. The agreement with Sybil Ferguson is
expected to contain appropriate non-competition
covenants.
Roger Ferguson's present consulting agreement with
the Company is expected to be extended on its present
terms so that it will expire at the same time as the
employment agreement with Mrs. Ferguson. Mr. Ferguson
is also expected to agree to non-competition covenants
similar to those of Mrs. Ferguson.
Although the parties have reached general
understandings with respect to the foregoing matters,
no written agreements have been entered into. * * *
The continued involvement of Sybil Ferguson in the activities of
AHC was an important aspect of the acquisition of AHC by CDI and
DC Acquisition.
The supplement to the offer to purchase also stated that the
$22.50 a share offer price represented a multiple of
approximately 16 times AHC's earnings a share for the year ended
March 31, 1988, a 24.1 percent premium over the market price for
the shares as of July 22, 1988 (the last trading day prior to the
announcement by AHC that it had received bids from prospective
acquirors), and a premium of approximately 1,084 percent over the
tangible book value of AHC shares as of June 30, 1988. In
addition, the supplement stated that, as of March 31, 1988, the
total book value a share of outstanding common stock exclusive of
treasury shares was $6.59, and such book value a share, exclusive
of goodwill, was $1.94.
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The terms of the tender offer provided that “No stockholder
of the Company [AHC] has executed any agreement obligating him to
tender Shares to the Purchaser [DC Acquisition] in response to
the Offer.” The terms of the tender offer provided that shares
tendered pursuant to the tender offer could be withdrawn, upon
valid notice, at any time prior to the expiration date of the
tender offer.
Pursuant to the tender offer, the stock of AHC was tendered
by AHC shareholders in the following manner:
Percentage of
Outstanding
Shares
Close of Shares Shares Tendered or
Business Date Tendered Guaranteed Guaranteed
8/15/88 33,924 -- 0.5
8/16/88 104,024 -- 1.5
8/17/88 318,678 -- 4.6
8/18/88 707,306 -- 10.2
8/19/88 723,886 -- 10.4
8/22/88 952,554 -- 13.7
8/24/88 1,594,736 -- 22.9
8/25/88 1,824,674 -- 26.2
8/26/88 2,189,329 -- 31.5
8/29/88 2,731,041 -- 39.3
8/30/88 2,894,132 -- 41.6
8/31/88 3,596,997 31,032 52.2
9/1/88 3,627,605 31,172 52.6
9/2/88 3,638,046 31,772 52.8
9/6/88 3,704,602 2,019 53.3
9/7/88 3,707,157 1,279 53.3
9/8/88 3,976,886 1,279 57.2
9/9/88 5,482,162 1,136,167 95.2
9/12/88 5,650,081 968,248 95.2
9/13/88 6,327,303 291,026 95.2
9/14/88 6,381,140 237,189 95.2
9/16/88 6,504,488 113,841 95.2
9/19/88 6,529,273 89,056 95.2
9/20/88 6,613,500 4,829 95.2
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Gifts by Michael Ferguson
On August 15, 1988, Michael Ferguson, in contemplation of a
tithing, executed a donation-in-kind record indicating his
intention to donate 30,000 shares of AHC stock to the Church of
Jesus Christ of the Latter Day Saints (the Church). On or about
August 16, 1988, Brett Floyd, a Merrill Lynch stockbroker,
assisted Michael Ferguson to open a new brokerage account and to
place 391,651 shares of AHC stock in that account. A legend
restricting transfer appeared on those shares, and Merrill Lynch
would not sell or otherwise transfer the shares until it was
advised that it could do so by its legal department; that
clearance process “took upwards of two weeks”. On or about
August 26, 1988, Michael Ferguson formed the Michael Ferguson
Charitable Foundation (MF Foundation). On September 8, 1988,
Brett Floyd caused an in-house journal entry to be made to
transfer from Michael Ferguson's brokerage account 30,000 shares
of AHC stock to an account maintained by the Church and 27,000
shares of AHC stock to the account maintained by the MF
Foundation. On September 9, 1988, Michael Ferguson executed an
authorization to transfer the shares that Brett Floyd transferred
by in-house journal entry the day before. A donation-in-kind
receipt issued to Michael Ferguson by the Church provides that
the date of donation for the 30,000 shares of AHC stock was
September 9, 1988. On October 5, 1988, Billy G. DuPree, Jr., an
officer of AHC, forwarded to the SEC a statement of changes in
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beneficial ownership of securities (SEC Form 4) with respect to
Michael Ferguson. That statement indicates that the gifts to the
Church and the MF Foundation occurred on September 9, 1988.
