United States v. Fort

[PUBLISH]

IN THE UNITED STATES COURT OF APPEALS

FOR THE ELEVENTH CIRCUIT

___________________________ FILED

U.S. COURT OF APPEALS

No. 10-13053 ELEVENTH CIRCUIT

____________________________ APRIL 19, 2011

JOHN LEY

D.C. Docket No. 1:08-cv-03885-TWT CLERK

UNITED STATES OF AMERICA,

Plaintiff-Appellee,

versus

DANNY C. FORT,

SHERRI E. FORT,

Defendants-Appellants.

____________________________

Appeal from the United States District Court

for the Northern District of Georgia

_____________________________

(April 19, 2011)

Before MARCUS and ANDERSON, Circuit Judges, and ALBRITTON,* District

Judge.

*

Honorable W. Harold Albritton, United States District Judge for the Middle District of

Alabama, sitting by designation.

ALBRITTON, District Judge:

This case presents an appeal by Danny C. Fort (“Fort”)1 of a grant of

summary judgment in favor of the United States. The government brought this

action against Fort to recover a tax refund of over $300,000 that it contends was

erroneously refunded. For the reasons set forth below, we affirm the district

court’s entry of summary judgment in favor of the government.

I. BACKGROUND

A. Ernst & Young Sells its Consulting Business to Cap Gemini

In early 2000, Ernst & Young (“E&Y”) prepared to spin off and sell its

information-technology consulting business to Cap Gemini, S.A. (“Cap Gemini”),

a French corporation. At this time, Fort was a partner in that consulting business.

On February 28, 2000, E&Y and Cap Gemini executed a Master Agreement that

detailed the terms of the transaction.

Under the Master Agreement, the proceeds of the sale were divided among

E&Y’s partners. For consulting partners who qualified as accredited investors

under SEC rules, such as Fort, the consulting partner agreed to terminate his or her

interest in E&Y, and in exchange, received a distribution of Cap Gemini shares.

1

Sherri E. Fort is also an appellant in this case, because she filed a joint tax return with

Danny C. Fort. For sake of simplicity, we will refer only to Danny C. Fort in this case.

However, this opinion is equally effective as to Sherry E. Fort.

2

Additionally, these partners would begin working at a new entity, Cap Gemini

Ernst & Young (“CGE&Y”), under employment agreements containing non-

compete clauses.

Cap Gemini shares would not be distributed outright to each partner.

Rather, 25% of each partner’s shares would be sold immediately to cover that

partner’s income taxes incurred as a result of this transaction, and the other 75% of

the shares (the “Restricted Shares”) were placed into an individual account in the

partner’s name at Merrill Lynch.

The Restricted Shares could not be withdrawn from the partner’s account at

Merrill Lynch immediately, and therefore, the Merrill Lynch accounts were like

escrow accounts. For four years and 300 days following the closing, partners

could only sell portions of the Restricted Shares at scheduled times. After the

four-year, 300-day period, the partners could withdraw all remaining Restricted

Shares from the Merrill Lynch account. Arthur Gordon (“Gordon”), the former

tax director of E&Y’s consulting practice, who helped structure this transaction,

stated that the reason for these restrictions was to prevent all of the partners from

selling too many Cap Gemini shares at once, thereby diminishing the value of the

shares.

The Restricted Shares were also subject to forfeiture as “liquidated

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damages” if a partner (1) breached his employment agreement; (2) voluntarily left

his employment; or (3) was terminated. The amount of forfeitable shares

decreased with each anniversary of the closing date that the partner remained at

CGE&Y, so, generally, the longer a partner worked for CGE&Y, the fewer shares

he or she would forfeit if the forfeiture provision were triggered.

Additionally, the termination forfeiture requirement applied to only two

types of termination, and the number of Restricted Shares forfeited upon

termination depended on under which type a partner was terminated. If a partner

was terminated “for cause,” the partner forfeited the full amount of the forfeitable

Restricted Shares. However, if a partner was terminated for “poor performance,”

the partner forfeited at least 50% of the forfeitable Restricted Shares, but could

keep a percentage of the remaining 50%, as determined by a review committee.

