Petition for Writ of Certiorari — Venture Funding, Ltd. v. Commissioner

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/) Supreme Court, U.&

eo, FILED

991682 FEB 7 - 200

No. 00- Ure tu. Qe tire vicet

gn The

Supreme Court of the Wnited States

VENTURE FUNDING, LTD.,

Petitioner

Vv.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

On Petition For A Writ of Certiorari

To The United States Court of Appeals

For the Sixth Circuit

PETITION FOR WRIT OF CERTIORARI

ROBERT J. ZINKEL, JR.

Zinkel & Associates, P.C.

255 E. Brown Street, Suite 320

Birmingham, MI 48009

(248) 644-5800

MO ae

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Pe, Ct ne cer tee

IV.

QUESTIONS PRESENTED FOR REVIEW

The Tax Court and Sixth Circuit erred as a matter of law in

holding that the transfer of property of an employer to an

employee was not deductible by the employer in the year of

transfer in contravention to the statute and all existing

precedent.

Whether the Tax Court and the Sixth Circuit Court of

Appeals erred in ruling that Treas. Reg. §1.83(a)(6)(2)

imposed a requirement that an employer is entitled to a

compensation deduction only if it issues a Form W-2 or

Form 1099 to the recipient.

Whether the Tax Court and the Sixth Circuit Court of

Appeals erred in ruling that an employer cannot take the

deduction under the accrual method of accounting pursuant

to Treas. Reg. §1.83(a)(6)(3).

Whether the ruling of the Sixth Circuit Court of Appeals

created an impermissible conflict between the federal circuits

in ruling that the transfer of lettered stock is not immediately

deductible to an employer upon transfer to an employee if

an employee does not report the receipt of the transfer in

the same year.

When the application of the treasury regulation conflicts

with other sections of the code and regulations, it is invalid.

CORPORATE DISCLOSURE

\ corporate disclosure has been filed with the Sixth Circuit

Court of Appeals and no amendments have been made since that

tiie

TABLE OF CONTENTS

PAGE

QUESTIONS PRESENTED FOR REVIEW | i

CORPORATE DISCLOSURE |... .. ores il

TABLE OF AUTHORITIES

OPINIONS AND ORDERS ENTERED BELOW

BASIS OF JURISDICTION

CONSTITUTIONAL PROVISION, TREATIES, STATUTES

ORDINANCES AND REGULATIONS INVOIVED IN

THIS CASE

STATEMENT OF THE CASE

ARGUMENT

I. THE TAX COURT AND SIXTH CIRCUIT ERRED

AS A MATTER OF LAW IN HOLDING THAT THE

TRANSFER OF PROPERTY OF AN EMPLOYER TO

AN EMPLOYEE WAS NOT DEDUCTIBLE BY THE

EMPLOYER IN THE YEAR OF TRANSFER IN

CONTRAVENTION TO THE STATUTE AND ALL

EXISTING PRECEDENT

Il. THE TAX COURT AND THE SiXTH CIRCUIT

COURT OF APPEALS ERRED IN RULING THAT

TREAS. REG. §1.83(a)(6)(2) IMPOSED A

REQUIREMENT THAT AN EMPLOYER IS

ENTITLED TO A COMPENSATION DEDUCTION

ONLY IF IT ISSUES A FORM W-2 OR FORM 1099

TO THE RECIPIENT 12

lll. THE TAX COURT AND THE SIXTH CIRCUIT

COURT OF APPEALS ERRED IN RULING THAT

AN EMPLOYEE CANNOT TAKE THE

DEDUCTION UNDER THE ACCRUAL METHOD

OF ACCOUNT PURSUANT TO TREAS. REC.