Gifts by Roger and Sybil Ferguson
On August 21, 1988, Roger Ferguson, in contemplation of a
tithing, executed a donation-in-kind record indicating the
intention of Roger and Sybil Ferguson to donate 31,111 shares of
AHC stock to the Church. On or about August 23, 1988, Brett
Floyd assisted Roger and Sybil Ferguson to open a new brokerage
account and to place 341,366 shares of AHC stock in that account.
A legend restricting transfer appeared on those shares, and
Merrill Lynch would not sell or otherwise transfer the shares
until it was advised that it could do so by its legal department;
that clearance process “took upwards of two weeks”. On
August 26, 1988, Roger and Sybil Ferguson formed the Roger and
Sybil Ferguson Charitable Foundation (R & S Foundation). On
September 8, 1988, Brett Floyd caused an in-house journal entry
to be made to transfer from Roger and Sybil Ferguson's brokerage
account 31,111 shares of AHC stock to an account maintained by
the Church and 26,667 shares of AHC stock to the account
maintained by the R & S Foundation. On September 9, 1988, Roger
and Sybil Ferguson executed an authorization to transfer the
shares that Brett Floyd transferred by in-house journal entry the
day before. On October 5, 1988, Billy G. DuPree, Jr., forwarded
to the SEC statements of changes in beneficial ownership of
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securities (SEC Form 4) with respect to Roger and Sybil Ferguson.
Those statements indicate that the gifts to the Church and the
R & S Foundation occurred on September 9, 1988.
Consummation of the Transaction
On September 9, 1988, Roger and Sybil Ferguson exchanged
133,334 shares of AHC stock for 100,000 shares of CDI common
stock and 20,000 shares of CDI preferred stock, and they tendered
their remaining shares in accordance with the tender offer.1 On
September 9, 1988, Michael Ferguson exchanged 33,333 shares of
AHC stock for 25,000 shares of CDI common stock and 5,000 shares
of CDI preferred stock, and he tendered his remaining shares in
accordance with the tender offer. Other members of the Ferguson
family engaged in similar transactions. The various charities
that received shares of AHC stock from petitioners tendered those
shares on September 9, 1988.
On September 12, 1988, DC Acquisition announced its
acceptance of all the tendered or guaranteed shares of AHC stock.
On September 13, 1988, DC Acquisition purchased the 6,618,329
tendered or guaranteed shares of AHC stock in exchange for $22.50
a share and became a shareholder of AHC.
As a result of DC Acquisition’s acquiring in excess of
90 percent of the stock of AHC, the merger was effected on or
1
It should be noted that some of the AHC stock owned by
petitioners Roger and Sybil Ferguson and Michael Ferguson was
transferred to an entity named Silver Hawk, Inc. Those transfers
are not in issue in the present case.
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about October 14, 1988, pursuant to a consent of the sole
director of DC Acquisition to a resolution stating the terms of
the merger, dated October 12, 1988. AHC thereupon became a
subsidiary of CDI. Sybil Ferguson became president of AHC, and
Roger Ferguson became a consultant for AHC. In addition, Roger
and Sybil Ferguson became members of AHC's executive committee
and CDI's board of directors.
OPINION
I. Introduction
A. Issue
Petitioners donated appreciated stock in American Health
Companies, Inc. (AHC), to the Church of Jesus Christ of the
Latter Day Saints (the Church), the Michael Ferguson Charitable
Foundation, and the Roger and Sybil Charitable Foundation
(collectively, the Charities). The Charities subsequently sold
that stock to DC Acquisition Corp. (DC Acquisition) pursuant to a
tender offer. The sole issue for decision is whether petitioners
are taxable on the gain in the stock transferred to the Charities
under the anticipatory assignment of income doctrine.
Petitioners bear the burden of proof. Rule 142(a).