Partners also would have dividend and voting rights in the Restricted

Shares. The dividends paid on the Restricted Shares were not subject to forfeiture,

and partners could withdraw these dividends shortly after they were declared. As

for voting, Merrill Lynch’s French affiliate would vote a partner’s shares “as

instructed by [the partner] as beneficial owner.”

Because of the restrictions placed upon the Restricted Shares, the Master

Agreement stated that, for tax purposes, the Restricted Shares would be valued at

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95% of the closing price of Cap Gemini stock on the closing date.

B. The Partners Vote to Approve the Transaction

To help the partners determine how to vote on the sale, E&Y prepared a

Partner Information Document (“PID”), which summarized the proposed

transaction and discussed its tax implications. The PID stated that the sale “is a

taxable capital gains transaction,” and that it “has been agreed that Ernst & Young,

its partners, and Cap Gemini will treat valuation and related issues consistently for

US federal income tax purposes.” The PID further included hypothetical tax

calculations that showed the gain from receiving the Restricted Shares was

reportable in full in 2000. It was generally expected that the stock would

appreciate in value, and this structure was designed to assure capital gains

treatment, with all tax on the then-value of all of the stock being paid in 2000.

At the conclusion of a meeting of partners in Atlanta on March 7 and 8,

2008, 95% of the consulting partners, including Fort, voted in favor of the

transaction.

Fort subsequently signed the Partner Agreement, making him a party to the

Master Agreement.

C. Fort’s 2000 Tax Return

The transaction closed on May 23, 2000. Twenty-five percent of Fort’s

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shares were sold at closing and the proceeds turned over to Fort, to cover taxes

due based on receipt of the full value of all the stock in 2000. The remaining 75%,

the Restricted Shares, were deposited into Fort’s Merrill Lynch account.

Fort reported gross proceeds of $1,759,097 from this transaction on his

2000 income tax return. At this time, the Cap Gemini stock was worth

approximately $156 per share.

In September 2003, Fort was terminated as part of a downsizing. At this

time, the value of the Cap Gemini shares had declined substantially. Cap Gemini

did not require Fort to forfeit any of his Restricted Shares. Shortly after his

termination, Fort learned that several former E&Y consulting partners had filed

amended year 2000 tax returns, claiming that they did not realize income from the

Restricted Shares in that year. Fort followed suit, filing his own year 2000

amended return, asserting that he did not realize income in 2000 from the then-

value of the Restricted Shares.

The IRS initially accepted Fort’s amended return and granted him a refund

for his 2000 tax return. Subsequently, however, the IRS determined that the

refund to Fort was in error, and the government filed this suit to recover the

refund.

D. The District Court Grants the Government’s Motion for Summary

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Judgment

The district court granted the government’s motion for summary judgment

and awarded it the disputed amount. United States v. Fort, No. 1:08-CV-3885-

TWT, 2010 WL 2104671, at *3 (N.D. Ga. May 20, 2010). The court stated that

taxable income during a given taxable year includes all income from whatever

source derived that is “actually” or “constructively” received during that year. Id.

at *1 (citing 26 U.S.C. § 61(a)(3); 26 C.F.R. § 1.61-2(a)). While the court

assumed that Fort did not actually receive the Restricted Shares, it concluded that

he constructively received them, because:

He alone stood to gain or lose money based on the stock’s performance.

He received the benefit of the dividends paid on the shares, and he had

the right to direct how the shares would be voted. Moreover, he

knowingly agreed to the sale restriction and the forfeiture provision. He

also agreed to the amount of the discount.

Id. at *2.

The district court also rejected Fort’s argument that the forfeiture provision

prevented him from constructively receiving the Restricted Shares in 2000. The

court explained that “the fact that the partners risked having to return some of their

shares at a later time does not mean that they did not constructively receive the

shares in the first place.” Id.

Subsequently, Fort filed a timely appeal to this court.

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II. STANDARD OF REVIEW

This court reviews a district court’s grant of summary judgment de novo,

applying the same legal standards used by the district court. Galvez v. Bruce, 552

F.3d 1238, 1241 (11th Cir. 2008). Summary judgment is appropriate where,

viewing the movant’s evidence and all factual inferences arising from it in the

light most favorable to the nonmoving party, there is no genuine issue of any

material fact, and the moving party is entitled to judgment as a matter of law. Id.

