Estate of John W. Clause, Thomas Y. Clause, Personal Respresentative v. Commissioner

122 T.C. No. 5
UNITED STATES TAX COURT
ESTATE OF JOHN W. CLAUSE, DECEASED, THOMAS Y. CLAUSE, PERSONAL
REPRESENTATIVE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12995-01. Filed February 9, 2004.
P, prior to his death, sold all of his shares in C to
C’s employee stock ownership plan in 1996. P purchased
qualified replacement property with most of the proceeds
from the sale within a year of the sale. P’s 1996 original
Federal tax return was filed timely (i.e., on or before Apr.
15, 1997) and did not report the transaction. On Nov. 28,
2000, after R began examining P’s original tax return for
1996, P filed an amended Federal tax return for 1996
indicating to R that certain proceeds from the sale had been
reinvested in qualified replacement property. On Oct. 17,
2001, R received a second Federal tax return for 1996 from P
that attached certain statements of election pursuant to
I.R.C. sec. 1042 regarding the sale in 1996.
Held: P is not able to defer recognition of the gain
that resulted from the sale because P failed to elect such
treatment as required by I.R.C. sec. 1042.
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Ronald L. Kahn and Ronald H. Isroff, for petitioner.
David S. Weiner, for respondent.
HAINES, Judge: Respondent determined a deficiency of
$395,279 in John W. Clause’s (Mr. Clause’s) Federal income tax
for 1996. The issue for decision is whether Mr. Clause duly
elected, under section 1042,1 to defer recognition of a gain that
resulted from a sale of stock to an employee stock ownership plan
(ESOP).
FINDINGS OF FACT
Mr. Clause was 74 years old when he testified at the trial
of this case on June 4, 2003. Mr. Clause died on November 13,
2003, and his estate was substituted as petitioner by Order of
the Court dated January 30, 2004. To avoid confusion, the
decedent, Mr. Clause, will be referred to as petitioner herein.
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. At the time he filed the
petition, petitioner resided in Gainesville, Florida.
Petitioner retired from W.J. Ruscoe Co. (the company) in
1995 after working for the company since 1956. The company was a
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue.
Amounts are rounded to the nearest dollar.
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domestic C corporation that had no stock outstanding that was
readily tradable on an established securities market. Petitioner
became the majority shareholder in the company when the company
founder passed away in 1975. Petitioner owned over 82 percent of
the outstanding shares of the company at retirement. Petitioner
did not receive these shares in a distribution from a plan
described in section 401(a) or in a transfer pursuant to an
option or other right to acquire stock to which section 83, 422,
or 423 applied.
At the time of his retirement, petitioner consulted with his
accountant, Ronald C. Midcap, C.P.A. (Mr. Midcap), and an
attorney hired by Mr. Midcap, who Mr. Midcap believed was
familiar with stock sales to ESOPs. Mr. Midcap had prepared
petitioner’s tax returns since 1978 and was also preparing the
tax returns for the company. Mr. Midcap prepared petitioner’s
tax returns for 1996 but had never prepared a tax return with a
transaction involving section 1042 before 1996.
On March 11, 1996, petitioner sold all of his shares in the
company to the W.J. Ruscoe Company Employee Stock Ownership Trust
created pursuant to an ESOP for $1,521,630. At the time of the
sale, petitioner had a basis in the shares of $115,613 and had
owned the shares for at least 3 years. On March 12, 1996,
petitioner deposited the $1,521,630 sale proceeds into an account
with South Trust Securities, Inc. (South Trust).
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On February 18, 1997, through a sales representative of
South Trust, petitioner made purchases of securities issued by
domestic corporations, totaling $1,399,775, which satisfied the
requirements of section 1042(c)(4) to be “qualified replacement
property”. All but approximately $120,000 of the proceeds was
thus reinvested in qualified replacement property.
On or before April 15, 1997, petitioner timely filed his
1996 Federal tax return (original tax return) but did not report
the sale of stock, in any manner, on the tax return. Further,
the original tax return did not include a statement of election
pursuant to section 1042, a statement from the company consenting
to the application of sections 4978 and 4979A, or a statement of
petitioner’s purchase of qualified replacement property with the
proceeds of the stock sale to the ESOP. Petitioner did not
request an extension of time to file the original tax return.
