Hutcheson v. Commissioner

T.C. Memo. 1996-127

UNITED STATES TAX COURT

RICHARD L. HUTCHESON AND DOLORES A. HUTCHESON, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8886-94. Filed March 14, 1996.

Robert E. Bergin, for petitioners.

Ewan D. Purkiss, for respondent.

MEMORANDUM OPINION

RAUM, Judge: The Commissioner determined a deficiency in

petitioners' 1989 income tax in the amount of $809,180. The

issues for decision are: (1) Whether petitioners must recognize

the entire gain from the sale of 100,000 shares of WalMart stock

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in January 1989 even though they "repurchased" 96,600 shares of

WalMart in December 1989, and alternatively (2) whether the sale

and "repurchase" of the stock qualifies as an involuntary

conversion under section 1033.1

At the time of the filing of the petition, Richard and Dolores

Hutcheson, petitioners, resided in Fresno, California. References

to petitioner in the singular will be to petitioner husband.

In May 1983, petitioners opened a cash management account,

account no. 567-96135, with the Merrill, Lynch, Pierce, Fenner &

Smith, Inc. (Merrill Lynch) Fort Smith, Arkansas, office.

Account no. 567-96135, managed and controlled by petitioner,

included a margin account. Petitioner delivered WalMart stock to

Merrill Lynch for deposit in the account. At all times, the

account held only WalMart stock. The account executive assigned

to the account was Ms. Ed Dell Wortz, petitioner's maternal

grandmother's niece. She had been with Merrill Lynch in Fort

Smith, Arkansas, since 1980 and had been in the securities

industry since 1955.

Petitioner's total annual sales through the account for 1983

through 1988 are summarized as follows:

1

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year in issue. All

Rule references are to the Tax Court Rules of Practice and

Procedure.

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Year Shares Sales Price

1983 -- --

1984 2,000 $ 80,199

1985 15,000 $537,979

1986 18,000 $748,081

1987 15,500 $812,326

1988 31,200 $891,008

Late in 1988, petitioner was advised by his account executive,

Ms. Wortz, that he needed to reduce the amount owed in the margin

account between $400,000 and $600,000. Petitioner and Ms. Wortz

agreed to make the margin account reduction in early January

1989. This agreement was not reduced to writing.

Prior to January 3, 1989, Merrill Lynch held in the

securities account 192,514 shares of WalMart stock. The stock

was valued at $6,040,126. By that time, petitioners through

their margin account had borrowed $3,080,889.75 and had $567,137

of available credit. The basis of the stock was eleven cents

($0.11) per share.

On January 3, 1989, petitioner telephoned Ms. Wortz from

Fresno, California. He understood his telephone instruction to

Ms. Wortz to be to sell $100,000 worth of WalMart. She

understood his instruction to be to sell 100,000 shares of

WalMart. On that day, January 3, 1989, Merrill Lynch made the

following sales on behalf of petitioner and account no. 567-

96135:

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WalMart Charge or SEC Fees Handling Gross Price

Shares Mark-up

69,200 $8,515.06 $69.20 $2.35 $2,076,000

10,500 $1,292.35 $10.59 $ 317,625

20,300 $2,497.92 $20.39 $ 611,537

Merrill Lynch sold 69,200 shares at 30; 10,500 at 30-1/4; and

20,300 at 30-1/8. Merrill Lynch used the proceeds from the

January 3, 1989, sales to pay off most of petitioners' margin

indebtedness. A sale of 3,400 shares of Walmart (sales were

always made in multiples of 100) at 30-1/4 (the highest price

received for WalMart shares on January 3) would have grossed

$102,850 and netted approximately $102,426 to reduce petitioners'

margin debt.

During subsequent attempts to resolve the dispute, Merrill

Lynch, in order to accommodate petitioner, offered to

"repurchase" WalMart stock "in excess of 10,500" (as stipulated

by the parties), and offered a refund of the commission on the

January 3 sales and to waive the commission on the "repurchase".

Petitioner rejected the offer on about January 17, 1989, in a

letter to Merrill Lynch's Little Rock, Arkansas, manager.

Petitioner closed account no. 567-96135 on or about March 15,

1989, by having Merrill Lynch retransfer the remaining WalMart

shares in the account.

