Cline v. C.I.R.

• Decision Date: 02 September 1994
• Docket Number: No. 93-2698,93-2698
• Citation: 34 F.3d 480
• Parties: -6144, 94-2 USTC P 50,468, 18 Employee Benefits Cas. 2029 Richard G. CLINE and Carole J. Cline, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 480

34 F.3d 480

74 A.F.T.R.2d 94-6144, 94-2 USTC P 50,468,

18 Employee Benefits Cas. 2029

Richard G. CLINE and Carole J. Cline, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 93-2698.

United States Court of Appeals, Seventh Circuit.

Argued Feb. 9, 1994.

Decided Sept. 2, 1994.

Roger J. Jones (argued), Joel V. Williamson, Thomas C. Durham, Bruce L. Gelman, Mayer, Brown & Platt, Chicago, IL, for petitioners-appellants.

Richard Farber, Gary R. Allen, Charles Bricken, Steven W. Parks (argued), Dept. of Justice, Tax Div., Appellate Section, Washington, DC, for respondent-appellee.

Before WOOD, Jr., EASTERBROOK and RIPPLE, Circuit Judges.

RIPPLE, Circuit Judge.

Richard G. Cline, a former senior executive of Jewel Companies, Inc. ("Jewel"), disputes the tax treatment accorded certain payments he received at the time of his resignation from Jewel Foods. The Tax Court concluded that these payments were received in connection with the acquisition of Jewel by American Stores Company ("American Stores") and constituted "excess parachute payments" under 26 U.S.C. Sec. 280G of the Internal Revenue Code. Consequently, the payments were subject to the golden parachute payments excise tax imposed under 26 U.S.C. Sec. 4999. Mr. Cline and his wife Carole J. Cline, who is a petitioner by virtue of having filed a joint return with her husband, appeal the Tax Court's decision. We have jurisdiction to review the decision under 26 U.S.C. Sec. 7482(a). For the reasons that follow, we affirm.

I BACKGROUND

A. Statutory Provisions

The "golden parachute" provisions, 26 U.S.C. Secs. 280G and 4999, were added to the Internal Revenue Code by the Deficit Reduction Act of 1984 in order to discourage the use of golden parachutes--payments to senior executives of a company in the event of a corporate takeover. See 1 Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates and Gifts p 22.2.5, at 22-35 (1989). Congress found that agreements to make such payments hindered "acquisition activity in the marketplace" by making target corporations less attractive to prospective suitors. Id. (quoting Staff of Joint Comm. on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, 98th Cong., 2d Sess. 199 (J.Comm.Print 1984)). The prospect of a handsome The provisions contain a complex set of definitions and interrelated applications. Section 280G(b) defines both "parachute payment" and "excess parachute payment," and section 4999(a) imposes a twenty-percent excise tax on excess parachute payments. For purposes of this case, section 280G defines a "parachute payment" as a payment to a corporate officer that is made contingent on a change in the control or ownership of the corporation. See Secs. 280G(b)(2)(A)(i)(I) & 280G(c)(2). To fall within the definition, however, the present value of that payment must equal or exceed three times the individual's "base amount," Sec. 280G(b)(2)(A)(ii), which is the average of the individual's compensation for the previous five years, Secs. 280G(b)(3) & (d)(2). The parachute payment rules do not apply to a payment that the individual establishes, by clear and convincing evidence, to be "reasonable compensation" for personal services rendered on or after the date of acquisition of the corporation. Sec. 280G(b)(4). An "excess parachute payment" is defined to mean any parachute payment that exceeds the individual's "base amount." Sec. 280G(b)(1). To the extent the rules apply, therefore, "any excess of the payments over the recipient's average annual compensation is generally nondeductible." ¹ 1 Bittker & Lokken, supra, p 22.2.5, at 22-37. The officer-recipient must pay a 20 percent excise tax on the amount the employer may not deduct. 26 U.S.C. Sec. 4999(a); see 1 Bittker, supra, p 22.2.5, at 22-37.

                payment tends to encourage management personnel of the target corporation to favor a proposed takeover, regardless of whether the takeover would be in the best interests of the target corporation's shareholders.  The payments promised to the executives also decrease the amounts paid to the target corporation shareholders.  For these reasons, Congress made such parachute payments "nondeductible to the payor and subject to an excise tax of 20 percent, in addition to the regular income tax, in the hands of the recipient."   Id. at 22-36
                

B. Facts

Both American Stores and Jewel were engaged in the sale of food, drug, and general merchandise through their retail stores. American Stores first made known its interest in acquiring Jewel and merging the two entities in mid-April 1984. Although Jewel management at first rejected the idea, American Stores (through the A.S. Acquisition Company) made a tender offer on June 1, 1984. After negotiations, Jewel's board of directors formally considered and accepted the proposed merger on June 14, 1984.