B. Arguments of the Parties
Petitioners contend that they are not taxable on the gain in
the stock transferred to the Charities. First, relying on our
decision in Palmer v. Commissioner, 62 T.C. 684 (1974), affd. on
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other grounds 523 F.2d 1308 (8th Cir. 1975), petitioners assert
that the Charities were not legally obligated, nor could they be
compelled, to tender their AHC stock in accordance with the
tender offer, and, therefore, the proceeds received by the
Charities in exchange for AHC stock that was voluntarily tendered
cannot be attributed to petitioners. Second, relying primarily
on Hudspeth v. United States, 471 F.2d 275 (8th Cir. 1972), and
Estate of Applestein v. Commissioner, 80 T.C. 331 (1983),
petitioners assert that the date on which the right to the tender
offer proceeds matured was October 12, 1988, when the board of
directors of DC Acquisition adopted a resolution stating the
terms of the merger, and that the gifts occurred prior to that
date. Petitioners argue, alternatively, that the earliest date
on which the right to the tender offer proceeds matured was
September 12, 1988, when DC Acquisition formally announced that
it had accepted all of the tendered or guaranteed shares of AHC
stock, and that the gifts occurred prior to that date.
Respondent, relying primarily on our decisions in Estate of
Applestein and Peterson Trust v. Commissioner, T.C. Memo. 1986-
267, affd. without published opinion 822 F.2d 1093 (8th Cir.
1987), contends that the July 28, 1988, merger agreement (the
merger agreement) coupled with the August 3, 1988, tender offer
at a price of $22.50 a share (the tender offer) was, in reality
and substance, the functional equivalent to a shareholder vote
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approving the merger agreement and that the gifts occurred
subsequent thereto.
Resolution of the competing positions advanced by the
parties requires an analysis of the circumstances surrounding the
merger agreement, the tender offer, and the gifts to the
Charities. Based on the facts of this case, we believe that the
stock of AHC was converted from an interest in a viable
corporation to the right to receive cash prior to the date of the
gifts to the Charities, and, therefore, petitioners are taxable
on the gain in the donated stock.
II. Analysis
A. Date of the Gifts
Section 170(a) allows a deduction for any charitable
contribution payment of which is made within the taxable year.
The term “charitable contribution” is defined in section 170(c)
as a contribution or gift to or for the use of various enumerated
entities and, therefore, is synonymous with the term “gift”. See
DeJong v. Commissioner, 36 T.C. 896, 899 (1961), affd. 309 F.2d
373 (9th Cir. 1962). Thus, the donation of AHC stock to the
Charities must satisfy the requirements of a valid inter vivos
gift in order to qualify as a charitable contribution under
section 170(a). See, e.g., Guest v. Commissioner, 77 T.C. 9, 15-
16 (1981). The existence of the gifts to the Charities, however,
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is not in dispute. The contested issue is the date of those
gifts.
Petitioners, relying on section 1.170A-1(b), Income Tax
Regs., assert that the gifts occurred when their AHC stock
certificates along with irrevocable instructions regarding their
donations to the Charities were delivered to Brett Floyd, who
served in the capacity of agent for the Charities. Thus,
petitioners contend that the gifts by Michael Ferguson occurred
on August 15, 1988, and that the gifts by Roger and Sybil
Ferguson occurred on August 21, 1988.
Section 1.170A-1(b), Income Tax Regs., provides:
Ordinarily, a contribution is made at the time delivery
is effected. * * * If a taxpayer unconditionally
delivers or mails a properly endorsed stock certificate
to a charitable donee or the donee's agent, the gift is
completed on the date of delivery or, if such
certificate is received in the ordinary course of the
mails, on the date of mailing. If the donor delivers
the stock certificate to his bank or broker as the
donor's agent, or to the issuing corporation or its
agent, for transfer into the name of the donee, the
gift is completed on the date the stock is transferred
on the books of the corporation. * * *
This Court in Londen v. Commissioner, 45 T.C. 106 (1965),
considered the application of section 1.170-1(b), Income Tax
Regs., the precursor to the regulation relied on by petitioners.
In that case, the taxpayer delivered an executed stock
certificate to his agent (though the taxpayer argued that the
agent was the agent of the donee) and instructed the agent to
transfer the stock to a charity in December 1959; the transfer
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became effective in January 1960. The Court held that the date
on which the donor instructed his agent to transfer the stock to
the donee was not determinative of when the gift was complete.
