Petition — Sakol v. Commissioner

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In The

October Term, 1977

No.

* 1 A

8214

MIRIAM SAK Ol.

Petitioner,

VS.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR WRIT OF CERTIORARI TO THE UNITED

STATES COURT OF APPEALS FOR THE SECOND

CIRCUIT *

BURTON G. LIPSKY

Attorney for Petitioner

230 Park Avenue

New York, New York 10017

(212) 661-9800

DELSON & GORDON

Of Counsel

LUTZ APPELLATE PRINTERS, INC.

Law and Financial Printing

South River, N.J. New York, N.Y. Philadelphia, Pa. Washington, D.C.

(201) 257-6850 (212) 840-9494 (215) 563-5587 (202) 783-7288

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Table of Authorities ess

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Questions Presente

Constitutional Provision and Statute

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Statement of the Case W „ „ „„ „„ „„ „„ „e

Reasons for Granting the Writ:

I. The decision of the Second Circuit

conflicts with decisions of

this Court such as Heiner v.

Donnan, 285 U.S. 312 (1932), and

applies an erroneous standard of

due process review to a federal

COE SCTACUTE] 2. ccccccccccccsccccecs

A. This Court has long held that

a statute that imposes a tax

on an amount which is no

economic benefit to the tax-

payer by means of a fictitious

conclusive presumption vio-

lates due process

B. The standard of due process

review set forth in Weinberger

v. Salfi, 422 U.S. 749 (1975),

is not applicable to a federal

tax statute eeeeeeeneenerteneneeeerte

11

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II. The decision of the Court below

is in direct conflict with the

Third Circuit's decision in

Gurmankin v. Costanzo, 556 F.2d

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111

TABLE OF AUTHORITIES

Cases

Cleveland Bd. of Educ. v. LaFleur, 414

Bebe 632 (1974) „„ „„ „„ „„ „„ „ „ „„ „ „ „ „

Gurmankin v. Costanzo, 556 F.2d 184

(3d Cir. 1977) „ % %% „ „„ „ „ „„ „ „% „ „ „ „ „4 „46 „

Hoe per v. Tax Commission, 284 U.S. 206

(1931) seep eevee ee ee „ „„ ee „ „ „„ „ ee „„ „ „

8, 10, 11,

Miller v. Carter, 547 F.2d 1314 (7th

Cir. 1977), aff'd, per curiam, 98

8. Ct. 786 (1978) „„ „„ „ e „ „ „ „ „

Murry, U.S. Dep't of Agriculture v., 413

U.S. 1973) „„ % „„ „% „„ „% „% „ „% „% „% „ „ „4 „46 «4665

Sal fi Weinberger v., 422 U.S. 749

11975) „ „„ „ „ „ „ „ e „ „ „ „ „ „

Schlesinger v. Wisconsin, 270 U.S. 230

(1926) eeeeev eevee ee ee ee eeeeeeeeeeeeaeeeee

Stanley v. Illinois, 405 U.S. 645

(1972) % „„ „ „ „ „ „ ee ee eee

Page

6,9

11,14

2

6-14

2,14

6,7

13,14

15

6,9

6

11-15

6-12

14

6,10

11,13

ly

Page

v. Turner Elkhorn Mining Co., 428

eeeree eee eee e ee ee ee „„ „„ „„ 12,13

Vlandis ». Kline, 412 U.S. 441 (1973) ... 6,9

10,11,13,14

United States Constitution

U.S. Comet. amend. V. . . . . . 0 eee 2,6

8,10

U.S. Const. amend. XIV sree ee ee „„ „% „% „ „ „ „ „ „46 „ 8,10

Statutes

Int. Rev. Code of 1954, 1633. 0 3,4

5,7,8,11,12

IN THE

SUPREME COURT OF THE UNITED STATES

October Term, 1977

No.

MIRIAM SAKOL,

Petitioner,

~against-

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Petitioner, Miriam Sakol, prays that a

writ of certiorari issue to review the judgment

and opinion of the United States Court of

Appeals for the Second Circuit entered in this

case on April 6, 1978, affirming the decision

of the United States Tax Court.

Opinions Below

The opinion of the Court of Appeals,

which has not yet been officially reported, is

annexed hereto as Appendix A, pages la to l3a.

The opinion of the Tax Court is reported at 67

T.C. 986 (1977). it appears at App. B, pp.

l4a to 30a.

Jurisdiction

The judgment of the Court of Appeals

sought to be reviewed was entered on April 6,

1978. App. C, pp. 3la to 32a. The jurisdic-

tion of this Court is invoked under 28 U.S.C.

1125401).

Questions Presented

1. did the Court below reach a dec is ion

in conflict with that of this Court in Heiner

v. Donnan, 285 U.S. 312 (1932), by ruling

erroneously upon an important constitutional

question of the standard of review under the

due process clause of the Fifth Amendment of a

federal tax statute?

2. Does the decision below conflict with

the decision of the Court of Appeals for the

Third Circuit in Gurmankin v. Costanzo, 556

F.2d 184 (1977)?

Constitutional Provision

and Statute Involved

The Fifth Amendment to the United States

Constitution provides:

"No person shall be held to answer

for a capital, or otherwise infamous

crime, unless on a presentment or indict-

ment of a Grand Jury, except in cases

arising in the land or naval forces, or in

the Militia, when in actual service in

time of War or public danger; nor shall

any person be subject for the same offence

to be twice put in jeopardy of life or

limb; nor shall be compelled in any

criminal case to be a witness against

himself, nor be deprived of life, liberty,

Or property, without due process of law;

nor shall private property be taken for

public use, without just compensation."

Section 83(a) of the Internal Revenue Code

provides:

“PROPERTY TRANSFERRED IN CONNECTION

WITH PERFORMANCE OF SERVICES.

(a) GENERAL RULE.--If, in connection

with the performance of services, property

is transferred to any person other than

the person for whom such services are

performed, the excess of--

(1) the fair market value of such

property (determined without regard

to any restriction other than a

restriction which by its terms will

never lapse) at the first time the

rights of the person having the

beneficial interest in such property

are transferable or are not subject

to a substantial risk of forfeiture,

whichever occurs earlier, over

(2) the amount (if any) paid for

such property,

shall be included in the gross income of

the person who performed such services in

the first taxable year in which the

rights of the person having the bene-

ficial interest in such property are

transferable or are not subject to a

substantial risk of forfeiture, whichever

is applicable. The preceding sentence

shall not apply if such person sells or

otherwise disposes of such property in an

arm's length transaction before his rights

in such property become transferable or

not subject to a substantial risk of

forfeiture."

Statement of the Case

This case involved the constitutionality

of Section 83(a) of the Internal Revenue

Code.

On May 7, 1971, petitioner purchased

140 shares of her employer's stock from her

employer, Chesebrough-Pond's, Inc.

("Chesebrough"), for $21.20 per share, or

$2,968 pursuant to its stock purchase plan.

Under the terms of the plan she could not sell,

pledge or transfer any interest in the shares

for the five-year period ending May 7, 1976.

The petitioner's purchase was also subject

to a forfeiture restriction which lapsed on May

7, 1972. Pursuant to Section 83, the taxable

event of the petitioner's purchase took place

on that date when her shares were no longer

subject to a "substantial risk of forfeiture."