This court may affirm a decision of the district court on any ground

supported by the record. Bircoll v. Miami-Dade Cnty., 480 F.3d 1072, 1088 n.21

(11th Cir. 2007).

III. DISCUSSION

Fort has appealed the grant of summary judgment in the government’s

favor, arguing that he did not “receive” the escrowed shares of stock in the year

2000 for tax purposes, and, therefore, was not taxable for their value in that year.

A. The Danielson Rule

The first issue is the application of the “Danielson Rule” to this case. See

Comm’r v. Danielson, 378 F.2d 771 (3d Cir. 1967). The government argues,

citing to Danielson, that Fort’s ability to challenge his 2000 tax return is limited,

because the CGE&Y agreement stated that Fort agreed to report his receipt of the

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Restricted Shares as income received in 2000. Fort responds that the Danielson

rule is inapplicable to this case.

The government’s argument is misplaced. Danielson and its progeny

recognize that parties may agree to a certain form of a transaction, and that if they

do, they face a difficult burden in convincing the court that they did not actually

engage in the form that they contracted to engage in. See id. at 774-75; Bradley v.

United States, 730 F.2d 718, 720 (11th Cir. 1984) (noting that the Danielson rule

applies if a taxpayer “challenge[s] the form of a transaction”) (emphasis added).

Agreeing to a certain form of transaction is significant, because different

transaction forms can yield different tax liability consequences. Yet agreeing to

form (e.g., agreeing to sell A for B on October 18, 1985) is different from agreeing

to a certain type of tax liability (e.g., agreeing that the result of the transaction will

yield no tax liability in 1985). In this case, Fort does not argue that the form of

this transaction differed from what was written in the CGE&Y agreement. Rather,

he argues that the agreed-upon form had particular tax consequences. Such an

argument is outside the scope of the Danielson rule. See, e.g., United States v.

Fletcher, 562 F.3d 839, 842-43 (7th Cir. 2009) (in a case dealing with this same

transaction and materially identical facts as the one at bar, the Seventh Circuit

rejected reliance on the Danielson rule, writing that “because [the former E&Y

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partner] does not try to recharacterize the transaction, doctrines that limit or

foreclose taxpayers’ ability to take such a step are beside the point”); United States

v. Nackel, 686 F. Supp. 2d 1008, 1019 (C.D. Cal. 2009) (in another case involving

this same transaction, the District Court for the Central District of California

wrote: “The government impermissibly conflates case law concerning a party’s

effort to look through and re-characterize the form of a transaction with that which

addresses what the parties intended would be the tax consequences of a

transaction. The former is subject to the heightened scrutiny sought now by the

government, the latter is not.”).

As the Fletcher court expressed it: “Income was constructively received in

that year not because the contract said that everyone would report it so to the IRS,

but because the parties were right to think that this transaction’s actual provisions

made the income attributable to 2000.” Fletcher, 562 F.3d at 845.

Because the Danielson rule is inapplicable to this case, we now turn to

evaluate the tax consequences of the form of this transaction.

B. Constructive Receipt

A taxpayer who uses the cash basis method of accounting, such as Fort,

must pay tax on income in “the taxable year in which [it is] actually or

constructively received.” Treas. Reg. § 1.446-1(c)(1)(I) (emphasis added). The

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district court found that, in 2000, Fort did not actually receive income from the

Restricted Shares, but constructively received it. The government does not dispute

this framing of the issue. Accordingly, the issue in this case is whether Fort

constructively received income in the amount of the agreed value of the Restricted

Shares in 2000.

The Treasury Regulations state that a taxpayer constructively receives

income when “it is credited to his account, set apart for him, or otherwise made

available so that he may draw upon it at any time, or so that he could have drawn

upon it during the taxable year if notice of intention to withdraw had been given.”

Treas. Reg. § 1.451-2(a). On the other hand, “income is not constructively

received if the taxpayer’s control of its receipt is subject to substantial limitations

or restrictions.” Id. (emphasis added). In other words, the more control a

taxpayer has over the receipt of income, the more likely the taxpayer has

constructively received the income. See, e.g., Fletcher, 562 F.3d at 843.