See id. at 110. Delivery of the gift of stock was complete upon
relinquishment of dominion and control of the stock by the donor,
which occurred upon actual transfer on the books of the issuing
corporation. Id.; Morrison v. Commissioner, T.C. Memo. 1987-112.
The Court noted that even if the taxpayer's obligation upon
delivery to his agent “were a legal instead of a moral one, the
existence of an obligation is not synonymous with its
implementation.” Londen v. Commissioner, supra at 110.
First, the facts indicate that Brett Floyd acted as
petitioners' agent and not the Charities' agent. Brett Floyd not
only facilitated the transfer of AHC stock to the Charities, but
also assisted petitioners in the exchange of their AHC stock for
shares of CDI and the tender of their remaining shares in
accordance with the tender offer. The fact that Brett Floyd may
have assisted the Church on previous occasions does not change
the nature of his role with respect to the transactions involving
petitioners. When petitioners Roger and Sybil Ferguson and
Michael Ferguson placed, with the assistance of Brett Floyd,
341,366 and 391,651 shares of AHC stock in their respective
accounts, Brett Floyd acted as petitioners' agent. Second,
petitioners delivered to Brett Floyd stock that Merrill Lynch
would not immediately sell or otherwise transfer. Merrill
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Lynch's process for receiving clearance to sell or transfer the
shares “took upwards of two weeks”. Indeed, the authorizations
to transfer the stock to the Charities are dated September 9,
1988. The donation-in-kind receipt from the Church received by
petitioner Michael Ferguson provides that the date of donation
for the 30,000 shares of AHC stock was September 9, 1988. The
statements of changes in beneficial ownership of securities
forwarded to the Securities and Exchange Commission by Billy G.
DuPree, Jr., indicate that the gifts occurred on September 9,
1988. Furthermore, petitioners have failed to explain how the
gifts to the charitable foundations occurred on August 15, 1988,
and August 21, 1988, respectively, when the foundations were
formed on or about August 26, 1988. Considering the substantial
documentary evidence, petitioners have failed to persuade us that
depositing stock in their brokerage accounts with instructions to
Brett Floyd to transfer some of the stock to the Charities
constituted the unconditional delivery of stock to a charitable
donee's agent pursuant to section 1.170A-1(b), Income Tax Regs.
In the alternative, petitioners, relying on Richardson v.
Commissioner, T.C. Memo. 1984-595, assert that petitioners'
transfer of the AHC stock to Brett Floyd created a voluntary
trust that completed the gifts on the date of delivery. In light
of our conclusion that Brett Floyd acted as petitioners' agent,
we reject petitioners' alternative argument.
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Based on the circumstances surrounding the gifts to the
Charities, we believe that Brett Floyd acted as petitioners'
agent in the transfer of the AHC stock and that petitioners
relinquished control of the stock on September 9, 1988, when the
letters of authorization were executed, and we so find. The
gifts to the Charities, therefore, were complete on September 9,
1988.
B. Anticipatory Assignment of Income
1. Case Law
It is a well-established principle of the tax law that the
person who earns or otherwise creates the right to receive income
is taxed. E.g., Lucas v. Earl, 281 U.S. 111, 114-115 (1930).
When the right to income has matured at the time of a transfer of
property, the transferor will be taxed despite the technical
transfer of that property. E.g., Estate of Applestein v.
Commissioner, 80 T.C. at 345. The mere anticipation or
expectation of income at the time of transfer, however, is
insufficient to create a fixed right to earned income. Id. The
reality and substance of a transfer of property govern the proper
incidence of taxation and not formalities and remote hypothetical
possibilities. E.g., Hudspeth v. United States, 471 F.2d at 277.
It is the province of the trial court to determine the proper
characterization of a particular transaction upon consideration
of all the facts and circumstances. See United States v.
Cumberland Pub. Serv. Co., 338 U.S. 451, 456 (1950) (application
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of substance-over-form doctrine); Harrison v. Schaffner, 312 U.S.
579, 583 (1941) (application of assignment of income doctrine).