On the last business day prior to May 7,

1972, Chesebrough's common stock traded on the

New York Stock Exchange at a mean quoted price

of $66.50. The respondent included in peti-

tioner's income under Section 83(a) the

entire excess of the $66.50 New York Stock

Exchange price over her $21.20 cost per share,

or $6,342 for the 140 shares. The Court of

Appeals, Tax Court and respondent acknowledge

that if freely traded shares on the New York

Stock Exchange were quoted on the valuation

date at $66.50 per share, petitioner's shares

subject to a four-year restriction (on the

valuation date) against sale, transfer or

pledge were worth significantly less.“ How-

ever, under the Internal Revenue Code (Section

83(a)) such a four-year restriction is disre-

garded for purposes of determining petitioner's

gross income,

Petitioner's position was that Section

83(a) is unconstitutional because that statute

(a) mandates a fictitious valuation of property

in excess of its fair market value (thereby

requiring petitioner to pay income tax on an

amount which is no economic benefit to her);

(b) precludes petitioner from proving the

actual amount of income which she received; and

(c) compels the taxation, as income, of an

amount which is not income.

The Tax Court upheld the constitutionality

of Section 83(a). The Second Circuit affirmed.

*The issue of the valuation of the restricted

shares was separated for trial from the

constitutional issue by Tax Court order,

pending final resolution of the constitutional

issue.

Reasons for Granting the Writ

I. The decision of the Second Circuit

conflicts with decisions of this

Court such as Heiner v. Donnan,

285 U.S. 312 (1932), and applies

an erroneous standard of due

process review to a federal tax

statute

The Second Circuit, in affirming the Tax

Court, has upheld a tax statute that deprives

petitioner of her property in violation of

the due process clause of the Fifth Amendment

by imposing an income tax measured in part by

an amount which has no economic benefit to her.

That holding is in direct conflict with the

long-established principle enunciated by

this Court in Heiner v. Donnan, 285 U.S. 312

(1932); Hoeper v. Tax Commission, 284 U.S. 206

(1931); and Schlesinger v. Wisconsin, 270 U.S.

230 (1926), that a statute which imposes a tax

on an amount which is no economic benefit to

the taxpayer based upon an assumption of

fact which the taxpayer is forbidden to con-

trovert is so arbitrary and unreasonable that

it cannot stand under the due process clause of

the Fifth Amendment to the Constitution.

The rationale of these earlier tax cases

has recently been approved and applied in a

number of non-tax cases, i.e., Cleveland Bd. of

Educ. v. LaFleur, 414 U.S. 632 (1974); Vlandis

v. Kline, 412 U.S. 441 (1973); U.S. Dept. of

Agriculture v. Murry, 413 U.S. 508 (1973); and

Stanley v. Illinois, 405 U.S. 645 (1972). This

Court did not apply (but did not reject) this

rationale in Weinberger v. Salfi, 422 U.S. 749

(1975), holding that a different standard

of due process review is appropriate for

— ee ce

statutes dealing with claims for non-

contractual government benefits.

A. This Court has long held that a

statute that imposes a tax on an

amount which is no economic

benefit to the taxpayer by means

of a fictitious conclusive

presumption violates due process.

This Court's holdings in Heiner v. Donnan,

Hoeper . Tax Commission and Schlesinger v.

Wisconsin are dispositive of the due process

violation of Section 83(a).

In Schlesinger v. Wisconsin, petitioner

challenged a Wisconsin statute that every

gift of a material part of a decedent's estate

made by him within six years of death "shall be

construed to have been made in contemplation

of death" (270 U.S. at 236) for death tax

purposes. The Supreme Court held that the

statute established an invalid conclusive

presumption and declared it to be in violation

of due process and equal protection. In Heiner

v. Donnan, this Court considered a challenge to

the constitutionality of a similar federal

estate tax statute (Section 302(c) of the

Revenue Act of 1926) providing that gifts made

within two years of death of the donor shall

"be deemed and held to have been made in

contemplation of death" (285 U.S. at 320).

In ruling the statute unconstitutional this

Court held that the conclusive presumption

established by the statute “constitutes an

attempt by legislative fiat to enact into

existence a fact which here does not, and

cannot be made to exist in actuality" (285

U.S. at 329). 7

oe ee ie ce

— — eee

The tax statutes involved in Donnan

and Schlesinger made relevant the fact of

motivation for a gift and then foreclosed

the taking of evidence of that fact. Likewise,

Section 83(a) of the Code makes fair market

value of the restricted property relevant

and then precludes evidence on the effect of

a contractual restriction on fair market

value even when that restriction substantially

affects fair market value. The constitutional

principle which underlies the decisions in both

Donnan and Schlesinger and is applicable here

is , that a statute which imposes a tax upon

an assumption of fact which the taxpayer is

forbidden to controvert is so arbitrary and

unreasonable that it cannot stand under the..."

due process clauses cf the Fifth and Fourteenth

Amendments to the Constitution. (Heiner v.

Donnan, 285 U.S. at 325). This Court said in

Donnan that it has held more than once that a

statute creating a presumption which operates

to deny a fair opportunity to rebut it violates

the due process clause. (285 U.S. at

329).

In Hoeper v. Tax Commission, a Wisconsin

statute measured a husband's income with

reference to his wife's income for state income

tax purposes. Under Wisconsin law a married

woman's earnings were her separate property.

This Court struck down the state income tax

statute which measured an income tax on an

amount that was not an economic benefit to

the taxpayer. A tax statute which, in effect,

presumed a fictitious amount to be an economic

benefit was held to violate due process.

This Court wrote in Donnan that, "We held [in

Hoeper] that, since in law and in fact the

wife's income was her separate property, the

state was without power to measure his tax in

part by the income of his wife." (285 U.S. at

326). Where a federal tax statute measured

estate tax with reference to property which was

no economic benefit to the estate, this Court

said, in Donnan (285 U.S. at 327):

"The result is that upon those who

succeed to the decedent's estate there is

imposed the burden of a tax, measured in

part by property...from which the estate

deserves no benefit of any description.

Plainly this is to measure the tax on A's

property by imputing to it in part the

value of the property of B, a result which

both the Schlesinger and Hoeper cases

condemn as arbitrary and a denial of due

process of law. Such an exaction is not

taxation but spoilat ion.

The Second Circuit in upholding a tax

statute which imposes an income tax on an

amount which is no economic benefit to the

petitioner (by ignoring a restriction which has

a significant effect on value) has reached a

decision that is in conflict with these deci-

sions of this Court. The Court below dismisses

Donnan and Schlesinger as "plainly not good law

today." (App. A, p. 7a). The only direct

authority for this statement is a conclusion

to that effect in a constitutional law case

book by Professor Tribe.

There is far superior authority available

that the rationale of the cases upon which

petitioner relies represents the state of

the law today--this Court has recently approved

the rationale of these three tax cases in

Cleveland Bd. of Educ. v. LaFleur, 414 U.S.

632, 644 (1974); Vlandis v. Kline, 412 U.S.

441, 446 (1973); U.S. Dept. of Agriculture

v. Murry, 413 U.S. 508, 512 (1973); and

—

10

Stanley v. Illinois, 405 U.S. 645 (1972). *

*For example, the Supreme Court stated in

Vlandis ». Kline that (412 U.S. at 446):

"Statutes creating permanent irrebutta-

ble presumptions have long been disfavored

under the Due Process Clause of the Fifth

and Fourteenth Amendments. In Heiner v.

Donnan, 285 U.S. 312, 52 S.Ct. 358, 76

L.Ed. 772 (1932), the Court was faced with

a constitutional challenge to a federal

statute that created a conclusive presump-

tion that gifts made within two years

prior to the donor's death were made in

contemplation of death, thus requiring

payment by his estate of a higher tax. In

holding that this irrefutable assumption

was so arbitrary and unreasonable as to

deprive the taxpayer of his property

without due process of law, the Court

stated that it had ‘held more than once

that a statute creating a presumption

which operates to deny a fair opportunity

to rebut it violates the due process

clause of the Fourteenth Amendment.’ Id.,

at 329, 52 8.Ct., at 362. See, e.g.,

Schlesinger v. Wisconsin, 270 U.S.