On January 12, 1999, after respondent began an examination
of the original tax return with regard to the stock sale,
petitioner signed a Form 2848, Power of Attorney and Declaration
of Representative, appointing Mr. Midcap and certain associates
from Mr. Midcap’s practice as petitioner’s representatives with
regard to the examination.
On November 28, 2000, respondent received petitioner’s
amended Federal tax return for 1996 (amended tax return). On the
amended tax return, petitioner reported the portion of the gain
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from the stock sale to the ESOP attributable to the proceeds that
had not been reinvested in qualified replacement property; i.e.,
$121,807.
On July 20, 2001, respondent mailed petitioner a notice of
deficiency for 1996. Respondent determined that petitioner
realized a long-term capital gain of $1,406,017 as a result of
the stock sale to the ESOP. Further, respondent determined that
the gain must be included in taxable income for 1996 because
petitioner did not make a timely election under section 1042 in
order to defer the gain. On October 17, 2001, petitioner filed a
petition with the Court with respect to the notice of deficiency.
Also on October 17, 2001, respondent received a second
Federal tax return for 1996 (second tax return) from petitioner,
which included the undated signature of petitioner and the
signature of Mr. Midcap dated March 4, 1997. The second tax
return had attached a statement of election pursuant to section
1042 predated to March 4, 1997, a statement of consent from the
company consenting to the application of sections 4978 and 4979A
predated to March 4, 1997, and a statement of petitioner’s
purchase of qualified replacement property predated to March 2,
1998.
On October 29, 2001, respondent received a second amended
Federal tax return for 1996 (second amended tax return), signed
by petitioner and dated October 27, 2000, and by Mr. Midcap and
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dated October 11, 2000. The second amended tax return computed
the same amount of tax owed as the amended tax return but
differed from the amended tax return by the attachment of a
statement of election under section 1042 predated to March 4,
1997, a statement of consent from the company consenting to the
application of sections 4978 and 4979A predated to March 4, 1997,
and a statement of petitioner’s purchase of qualified replacement
property predated to March 2, 1998.
OPINION
Section 1042 provides, generally, that a taxpayer may elect
to defer recognition of the gain from a sale of stock to an ESOP
in certain circumstances. In relevant part, section 1042
provides:
SEC. 1042(a). Nonrecognition of Gain.--
If–-
(1) the taxpayer or executor elects in such form
as the Secretary may prescribe the application of this
section with respect to any sale of qualified
securities,
(2) the taxpayer purchases qualified replacement
property within the replacement period, and
(3) the requirements of subsection (b) are met
with respect to such sale,
then the gain (if any) on such sale which would be
recognized as long-term capital gain shall be recognized
only to the extent that the amount realized on such sale
exceeds the cost to the taxpayer of such qualified
replacement property.
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(b) Requirements To Qualify for Nonrecognition.--A
sale of qualified securities meets the requirements of
this subsection if–
(1) Sale to employee organizations.--The qualified
securities are sold to–
(A) an employee stock ownership plan (as
defined in section 4975(e)(7)), or
(B) an eligible worker-owned cooperative.
* * * * * * *
(3) Written statement required.--
(A) In general.--The taxpayer files with the
Secretary the written statement described in
subparagraph (B).
(B) Statement.--A statement is described in
this subparagraph if it is a verified written
statement of –
(i) the employer whose employees are
covered by the plan described in paragraph
(1), or
(ii) any authorized officer of the
cooperative described in paragraph (1),
consenting to the application of sections 4978 and
4979A with respect to such employer or
cooperative.
* * * * * * *
(c) Definitions; Special Rules. * * *
* * * * * * *
(6) Time for filing election.--An election under
subsection (a) shall be filed not later than the last
day prescribed by law (including extensions thereof)
for filing the return of tax imposed by this chapter
for the taxable year in which the sale occurs.