In Hudspeth v. United States, supra, the taxpayer, who was
an 81.5-percent shareholder, a director, president, and treasurer
of a corporation, donated to various charitable organizations
stock in the corporation, which had previously adopted a plan of
liquidation pursuant to resolution by its board of directors and
ratification by the shareholders. The Court of Appeals for the
Eighth Circuit rejected the taxpayer's contention “that the date
of the gift preceded the time when an enforceable right to the
liquidation proceeds accrued (i.e., when the corporation's board
passed the final resolution of dissolution)” and, instead,
focused on the reality and substance of the events. Id. at 277,
280. Noting the taxpayer's continued control of the corporation
and the transferees' inability to vitiate the taxpayer's
intention to liquidate, the court determined that the affirmative
vote of the shareholders to liquidate the corporation was
sufficient to sever the gain from the stock such that the
transfer to the charities constituted a transfer of liquidation
proceeds rather than an interest in a viable corporation. Id. at
278-279. The court would not “eviscerate established principles
of anticipatory assignment of income by considering remote,
hypothetically possible abandonments in the face of unrebutted
evidence that the taxpayer intended to and did, in fact, complete
the liquidation of his corporation.” Id. at 280.
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In Kinsey v. Commissioner, 477 F.2d 1058 (2d Cir. 1973),
affg. 58 T.C. 259 (1972), the taxpayer donated to his alma mater
a controlling interest in a corporation that previously had
adopted a plan of liquidation pursuant to recommendation by its
board of directors and approval by its shareholders. The Court
of Appeals for the Second Circuit recognized that the
Commissioner's case in Hudspeth v. United States, supra, was
stronger because the donor in that case retained a majority of
the corporation's stock, but, nevertheless, applied the basic
principle in Hudspeth v. United States, supra, that the reality
and substance of events determine the incidence of taxation and
not formalities and remote hypothetical possibilities. Kinsey v.
Commissioner, supra at 1063; see also Jones v. United States, 531
F.2d 1343, 1346 (6th Cir. 1976) (rejecting taxpayer's attempt to
distinguish Hudspeth v. United States, supra, the court stated,
“we view a taxpayer's control over the corporation as only one
factor in determining whether a liquidation is practically
certain to occur” (fn. ref. omitted)). The court focused on the
fact that although the donee received a majority of the
corporation's shares, the donee could not have unilaterally
stopped the liquidation because it did not have the requisite
two-thirds control. Kinsey v. Commissioner, supra at 1063. The
court concluded that, considering all of the circumstances, the
transfer of stock to the donee was an anticipatory assignment of
liquidation proceeds. Id.
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In S.C. Johnson & Son, Inc. v. Commissioner, 63 T.C. 778(1975), the taxpayer contributed to a charitable organization two
forward sales contracts that had substantially appreciated in
value as a result of the November 1967 devaluation of the British
pound. After assignment of the currency contracts by the
taxpayer, the charitable organization entered into negotiations
with and sold the contracts to an unrelated third party. The
Commissioner asserted that the assignment of the contracts was
actually an assignment of “fixed” or “earned” income in light of
the fact that the taxpayer “could have closed out its forward
position in an economic sense after the devaluation and assured
eventual realization of gain under one of three methods”. Id. at
784, 787. First, this Court noted that the taxpayer had no legal
right to the appreciation in the contracts prior to delivery of
the British pounds on the maturity date. Id. at 786. The
inquiry, however, did not end. We determined that the taxpayer
had not taken any steps to close out its forward position under
the sales contracts prior to the gift. We also considered as
significant the donee's control over the timing of the receipt of
the income and the donee's exposure to potential liabilities in
the event of a revaluation of the British pound prior to the
maturity date. Id. at 787-788; see also Carborundum Co. v.
Commissioner, 74 T.C. 730, 742 (1980) (on facts similar to S.C.
Johnson & Son, Inc., we distinguished Kinsey v. Commissioner,
supra, and Jones v. United States, supra, because the taxpayers
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(and, derivatively, the donees) in those cases “had virtually no
control over the course of events once the corporation's plan of
complete liquidation had been adopted”); Palmer v. Commissioner,
62 T.C. at 695 (noting that shareholder vote approving redemption
did not occur prior to gift and that donee possessed sufficient
voting power to prevent redemption, we distinguished Hudspeth v.
United States, 471 F.2d 275 (8th Cir. 1972), and Kinsey v.