1. 83(a6)(3) 1b

PAGE

IV. THE SIXTH CIRCUIT COURT OF APPEALS

CREATED AN IMPERMISSIBLE CONFLICT

BETWEEN THE FEDERAL CIRCUITS IN RULING

THAT THE TRANSFER OF LETTERED STOCK IS

NOT IMMEDIATELY DEDUCTIBLE TO AN

EMPLOYER UPON TRANSFER TO AN

EMPLOYEE IS AN EMPLOYEE DOES NOT

REPORT THE RECEIPT OF THE TRANSFER IN

i, 2 A rer rrr rer Tre rr er rrr se 18

V. WHEN THE APPLICATION OF THE TREASURY

REGULATION CONFLICTS WITH OTHER

SECTIONS OF THE CODE AND REGULATIONS

OS Pe SP he hee hand eee ase dees s aes 21

$i. & PU} rey rrr errr rrr re ye er 22

TABLE OF AUTHORITIES

CASES

Arrow Fastener Co. v. Commissioner, 76 T.C. 423 (1981) .

Bingler v. Johnson, 394 U.S. 741 (1969) ................

Cassetta v. Commissioner, T.C. Memo 1979-284 (1979) ...

Chalmette General Hospital v. United States, 90-2 U.S.

p tke EB es £m a eee

ere ee err oe eee

MPR EP ee LT ERIC Sy

Estate of Boeshore v. Commissioner, 78 T.C. 656 (1981),

affd., 692 F.2d 128 (D.C. Cir. 1982) ...............

Halligan, et al v. Commissioner, T.C. Memo 1986-243

oo ee ee Mery pee biter” Lond We:

Koshland v. Helvering, 298 U.S. 441 (1936) .............

Pledger v. Commissioner, 641 F.2d 287 (5th Cir.) ........

Robinson v. Commissioner, T.C. Memo 1985-275 (1985) ..

Robinson v. Commissioner, 82 T.C. 444 (1984) ..........

Robinson v. Commissioner, 82 T.C. 467 (1984) ..........

Rotolo v. Commissioner, 88 T.C. No. 85 (1987) ..........

Schmidt v. Commissioner, 107 T.C. 271 (1996) ..........

United States v. Correll, 389 U.S. 299 (1967) ...........

United States v. Vogel Fertilizer Co., 455 U.S. 16 (1982)

Venture Funding v. Commissioner, 110 T.C. No. 19, 34-36

(OE. ah ck ocd Cae eee eee

Wemgarden v. Commissioner, 825 F.2d 1027

rr eae ear

PAGE

13,

1],

COURT RULES, STATUTES AND REGULATIONS

Treas. Reg. §1.83(a)(6)(2) Multiple

Treas. Reg. §1.83(a)(6)(3) Multiple

26 U.S.C. §83

ILR.C. $83 Multiple

Securities and Exchange Act of 1933, §144 12

OPINIONS AND ORDERS ENTERED BELOW

The Opinion of the Sixth Circuit Court of Appeals (Appendix

A, infra), is unpublished, cited as 198 F.3d 248; 1999 WL 1045181

(6th Cir.)).

The Order of the U.S. Tax Court dismissing this action

(Appendix B, infra), is reported at 110 T.C. 236 (1998).

BASIS OF JURISDICTION

The Decision of the Sixth Circuit Court of Appeals was entered

on November 9, 1999. The jurisdiction of this Court is invoked

under Rule 10 of the Rules of the Supreme Court of the United

States for the reason that a United States Court of Appeals has

decided an important question of federal law that has not been,

but should be, settled by this Court because an important federal

question has been decided in a way that conflicts with other

United States Courts of Appeal and rulings of the United States

Tax Court.

CONSTITUTIONAL PROVISION, TREATIES,

STATUTES, ORDINANCES AND REGULATIONS

INVOLVED IN THIS CASE

The provisions involved are lengthy and the pertinent text shall

be set out in the Appendix attached hereto. The primary statutes

and regulations involved are 26 U.S.C. §83 and Treas. Reg. §1.83

of the Internal Revenue Code.

STATEMENT OF THE CASE

In this case, Venture Funding, Ltd., took an income tax

deduction equal to the value of property transferred to its

employees in the year of transfer, 1988. I.R.C. §83 mandates that

transfers of property are taxable to the employee and deductible

by the employer in the year of transfer. Whether the particular

type of property involved in this case, “lettered stock”, is

immediately deduct‘ble by the employer and taxable to the

employee has been litigated on several occasions prior to this

case. Without exception, every decision to date has held that the

transfer of lettered stock is deductible by the employer and

taxable to the employee in the year of transfer.