230, 46 S.Ct. 260, 70 L.Ed. 557 (1926);

Hoeper v. Tax Comm'n, 284 U.S. 206, 52

S. Ct. 120, 76 L.Ed. 248 (1931)."

— — — —

11

B. The standard of due process

review set forth in

Weinberger v. Salfi, 422

U.S. 749 (1975), is not

applicable to a federal tax

statute.

The Court below reached its conclusion

of the constitutionality of section 83(a) on

a singular and misplaced reliance on Weinberger

v. Salfi. Contrary to the Second Circuit's

interpretation, this Court did not reject the

Donnan, Schlesinger and Hoeper rationale in

Salfi. Inetead, this Court was careful to

distinguish two cases that followed that

rationale (Stanley and LaFleur) on the ground

that Salfi involved merely a claim for a

non-contractual government benefit. The Court

also distinguished Vlandis, which like Salfi,

did involve a government benefit program (in

the form of reduced college tuition for in-

state residents) on the ground that, since the

Connecticut statute tested its benefit by the

factual question of residency, it could not at

the same time deny to one seeking to meet the

residency test the opportunity to show factors

clearly bearing on that issue.

Neither Salfi distinction is applicable

here. Section 83(a), like the Connecticut

statute in Vlandis, makes one fact relevant

on the measure of income--the fair market

value of the restricted stock--and then ex-

cludes evidence of the substantial effect on

fair market value of the restriction. Nor is

there any support for the Commissioner in

applying the minimum Salfi standard of due

process review for government benefit programs

to such burdens as deprivation of property

through estate or income taxation.

*

—

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—

12

The Salfi opinion did not withdraw the

Donnan and Schlesinger due process protection

from such legislative deprivations of property.

Rather, the majority opinion in Salfi only

limited judicial due process review to statutes

“prescribing the conditions upon which funds

shall be dispensed from the public treasury,"

or those “regulating the private sector of the

economy." (422 U.S. at 774). Section 83 of

the Internal Revenue Code cannot be charac-

terized as falling within either category.

The Court below appears to find (App. A,

p. 5a) support for his thesis that Donnan and

Schlesinger no longer have validity in Usery v.

Turner Elkhorn Mining Co., 428 U.S. 1 (1976).

Here again, it selects a few words in an

Opinion of this Court, out of context, and

thereby claims that Turner is authority for the

proposition that the limited Salfi standard

applies to all statutes regulating economic

matters. In Turner, this Court upheld a

statute “regulating the private sector of the

economy" by providing benefits to coal miners

suffering from “blacklung disease", and stated

(428 U.S. at 23-24):

"Since Congress can clearly draft a

statute to accomplish precisely what it

has accomplished through §411(c)(3)'s

presumption of disability, the argument is

essentially that Congress has accomplished

its result in an impermissible manner--by

defining eligibility in terms of total

disability’ and enacting an ‘irrebuttable

presumption’ of total disability upon a

factual showing that does not necessarily

satisfy the statutory definition of total

disability. But in a statute such as

this, regulating purely economic matters,

we do not think that Congress’ choice of

statutory language can invalidate the

13

enactment when its operation and effect

are clearly permissible. Cf. Weinberger

Vv. Salfi...." ;

The equation between statutes regulating

economic matters in the private sector of the

economy and an income tax statute does not

exist. Nowhere in Salfi or Turner is there

any indication, let alone a conclusion, that

the due process review of a federal income

tax statute would be judged under the Salfi

standard.

It should also be noted that Justice

Marshall, in his majority opinion (428 U.S.

at 24) in Turner, distinguished Stanley and

Vlandis on the ground that Congress could

directly legislate for coal mine operators

to provide benefits for miners suffering

complicated pneumoconiosis and, therefore,

that it chose to legislate by means of presum-

ing compensable “total disability" by clinical

evidence of complicated pneumoconiosis is not

violative of due process. This distinction is

not applicable here. Congress cannot directly

legislate that an amount is "income" by

labelling as income something which has no

economic value or benefit. The due process

clause is violated when a statute puts upon

a taxpayer the burden of a tax measured in

part by the value of the property never owned

by him...." (Heiner v. Donnan, 285 U.S. at

328. This Court has stated "that which is not

in fact the taxpayer's income cannot be made

such by calling it income" (Hoeper v. Tax

Commission, 284 U.S. at 215 (1931), and these

holdings are good law today.

— Oe ete en

— we -

14

Il. The decision of the Court below

is in direct conflict with the

Third Circuit's decision in

Gurmankin v. Costanzo, 556 F.2d

184 (1977)

The decision below represents the second

time that a Court of Appeals was faced with

the argument that Salfi, in effect, overruled

Donnan, Schlesinger and the recent cases in-

cluding Vlandis and LaFleur that have followed

their rationale.

The Third Circuit, however, came to

the opposite conclusion than the Court below.

In Gurmankin v. Costanzo, supra, the Third

Circuit held a Philadelphia School District

policy of preventing blind teachers from

teaching sighted students created an irrebutta-

ble presumption that blind persons could not be

competent teachers in violation of due process.

The Third Circuit relied on Cleveland Board of

Education v. LaFleur, 414 U.S. 632 (1974),

which held unconstitutional regulations requir-

ing that teachers take leaves of absence in the

fifth or sixth month of pregnancy. The irre-

buttable presumption of disability was struck

down in LaFleur as not being universally true

under the Vlandis case which relied on Donnan,

Schlesinger and Hoeper for its support.

The School Board argued that Salfi had

overruled LaFleur, just as the respondent

argued in the Court below that Salfi had

overruled Donnan, Schlesinger and Hoeper.

_The Third Circuit rejected the argument that

Salfi had overruled LaFleur because "Salfi is

distinguishable because it is a government

benefits case." (556 F.2d at 187).

äↄꝛ:— U çũm —ę ee — —

The expanded reading of Salfi, rejected

by the Third Circuit in Gurmankin, has been

adopted in error by the Court below.*

It is respectfully submitted that the

conflict between the Second and Third Circuits

and the uncertainty which that conflict has

created as to the scope and application of

the Salfi limitation on the irrebuttable

presumption doctrine justify the grant of

certiorari and resolution of the conflict by

this Court.

Conclusion

For all of the foregoing reasons it

is respectfully submitted that certiorari

should be granted.

Dated: New York, New York |

July 3, 1978

Respectfully submitted,

BURTON G. LIPSKY, ESQ.

Attorney for Petitioner

230 Park Avenue

New York, N. 1. 10017

(212) 661-9800

Of Counsel:

DELSON & GORDON

*This issue was also raised, but not decided

by the Seventh Circuit in Miller v. Carter,

547 F.2d 1314 (1977), aff'd, per curiam, 98

S.Ct. 786 (1978).

la

APPENDIX A

UNITED STATES COURT OF APPEALS

For tHe Szconp Cmourr

—

238

No. 355— September Term, 1977.

(Argued January 13, 1978 Decided April 6, 1978.)

Docket No. 77-4143

Mika Sako,

Appellant,

v.

CoMMISSIONER OF INTERNAL REVENUE,

Appellee.

Before:

FEIN BEN and Oakes, Circuit Judges,

and Wrarr, District Judge.“

—

Appeal from a decision of the United States Tax Court

upholding the constitutionality of 26 U.S.C. § 83(a) under

the Fifth and Sixteenth Amendments.

Affirmed.

Burton G. Lirsxy, New York, N.Y. (Delson &

Gordon, New York, N.Y., of counsel), for

Appellant.

WuuuMm A. Friepuanper, Washington, D.C.

(M. Carr Ferguson, Assistant Attorney

General, Gilbert E. Andrews, Jonathan S.

