Pledger v. C. I. R., 79-3279

• Decision Date: 02 April 1981
• Docket Number: No. 79-3279,79-3279
• Parties: 81-1 USTC P 9314 Thomas R. PLEDGER and Phyllis R. Pledger, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. . Unit B
• Court: U.S. Court of Appeals — Fifth Circuit

Page 287

641 F.2d 287

81-1 USTC P 9314

Thomas R. PLEDGER and Phyllis R. Pledger, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 79-3279.

United States Court of Appeals, Fifth Circuit.

Unit B

April 2, 1981.

Rehearing and Rehearing En Banc Denied April 29, 1981.

Robert O. Rogers, David S. Meisel, Palm Beach, Fla., for petitioners-appellants.

M. Carr Ferguson, Asst. Atty. Gen., Tax Div., Gilbert E. Andrews, Act. Chief, Appellate Section, Gary R. Allen, Atty., Donald B. Susswein, Atty., U. S. Dept. of Justice, Washington, D. C., N. Jerold Cohen, Chief Counsel, Internal Rev. Service, Washington, D. C., for respondent-appellee.

Appeal from the Tax Court of the United States.

Before MORGAN, FAY and FRANK M. JOHNSON, Jr., Circuit Judges.

LEWIS R. MORGAN, Circuit Judge.

In this appeal from the Tax Court decision, 71 T.C. 618, sustaining the Commissioner's finding of deficiency, petitioner-appellant Pledger questions whether the full value of corporate stock purchased pursuant to an employee stock option and subject to certain securities restrictions can constitutionally be taxed as income under Section 83(a) of the Internal Revenue Code. The taxpayer also challenges the decision of the Tax Court that the term "any restriction" in section 83(a) includes the restrictions of an investment letter. Responding to these challenges, we affirm the decision of the Tax Court below.

The stipulated facts in this dispute reveal that Thomas R. Pledger ¹ (Appellant) purchased 30,000 shares of common stock of Burnup & Sims, Inc. pursuant to an option given to him in the previous year by Mr. Riley V. Sims, the president of the company, as compensation for services. Appellant purchased 6,000 shares in October of 1971 and purchased the remaining 24,000 shares in November. Upon acquiring the stock appellant executed and delivered to Mr. Sims an investment letter indicating that the stock was acquired for investment and not for sale. ² The letter also stated that the stock certificates were to be stamped with a legend indicating that the shares were not registered under the Securities Act of 1933 and could not be sold absent an effective registration or a "no action" letter from the SEC.

Because of the restrictions imposed by the investment letter, the shares of stock were worth as stipulated only 65 percent of their fair market value if sold pursuant to another private placement during a two-year period after purchase. The taxpayer for the taxable year 1971 calculated the excess of the discounted value of the stock over the amount paid for the stock and reported as income $195,363. ³ The Commissioner on audit increased the amount of compensation by $239,137 based on the difference between the amount the full fair market value exceeded the taxpayer's cost and the amount of taxes the taxpayer had paid. ⁴ From this the Commissioner determined a deficiency in the amount of $155,416 and accordingly adjusted the taxpayer's basis in the stock.

Appellant filed a petition for a redetermination of deficiency in the United States Tax Court. The Tax Court upheld the deficiency and the taxpayer appealed to this court.

I.

The first issue raised by the appellant presents the recurring question of what is income. All parties agree that the option to purchase stock was compensation for services and that the purchase of the stock was a taxable event. Taxpayer asserts, however, that the government is utilizing Section 83(a) of the Internal Revenue Code ⁵ to tax a nonexisting value, i. e., the excess of the fair market value of the stock over the discounted value. Section 83(a) provides that the value of compensation in the form of stock or other property for purposes of income taxation is to be determined by reference to the fair market value of the property "without regard to any restriction other than a restriction which by its terms will never lapse." 26 U.S.C. § 83(a). To the degree this statute allows taxation of an amount in excess of the value for which taxpayer could sell the stock during the time of restriction, taxpayer argues that the statute exceeds the powers of Congress to tax under the Sixteenth Amendment and Article 1, Section 8 of the Constitution. ⁶ Relying on the classic definition of income as presented in Eisner v. Macomber, ⁷ 252 U.S. 189, 207, 40 S.Ct. 189, 193, 64 L.Ed. 521 (1920), taxpayer argues that the excess value is not realized gain or "something of exchangeable value ... derived from property." Id. With these contentions, we disagree.

