Foote v. Comm'r of Internal Revenue

• Decision Date: 07 December 1983
• Docket Number: Docket No. 9667–81.
• Citation: 81 T.C. No. 57,81 T.C. 930
• Parties: MERRILL J. FOOTE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

81 T.C. 930

81 T.C. No. 57

MERRILL J. FOOTE, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 9667–81.

United States Tax Court

Filed December 7, 1983.

Petitioner, a tenured professor at Southern Methodist University, resigned his position and gave up his tenure in return for negotiated compensation.

Held: Tenure is not a capital asset and petitioner's release of his tenure was not a sale or exchange. The amount received by petitioner on termination of his contract was taxable as ordinary income rather than capital gain. Merrill J. Foote, pro se.

Gary A. Benford, for the respondent.

DRENNEN, Judge:

Respondent determined deficiencies in petitioner's Federal income taxes for the years 1977 and 1978 in the amounts of $2,715 and $4,074, respectively. The primary issue is whether money paid to petitioner pursuant to his resignation of his tenured faculty position at Southern Methodist University is taxable as ordinary income or as long term capital gain. Petitioner also argues that the Court erred in sustaining respondent's objection to a question posed to a witness at trial.

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly. The stipulation of facts and exhibits attached thereto are incorporated herein by reference.

Petitioner, Merrill J. Foote, timely filed joint Federal income tax returns with his spouse for the years 1977 and 1978.¹ At the time of the filing of his petition and throughout the period discussed herein, petitioner was a resident of Dallas, Texas.

In 1968 petitioner accepted a position as an Associate Professor of Management Science at the Southern Methodist University School of Business Administration (University). In 1971 he was promoted to the rank of Assistant Professor. ²

In 1972 the University officially recognized petitioner's tenure. Normally, a professor is accorded the status of tenure only by a process of review after the individual has taught for a period of six years. Petitioner, however, received tenure by the less common procedure called “de facto” tenure, whereby a faculty member is deemed to have received tenure if he has taught for more than six years without the University taking the necessary administrative steps to review his performance. Petitioner's de facto tenure arose unintentionally and without the knowledge of the University, due to the fact that, under guidelines followed by the University, petitioner's prior teaching experience at another university counted towards his tenure at SMU.

Contrary to general understanding, tenure is not “granted” by the University. Rather, it is a status that arises as a result of a faculty member's service to the university; it is then recognized by the university. Tenure is essentially an assurance of life-time employment with the University. A tenured professor at SMU can be dismissed only on the grounds of moral turpitude or gross incompetence. Tenure generally allows a professor more freedom to engage in scholarly activities such as research and writing, as well as activities outside of the university, such as consulting and other professional work, than would a non-tenured professor be permitted.³ Tenure cannot be purchased, and a tenured faculty member cannot sell his tenure to another person.

While tenure may be viewed as an informal employment contract with the university, it does not guarantee any specific salary. Petitioner entered into annual employment contracts with the University that specified his salary.

During his employment with the University, petitioner taught courses and engaged in other academic activities in a normal manner. However, during 1975 and 1976, some students and faculty members expressed concerns about his work, and friction apparently developed between petitioner and the administration. Petitioner was inclined to devote more time to his outside business activities than to his teaching and other university responsibilities. He described himself as “not a team player.”

In January, 1977, petitioner and the University entered into an agreement whereby petitioner resigned his tenured appointment in exchange for a sum of $45,640, to be paid him by the University in monthly installments throughout 1977 and 1978.⁴ Under the agreement, petitioner had no further obligations to the University, and he ceased teaching at that time.

During 1977 and 1978, petitioner realized net losses from consulting of $4,435 and $1,700, respectively.

Pursuant to the agreement, petitioner received monthly payments of $1,901.67 from the University. Petitioner reported these payments as long-term capital gain on his income tax returns for those years.

Respondent issued a joint notice of deficiency to petitioner and his spouse, Janet, in which he determined that the payments received by petitioner from the University were ordinary income.