Commissioner, supra, and stated, “at the time of the gift, the
redemption had not proceeded far enough along for us to conclude
that the foundation was powerless to reverse the plans of the
petitioner”). We found that there was no fixed right to income
in either a legal or an economic sense prior to the gift of the
currency contracts, and, therefore, the gift was not an
anticipatory assignment of income.
An examination of the cases that discuss the anticipatory
assignment of income doctrine reveals settled principles. A
transfer of property that is a fixed right to income does not
shift the incidence of taxation to the transferee. The reality
and substance of a transfer of property govern the proper
incidence of taxation and not formalities and remote hypothetical
possibilities. In determining the reality and substance of a
transfer, the ability, or the lack thereof, of the transferee to
alter a prearranged course of disposition with respect to the
transferred property provides cogent evidence of whether there
existed a fixed right to income at the time of transfer.
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Although control over the disposition of the transferred property
is significant to the assignment of income analysis, the ultimate
question is whether the transferor, considering the reality and
substance of all the circumstances, had a fixed right to income
in the property at the time of transfer. See Greene v. United
States, 13 F.3d 577, 582 (2d Cir. 1994); Allen v. Commissioner,
66 T.C. 340, 347-348 (1976).
2. The Right to Receive $22.50 a Share in Cash
On July 28, 1988, AHC, CDI Holdings, Inc. (CDI), and DC
Acquisition entered into the merger agreement. According to the
merger agreement, DC Acquisition would be merged into AHC, and
AHC would thereupon become a wholly owned subsidiary of CDI as
soon as practicable after DC Acquisition had purchased the stock
of AHC pursuant to the tender offer. The merger agreement
provided that each outstanding share of AHC stock, following the
purchase of AHC stock pursuant to the tender offer, would be
converted into the right to receive $22.50 a share in cash. On
August 3, 1988, DC Acquisition made a tender offer for the stock
of AHC at $22.50 a share. By the close of business on August 31,
1988, more than 50 percent of the outstanding shares of AHC stock
had been tendered or guaranteed. At that time, despite the
various contingencies to be discussed infra, we believe the
reality and substance of the merger agreement and the tender
offer indicate that the stock of AHC was converted from an
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interest in a viable corporation to a fixed right to receive
cash.
The tender or guarantee of more than 50 percent of the
outstanding shares of AHC stock was the functional equivalent to
a vote by the shareholders of AHC approving the merger. The
terms of the tender offer provided that DC Acquisition, with the
acquisition of a majority of AHC stock, could assure that the
requisite number of affirmative votes in favor of the merger
would be received even if no other shareholder voted in favor of
the merger. Therefore, with the exception of the hypothetical
possibility that a sufficient number of tendered or guaranteed
shares of AHC stock could be withdrawn, DC Acquisition was
positioned to proceed unilaterally with consummation of the
merger by the close of business on August 31, 1988.
Shareholders who tendered their shares maintained withdrawal
rights prior to the expiration date of the tender offer. We
believe that the existence of withdrawal rights and the potential
ability of AHC shareholders to withdraw shares sufficient to make
the number of shares tendered or guaranteed fall below a majority
of the outstanding shares is analogous to the ability, in theory,
of shareholders to rescind a prior shareholder vote approving a
merger agreement or a plan of liquidation. In Hudspeth v. United
States, supra, and Kinsey v. Commissioner, 477 F.2d 1058 (2d Cir.
1973), the issue as to whether the plan of liquidation was
theoretically irreversible was not a significant factor in the
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anticipatory assignment of income analysis. Instead, the
ability, or lack thereof, of the transferee to vitiate the
intention of the transferor and of other shareholders who voted
to liquidate the corporation was crucial to determining whether
there existed a fixed right to income at the time of the
transfer.
First, the existence of withdrawal rights with respect to
petitioners was contrary to their express intention to tender all
of their shares of AHC stock that was not exchanged for stock in
CDI and, in the case of Roger and Sybil Ferguson, to participate
in the affairs of AHC and CDI after consummation of the merger.
