Gudmundsson v. United States

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 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.
1
Plaintiffs were married at all relevant times. They
are now divorced but have pursued this claim together.
- 2 -
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
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.
- 3 -
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 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
- 4 -
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
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.
2
Several senior-level executives resigned. 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
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.
- 5 -
July 1, as originally reported. The Internal 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 received. See
Gudmundsson v. United States, 665 F. Supp. 2d 227, 236-39 (W.D.N.Y.
2009). This appeal followed.
- 6 -
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--
(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
- 7 -
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 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.
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).
- 8 -
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 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
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
not necessarily the first day on which the Stock was reportable
under § 83. See Gudmundsson, 665 F. Supp. 2d at 232 n.2.
- 9 -
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, 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 property given
- 10 -
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.
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
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.
- 11 -
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,
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
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.
- 12 -
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' 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,
- 13 -
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 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
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.- 14 -
Tanner, 2003 WL 1922926, at *2 (deeming stock to be transferable
despite two-year 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
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
8
As Gudmundsson did not pay for the Stock, the amount of
income is only a question of its fair market value.
- 15 -
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 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
- 16 -
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 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).
- 17 -
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
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
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).
- 18 -
restrictions." Id. Applying these rules, the district court
determined that the Agreement and Rule 144 both 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 taxed
either when the restrictions lapsed or when the stock was sold,"
and the tax was levied "upon the difference between the purchase
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
employee "with dollars that, because they may be tax-free or
tax-favored, may be fewer." Id. at 699.
- 19 -
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,
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.
- 20 -
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
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
- 21 -
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 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
- 22 -
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
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.
- 23 -