The doctrine of constructive receipt is implicated when a taxpayer receives

an asset, but that asset is placed in an escrow account, only to be released to the

taxpayer upon the occurrence of some contingency. The fact that an asset is

placed in such an account is relevant, but not dispositive, as to the question of

whether the taxpayer has constructively received income. As the IRS has stated in

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a General Counsel Memorandum:

Generally, when assets are placed in escrow as security or otherwise and

the taxpayer receives no right to control or otherwise enjoy those assets,

the courts and the Service have held that income is not realized until

such time as the contingency is satisfied and the funds are paid over to

the taxpayer. . . .

However, in those cases in which the facts are such that the taxpayer

exercises a considerable degree of domination and control over the

assets in escrow, the courts and the Service have generally held . . . that

income is presently realized notwithstanding that the taxpayer lacks an

absolute right to possess the escrowed assets.

I.R.S. G.C.M. 37073 (Mar. 31, 1977) (emphasis added) (citing Chaplin v.

Comm’r, 136 F.2d 298 (9th Cir. 1943); Bonham v. Comm’r, 89 F.2d 725 (8th Cir.

1937)). Consistent with the IRS’s position, courts have held that a taxpayer

presently realizes income when he or she possesses sufficient indicia of control

over the assets held within an escrow account or escrow-type arrangement.

In Chaplin v. Commissioner, a company delivered shares of stock to Charlie

Chaplin in 1928, who then was required to place the shares in escrow, only to be

released when he delivered photoplays to the company in later years. 136 F.2d at

300. The Ninth Circuit held that the shares were income to Chaplin at the time of

the initial delivery in 1928, not later, when Chaplin delivered the photoplays and

the shares were released. Id. The Ninth Circuit emphasized that Chaplin

possessed the following indicia of control over the shares in escrow: (1) the

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contract at issue vested ownership immediately in Chaplin and the shares were

issued in his name; (2) Chaplin had voting rights in the shares; (3) dividends on

the shares were declared and paid to an escrow agent who held them for Chaplin’s

benefit; and (4) Chaplin was considered the owner of the shares. Id. at 300-02.

In Bonham v. Commissioner, a taxpayer and a company agreed that the

taxpayer would receive title in 750 shares of stock, but the shares would be

deposited with the company “as a guarantee for [his] performance.” 89 F.2d at

726-27. The Eighth Circuit held that the taxpayer realized immediate income

when he initially received the 750 shares, not when the shares were later

withdrawn. Id. at 726-28.

Because Fort was one of multiple former E&Y partners who have argued

that receipt of the Restricted Shares did not constitute taxable income in 2000, this

court has had the benefit of considering the legal analysis of other courts which

have analyzed cases with facts materially identical to those before us today. In

each of these cases, the courts held that the receipt of the Restricted Shares

constituted income in the year 2000. United States v. Bergbauer, 602 F.3d 569,

581 (4th Cir. 2010), cert. denied, 131 S. Ct. 297 (2010); Fletcher, 562 F.3d at 845;

Nackel, 686 F. Supp. 2d at 1026; United States v. Berry, No. 06-CV-211-JD, 2008

WL 4526178, at *7 (D.N.H. Oct. 2, 2008); United States v. Culp, No.

13

3:05-CV-0522, 2006 WL 4061881, at *1 (M.D. Tenn. Dec. 29, 2006).

United States v. Fletcher, the case relied upon most heavily by the

government, and cited by the district court, is particularly instructive. In Fletcher,

the Seventh Circuit stated that “a taxpayer’s willingness to defer consumption

does not defer taxation.” 562 F.3d at 843. The court concluded that the CGE&Y

agreement was merely a deferral of consumption, not income, for three reasons.

Id. First, the partners bore the market risk that the Restricted Shares would

appreciate or depreciate from the date of the closing, because the market price of

the Restricted Shares could rise or fall while the shares were in the Merrill Lynch

accounts.2 Id. at 844. Second, because Cap Gemini had already paid the

Restricted Shares into the partners’ Merrill Lynch accounts, the partners merely

agreed to postpone unrestricted access to the stock, rather than to allow Cap

2

Fort argues that whether he bore the risk is irrelevant in determining constructive receipt.