The Charities' ability to vitiate petitioners' intention to
maintain the course of events that would result in the planned
merger was not enhanced by the remote and hypothetical
possibility that petitioners could exercise their withdrawal
rights against their interests. Second, petitioners had not
tendered their shares by the close of business on August 31,
1988. Notwithstanding petitioners' direct control, collectively,
of over 16.9 percent of AHC stock, the existence of withdrawal
rights with respect to petitioners was relevant only after they
tendered their shares on September 9, 1988, when over 95 percent
of the outstanding shares of AHC stock had been tendered or
guaranteed. At that time, petitioners' ability to withdraw their
shares would not have changed the fact that more than 50 percent
of the outstanding shares of AHC stock had been tendered or
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guaranteed. That is also true for the shares tendered by the
Charities. In sum, the existence of withdrawal rights with
respect to both petitioners and the Charities did not enhance the
Charities' ability to vitiate the intention of shareholders who
had tendered or guaranteed a majority of AHC stock and in effect
approved the merger agreement.
The fact that the tender offer was conditioned on DC
Acquisition’s acquiring and owning at least 85 percent of the AHC
stock upon consummation of the tender offer (minimum tender
condition) also does not change our conclusion. The minimum
tender condition could be waived by DC Acquisition in its sole
discretion and, therefore, would not have prevented DC
Acquisition from proceeding unilaterally with consummation of the
merger by the close of business on August 31, 1988. The minimum
tender condition had no bearing on the ability of the Charities
to affect the course of events initiated on July 28, 1988, with
the merger agreement and crystallized on August 31, 1988, with
“approval” of the merger agreement by shareholders owning a
majority of AHC stock. Also, the limited significance of the
minimum tender condition from the perspective of DC Acquisition
and its impact on our determination of whether there existed a
fixed right to income at the time of the gifts is addressed in
our discussion regarding the material change condition of the
tender offer, infra.
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Petitioners argue that Hudspeth v. United States, 471 F.2d
275 (8th Cir. 1972), and our decision in Estate of Applestein v.
Commissioner, 80 T.C. 331 (1983), stand for the proposition that
the right to merger or liquidation proceeds “matures” or “ripens”
under the anticipatory assignment of income doctrine upon the
occurrence of a shareholder vote approving the transaction.
Petitioners assert that, in the present case, the consent of the
sole director of DC Acquisition to a resolution stating the terms
of the merger, dated October 12, 1988, was tantamount to a vote
by the shareholders of AHC for purposes of applying the legal
reasoning of Hudspeth and Estate of Applestein, and, therefore,
the right to receive merger proceeds did not mature or ripen
until that time.
The principle set forth in the cases cited by petitioners is
not as formalistic as petitioners assert. Those cases stand for
the proposition that the reality and substance of events
determine tax consequences. The date of the shareholder votes in
Hudspeth v. United States, supra, and Estate of Applestein v.
Commissioner, supra, was crucial to determining the reality and
substance of events; however, we do not believe that application
of the anticipatory assignment of income doctrine is conditioned
on the occurrence of a formal shareholder vote. The shareholder
vote in both cases was considered sufficient to constitute a
severance of the economic gain from the investment in the
corporation, Hudspeth v. United States, supra at 279; see Estate
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of Applestein v. Commissioner, supra at 343, 345, and not a
formalistic prerequisite.
In Estate of Applestein v. Commissioner, supra, the taxpayer
transferred to custodial accounts for his children stock in a
corporation that had entered into a merger agreement with another
corporation. The merger agreement was approved by the
shareholders of both corporations prior to the transfer.
Although the transfer occurred prior to the effective date of the
merger, this Court held that the “right to the merger proceeds
had virtually ripened prior to the transfer and that the transfer
of the stock constituted a transfer of the merger proceeds rather
than an interest in a viable corporation.” Id. at 346 (fn. ref.
omitted). In rejecting the taxpayer's argument that the
consummation of the merger was not a certainty, this Court
stated:
In the instant case, at the time of transfer, the
merger had been agreed upon by the directors and
shareholders of both companies and there were no other
necessary steps to be taken before the merger became
effective. Any possibilities that the merger would be
abandoned by the companies themselves or stopped by a
regulatory agency were “remote and hypothetical.” [Id.
at 346-347.]