By December 28, 1989, the price of WalMart had risen to 44-

1/2. On December 28, 1989, petitioner and Merrill Lynch agreed

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to reopen account no. 567-96135. Merrill Lynch provided

$2,948,702 of margin funds and petitioner deposited fresh funds

of $1,350,000 (which he had borrowed from his father) into the

account to purchase WalMart and to reestablish petitioner's

position in WalMart common stock. At petitioner's direction,

Merrill Lynch acquired 96,6002 shares of WalMart common stock on

his behalf for the account for a total purchase price of

$4,298,702. Merrill Lynch waived the purchase commissions and

located year end sellers of stock which had recently increased

substantially in value.

Petitioner had borrowed the $1,350,000 from his father, as

noted above, in order to complete the December 28, 1989,

purchase. Prior to that time, petitioner was not indebted to his

father for the purchase of any WalMart shares. The parties

stipulated that petitioner's purpose for the December 28 purchase

was to reacquire his investment in WalMart and to formally

implement a rescission of the January 3 sales in the same year by

attempting to bring the case within situation one of Rev. Rul.

80-58, 1980-1 C.B. 181, hereinafter described. The IRS did not

stipulate that petitioner's action accomplished a rescission.

Petitioners filed a formal arbitration claim for rescission

against Merrill Lynch with the National Association of Securities

2

Petitioners do not contest the sale of the first 3,400

shares, since their sale approximates the $100,000 worth of

Walmart stock petitioner unquestionably authorized.

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Dealers as required by the cash management account agreement on

December 29, 1989. The arbitration claim was settled in October

1990. Merrill Lynch agreed to pay petitioners $250,000 but did

not admit any liability in making the January 3 sales of

petitioner's WalMart stock.

The 96,600 shares of Walmart stock purchased by Merrill

Lynch on behalf of petitioner and account no. 567-96135 on

December 28, 1989, were not the same shares of stock sold on

January 3, 1989. The number of purchased shares represented the

equivalent shareholder rights as the 96,600 shares sold on

January 3, 1989. The January 3, 1989, sales were to unrelated

third parties and the sales were without condition, other than

payment for the shares of stock. The January 3 purchasers of the

WalMart shares did not agree, at the time of sale, or at any

other time, that Merrill Lynch on behalf of the account or

petitioner could repurchase the shares.

Section 61(a)(3) includes in gross income "all income from

whatever source derived, including * * * Gains derived from

dealings in property". Section 1001(a) defines the amount of

gain from sale or other disposition of property as "the excess of

the amount realized therefrom over the adjusted basis". Section

1001(c) requires that "Except as otherwise provided in this

subtitle, the entire amount of the gain or loss * * * on the sale

or exchange of property shall be recognized." Petitioners do not

dispute that there was a sale of stock which gave rise to a

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corresponding realization of gain. They contend, however, that

because they rescinded the January 3 sale to the extent of 96,600

shares, they need not recognize the gain on those 96,600 shares

at this time. Alternatively, they argue that the sale of the

stock to the extent of 96,600 shares by Merrill Lynch was an

involuntary conversion pursuant to section 1033 which enables

them to claim nonrecognition treatment.

1. Rescission

Rev. Rul. 80-58, 1980-1 C.B. 181 discusses two situations

involving the income tax consequences of a reconveyance to a

taxpayer of property previously sold by that taxpayer. In the

first situation, A sold B a tract of land in 1978. The contract

required A to accept the land back if B was unable to obtain

business zoning within 9 months after the sale. Later that year,

when B failed to get the zoning, he returned the land to A, and A

returned the sales price. In the second situation, the facts are

the same except that the period within which B could reconvey the

property to A was 1 year and the reconveyance occurred in 1979.

Id. at 181.

Rev. Rul. 80-58, supra, defines rescission as "the

abrogation, canceling, or voiding of a contract that has the

effect of releasing the contracting parties from further

obligations to each other and restoring the parties to the

relative positions that they would have occupied had no contract

been made. A rescission may be effected by mutual agreement of

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the parties, by one of the parties declaring a rescission of the

contract without the consent of the other if sufficient grounds

exist, or by applying to the court for a decree of rescission."

Id. at 181-182. When the annual accounting principle is taken

into account, however, it supersedes the rescission if the

rescission occurs in a different year. Id.

In situation one, the rescission occurred in the same

taxable year as the sale. As a result, the income tax

consequences of the original sale would be disregarded for

Federal income tax purposes. In situation two, the rescission

did not occur until the following year. At the end of the sale

year, A and B were not in the same positions they were in before

the sale. In consequence, only the events of the first year,

1978, are considered in determining A's and B's income tax

liabilities for 1978. "In both situations, the annual accounting

period principle requires the determination of income at the

close of the taxable year without regard to subsequent events."