We reject Fort’s argument. See, e.g., Rupe Inv. Corp. v. Comm’r, 266 F.2d 624, 630 (5th Cir.

1959) (considering, in determining that a taxpayer did not own stock for tax purposes, the fact

that the taxpayer “was protected against risk of loss and was not entitled to any enhancement in

the value of the stock”); Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11th Cir. 1981) (en

banc) (adopting as binding precedent all decisions of the former Fifth Circuit issued before

October 1, 1981); see also Treas. Reg. § 1.83-3(a)(6) (suggesting that in the context of employee

stock options, “[a]n indication that no transfer has occurred is the extent to which the transferee

does not incur the risk of a beneficial owner that the value of the property at the time of transfer

will decline substantially”).

Fort also argues that, factually, due to the potential his shares could be forfeited, other

parties besides Fort bore some of the risk. Fort’s argument is unpersuasive. While the potential

for forfeiture existed in Chaplin and Bonham, the courts in those cases did not find that this

potential eliminated constructive receipt. We agree with this reasoning.

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Gemini to pay them later. Id. Third, the partners agreed to value the Restricted

Shares at a discount—95% of the market price of the underlying shares on the

closing date—which reflects “not only illiquidity but also the risk that [Cap

Gemini] would use its power over the account in an unauthorized way, or that

Merrill Lynch might fail in its duty as a custodian.” Id.

We are persuaded by the Seventh Circuit’s opinion and agree with its

reasoning. We find that the transfer restrictions, which prohibited Fort from

accessing the shares in the Merrill Lynch account for several years, were merely a

delay of consumption, not a delay of income. Indeed, the partners wanted to

restrict transfer of the shares to prevent a massive sell-off shortly after the closing

date, which would have depressed Cap Gemini’s stock price.

In any event, Fort had several rights over the Restricted Shares that

constitute evidence of constructive receipt under Chaplin and Bonham.3 First, the

Restricted Shares were deposited into a Merrill Lynch account in Fort’s name, and

were held in that account for Fort’s benefit. See Chaplin, 136 F.2d at 300-02

(finding it significant that the stock was issued in the taxpayer’s name and that the

3

Fort argues that Chaplin and Bonham turned on whether the taxpayers in those cases

initially received the shares of stock, and then deposited those shares into an escrow account, a

fact not present in Fort’s case. We reject that contention, as the Chaplin court did not appear to

find this fact significant, and the Bonham court specifically stated that “[t]he circumstance is

unimportant that the stock was not physically delivered to petitioner and then redelivered by him

to the company upon the pledge.” Bonham, 89 F.2d at 727-28.

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taxpayer was considered the owner of the stock). Second, Fort had both dividend

and voting rights over the Restricted Shares. See id. at 301-02 (finding dividend

and voting rights significant). Third, the shares were to be released only if Fort

stayed at CGE&Y for four years and 300 days, and therefore, the shares served as

a guarantee of Fort’s performance. See id. at 300-02 (finding constructive receipt

when escrow account deposit acted to ensure taxpayer’s performance); Bonham,

89 F.2d at 726-27 (noting that stock was held as a guarantee for taxpayer’s

performance).

Fort argues that, regardless of the above facts, he did not have “control”

over whether he ultimately received the Restricted Shares, because the shares were

subject to forfeiture if he was terminated for “poor performance.” Fort contends

that “poor performance” really means any reason at all. Fort argues that if he

could be fired for any reason at all, then the Restricted Shares were not simply

being held as a guarantee for his performance, as in Chaplin and Bonham, but

rather, they were being held completely at the will of CGE&Y. Fort notes that

Gordon testified that approximately 10% of the consulting partners forfeited their

shares for reasons he defined as “involuntary” or “involuntary resignation.” Fort

further asserted that Gordon described these employees as ones who were

terminated “not because they are not trying, [but] because the industry has

16

changed or their expertise is gone.”4

If the Restricted Shares could be forfeited for reasons completely out of

Fort’s control, this would be some evidence that Fort lacked control over the

Restricted Shares. See Nackel, 686 F. Supp. 2d at 1022 (“The likelihood of the

forfeiture provisions being effectuated, and who controls the realization of that

fact, are important in determining whether the stock so held is nonetheless

constructively received.”) (citing Chaplin, 136 F.2d at 299-302). However, we

conclude that Fort had sufficient control over whether his shares would be

forfeited.