. Of the Southern District of New York, sitting by designation.

2323

2a

Cohen, Tax Division, Department of Jus-

tice, Washington, D.C., of counsel), for

Appellee.

Oakes, Circuit Judge:

Is it constitutional under the Fifth and Sixteenth

Amendments for Congress, in taxing a corporate employee

in connection with his purchase of his employer’s stock, not

to take into account any diminution in value of the stock

that may be present by virtue of temporary restrictions

on transfer in the employer’s underlying stock purchase

plan? Section 83(a) of the Internal Revenue Code governs

the taxation of certain stock transfers to employees in

connection with the performance of services.“ ! It requires

a taxpayer to include in gross income the excess of the

stock’s fair market value over its cost, as soon as the tax-

payer’s interest is no lenger subject to a substantial risk

1 Section 83(a), which is not confined to transfers of stock, provides:

Property transferred in connection with performance of services

(a) General rule.—If, in connection with the performance of

services, property is transferred to any person other than the

person for whom such services are performed, the excess of —

(1) the fair market value of such property (determined with-

out regard to any restriction other than a restriction which by

its terms will never lapse) at the first time the rights of the

person having the beneficial interest in such property are trans

ferable or are not subject to a substantial risk of forfeiture,

whichever occurs earlier, over

(2) the amount (if any) paid for such property,

shall be included in the gross income of the person who performed

such services in the first taxable year in which the rights of the

person having the beneficial interest in such property are trans-

ferable or are not subject to a substantial risk of forfeiture, which-

ever is applicable. The preceding sentence shall not apply if such

person sells or otherwise disposes of such property in an arm's

length transaction before his rights in such property become trans-

ferable or not subject to a substantial risk of forfeiture.

26 U.S.C. 6 83(a).

2324

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of forfeiture. The actual value of the stock arguably may

be less than the value of stock readily transferable on the

open market because of restrictions imposed by the stock

purchase plan. Nevertheless, these restrictions, other than

permanent, nonlapsing restrictions, may not be considered

in determining fair market value. Appellant argues that

the Tax Court erroneously concluded that the statute was

constitutional under the Fifth and Sixteenth Amendments.

67 T.C. 986 (Mar. 23, 1977). We disagree, and accordingly

affirm the Tax Court.

I. Facts AND Procegpines BLOW

During 1972, taxpayer was employed by Chesebrough-

Pond’s Inc. (Chesebrough). Chesebrough offered to its

officers and administrative employees a stock purchase plan

under a standard stock purchase agreement. The agree-

ment, executed by all purchasers, provided that one dollar

par value common stock could be purchased for an amount

equal to fourteen times Chesebrough’s average per share

earnings during the preceding five years. It also contained

a restriction on transfer referred to below.

On May 7, 1971, taxpayer agreed to purchase 140 shares

at $21.20 per share. For a period of one year thereafter,

her shares were subject to forfeiture if she ceased to be

employed by Chesebrough for any reason other than

death.“ In addition, she was bound not to sell, pledge or

transfer any interest in the shares for a five-year period

ending May 7, 1976.“ The transfer restriction, however,

could be waived by Chesebrough.

As of May 7, 1972, taxpayer’s 140 shares were no longer

subject to forfeiture. Thus, the excess of the stock’s fair

2 The shares were forfeitable at a price equal to that paid by her.

3 Chesebrough was willing to retain the shares for safekeeping until

expiration of the five-year restriction period. Shares delivered were to

bear a legend noting the transferability restrictions.

2325

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4a

market value over its cost became includable in taxpayer’s

gross income in the 1972 tax year.‘ On the last business

day prior to May 7, the average New York Stock Exchange

quotation for Chesebrough stock was $66.50 per share.

Taxpayer’s required inclusion under the statute, therefore,

is measured by the difference between her cost of $21.20

and the market price of $66.50, or $45.30 per share for a

total of 66,342. Because taxpayer both included the $6,342

in gross income and then deducted that amount in arriving

at her adjusted gross income, the Commissioner deter-

mined a deficiency. It was in a redetermination petition

that taxpayer challenged the constitutionality of Section

83(a).

II. Discussion

A. The Fifth Amendment Ground

Appellant rests her Fifth Amendment argument on

the irrebuttable presumption doctrine.’ She contends that

the conclusive legislative generalization embodied in Sec-

tion 83(a) violates the Due Process clause because the

statute imposes a tax on an amount which. .. does not,

4 See note 1 & accompanying text supra, Under 26 U.. C. §§ 421-25,

transfers of stock to an employee exercising a “qualified stock option,”

id. 6 422, an option under a qualified “employee stock purchase plan,”

id. § 423, and certain “grandfathered” restricted stock options, id. § 424,

receive more favorable tax treatment than permitted by Section 83(a).

5 See, ¢.g., Vlandis v. Kine, 412 U.S. 441, 452 (1978) (conclusive pre-

sumption of nonresidence held unconstitutional since the presumption “is

not necessarily or universally true in fact, and... the State has rea-

sonable alternative means of making the crucial determination”); Craw-

ford v. Cushman, 531 F.2d 1114, 1124-26 (2d Cir, 1976) (mandatory

discharge from Marine Corps for pregnancy violates equal protection

and creates an unconstitutional irrebutable presumption in violation of

the Due Process clause). For one critique of the doctrine, see Note,

The Irrebuttable Presumption Doctrine in the Supreme Court, 87 Harv.

L. Rev. 1534, 1544-56 (1974).

2326

— ea ceile aseS OR

N —— — TE ꝓ(——äͤk—

5a

and cannot be made to, exist in actuality ....” Heiner v.

Donnan, 285 U.S. 312, 329 (1932).*

The doctrinal underpinning for taxpayer’s argument

flowered in the early 1970’s when the dormant irrebuttable

presumption doctrine was revived in constitutional analy-

sis. See, ¢.g., Viandis v. Kline, 412 U.S. 441 (1973) (hold-

ing unconstitutional a conclusive presumption of nonresi-

dence whenever a person applied to a Connecticut state

university from out of state); Cleveland Board of Educa-

tion v. LaFleur, 414 U.S. 632 (1974) (invalidating local

education board rules requiring pregnant teachers to take

maternity leave without pay a specified number of months

before and after the expected birth of her child).’ Earlier,

Heiner with the aid of this analysis, had held unconstitu-

tional a federal statutory presumption that gifts made

within two years of a donor’s death were made in contem-

plation of death.“

6 To illustrate the point, counsel for taxpayer at oral argument sug-

gested hypothetically that the restrictions on the stock reduced its value

from $66.50 per share to perhaps $45.00 per share. Thus, taxpayer

argued, she should have included in her return only the difference be

tween the value as depreciated by the restrictions and her cost.

7 See also United States Dep’t of Agriculture v. Murry, 413 U.S. 508,

514 (1978) (provision of Food Stamp Act denying eligibility to a

household which has a member 18 years or older who is claimed as a

federal income tax dependent by a taxpayer who is not a member of

an eligible housebold held unconstitutional); Stanley v. Illinois, 405

U.S. 645, 658 (1972) (statute presuming that unmarried fathers are

unfit to take custody of their children upon mother’s death is uncon-

stitutional); Bell v. Burson, 402 U.. 535 (1971) (statute providing

that an uninsured motorist involved in an accident loses his license

without a hearing pending a final determination of liability held un-

constitutional).

0 In addition to relying specifically on Heiner v. Donnan, 285 U.S. 312

(1982), the Court in Viandis v. Kline, supra, 412 U.S. at 446, also cited

Schlesinger v. Wisconsin, 270 U.S. 230 (1926), holding unconstitutional

a state statute which conclusively presumed that gifts made within six

years of the donor’s death were made in contemplation of death.