OPINION

The primary issue is whether petitioner is allowed to treat the payments received from the University pursuant to his resignation of his tenured appointment as Assistant or Associate Professor as long-term capital gain, rather than or ordinary income. Petitioner contends that his tenure was a capital asset, which he “sold” to the University. Respondent contends that the transaction cannot be viewed as the sale or exchange of a capital asset within the meaning of sections 1221 and 1222,⁵ but rather represents a termination of petitioner's rights under an employment agreement, the payment for which is ordinary income.

Petitioner cites no authority supporting his position,⁶ but presents us with a comprehensive discussion of why tenure, from the viewpoint of economics, constitutes an intangible capital asset. His argument, briefly stated, is that tenure affords a faculty member the freedom and opportunity to use the benefits of his university affiliation to generate income from activities such as consulting, speaking and writing. The university affiliation provides resources such as contacts, prestige, visibility, and marketing channels for business activities. Because tenure assures job security, the faculty member is free to devote most of his time and energy to such personal business pursuits, contrary to the wishes of the university. Petitioner asserts that the aggressive exploitation of the business potential of his tenure can produce income and capital appreciation far in excess of his teaching salary. Furthermore, he argues, as he exploits his tenure in this fashion, its value increases, as does the university's incentive to disassociate itself from him by “purchasing” his tenure.⁷

Thus, according to petitioner's economic thesis, the agreement in question constitutes a sale of an intangible capital asset, his tenure, the consideration for which primarily reflects the capital asset value of the tenure rather than the value of the right to receive future salary, and hence is properly taxable as capital gain.

While we find petitioner's argument to be ingenious and well presented, we are not so free to approach the question unencumbered by the statute and the case law. In order to entitle himself to preferential capital gain treatment, petitioner must demonstrate that the gain was produced by the (1) “sale or exchange” of (2) a “capital asset.” Sections 1221, 1222. We think it is clear, from the extensive case law interpreting the capital gains provisions, that petitioner does not satisfy either of these requirements, and we therefore must find for the respondent.

“Capital asset” is defined in section 1221. Generally, it is property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade or property held primarily for sale to customers in the ordinary course of his trade or business, or depreciable property used in his trade, or certain other specified types of property.

It is well established that a taxpayer does not bring himself within the capital gains provisions merely by showing that a contract constitutes “property”, that he held a contract, and that his contract does not fall within a specified exclusion of section 1221. Commissioner v. Gillette Motor Transport, Inc. 364 U.S. 130, 134 (1960); Bisbee-Baldwin Corp. v. Tomlinson, 320 F.2d 929, 932 (5th Cir. 1963); Commissioner v. Ferrer, 304 F.2d 125, 129 (2d Cir. 1962); Buena Vista Farms, Inc. v. Commissioner, 68 T.C. 405, 411 (1977). Generally, the consideration received for the transfer or termination of a contract right to receive income for the performance of personal services is taxable as ordinary income. Bisbee-Baldwin Corp. v. Tomlinson, supra; United States v. Woolsey, 326 F.2d 287, 291 (5th Cir. 1963); United States v. Eidson, 310 F.2d 111, 114–115 (5th Cir. 1962); Kingsbury v. Commissioner, 65 T.C. 1068, 1081 (1976); Flower v. Commissioner, 61 T.C. 140, 148 (1973).

The central theme of the many cases denying capital gains treatment on the termination of such contract rights is that the payment received is essentially a substitute for ordinary income which would have been earned in the future. See Kingsbury v. Commissioner, supra at 1082–1083 and Commissioner v. P.G. Lake, Inc., 356 U.S. 260, 266 (1958). Despite petitioner's effort to imbue his tenure with the attributes of a capital asset, we think his rights were not substantially different than the rights under any long term term employment or agency agreement.⁸

It is clear from petitioner's own testimony that petitioner's tenure put him into a position to earn additional income. Not only could he continue to earn his salary with a minimum amount of teaching, but he was put in a position to earn fees from consulting,...