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Thus, the election to apply section 1042 to a sale of stock
(statement of election) and the verified written statement from
the employer or authorized officer consenting to the application
of sections 4978 and 4979A (statement of consent) are statutory
requirements. The statute also requires that the taxpayer elect
to be treated under section 1042 by the due date of the tax
return, including extensions. Sec. 1042(c)(6).
The Secretary has prescribed a regulation for the form of
the election required under section 1042. Sec. 1.1042-1T,
Temporary Income Tax Regs., 51 Fed. Reg. 4333 (Feb. 4, 1986);2
see sec. 1042(a). Our analysis of the regulation is informed by
Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S.
837, 842-843 (1984). In Chevron, the U.S. Supreme Court stated
the analysis as follows:
When a court reviews an agency’s construction of the
statute which it administers, it is confronted with two
questions. First, always, is the question whether Congress
has directly spoken to the precise question at issue. If
the intent of Congress is clear, that is the end of the
matter; for the court, as well as the agency, must give
effect to the unambiguously expressed intent of Congress.
If, however, the court determines Congress has not directly
addressed the precise question at issue, * * *. * * * the
question for the court is whether the agency’s answer is
based on a permissible construction of the statute. [Fn.
refs. omitted.]
2
Temporary regulations are entitled to the same weight as
final regulations. See Peterson Marital Trust v. Commissioner,
102 T.C. 790, 797 (1994), affd. 78 F.3d 795 (2d Cir. 1996); Truck
& Equip. Corp. v. Commissioner, 98 T.C. 141, 149 (1992).
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Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., supra at
842-843.
Using the Chevron analysis, we find Congress intended the
Secretary to prescribe the regulation as to the form of the
election. First, the regulation was prescribed by the Secretary
pursuant to the specific grant of authority stated in section
1042(a) that authorizes him to prescribe the form in which “the
application of this section with respect to any sale of qualified
securities” is to be elected by a taxpayer or executor. Sec.
1042(a). Further, the legislative history of section 1042 states
that Congress intended the Secretary to prescribe the form of the
election: “Under the bill, the seller’s nonrecognition election
is made by filing (as prescribed by the Secretary) an election no
later than the due date of the seller’s income tax return for the
taxable year in which the sale occurs.” S. Rept. 98-169 (Vol.
I), at 333 (1984).
With regard to the form of the election, section 1.1042-1T,
Temporary Income Tax Regs., supra, is a legislative regulation
expressly authorized by the statute. Sec. 1042(a). A
legislative regulation is given controlling weight unless it is
arbitrary, capricious, or manifestly contrary to the statute.
Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., supra at
844. We do not find the regulation to be arbitrary, capricious,
or manifestly contrary to section 1042 because the regulation is
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consistent with the statute’s prescription; i.e., to prescribe
the form of the election. All items required by the regulation
to be included in the election serve the purpose of carrying out
the statute.
The regulation provides the information required in the
statement of election, which includes a notarized statement of
purchase of qualified replacement property, in order to elect
treatment under section 1042. Sec. 1.1042-1T, Q&A-3(b),
Temporary Income Tax Regs., 51 Fed. Reg. 4334 (Feb. 4, 1986). In
relevant part, the regulation provides:
A-2: (a) Under section 1042(b), a sale of qualified
securities is one under which all of the following
requirements are met:
* * * * * * *
(4) The taxpayer files with the Secretary (as part
of the required election described in Q&A-3 of this
section) a verified written statement of the domestic
corporation (or corporations) whose employees are
covered by the plan acquiring the qualified securities
or of any authorized officer of the eligible worker-
owned cooperative, consenting to the application of
section 4978(a) with respect to such corporation or
cooperative.
* * * * * * *
Q-3: What is the time and manner for making the
election under section 1042(a)?
A-3: (a) The election not to recognize the gain
realized upon the sale of qualified securities to the extent
provided under section 1042(a) shall be made in a “statement
of election” attached to the taxpayer’s income tax return
filed on or before the due date (including extensions of
time) for the taxable year in which the sale occurs. If a
taxpayer does not make a timely election under this section
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to obtain section 1042(a) nonrecognition treatment with
respect to the sale of qualified securities, it may not
subsequently make an election on an amended return or
otherwise. Also, an election once made is irrevocable.