First, the Partnership Agreement required complete forfeiture on

involuntary termination only if the termination was for cause or, in a lesser

amount, if it was for poor performance. There was no forfeiture at all if

termination was for any other reason. Moreover, factually, CGE&Y did not use

the poor performance provision to terminate partners for any reason at all. Instead,

Gordon explained that consulting partners who were terminated for poor

4

Fort cites the case of Palowitch v. Cap Gemini Ernst & Young, US., LLC, No.

114312/01, 2004 WL 2964426 (N.Y. Sup. Ct. June 3, 2004), in which the plaintiff claimed that

CGE&Y terminated him for “poor performance,” but did so “without stating a reason.” Id. at *1.

However, as the government correctly points out, Palowitch does not establish that the taxpayer

was terminated for no reason, but rather, it shows that the termination letter sent to the taxpayer

did not state a reason for his termination. See id. In any event, the Palowitch court did not

analyze whether CGE&Y had a reason for termination in that case.

17

performance were individuals who “did not meet their objective in one or more of

[the] categories” upon which performance was judged and individuals who “were

collecting a check and not worrying about trying to do their best.” In fact, when

partners were terminated for reasons outside of their control, such as shifts in

needs of industries, Gordon stated that those partners were allowed to keep their

shares. And, as noted earlier, Fort himself was not required to forfeit any of his

Restricted Shares when he was terminated due to downsizing.

Additionally, the Nackel court squarely confronted this issue and concluded

that “poor performance” did not mean termination for any reason. Nackel, 686 F.

Supp. 2d at 1023. That court concluded that “poor performance” referred to the

“poor quality of the ex-consulting partner’s performance” and that the “emphasis

under this condition remains on the partner’s relative performance . . . [and this] is

something within that partner’s means to control.” Id.

We agree, and also note that the plain meaning of being terminated for

“poor performance” is not being terminated for any reason at all. Rather, poor

performance clearly refers to unsatisfactory performance. It would be a strained

interpretation, and one we will not adopt, to hold that “poor performance” does not

really mean poor performance, but actually means “any reason at all.” To do so

would be to expand the reasons for which forfeiture could be required beyond

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those to which the partners agreed.

Fort also suggests that “poor performance” allows for termination on the

basis of a subjective judgment. While we agree that the term “poor performance”

potentially might require some subjective judgment by an employer, we conclude

that the mere potential for subjective judgment does not foreclose constructive

receipt. Cf. Nackel, 686 F. Supp. 2d at 1023 (suggesting that the “poor

performance” provision is an objective measure, which focuses on a partner’s

relative performance); Fletcher, 562 F.3d at 845 (“The sort of contingencies that

could lead to forfeitures were within the ex-partners’ control.”).

Additionally, we reject Fort’s argument that he lacked control due to the fact

that his performance could have been considered “poor” in part due to market

conditions. To have sufficient control for constructive receipt does not require

“total control.” In any event, as previously noted, CGE&Y in practice did not seek

forfeiture when a partner’s poor performance was primarily caused by market

shifts and not the partner’s poor efforts.

In sum, Fort constructively received the Restricted Shares in 2000. The fact

that Fort could not access the shares immediately was merely a postponement of

consumption, not income: CGE&Y paid the full consideration of the shares into

Fort’s Merrill Lynch account on the closing date, and therefore, Fort bore the

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market risk of share appreciation or depreciation beginning on the closing date.

This conclusion is buttressed by the fact that Fort possessed indicia of control over

the shares: he had dividend and voting rights in the shares, and the shares were

held in an individual account in Fort’s name. Additionally, constructive receipt

was not impossible simply because Fort was required to forfeit the shares upon the

occurrence of certain conditions, because Fort had sufficient control over whether

those conditions would occur. Therefore, Fort realized income at the time the

Restricted Shares were transferred into his Merrill Lynch account in 2000.

IV. CONCLUSION

For the foregoing reasons, we AFFIRM.

AFFIRMED.

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