Venture Funding deducted the transfer of property as

compensation to its employees in the year of transfer, 1988, but

the deduction was denied by the United States Tax Court when it

found that certain employees did not report the receipt on their

1988 U.S. Income Tax return Form 1040. At trial and at the Sixth

Circuit it was undisputed that as a matter of law the transaction

should have been deducted and taxed in 1988 pursuant to I.R.C.

§83, according to all existing precedent dealing with transfers of

this exact type of property. However the Tax Court and Sixth

Circuit broke away from all existing precedent in ruling that the

employer is not entitled to take the deduction in the year of

transfer if the employees do not report the receipt in 1988.

On this unprecedented basis, the Tax Court denied Venture’s

income tax deduction it took in 1988, the year of transfer, because

employees did not report the receipt of income nor was it

reported on the employees’ Form W-2. This ruling was upheld by

the Sixth Circuit:

Per Curiam. Petitioner-Appellant Venture Funding challenges

the determination of the United States Tax Court that the

Commissioner of Internal Revenue correctly found that under

26 U.S.C. § 83 Venture Funding was not entitled to a deduction

for the-business expense of compensation for personal services.

Venture Funding had claimed such a deduction equal to the

value of stock it had transferred to employees, even though

Venture Funding made no withholding of payroll taxes, did not

include the amounts in the employees’ W-2 or 1099 forms and

the employees did not declare the amounts as income in 1988.

(Opinion at 1) (Emphasis added)

Not only does this ruling conflict with all existing precedent

from the United States Circuit Courts and Court of Appeals it has

created an open ended “loophole” enabling an employer and/or

employee to manipulate the taxation of such transfers in direct

contravention of the statute that was specifically designed to

prevent any such manipulation whatsoever and recognize the tax

attributes in the year of transfer. If the decision of the Sixth

Circuit was upheld it would create an irreconcilable contradiction

between its ruling and the clear mandate of the statute and every

single case ever decided up to this date. It is clear under the

statute and all existing case law that the legally enforceable tax

consequences of the transfer occurred in 1988 and as a matter of

law the deduction was properly taken in that year. The Sixth

Circuit's ruling is totally at odds with the existing law and is an

inaccordant aberration that will totally undermine the intent of

the statute to prevent the manipulation of the time frame when

the tax event arises. Based upon the Sixth Circuit's ruling, an

employer and/or employee may now circumvent the law by

manipulating the lawful tax consequences by choosing not to

reveal the transfer or reporting it in any year desired thereby

thwarting the legal obligation to recognize the tax consequences

in the year of transfer. There has NEVER been a recorded case

where the failure of an employee to report income caused an

innocent, unrelated party to lose its lawful compensation

deduction. If the Sixth Circuit's ruling is upheld it will create the

unintended, unworkable, and preposterous obligation for an

employer to monitor/audit its employees personal income tax

returns to determine if they were filed correctly before it can take

a legitimate deduction. This is clearly not the law.

This case is on appeal from the United States Court of Appeals

for the Sixth Circuit, which affirmed a decision of the United

States Tax Court. The Sixth Circuit did not elaborate on the legal

basis for its opinion. The opinion of the Tax Court was sharply

divided, with nine judges for the Majority and eight judges

Dissenting in favor of Petitioner Venture Funding. The case

involved a company by the name of Venture Funding, Ltd., that

distributed stock to its employees as compensation. This particular

stock is known as “lettered stock” pursuant to Rule 144 of the

Securities & Exchange Commission. The recipients of the stock

were precluded from transferring the stock for two years from the

date of receipt. On the face of the stock certificates was the term

“Restricted”. The transfer took place in April of 1988 and Venture

Funding took an income tax deduction on its 1988 income tax

return for the transfer of stock to its employees. The Internal

Revenue Service audited Venture’s 1988 corporate income tax

return and denied the deduction in its entirety.