Id. at 182.

Petitioners liken themselves to the taxpayers in situation

one above. In petitioners' case, the original sale took place on

January 3, 1989, when the 100,000 shares of WalMart stock were

sold. After unsuccessful negotiations with Merrill Lynch,

petitioner attempted to utilize the unilateral rescission clause

in Rev. Rul. 80-58, supra: "A rescission may be effected * * *

by one of the parties declaring a rescission of the contract

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without the consent of the other if sufficient grounds exist".

Id. at 181-182. As more fully set forth hereinafter, petitioner,

on December 28, 1989, through Merrill Lynch, "reacquired" 96,600

shares of WalMart stock. Petitioners assert that their

"repurchase" of shares put them in all material respects in the

same position they occupied in January 1989. They contend that

the "sufficient grounds" for rescission with Merrill Lynch are

either mutual mistake or conversion.

Petitioner attempted to bring himself within the first

situation described in Rev. Rul. 80-58, supra, to reflect a

rescission to the extent of 96,600 of the 100,000 shares sold on

January 3, 1989, by having Merrill Lynch purchase for him 96,600

shares of WalMart on December 28, 1989. He wanted Merrill Lynch

to report to the IRS on Form 1099 a sale of only 3,400 shares for

1989. However, the record indicates that Merrill Lynch was

advised by tax experts not to change Form 1099 to reflect a

rescission, and was warned by the tax experts that it "could be

subject to civil and possibly criminal sanctions by the IRS if it

did so." Nevertheless, Merrill Lynch agreed to help petitioner

"repurchase" 96,600 shares in his attempt to claim the benefits

of Rev. Rul. 80-58, supra, but made no representation as to what

effect such "repurchase" might have. In a letter to petitioner's

lawyer, Merrill Lynch's counsel stated that it "is merely

treating this as a customer who is purchasing shares in his

account." However, because it would be assisting in the

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transaction, Merrill Lynch agreed not to charge commissions, but

required that petitioner deposit sufficient funds or stock "to

immediately pay for the purchase of 96,600 shares." The record

further indicates that petitioner accepted Merrill Lynch's offer,

and, as previously stated above, deposited cash with Merrill

Lynch prior to the December 28, 1989, purchase of 96,600 shares.

While petitioners focus on the misunderstanding between

petitioner and Merrill Lynch on January 3, 1989, it is the sale

of the 96,600 share portion of the 100,000 shares of WalMart

stock that they are attempting to rescind. In this attempt, they

have confused Merrill Lynch with the actual purchasers of the

stock. Merrill Lynch was merely the seller's agent.

Rev. Rul. 80-58, supra, discusses the income tax

consequences of a rescission between a buyer and a seller. For

the rescission to be effective, both buyer and seller must be put

back in their original positions. Rev. Rul. 80-58, supra, 1980-1

C.B. 181, 181. In their brief, petitioners address only the

relationship between themselves and Merrill Lynch. However, the

buyer and the seller in the instant case are the January 3

purchasers of the WalMart stock and the petitioners,

respectively, not Merrill Lynch and petitioners. As noted above,

Merrill Lynch acted merely as an agent.3

3

There is not here involved any issue as to Merrill

Lynch's liability as an agent. Accordingly, we need not address

that subject here. However, even if petitioners could establish

that Merrill Lynch was liable to petitioners, see Restatement,

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Neither buyer nor seller was put back into "the relative

positions that they would have occupied had no contract been

made." Id. at 181. The parties (petitioners and the IRS)

stipulated that the January 3 sales were made without condition.

The buyers never relinquished to petitioner the stock purchased

on January 3, 1989. Although petitioner purchased 96,600 shares

of WalMart stock in December 1989, he stipulated that those

shares were not the same shares of stock sold on January 3, 1989.

To facilitate the December 28 purchase, petitioner borrowed

$1,350,000 from his father. Petitioner did not owe any money to

his father for stock purchases prior to the January 3 sale.

Even if the parties involved are petitioners and Merrill

Lynch, as petitioners contend, the requirements of Rev. Rul. 80-

58, supra, have still not been satisfied. Before the end of

1989, petitioners submitted the rescission claim against Merrill

Lynch to arbitration. As an alternative to the unilateral

rescission theory, petitioners allege that this claim was the

equivalent of application to a court for a decree of rescission

because the agreement between petitioners and Merrill Lynch

contained an enforceable arbitration provision.

