Sakol v. Comm'r of Internal Revenue

• Decision Date: 23 March 1977
• Docket Number: Docket No. 4834-74.
• Citation: 67 T.C. 986
• Parties: MIRIAM SAKOL, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

67 T.C. 986

MIRIAM SAKOL, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 4834-74.

United States Tax Court

Filed March 23, 1977.

Sec. 83(a), I.R.C. 1954, measures income derived from the transfer of property in connection with the performance of services without regard to contractual restraints on the transfer of that property which will lapse. Held, sec. 83(a) is not unconstitutional under the 5th or 16th Amendment. Burton G. Lipsky, for the petitioner.

Peter Matwiczyk, for the respondent.

OPINION

GOFFE, Judge:

The Commissioner determined a deficiency in petitioner's Federal income tax for the taxable year 1972 in the amount of $3,318.80. Concessions having been made, the sole issue for decision is whether section 83(a)¹ is unconstitutional because it measures petitioner's gross income derived from an employee stock purchase agreement without regard to certain contractually imposed restrictions on the transferability of the shares purchased under the agreement.

All of the facts have been stipulated and are so found. Ms. Miriam Sakol (petitioner) filed her Federal income tax return for the taxable year 1972 with the Internal Revenue Service Center, Holtsville, N.Y. At the time the petition was filed, petitioner resided in New York City, N.Y.

During 1972 petitioner was employed by Chesebrough-Pond's, Inc. (Chesebrough,) which had in effect a stock purchase plan for its officers and administrative employees (the plan). Officers and employees electing to purchase stock under the plan were required to enter into a stock purchase agreement with Chesebrough. The standard agreement provided that $1 par value common stock could be purchased for an amount equal to 14 times Chesebrough's average per-share earnings during the preceding 5 years. Payment of the purchase price could be made in installments over a period not to exceed 5 years; however, the employee could prepay the balance at any time. Shares purchased under the agreement would not be issued or delivered and title to the purchased shares would not vest in the employee until the purchase price was paid in full.

On May 7, 1971, petitioner entered into such a stock purchase agreement with Chesebrough, agreeing to purchase 140 shares of $1 par value common stock at a price of $21.20 per share. For a period of 1 year, the shares purchased by petitioner were subject to forfeiture at a price equal to that paid by her in the event that she ceased to be employed by Chesebrough for any reason other than death. In addition, petitioner agreed that she would continue to own and not sell, pledge, or transfer any interest in the shares for a period of 5 years or until May 7, 1976. Chesebrough was willing to retain the shares for safekeeping until the expiration of the 5-year period, and shares delivered to petitioner would bear a legend noting the restrictions on the transferability of the shares.

On Sunday, May 7, 1972, the 140 shares acquired by petitioner were no longer subject to forfeiture. On the last business day prior to that date, the average New York Stock Exchange price quotation for Chesebrough common stock was $66.50 per share. Therefore, the difference between the average market price of Chesebrough common and the amount paid by petitioner for her shares acquired under the stock purchase agreement was $6,342 when the shares were no longer subject to forfeiture. The Commissioner, in his statutory notice of deficiency, determined that this amount represented compensation for services, includable in petitioner's gross income pursuant to section 83(a) for the taxable year 1972.

Petitioner has launched a serious constitutional assault on section 83(a) on two fronts. On one front, petitioner contends that the section imposes a ‘conclusive presumption’ as to the amount of income derived from the May 7, 1971, stock purchase without a fair opportunity to rebut and, therefore, amounts to a denial of due process of law within the meaning of the Fifth Amendment of the Constitution of the United States. On the other, she contends that section 83(a) disregards certain restrictions on transferability in defining income, exceeding the power granted to Congress by the 16th Amendment.

From the outset it is important to note the presumption in favor of the validity of an act of Congress, which is particularly strong in the case of a taxing statute. Penn Mutual Indemnity Co., 32 T.C. 653, 658 (1959). Moreover, a revenue measure will not, in general, be set aside if any state of facts can be shown to rationally justify the provision. United States v. Maryland Savings-Share Insurance Corp., 400 U.S. 4, 6 (1970).