On June 15, 1984, Mr. Cline and other senior managers ² of Jewel Company each entered into a severance pay agreement. The stated purpose of the agreement was to "foster the continuing employment of [Jewel's] key management personnel" during the change in control. Ex. 44-AR at 1 (Appellant's App. 3). This original agreement provided that, if an executive were terminated as a result of the merger, he would receive an amount equal to three times the sum of his annual salary and target bonus in effect either on the date of change in control or on the date of termination, whichever amount was greater.

On July 12, 1984, American Stores announced that it had control of Jewel. On the same date, Jewel entered into amended severance agreements with its senior executives. The parties had to amend the agreements because, at the time the earlier agreements were executed, the general counsel of each of the two merging stores had erroneously believed that the "golden parachute" provisions of the Deficit Reduction Act (then newly-enacted) applied only to agreements entered into after June 15, 1984, the date the original severance agreements were executed. The "golden parachute" provisions, however, actually applied to agreements entered into The amended severance agreement signed by each executive expressly stated that their severance pay was reduced to avoid imposition of the golden parachute excise tax:

after June 14, 1984. Thus, under the original agreements, the executives' severance payments would be subject to the excise tax and Jewel would be unable to deduct those payments. The companies therefore revised their agreements by reducing the severance pay amount so that it would not be considered an excess parachute payment under sections 280G and 4999.

Jewel Companies, Inc. (the "Company") entered into an agreement with you dated June 15, 1984, under which the Company agreed to pay you certain benefits upon termination of employment. You have offered to reduce the amount payable to you under the Agreement with the intended result that no amount payable to you shall become subject to an excise tax under the so-called "golden parachute" provisions of the tax legislation which had recently been enacted by Congress, but has not yet been signed into law by the President of the United States. You have requested that termination of your employment by the Company be eliminated as a condition to your rights under the Agreement. Your proposal is acceptable to the Company.

Ex. 45-AS at 1 (Appellant's App. 4). American Store's general counsel and a senior vice president assured the Jewel executives that American Stores intended to make a good faith effort to offer them employment to make up for the reduction in severance pay. American Stores did in fact employ the Jewel executives after the acquisition of Jewel. According to a senior vice-president of American Stores handling the matter, the compensation of these individuals was determined by considering the difference between the severance pay amounts in the original and amended agreements, not by the time spent performing additional services. He testified that a $300,000 bonus Mr. Cline received in April 1985 was approximately equal to the amount by which the amended agreement reduced his severance pay.

Prior to the merger, Mr. Cline had been president and chief operating officer of Jewel; his annual salary was $365,000, and his target bonus in 1984 was $110,000. Mr. Cline's amended agreement eliminated termination of employment as a condition of his right to receive benefits. It also limited his lump-sum benefit to $1,210,000, an amount below his individual golden parachute tax level, $1,216,197. His amended agreement superseded other agreements, and its benefits were in lieu of any to which he would have been entitled. On July 13, 1984, the day after American Stores announced that it had control of Jewel, he became chairman of the board and chief executive officer of Jewel. His annual salary was increased accordingly to $475,000. Pursuant to the amended severance agreement, Mr. Cline received $1,210,000 in severance pay in 1984. Mr. Cline remained with Jewel during the transition period, until February 3, 1985. When he resigned, he received $409,163 as compensation for his services from January 1, 1985 through February 2, 1985. Some of that amount, $109,163, is attributable to his prorated annual salary of $475,000, his unused vacation pay, and other miscellaneous items. The remainder is a $300,000 bonus. The Commissioner of Internal Revenue (the "Commissioner") agreed that $109,163 of the $409,163 was a reasonable month's compensation for Mr. Cline in 1985, but that no portion of the $300,000 bonus constituted reasonable compensation. Accordingly, the Commissioner concluded that the amount of income tax deficiency Mr. and Mrs. Cline owed under the golden parachute payment excise tax was $60,000 for 1985.

C. Tax Court Proceedings

Following a two-day trial and post-trial briefing by the parties, the Tax Court ruled that the bonus payments made to...