2327

— ——

6a

More recently, however, the Court has narrowed the

broad scope of the irrebuttable presumption doctrine’

evinced in Vlandis and progeny. See note 7 supra, For

example, Weinberger v. Salfi, 422 U.S. 749 (1975), upheld

a federal statute precluding widows and their children

from receiving Social Security survivors’ benefits unless

the claimant’s relationship to the wage-earner existed at

least nine months before his death. The Court articulated

a rational relationship test for testing the validity of con-

clusive legislative presumptions in the context of a “non-

contractual claim to receive funds from the public trea-

sury,” id. at 772:

The juestion is whether Congress, its concern having

been reasonably aroused by the possibility of an abuse

which it legitimately desired to avoid, could rationally

have concluded both that a particular limitation or

qualification would protect against its occurrence, and

that the expense and other difficulties of individual de-

terminations justified the inherent imprecision of a

prophylactic rule.

Id. at 777. The extent of the Weinberger v. Salfi limitation

on the scope of the irrebuttable presumption doctrine was

apparently clarified in Usery v. Turner Elkhorn Mining

Oo., 428 U.S. 1 (1976). Turner Elkhorn validated a federal

law utilizing two irrebuttable presumptions: a miner “af-

flicted with complicated pneumoconiosis is [conclusively

deemed] to be totally disabled due to pneumoconiosis; if

he has died, it is [also] irrebuttably presumed that he was

totally disabled by pneumoconiosis at the time of his

death, and that his death was due to pneumoconiosis.” Id.

9 This development was perhaps presaged in Mourning v. Family Pub-

ications Serv., Inc., 411 U.. 356, 377 (1978) (upholding constitution

ality of truth-in-lending rules requiring disclosure when installment pur-

chase provides for four or more payments).

2328

*

Le ee Sens — — ee —e

7a

at 11. The Court sustained this potentially overinclusive

legislative determination on the basis that Congress is

ordinarily accorded great leeway in “reguinting purely

economic matters.” Id. at 23-24. And it emphasized that

conclusive presumptions in economic matters cannot be

“equat[ed]” with presumptions “in the mold of Stanley

and Vlandis.” Id. at 22.

While it is difficult to reconcile all of the Supreme Court’s

pronouncements on the irrebuttable presumption doc-

trine,“ it seems that in the wake of Turner Elkhorn and

Salfi “purely economic matters” will not be subject to the

demanding test of Vlandis v. Kline, see note 5 supra, but

rather will be governed by Turner Elkhorn’s more deferen-

tial standard of review.“ That is to say congressional

judgments in the form of “irrebuttable presumptions” in

the economic area will be upheld where there is a rational

relationship between the criteria set forth in the statutory

mandate and a legitimate congressional purpose. See Gold-

berg v. Weinberger, 546 F.2d 477, 480 (2d Cir. 1976), cert.

denied, 431 U.S. 937 (1977) (rational relationship test

appropriate for due process and equal protection challenge

to Social Security law denying certain benefits to widows

who remarry before reaching age 60); cf. Image Carrier

Corp. v. Beame, 567 F.2d 1197, 1202-03 (2d Cir. 1977)

10 Professor Tribe has carefully detailed the problems in reconciling the

various irrebuttable presumption decisions of the High Court. See JL.

Tribe, American Constitutional Law § 16-32, 1095-06 4 n.25 (1978),

Nut we are as satinfied as he that the early tax cases, Heiner v. Donnan,

eu pro, and Schlesinger v. Wisconsin, supra, although cited with approva

in Vlandis v. Kline, supra, 412 U.S. at 446, are “plainly not good law

today.” L. Tribe, supra, at 1005 n.28. They can no longer withstand

analysis in the light of Usery v. Turner Elkhorn Mining Co., 428 U.S,

1 (1976), Weinberger v. Saif, 422 U.8. 749 (1975), and Mourning v.

Family Publications Serv, Inc., supra.

11 Cf. Tribe, Structural Due Process, 10 Harv. C. R. C. L. I. Rev. 269,

310-14 (1075) (individualized inquiry more fitting where fundamental

rights are involved).

2329

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— —

8a

(rational relationship test appropriate for equal protec-

tion challenge to economic regulation).

Applying, then, the rational relationship test to Section

83(a), we note and the taxpayer concedes, Brief for Ap-

pellant at 19, that Congress could legitimately have judged

that the law prior to the enactment of Section 83 permitted

undue income tax avoidance through the use of restricted

stock options. The value received by the employee was

not taken into income until the restrictions lapsed,” yet

such arrangements generally permitted taxpayers to enjoy

the voting and dividend benefits of stock ownership, de-

spite restrictions on transfer. Section 83(a), which en-

tered the Internal Revenue Code as part of the Tax Re-

form Act of 1969,"* was a congressional attempt to elim-

inate such tax avoidance, clearly a legitimate governmental

purpose. While taxpayer takes exception to the possibly

overbroad means utilized to effectuate the congressional

purpose, the statutory scheme!“ satisfies constitutional

standards of rationality for three reasons,

First, whatever depreciating effect transfer restrictions

may have on stock value adversely affects only the tax-

payer-employee who wishes to sell his stock during the

restriction period and is denied the right to do so by the

corporation. Prior to enactment of Section 83 most of these

restrictions were cooperatively imposed by the corporation

12 In addition to deferring taxation, prior law operated to convert ordi-

nary income into capital gain, Moreover, the capital gain was long-term

since the holding period commenced at the time of acquisition of the

restricted stock. Sea Mertens, Federal Income Taxation, Code Com-

mentary § 83, at 98 (Malone ed, 1971).

18 Section 83(a) was added to the Code by Section 321(a) of the Tax

Reform Act of 1969, Pub. L. 91-172, 83 Stat. 487, 588 (1969).

14 The method adopted to deal with what was essentially a timing prob.

lem has two facets: delaying the time of recognition until no substan.

tial risk of forfeiture remains, while ignoring any value-depressing effect

of transfer restrictions, See note 1 supra; notes 21-22 infra.

2330

eee ee

— 9 —— 2 — he

—— alge >

OO ae ees me nats eb —

mee am —

——

9a

with the aim of providing a tax benefit to the employee

rather than advancing purely corporate objectives. Sec-

tion 83(a) is a reasonably well tailored means of defeating

a device the only business purpose of which could be to

pay employees with dollars that, because they may be tax-

free or tax-favored, may be fewer. Second, the corpora-

tion always retains, expressly or by implication of law,

the power to waive any restriction. The waiver power thus

renders the amount of value depreciation both speculative

and dependent upon the subjective intentions of the parties

to the plan. Congress was therefore justified in adopting

nonindividualistic means, see note 11 supra, because the

factual determinations otherwise necessary accurately to

value the shares would depend upon matters entirely with-

in the knowledge and control of the corporate employer

and its employee. Since a corporation such as Chesebrough

could always release its employee from the restrictions,

determining share value with any degree of certainty

would be most difficult, expensive and, to the tax collector,

administratively inordinately inconvenient. See Mathews

v. Lucas, 427 U.S. 495, 509-10 (1976). Finally, it is not

insignificant that those who choose to participate in a

restricted stock option purchase plan do so voluntarily,

presumably aware of Section 83’s tax consequences. That

taxpayers participate in such plans with open eyes min-

imizes the arbitrariness which flows from the lack of per-

fect fit between the congressional means and its purpose.

Section 83(a) creates a blanket rule, to be sure, unfair

perhaps in an individual case, that transfer restrictions

generally are to be given no effect in computing the Sec-

tion 83(a) inclusion. We nevertheless find the requisite

rational relationship between congressional means and the

legitimate congressional purpose in curbing tax avoidance

from the use of restricted stock options. The statutory

scheme does not exhibit the kind of “extreme and glaring”

2331

ditch ttt atincees ih

tate

10a

disregard of “fair dealing,’ Cohan v. Commissioner, 39

F.2d 540, 545 (2d Cir. 1930), which amounts to conflsca-

tion, rather than taxation, in violation of the Fifth Amend-

ment.