Petitioners' attempt to impose formalistic obstacles to
application of the anticipatory assignment of income doctrine is
rejected. The absurd conclusion to petitioners' assertion that
the right to receive merger proceeds matured on October 12, 1988,
upon consent of the sole director of DC Acquisition to a
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resolution stating the terms of the merger, is that the right to
receive merger proceeds matured subsequent to payment of those
proceeds by DC Acquisition on September 13, 1988. We believe,
instead, that when more than 50 percent of the outstanding shares
of AHC stock had been tendered or guaranteed, which in effect was
an approval of the merger agreement, and the Charities could not
vitiate the intention of the shareholders who had tendered or
guaranteed a majority of AHC stock, of petitioners, and of DC
Acquisition and CDI, the right to merger proceeds matured. When
the Charities received AHC stock on September 9, 1988, payment in
exchange for those shares pursuant to the tender offer was
imminent; i.e., 4 days from the date of the gifts. Moreover, the
Charities did not even need to tender their shares, but would
have received $22.50 a share in cash because the merger agreement
provided that shares outstanding after the tender offer would be
converted into the right to receive $22.50 in cash.
The fact that AHC shareholders may not have had a legal
right to the merger proceeds prior to acceptance of the tendered
or guaranteed shares by DC Acquisition does not change our
conclusion. The Court of Appeals for the Eighth Circuit in
Hudspeth v. United States, supra, rejected the taxpayer's
contention that the gifts preceded the time when an enforceable
right to the liquidation proceeds accrued and focused, instead,
on the fact that the donees could not change the future course of
events; i.e., the liquidation of the corporation. The inquiry in
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S.C. Johnson & Son, Inc. v. Commissioner, 63 T.C. 778 (1975), did
not end with a determination that the taxpayer did not have a
legal right to the appreciation in the currency contracts prior
to delivery of the British pounds on the maturity date. Indeed,
this Court, among other things, considered as significant the
fact that the taxpayer had not taken any steps to close out its
forward position under the sales contracts prior to the gift.
That inquiry would have been unnecessary if the issue as to
whether a taxpayer has a legally enforceable right to income is
dispositive of the anticipatory assignment of income analysis.
We, therefore, consider petitioners' argument as only one factor
in our inquiry to determine the reality and substance of the
events surrounding the merger agreement, the tender offer, and
the gifts to the Charities.
Petitioners contend that DC Acquisition was not legally
obligated to accept the tendered shares and proceed with the
merger until September 12, 1988, when DC Acquisition announced
its acceptance of the tendered shares. Petitioners characterize
DC Acquisition's right to proceed with the merger as an option in
light of the material change condition to the tender offer and
the occurrence of the fire that destroyed AHC's product
manufacturing plant on August 25, 1988. Petitioners assert that
DC Acquisition waived the material change condition for the first
time when it announced acceptance of the tendered shares.
The occurrence of the fire to AHC's product manufacturing
plant and the fact that DC Acquisition and CDI proceeded with the
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merger, notwithstanding, demonstrates the extent to which the
right to the merger proceeds was fixed once a majority of the
outstanding shares of AHC stock had been tendered or guaranteed.
A fire that totally destroyed AHC's product manufacturing plant
could not shake the resolve of DC Acquisition and CDI in
acquiring the central asset of AHC, Sybil Ferguson and the
relationships that she had created. DC Acquisition's offering
price represented a premium of approximately 1,084 percent over
the tangible book value of AHC shares as of June 30, 1988. The
value of AHC was not embodied in the company's tangible assets.
The value of AHC, and the asset that DC Acquisition and CDI
sought, was primarily in the person of Sybil Ferguson and the
relationships that she had created. As long as the understanding
was in place between DC Acquisition and CDI and the Fergusons
that Sybil Ferguson would maintain continued involvement with
AHC, the consummation of the merger was a foregone conclusion
once the shareholders of AHC “approved” of the merger. To accept
any other conclusion would eviscerate established principles of
the anticipatory assignment of income doctrine by ignoring the
reality and substance of events and attaching significance to
remote and hypothetical possibilities.
III. Conclusion
The reality and substance of events surrounding the merger
agreement, the tender offer, and the gifts to the Charities
indicate that the stock of AHC was converted from an interest in
a viable corporation to a fixed right to receive cash prior to
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the date of the gifts. Therefore, petitioners are taxable on the
gain in the stock transferred to the Charities under the
anticipatory assignment of income doctrine. To reflect the
foregoing,
Decisions will be entered
under Rule 155.