Section 83² is the congressional response to certain tax advantages which could be obtained through use of restricted stock plans³ to compensate employees. The section provides that property transferred in connection with the performance of services is to be included in the income of the transferee in an amount which exceeds the employee's cost by the fair market value of the property transferred, without regard to any contractual restriction on its disposition except a restriction which by its terms will never lapse. The proper time to include that amount is deemed to be the taxable year in which the property is transferable or no longer subject to a substantial risk of forfeiture.

To properly evaluate petitioner's attack on section 83, it is helpful to consider the background of restricted stock purchase plans and the unwarranted tax avoidance made possible by their use.

Restricted stock purchase plans became more popular after two decisions of this Court. In Harold H. Kuchman, 18 T.C. 154 (1952), we held that stock issued under an agreement restricting its disposition prevented the stock from having a fair market value when acquired and, therefore, did not require reporting income at the time the stock was issued. Previously, in Robert Lehman, 17 T.C. 652 (1951), we held that income was not realized when the restrictions terminated, thus taxation was deferred until the subsequent disposition of the property. In 1956, regulations were proposed to the effect that income would be realized in an amount equal to the fair market value of the property over the employee's cost at the time the restrictions lapsed. The regulations adopted in 1959 as section 1.421—6(d)(2), Income Tax Regs., provided, with respect to bargain purchases of stock subject to restrictions having a significant effect on value, that tax would be imposed only when the restrictions lapsed or the property was sold in an arm's-length transaction. However, the measure of income was changed. The amount taxable as ordinary income was the lesser of the fair market value of the stock at the time of its acquisition, determined without regard to any restrictions, or at the time the restrictions lapsed, over the employee's cost of the stock.

Quite obviously, under this scheme, substantial benefits were available to an employee in a restricted stock purchase plan. Dividends were immediately available while the tax on the value of the shares was deferred and capital gains treatment was accorded the capital appreciation occurring in the period between the acquisition of the stock and the lapse of the restrictions.

In 1968 regulations were again proposed⁴ which would have taxed the fair market value of the restricted stock at the time of the lapse of the restrictions, thereby eliminating the capital gain potential on the postacquisition appreciation. However, it was at this point that Congress responded with section 83, designed to reduce the potential for tax avoidance and to accord more equitable treatment to similar deferred compensation arrangements. S. Rept. No. 91—552 (1969), 1969—3 C.B. 500, is clear in this regard:

General reasons for change.—The present law treatment of restricted stock plans is significantly more generous than the treatment specifically provided in the law for other types of similarly funded deferred compensation arrangements. An example of this disparity can be seen by comparing the situation where stock is placed in a nonexempt employees' trust rather than given directly to the employee subject to restrictions. If an employer transfers stock to a trust for an employee and the trust provides that the employee will receive the stock at the end of 5 years if he is alive at that time, the employee is treated as receiving and is taxed on the value of the stock at the time of the transfer. However, if the employer, instead of contributing the stock to the trust, gives the stock directly to the employee subject to the restriction that it cannot be sold for 5 years, then the employee's tax is deferred until the end of the 5-year period. In the latter situation, the employee actually possesses the stock, can vote it, and receives the dividends, yet his tax is deferred. In the case of the trust, he may have none of these benefits, yet he is taxed at the time the stock is transferred to the trust.

Congress resolved to alter the timing of the recognition of income derived from such stock purchase agreements. Income would be recognized at such time as the shares were either transferable, as defined in the statute, or when they were no longer subject to a substantial risk of forfeiture.

In addition, to minimize the potential for continued tax avoidance and to further discourage the use of restricted stock purchase plans as a means of obtaining an equity interest in one's employer, Congress decided to measure the income derived from such arrangements without regard to transitory restrictions imposed by the parties on the shares purchased.

Petitioner maintains that section 83, in disregarding contractual restrictions, imposes a tax on an amount which has not been realized and, therefore, is not income within the purview of the 16th Amendment.

In support of this contention, petitioner relies on language extracted from two early cases, MacLaughlin v. Alliance...