B. The Siateenth Amendment Cround

Taxpayer’s second contention is premised ox the Six-

teenth Amendment“ and the well-known, but often dis-

tinguished, decision in Eisner v. Macomber, 252 U.S. 189

(1920). That case, the only Supreme Court decision ever

to hold an income tax provision unconstitutional on Six-

teenth Amendment grounds, concluded that Congress had

no power to tax stock dividends as income without appor-

tionment. Taxpayer urges Eisner’s applicability because

her tax liability was computed on the basis of the value of

freely transferable stock, an amount in excess of the actual

fair market value of her restricted stock. See note 6 & ac-

companying text supra. She suggests that Section 83(a)

imposes an unapportioned direct tax on property because

it is a tax on unrealized income. We are unable to accept

this proposition.

The tax here levied was not a direct tax on property but

was rather a tax on the receipt of value transferred to an

employee by an employer in return for services. It was,

therefore, a tax on income received as compensation for

services. Thus, if appellant’s position were that a direct

tax on property is implicated because her compensation

was in the form of stock, the argument would be plainly

off base. Tax on compensation, whether received in cash

or some other form of property, need not be apportioned.

15 “The Congress shall have power to lay and collect taxes on incomes,

from whatever source derived, without apportionment among the severn!

States, and without regard to any census or enumeration.” U.S. Const.

amend. XVI.

2332

-_—-? 6

— . —

lla

See Springer v. United States, 102 U.S. 586, 602 (1880);

Penn Mutual Indemnity Co. v. Commissioner, 32 T.C. 653,

659-66 (1969) (en banc), af d, 277 F. 2d 16 (3d Cir. 1960).

However, appellant’s real argument appears to be that

she should be taxed only on the compensation she actually

received—the value of the stock with the restrictions. Re-

lying on the language of Kisner, she urges that income

must in fact be realized before it can be taxed, and that

the realization requirement carries with it the additional

implication that an amount greater than value actully

derived is not income within the meaning of the Sixteenth

Amendment, But the Eisner concept that there must be

“gain” to have “income,” Eisner v. Macomber, supra, 252

U.S. at 207, has been modified by subsequent decisions.

Among these are decisions accepting the accrual method of

accounting,“ adopting the doctrine of constructive re-

ceipt, “ and disallowing the shifting of taxation burdens by

assignment of income or by certain transfers in trust.“

These decisions recognize that concepts of income are dy-

namic, not static—elastic, not rigid. 1 Mertens, Federal

Income Taaation § 5.03, at 4-8 (Malone ed. 1974).

We conclude that a workable, practical system“ of tax-

ing employees’ restricted stock options can overlook, at

16 F. ., Burnet v. Sanford / Brooks Co., 282 U.. 359, 364-66 (1931)

(Sixteenth Amendment permite accrual method); Aluminum Castings

Co. v. Routsahn, 282 U.S. 98, 97 (1980) (accrual method “born of

necessity”).

17 F.., Corties v. Bowers, 281 U.8. 376, 878 (1930) (grantor taxable

on transfer in trust where he retains right to alter, amend or revoke

trust).

18 F.., Helvering v. Horst, 311 U.. 112 (1940) (assignment of in-

come); Helwering v. Clifford, 309 U.. 831 (1940) (grantor taxable on

income of five-year trust even though income was payable to his wife

since grantor retained sufficient incidents of ownership).

19 See, ¢.g., Burnet v. Sanford d Brooks Co., supra, 282 U.. at 365;

Farmers Loan d Trust Co. v. Minnesota, 260 U.. 204, 212 (1980).

2333

12a

least temporarily,“ a speculative decrease in value in as-

certaining the amount of compensation received in the

form of restricted stock where the employee has obtained

both voting power and dividend rights. Absent the statate,

some stock restrictions might in the abstract make deter-

mination of a fair marke; value exceedingly difficult or

downright impossible. See Helvering v. Tez-Penn Oil Co.,

300 U.S. 481, 499 (1937). By the statute, Congress has

drawn a decisive line between restrictions which either

defer taxation“ or by their own terms affect the fair mar-

ket value calculation“ and those restrictions which are not

considered in measuring fair market value. Congress is

not required to take each and every restriction into ac-

count in combating tax-avoidance, or to make equally diffi-

cult individual evaluations which depend upon the parties’

subjective intentions. Rather, the Sixteenth, and Fifth,

Amendments permit the line drawn to be a rough one, in

the interest of realistically solving a practical problem, by

making a “gross accommodation to the economic reality.”

Fraser v. Commissioner, 25 F.2d 653, 655 (2d Cir. 1928)

(L. Hand, J.). Congress has distinguished qualified from

20 Because her basie for the acquisition of the stock will be its Sec-

tion 88 (a) value, if she sells it for less she will be entitled at least to

capital loss treatment. In the end, then, Section 83 relates principally

to the timing of taxation rather than to what is being taxed.

21 Until the employee's ownership interest is not mubject to a substan-

tial risk of forfeiture, there is no taxation under Section 83(a). See

note 1 supra.

22 Restrictions that will never lapee are taken into account in deter-

mining fair market value. See note 1 supra. Thus, where the stock may

be sold only at book value or at a value fixed by formula, if the re-

striction will never lapse, that formula-determined value is deemed to

be the fair market value unless the Commissioner proves the contrary.

26 U.. C. 688 (d) (1). In such a case,” runs the legislative rationale,

“the restriction is an inherent limitation on the recipient’s property

rights, and his income should be determined accordingly. 8. Rep. No.

91-552, diet Cong., let Sess. 121, reprinted in [1969] U.. Code Cong.

& Ad. News 2027, 2158.

2334

8 F ²˙ —·Wt· w

13a

nonqualified stock option plans and in connection with the

latter it has drawn a sharp line of differentiation on the

basis of forfeiture and a rough one on the basis of value.

Because nonqualified plans have been the vehicles of tax

' avoidance Congress may clothe the tax incidental to them

with a ready-made, rather than a custom-tailored, suit.

Judgment affirmed. No costs.

L4a

67 T. C. No. 81

UNITED STATES TAX COURT

MIRIAM SAKOL, Petitioner v. COMMISSIONER OF

INTERNAL REVENUE, Respondent

Docket No. 4834-74 Filed March 23, 1977

Sec. 83(a), I.R.C. 1954, measures

income from the transfer of property in

connection with the performance of

services without regard to contractual

restraints on the transfer of that prop-

erty which will lapse. Held, sec. 83(a)

is not unconstitutional under the 5th

or 16th Amendments,

Burton G. Lipsky, for the petitioner.

Patrick 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 em-

ployee stock purchase agreement without regard

1/ All section references are to the Internal

Revenue Code of 1954, as amended, unless

otherwise noted.

— — —

—— — — 2 ——⁊˖⁊⁊It — —;. —— — ——

15a

to certain contractually imposed restrictions

on the transferability of the shares re

under the agreement.

All 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, New York. At the time

the petition was filed, petitioner resided in

New York City, New York.

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 five years. Payment

of the purchase price could be made in install-

ments over a period not to exceed five 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 one 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.

n — >

l6a

In addition, petitioner agreed that she would

continue to own and not sell, pledge or trans-

fer any interest in the shares for a period. of

five years or until May 7, 1976. Chesebrough

was willing to retain the shares for safekeep-

ing until the expiration of the five-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 repre-

sented compensation for services, includable in

petitioner's gross income pursuant to section

83(a) for the taxable year 1972.