(b) The statement of election shall provide that the
taxpayer elects to treat the sale of securities as a sale of
qualified securities under section 1042(a), and shall
contain the following information:
(1) A description of the qualified securities
sold, including the type and number of shares;
(2) The date of the sale of the qualified
securities;
(3) The adjusted basis of the qualified
securities;
(4) The amount realized upon the sale of the
qualified securities;
(5) The identity of the employee stock ownership
plan or eligible worker-owned cooperative to which the
qualified securities were sold; and
(6) If the sale was part of a single, interrelated
transaction under a prearranged agreement between
taxpayers involving other sales of qualified
securities, the names and taxpayer identification
numbers of the other taxpayers under the agreement and
the number of shares sold by the other taxpayers. See
Q&A-2 of this section.
If the taxpayer has purchased qualified replacement property
at the time of the election, the taxpayer must attach as
part of the statement of election a “statement of purchase”
describing the qualified replacement property, the date of
the purchase, and the cost of the property, and declaring
such property to be the qualified replacement property with
respect to the sale of qualified securities. Such statement
of purchase must be notarized by the later of thirty days
after the purchase or March 6, 1986. In addition, the
statement of election must be accompanied by the verified
written statement of consent required under Q&A-2 of this
section with respect to the qualified securities sold.
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(c) If the taxpayer has not purchased qualified
replacement property at the time of the filing of the
statement of election, a timely election under this Q&A
shall not be considered to have been made unless the
taxpayer attaches the notarized statement of purchase
described above to the taxpayer’s income tax return filed
for the taxable year following the year for which the
election under section 1042(a) was made. Such notarized
statement of purchase shall be filed with the district
director or the director of the regional service center with
whom such election was originally filed, if the return is
not filed with such director.
Sec. 1.1042-1T, A-2, Q&A-3, 51 Fed. Reg. 4334 (Feb. 4, 1986).
Having not literally complied with the election requirements
in the statute and the regulation, petitioner argues that he
substantially complied with the requirements of section 1042 and
should, therefore, receive the benefits of the section because
the failure to file the elections was “purely administrative in
nature”. We disagree.
Section 1042 requires that an election, in the form
prescribed by the Secretary, be made by the due date (including
extensions) for filing the return for the year of the sale.3
3
We note that, in certain circumstances, the Commissioner
may grant an extension of time to make an election. If the
taxpayer has not filed a request for an extension, an automatic
extension of 6 months from the due date of the original tax
return may be granted if the taxpayer has taken corrective action
within the 6-month extension period. Sec. 301.9100-2T(b),
Temporary Proced. & Admin. Regs., 61 Fed. Reg. 33368 (June 27,
1996). As relevant here, “corrective action” is defined as
“filing an original or an amended return for the year the
regulatory or statutory election should have been made and
attaching the appropriate form or statement for making the
election.” Sec. 301.9100-2T(c), Temporary Proced. & Admin.
Regs., 61 Fed. Reg. 33368 (June 27, 1996). Petitioner timely
(continued...)
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According to the regulation, the election is to be made in the
form of statements attached to the return. Not only did
petitioner’s return for the year of sale fail to include such
statements, it reported none of the information required to be
provided in such statements. Indeed, the return made no mention
of the sale at all.
The Commissioner must be notified in some manner of a
taxpayer’s intentions to elect the benefit of section 1042 in
order to facilitate the Commissioner’s duty to ensure compliance
with the tax laws and minimize disputes between taxpayers and the
Internal Revenue Service. Knight-Ridder Newspapers, Inc. v.
United States, 743 F.2d 781, 795 (11th Cir. 1984); Young v.
Commissioner, 83 T.C. 831, 841 (1984), affd. 783 F.2d 1201 (5th
Cir. 1986). As we stated in Dunavant v. Commissioner, 63 T.C.
316, 320 (1974): “We are not at liberty to infer that an
election existed when the unequivocal proof required by Congress
does not exist.” Petitioner did not alert respondent to the
intended “election” under section 1042 until respondent received
the amended tax return on November 28, 2000, over 3 years after
the due date of the original tax return.