First, we note that the Sixteenth Amendment did not limit or expand the power of Congress to tax under Article 1, Section 8 of the Constitution. See Brushaber v. Union Pac. R. R., 240 U.S. 1, 36 S.Ct. 236, 60 L.Ed. 493 (1916). The Sixteenth Amendment simply provided for taxation of income without apportionment. In Eisner v. Macomber, supra, 252 U.S. 189, 40 S.Ct. 189, 64 L.Ed. 521, the Court attempted to define the term "income" used, but left undefined, in the Sixteenth Amendment. In that case, the court struck down a taxing statute on the ground that it attempted to tax stock dividends which were not income within the meaning of the Sixteenth Amendment. The case distinguished between income and capital without focusing particularly on the issue of compensation presented in this case. In defining income as "something of exchangeable value," the Court was stating what was income, not defining the amount of income received. Later developments in the tax law reveal that the definition was not intended as an all-encompassing implication of income. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431, 75 S.Ct. 473, 476, 99 L.Ed. 483 (1955). See generally Note, "Apparent Abandonment of a Definitive Concept of Income," 45 Harv.L.Rev. 1072 (1923). The parties in this case agree that income was received; the only question is whether 65 percent of the fair market value or the full fair market value was received for purposes of taxation. The language of Eisner does not control this case. The taxing scheme does not contravene the language of Eisner defining income under the Sixteenth Amendment, and even if it did, the language of Eisner is not controlling where a different issue of income is presented.

In a challenge similar to the one in this case the Second Circuit held in Sakol v. Commissioner, 574 F.2d 694 (2d Cir.), cert. denied 439 U.S. 859, 99 S.Ct. 177, 58 L.Ed.2d 168 (1978), that Section 83(a) did not violate the Sixteenth Amendment. In that case the taxpayer received as compensation what she claimed to be a lesser value than the fair market value of stock purchased pursuant to a stock option plan and subject to contractually imposed restrictions on the sale. The court considered that the language of Eisner requiring "gain" to be realized for "income" to exist had been modified by subsequent decisions upholding the accrual method of accounting, Burnet v. Sanford & Brooks Co., 282 U.S. 359, 51 S.Ct. 150, 75 L.Ed. 383 (1931), the doctrine of constructive receipt, Corliss v. Bowers, 281 U.S. 376, 50 S.Ct. 336, 74 L.Ed. 916 (1930), and the tax rules prohibiting assignment of income, Helvering v. Horst, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75 (1940). Id. at 700. The court concluded that the power of Congress to create a realistic and workable tax scheme to prevent tax avoidance was sufficiently broad to permit the taxation scheme of Section 83(a). ⁸

In this case when the taxpayer obtained the stock option, he received something of value. When he purchased the stock, the value of his compensation for purposes of taxation could be determined by reference to the fair market value of the stock on the day of purchase. Although taxpayer argues that the stock subject to the securities restrictions was worth only 65 percent of its fair market value, taxpayer ignores the fact that the stipulation regarding the 65 percent value pertained only to the discounted value if the stock were sold in another private placement sale. ⁹ A stipulation as to the value of property if sold under certain circumstances does not necessarily reflect the value of the property in the hands of the current owner. ¹⁰ Although the taxpayer could receive only 65 percent of the fair market value of the stock if sold during the period of the restriction, it does not necessarily follow that the only value the taxpayer received as compensation was 65 percent of the stock's fair market value. The full value of the stock existed from the moment of purchase; it was only temporarily subject to a diminution in value if exchanged because of the securities restrictions. Despite taxpayer's claim to the contrary, there was no nonexistent value upon which he was taxed.

The problem in this case is primarily one of timing rather than value of what was received. If taxpayer were taxed on only 65 percent of the fair market value at the time of purchase, but held the stock until the restrictions lapsed, the remaining 35 percent of the fair market value which was also compensation to the taxpayer would be taxed upon sale at the more favorable capital gains rate. This 35 percent value is not an investment increase that the capital gains tax was designed to benefit. Assuming that the stock maintained its value, the 35 percent value was certain to accrue when the restriction lapsed. Appellant, however, argues that if the stock decreased in value, the taxpayer would initially be taxed at ordinary income rates for the full value but would only be allowed to deduct any decrease in value as a capital loss. This fact is arguably true ¹¹ but is part of the risk any stockholder encounters when he purchases stock. A corporate employee purchasing stock pursuant to a stock option is not entitled to receive special tax benefits that a general purchaser of stock cannot receive, and indeed the corporate employee should not be heard to complain that he is unfairly taxed on the full fair market value of his...