Petitioner has launched a serious consti-

tutional 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 fair

opportunity to rebut and, therefore, amounts

to a denial of due process of law within the

meaning of the Fifth Amendment of the Consti-

tution 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.

17a

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 Insur-

ance Corp., 400 U.S. 4, 6 (1970).

Section 832/ is the Congressional response

to certain tax advantages which could be

2/ SEC. 83. PROPERTY TRANSFERRED IN CONNEC-

TION WITH PERFORMANCE OF SERVICES.

(a) GENERAL RULE.--If, in connection

with the performance of services, property

is transferred to any person other than the

person for whom such services are per-

formed, the excess of--

(1) the fair market value of such

property (determined without regard to

any restriction other than a restric-

tion which by its terms will never

lapse) at the first time the rights

of the person having the beneficial

interest in such property are transfer-

able or are not subject to a substan-

tial risk of forfeiture, whichever

occurs earlier, over

(2) the amount (if any) paid for

such property,

[continued on next page]

18a

27

[continued]

shall be included in the gross income of

the person who performed such services in

the first taxable year in which the rights

of the person having the beneficial inter-

est in such property are transferable or

are not subject to a substantial risk of

forfeiture, whichever is applicable.

The preceding sentence shall not apply if

such person sells or otherwise disposes of

such property in an arm's length transac-

tion before his rights in such property

become transferable or not subject to

a substantial risk of forfeiture.

* * *

(e) SPECTAL RULES.--For purposes of

this section--

(1) SUBSTANTIAL RISK OF FOR-

FEITURE.--The rights of a person in

property are subject to a substantial

risk of forfeiture if such person's

rights to full enjoyment of such

property are conditioned upon the

future performance of substantial

services by any i dividual.

(2) TRANSFERABILITY OF PROPERTY .--

The rights of a person in property are

transferable only if the rights in such

property of any transferee are not

subject to a substantial risk of

forfeiture.

19a

obtained through use of restricted stock

plans3/ to compensate employees. The section

provides that property transferred in connec-

tion with the performance of services is to be

included in the income of the transferee in an

amount which exceeds "he 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 inc lude that amount is deemed to be the

taxable year in which the property is transfer-

able 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 become

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

3/ See s. Rept. No. 91-552, 91 Cong. let Sess.

(1969), 1969-3 C.B. 500.

— —

20a

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 eliminat-

ing the capital gain potential on the post-

acquisition 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 treat-

ment to similar deferred compensation arrange-

ments. 8. Rept. No. 91-552, 91 Cong., let

4/ Sec. 1.421-6, Income Tax Regs., 33 Fed. Reg.

15870 (1968).

21a

Sess. (1969), 1969-3 C. 3. 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 non-exempt 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 actu-

ally 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.

aye

aS a , , , ee

22a

In addition, to minimize the potential for

continued tax avoidance and to further dis-

courage 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 arrange-

ments 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 Ins. Co.,

286 U.S. 244 (1932), and Eisner v. Macomber,

252 U.S. 189 (1920). However, in our view

petitioner has placed too much reliance on

these cases and the Supreme Court's long-aban-

doned effort to fashion a concept of income.

The powers granted to the Congress to define

income are broad and plenary. Penn Mutual

Indemnity co., 32 T. c. 653, 666 (1959). The

formalistic concept of realization articulated

in the cases upon which petitioner relies has

been eroded by the passage of time and subse-

quent cases and clearly was never intended

to define for all times the parameters of

income subject to taxation. Commissioner

v. Glenshaw Glass Co., 348 U.S. 426 (1955);

Helvering v. Horst, 311 U.S. 112 (1940);

Helvering v. Bruun, 309 U.S. 461 (1940).

Moreover, taxation despite nonreceipt is common

and the actual reduction to possession is not a

constitutional requirement. See, e.g.,

Harrison v. Schaffner, 312 U.S. 579 (1941);

Helvering v. Horst, supra; Lucas v. Earl, 281

U.S. 111 (1930).

— . ~~ wee eo eae

23a

In any event, the 16th Amendment is not a

limitation on the taxing power granted to

Congress by the Constitution. It is, instead,

designed to insure that the power to tax

income is not placed into the category of

direct taxation subject to apportionment. It

is clear that section 83 does not impose a

direct tax within the meaning of the Const itu-

tion and, therefore, is entirely within the

taxing power of Congress under article 1,

section 8, without regard to the 16th Amend-

ment. Cf. Spreckels Sugar Refining Co. v.

McClain, 192 U.S. 397 LOR See also, Penn

Mutual Indemnity Co., supra, at 662-663.

Accordingly, we hold that section 83 does

not exceed the Congressional authority to tax

income.

Although an amount may properly be viewed

as income within the meaning of the Constitu-

tion, the question remains whether the imposi-

tion of a tax on that amount is consonant

with due process under the Fifth Amendment.

Riverfront Groves, Inc., 60 T.C. 435 (1973).

Herein, petitioner takes the position that

her income may not exceed the fair market value

of the restricted stock she received under the

agreement. She argues that section 83,

in its conclusive measurement of income without

regard to the restrictions on the transfera-

bility of her shares, is so arbitrary and

unreasonable as to amount to a denial of

due process within the meaning of the Fifth

Amendment.

On its face, section 83 does not utilize

the language of presumptions; it merely defines

income earned when property is received "in

connection with the performance of services."

However, the substance and impact of the

section is substantially the same as a conclu-

24a

sive presumption of the amount of income. In

recent years, a considerable body of law has

developed with regard to conclusive presump-

tions and the due process clause of the Fifth

Amendment. See, e.g., Cleveland Board of

Education v. LaFleur, 414 U.S. 632 (1974);

VIandie v. Kline, 412 U.S. 441 (1973); U.S.

Dept. of Agriculture », Murry, 413 U.S. 508

1973). Much of the analysis applied in these

cases can be traced to Heiner v. Donnan, 285

U.S. 312 (1932), and Schlesinger v. Wisconsin,

270 U.S. 230 (1926), upon which petitioner

relies herein.

In Donnan,5/ an estate tax case, the

Court found unconstitutional under the due

process clause section 302(c) of the Revenue

Act of 1926 which deemed any transfer made by

a decedent within two years of death to have

been made in contemplation of death and,

therefore, includable in the decedent's gross

estate for tax purposes. The Court reasoned

that the statute operated arbitrarily by not

allowing the estate's executor any opportunity

to establish that the gifts were not, in fact,

made in contemplation of death. Moreover,

the result was further justified by the fact

that the estate was burdened by a tax measured

5/ The issue and reasoning in Schlesinger

v. Wisconsin, 270 U.S. 230 (1926), is

substantially the same, dealing, however,

with a section of the Wisconsin tax code.

In addition, petitioner has on brief

argued that we approved the theory of

Heiner v. Donnan, 285 U.S. 312 (1932),

in Charles Wilson, 39 T. c. 362 (1962).

However, we did not pass upon the consti-

tutional issue presented there and, there-

fore, find it unpersuasive.

25a

in part by the value of property which was

never owned by the estate.

More recently in Vlandis, supra, the

Court found unconstitutional a Connecticut

statute which classified prospective students

as permanent nonresidents for purposes of

tuition payment in the state university when

their legal address was outside the state at

the time their application for admission was

made or at some point during the preceding

year. Seemingly, the Court was primarily

concerned with whether the individuals were

accurately grouped and it stated:

We hold only that a permanent irre-

buttable presumption of nonresidence--

the means adopted by Connecticut to

preserve that legitimate interest-~is

violative of the Due Process Clause,

because it provides no opportunity for

students who applied from out of State

to demonstrate that they have become

bona fide Connecticut residents. * * *

[Vlandis v. Kline, 412 U.S. at 453.]