3
(...continued)
filed the original tax return on or before Apr. 15, 1997.
Petitioner’s first amended tax return was not received by
respondent until Nov. 28, 2000. We conclude that petitioner did
not take the appropriate corrective action in order to receive an
automatic extension of time for filing the election under sec.
1042.
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There is no defense of substantial compliance for failure to
comply with the essential requirements of the governing statute.
See Tipps v. Commissioner, 74 T.C. 458, 468 (1980); Penn-Dixie
Steel Corp. v. Commissioner, 69 T.C. 837, 846 (1978). As the
plain language of section 1042 indicates, the “essence” of the
statute is to demand evidence of a binding election to accept the
tax consequences imposed by the section. See Dunavant v.
Commissioner, supra at 320. Inasmuch as there was nothing on
petitioner’s return to inform the IRS that an election was made
and nothing on the return indicating that the sale had even
occurred, the essence of a valid election was missing, and the
use of the substantial compliance doctrine is insufficient to
secure the benefits of section 1042. Knight-Ridder Newspapers,
Inc. v. United States, supra.
Petitioner argues that we have held that a taxpayer
substantially complied with the requirements for an election even
though the taxpayer failed to meet the literal requirements for
an election. See Bond v. Commissioner, 100 T.C. 32 (1993);
Taylor v. Commissioner, 67 T.C. 1071, 1080 (1977); Hewlett-
Packard Co. v. Commissioner, 67 T.C. 736, 748 (1977); Columbia
Iron & Metal Co. v. Commissioner, 61 T.C. 5 (1973); Sperapani v.
Commissioner, 42 T.C. 308 (1964); Cary v. Commissioner, 41 T.C.
214 (1963). The cases that petitioner cites are inapplicable
because, as discussed above, the substantial compliance doctrine
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may not be used as a defense in the instant case. Even if we
assume, arguendo, that the cases apply, in each of those cases
the taxpayer’s attempt to make the election was evident on the
original tax return, the taxpayers had provided most of the
information required, and the information missing was not
significant. See Bond v. Commissioner, supra at 41-42; Taylor v.
Commissioner, supra at 1080; Hewlett-Packard Co. v. Commissioner,
supra at 747-750; Columbia Iron & Metal Co. v. Commissioner,
supra at 9; Sperapani v. Commissioner, supra at 329-332; Cary v.
Commissioner, supra at 218; cf. Hewitt v. Commissioner, 109 T.C.
258, 264 (1997) (holding that the taxpayers were not entitled to
deduct amounts in excess of those allowed by the Commissioner for
stock contributions because the taxpayers provided “practically
none of the information required by either the statute or the
regulations”), affd. without published opinion 166 F.3d 332 (4th
Cir. 1998). In the instant case, petitioner provided none of the
information required by either the statute or the regulation
regarding the transaction with the ESOP on his original tax
return. Respondent, therefore, had no indication from the
original tax return that the sale had even occurred.
It is clear to the Court that petitioner relied upon Mr.
Midcap’s knowledge in filing his tax returns for 1996. While we
are sympathetic to petitioner regarding Mr. Midcap’s failure to
file a proper election under section 1042 on petitioner’s behalf,
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the general rule is that the duty of filing an accurate tax
return cannot be avoided by placing responsibility on an agent,
and taxpayers bear responsibility for the failure of their
agents. Pritchett v. Commissioner, 63 T.C. 149, 174 (1974); Am.
Props. Inc. v. Commissioner, 28 T.C. 1100, 1116 (1957), affd. 262
F.2d 150 (9th Cir. 1958). Therefore, petitioner must bear
responsibility for the failure to file a timely election pursuant
to section 1042.
We hold that petitioner is not able to defer recognition of
a gain that resulted from a sale of stock to the ESOP because he
failed to elect such treatment as required by section 1042.
We have considered all of petitioner’s contentions,
arguments, and requests that are not discussed herein, and we
conclude that they are without merit or irrelevant.
To reflect the foregoing,
Decision will be
entered for respondent.