Clause v. Comm'r of Internal Revenue (In re Estate of Clause)

• Citation: 122 T.C. No. 5,122 T.C. 115,32 Employee Benefits Cas. 2650
• Decision Date: 09 February 2004
• Docket Number: No. 12995–01.,12995–01.
• Parties: ESTATE OF John W. CLAUSE, Deceased, Thomas Y. Clause, Personal Representative, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

122 T.C. 115

122 T.C. No. 5

32 Employee Benefits Cas. 2650

ESTATE OF John W. CLAUSE, Deceased, Thomas Y. Clause, Personal Representative, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 12995–01.

United States Tax Court.

Feb. 9, 2004.

Ronald L. Kahn and Ronald H. Isroff, for petitioner.

David S. Weiner, for respondent.

HAINES, J.

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.

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 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).

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 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 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.

(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.

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, 104 S.Ct. 2778, 81 L.Ed.2d 694 (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...