The standard employed was meticulous;

the due process clause would be violated if the

conclusive presumption were not necessarily

and universally true in fact. The remedy

afforded was to ascertain whether the treatment

of the individual was consistent with the

statute's purpose.

Justice Rehnquist, in his dissent, argued

that the majority's analysis of and its

reliance on Donnan were reminiscent of and

inexorably linked to the long-repudiated

principles of "substantive due process" and

contrary to the teaching of Ferguson v. Skrupa,

372 U.S. 726 (1963), which held that courts

should not substitute their social and economic

26a

beliefs for those of the elected legislative

bodies.

From a close examination of the conclusive

presumption cases, it is apparent that the

concern with the statutory accuracy of what is,

in essence, a delineation of a class of persons

who are to bear a burden or receive a benefit

under prescribed circumstances closely resem-

bles the analysis applied in equal protection

cases.

Finally, in Weinberger v. Salfi, 422 U.S.

749 (1975), Justice Rehnquist, writing for the

majority, noted that various holdings in

similar cases dealing with irrebuttable

presumptions did not “sound precisely the same

note“ and, therefore, discussed at some length

the proper test to be applied in cases of this

sort. Returning to a more traditional equal

protection analysis, the Court stated:

The question is whether Congress, its

concern having been reasonably aroused

by the possibility of an abuse which

it legitimately desired to avoid, could

rationally have concluded both that

a particular limitation or qualification

would protect against its occurrence,

and that the expense and other diffi-

culties of individual determinations

justified the inherent imprecision of a

prophylactic rule. „ * [422 U.S. at

777.)

The Court also quoted with approval

from Richardson v. Belcher, 404 U.S. 78 (1971),

where it was held that an act of Congress

will not be so arbitrary as to offend due

process where the legislative classification

is rationally related to the achievement of

legitimate legislative goals. Moreover, a

1 ti

27a

legislative enactment need not be in every

respect logically consistent with those goals

to be constitutional. Williamson v. Lee

Optical Co., 348 U.S. 483, 487 (1955).

It is also important to consider that

in neither Dornan nor Viandis was the Court

confronted witn che same kind of clear consti-

tutional power which is granted to Congress to

define income subject to taxation. The salient

distinction in Donnan is the fact that the

taxpayer's estate never owned the property,

while petitioner herein is merely charged in

advance with an incremental value which in

some sense is inherent in the property and in

all probability the real measure of the compen-

sation intended by the parties. Moreover, the

tax consequences were clearly delineated in

the Chesebrough stock purchase plan and pre-

sumably petitioner was aware of the measure of

her compensation.

Prior to enactment of section 83, contrac-

tual restrictions were utilized to maximize

both tax deferral and capital gain potential

on the ultimate disposition of the shares.

Cognizant of such abuse, Congress chose to

recognize only those restrictions which it felt

were not utilized to produce such unwarranted

tax benefits.

H. Rept. No. 91-413, 91 Cong. let Sess.

(1969), 1969-3 C.B. 255 states:

Explanation of provision.--For the

above reasons, your committee's bill

provides that a person who receives

a beneficial interest in property by

reason of the performance of services is

to be taxed with respect to the property

at the time of receipt, either if his

interest in the property is transferable

28a

or if it is not subject to a substantial

risk of forfeiture. In this case, the

person is to be required to include

in income the amount by which the fair

market value of the property exceeds

the amount (if any) he paid for the

property. For this purpose, the fair

market value of the property is to be

determined without regard to any restric-

tion, except a restriction which by its

terms never lapse, for example, a require-

ment that an employee sell the stock back

to the employer * * * are not, in your

committee's opinion, tax-motivated and

should be distinguished from restrictions

designed to achieve deferral for tax

saving purposes. [Emphasis added.

Undoubtedly, the efficacy of the Con-

gressional design to eliminate the dual bene-

fits of tax deferral and capital gain would

have been dangerously undermined without a

strict measure of the income resulting from

such agreements. There can be no doubt that

Congress may adopt a measure calculated

to prevent an avoidance of tax. Helvering v.

City Bank, 296 U.S. 85, 90 (1935). The

plethora of contractual restrictions which

could be designed would create substantial

problems of valuation; an alternative Congress

may seek to avoid. Helvering v. Lerner Stores

Co., 314 U.S. 463, 468 (1941). Moreover, the

recognition of contractual restrictions would

build into every share of stock a deferral and

potential capital gain increment, albeit on a

smaller scale, resulting from the immediate

imposition of tax under the proscribed statu-

tory conditions.

Traditionally, to invalidate a taxing

statute, it must be shown that Congress did

a wholly arbitrary thing or found equivalent

29a

where there was none or anything approaching

it. United States v. Manufacturers National

Bank, 363 U.S. 194 (1960); Burnet v. Wells, 289

U.S. 670 (1933).

As respondent points out, there are

other examples of conclusive presumptions in

the tax code. The Civil Service Retirement Act

is a prime example wherein the employee is

presumed to have consented to payroll deduc-

tions for contributions to the retirement plan

while taxed currently on those amounts. A tax

on the full amount has been sustained in Hogan

v. United States, 513 F.2d 170 (6th Cir. 1975),

and Lawrence J. Cohen, 63 T.C. 267 (1974),

although based primarily on the facts and not

the constitutional validity of a tax on

amounts arguably in excess of the current

economic benefit. However, the continued use

of conclusive presumptions as a statutory

technique in taxing statutes lends credibility

to the notion that their use in this regard is

not arbitrary or unreasonable.

We are unable to say that Congress,

in responding to an area of tax avoidance

created by the use of such restrictions which

it now refuses to recognize, acted arbitrarily.

While some unfairness and inequity may result

from the operation of section 83, Congress

could rationally have concluded that such a

result was justified by the ease and certainty

of the section's operation. Weinberger v.

Salfi, 422 U.S. at 777. We are convinced,

moreover, that section 83 is a rational

response to an area of substantial tax abuse.

Moritz v. Commissioner, 469 F.2d 466 (10th Cir.

1972), cert. denied 412 U.S. 906 (1973).

We conclude that section 83 is a valid

exercise of the taxing power and consonant wiih

the principles established in Weinberger,

2 9

30a

supra, and Burnet, supra. In any event, the

question is clearly not so free from doubt so

as to rebut the real and vital presumption in

favor of the validity of a taxing statute.

Penn Mutual Indemnity Co., 32 T.C. 653 (1959).

Accordingly, we hold that section 83 is

constitutional.

Decision will be entered

under Rule 155.

|

3la

APPENDIX C

UNITED STATES COURT OF APPEALS

SECOND CIRCUIT

At a stated Term of the United States

Court of Appeals for the Second

Circuit, held at the United States

Courthouse in the City of New

York, on the sixth day of April,

one thousand nine hundred and

seventy-eight.

*

2

+

i

:

*

*

Present:

HON. WILFRED FEINBERG

HON. JAMES L. OAKES

Circuit Judges

: HON. INZER B. WYATT

District Judge

77-4143

MIRIAM SAKOL,

Petitioner-Appellant,

~against-

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

MOURNS ARR, MITRE ws

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wer

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PRG

LTP PSS

ET OSA IO ERS:

I cae ge te ew

32a

Appeals from the Tax Court of the United

States.

This cause came on to be heard on the

transcript of record from The Tax Court of

the United States, and was argued by counsel.

ON CONSIDERATION WHEREOF, it is now

hereby ordered, adjudged, and decreed that

the order of said Tax Court of the United

States be and it hereby is affirmed without

costs in accordance with the opinion of

this court.

A. DANIEL FUSARO,

Clerk

By ARTHUR HELLER,

Deputy Clerk

Docketed on April 6, 1978.