Agency 2 sec. 44 (1958) ("If an authorization is ambiguous

because of facts of which the agent has no notice, he has

authority to act in accordance with what he reasonably believes

to be the intent of the principal although this is contrary to

the principal's intent"), petitioners would be bound to the

January 3 buyers by the apparent authority Merrill Lynch

exercised on behalf of petitioners. See 3 Am. Jur. 2d, Agency,

secs. 71, 270 (1986).

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In Hope v. Commissioner, 55 T.C. 1020 (1971), affd. 471 F.2d

738 (3d Cir. 1973), the taxpayer sold his stock for $20 a share,

but later discovered that the stock at that time was trading for

over $50 a share on the market. Id. at 1026. In the year of the

sale, he filed a complaint for rescission against the agent and

the purchasers of the optioned stock. Id. The following year,

the parties settled the dispute. Id. at 1027. When his case

came before the Tax Court, the taxpayer argued that "his

complaint requesting a rescission of the sale postponed his

obligation to return the income from the sale until the year in

which the suit was settled." Id. at 1030. This Court disagreed,

holding that since the taxpayer had unfettered discretion to use

the funds when he received them, "the mere filing of the suit by

the petitioner was not of itself sufficient to postpone the

realization of gain on the completed sale." Id. at 1030-1031.

The Court also held that settlement of the suit was not the same

as rescission. Id.

Like the taxpayer in Hope, petitioners here had unhindered

control over the funds they received from the January 3, 1989,

sale. Although they brought proceedings for rescission, since

both the funds and the decision to seek a rescission were wholly

within their control, they have failed to demonstrate that a

rescission occurred which would postpone realization of the gain.

See Hope v. Commissioner, 471 F.2d 738, 742 (3d Cir. 1973).

Moreover, the settlement of petitioners' proceedings, which

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occurred in the year following the transaction, does not amount

to a rescission. Hope v. Commissioner, 55 T.C. at 1031.

Petitioners present other arguments explaining why they have

sufficient grounds for a unilateral rescission under Rev. Rul.

80-58, 1980-1 C.B. 181. In light of our conclusions above, that

petitioners confused the buyers with the agent, that neither

buyers nor seller were put back into their pre-sale positions,

and that a settlement is not a rescission, we need not address

these arguments.

2. Involuntary Conversion

Section 1033(a) allows nonrecognition of gain "If property

(as a result of its destruction in whole or in part, theft,

seizure, or requisition or condemnation or threat or imminence

thereof) is compulsorily or involuntarily converted".

Petitioners contend that the sale of the WalMart stock by Merrill

Lynch constituted a "seizure", and thus there was an involuntary

conversion under section 1033(a). Petitioners look to Webster's

Third International Dictionary (1966) and define seizure as "to

take by force" or "to take hold of." Because the sale by Merrill

Lynch was unauthorized, they argue, the stock was "seized".

Petitioners equate Merrill Lynch's actions with common-law

conversion. Since a common-law conversion has occurred, they

assert, they should be given the benefit of section 1033. We

think that petitioner's argument stretches the statute beyond

permissible limits. Petitioners' arguments to the contrary,

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involuntary conversion pursuant to section 1033 is statutory, not

defined by the common law. Indeed, it has even been stated that

"Congress clearly intended to extend the benefits of section 1033

and its predecessor only to public takings and casualty-like

conversions, and the limitation of its benefits to involuntary

conversions--i.e., those 'wholly beyond control of the one whose

property has been taken'--reflects that intent." Wheeler v.

Commissioner, 58 T.C. 459, 463 (1972).

In addition to their common-law conversion argument,

petitioners treat "seizure", defined by them as "to take by

force," as equivalent to theft. Petitioners seek to compare

themselves to the taxpayer in Rev. Rul. 66-355, 1966-2 C.B. 302.

There, the taxpayer's financial manager pledged shares of the

taxpayer's stock to a bank, without the taxpayer's permission, to

secure the manager's personal loan. The bank subsequently sold

the shares to liquidate the loan. Id. at 302. The ruling holds

that the manager's actions amounted to theft for purposes of

section 1033. Once again, petitioners' situation is quite

different. Despite the settlement between Merrill Lynch and

petitioners, Merrill Lynch has never agreed, and petitioners have

not demonstrated, that Merrill Lynch was at fault civilly, much

less criminally. At most, there was only a mutual mistake of

fact between petitioner and Merrill Lynch. Petitioners have

failed to establish that an involuntary conversion has occurred.

Cf. Hope v. Commissioner, 55 T.C. at 1033-1035.

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Accordingly,

Decision will be entered

for respondent.