The taxation of property transfers between employers and

employees is governed by I.R.C. §83. The general rule prescribed

by Code §83 mandates that such transfers are immediately

deductible by the employer and taxable to the employee at the

time of transfer. There is an exception to the general rule that if

the property transfer “bore a substantial risk of forfeiture” then

the transfer would not be deductible or taxable until that restriction

lapsed. The issue of whether or not lettered stock is such a

transfer that would delay the timing of the deduction and

recognition of income has been previously litigated and uniformly

held that the employer is entitled to deduct the fair market value

of the lettered stock in the year of transfer, and correspondingly,

the employee must report as income the fair market value of the

transfer included in income in the year the lettered stock is

received.

In the Venture Funding case, the Internal Revenue Service

denied Venture Funding’s income tax deduction in the year of

transfer, 1988, for the reason that Venture Funding did not report

the transfer of lettered stock on a Form W-2 or Form 1099,

although the transfer was reported on the corporate tax return,

Form 1120, and in addition because the employees did not report

the income on their individual 1988 income tax returns. Never

before in any reported decision has the timing of the recognition

of the deduction and income been at any other point in time

other than when the property is transferred. Never before has the

timing of the recognition of income and deduction been governed

by the reporting of the employee. All other Federal Circuits and

Tax Court decisions have held the tax consequences occur upon

transfer.

This point was addressed in the Tax Court's Dissenting Opinion

because it realized that the Majority opinion created an unintended

loophole permitting an employee to avoid the recognition of

income and in turn unintentionally punishing the employer for an

employee's failure to report the receipt of income in the proper

year. The Dissenting opinion also recognized that a treasury

regulation did set forth a procedure for reporting property

transfers on a Form W-2 or 1099, but that the procedure was

merely a “safe harbor provision” designed to establish the value of

the property transferred both to the employer and the employee

and was not a mandatory prerequisite to the taking of an income

tax deduction. This safe harbor does not affect the timing of the

reporting. The time for recognition is still upon transfer. The W-2

provisions only affects the valuation of the transfer and not the

timing of when the transfer is recognized.

The Majority opinion ignored all existing case law of the other

circuits and Tax Court decisions that have uniformly held that

such transfers were immediately deductible upon transfer. The

Majority erroneously ruled that the Treas. Reg. §1.83(a)(6)(2),

entitled “Special Rule”, created a mandatory requirement that an

employer could not take an income tax deduction for property

transfers to employees unless:it issued a Form W-2 or 1099 to the

employee. This interpretation creates an impermissible conflict

between the “general” provision of I.R.C. §83 and Treas. Reg.

§1.83(a)(6)(2), the “General Rule”. The Majority’s opinion was

affirmed by the United States Court of Appeals for the Sixth

Circuit.

The issue becomes whether the procedure identified in Treas.

Reg. §1.83(a)(6)(2) is a mandatory prerequisite or merely a safe

harbor provision. All seventeen Tax Court judges agreed that as a

matter of law the transaction should have been deducted by

Venture in 1988 and reported by the employees in 1988. The

difference arises over the effect of whether the employee reported

the income in the same year. Nine judges held that the employer's

deduction was contingent upon the employees reporting the

receipt of income in 1988, and eight judges held that Venture’s

deduction was not contingent upon a failure of an employee to

properly report.

The Dissent also noted that the purpose for reporting the

transfer on a Form W-2 in the regulation in question entitled

“Special Rule”, was designed to create a safe harbor as to the

value of the transfer only. Often times an employer and employee

report the property transfer in the same year but at different

values. The “Special Rule” for reporting the transfer on a W-2 was

solely designed to eliminate valuation issues by bringing the

amount of the value in harmony for both the employer and

employee by reporting the value on a W-2. The Majority views

this option as a mandatory reporting requirement necessary as a

prerequisite to taking the compensation deduction. This

exponential extrapolation is not supported by any authority in the

statute, regulations, case law or committee notes. No where is it

found that the transfer would not be immediately deductible nor

would it be included in income without the filing of a W-2.

Venture maintains that this regulation provides a “Safe Harbor”

procedure to follow which is not a mandatory prerequisite to the

taking of a compensation deduction. Rather, the “Safe Harbor” is

optional and not mandatory.

Venture further points out that the “Safe Harbor” analysis

eliminates any conflict between the Code sections, the Regulations

and existing case law that is created by the expansive interpretation

offered by the Majority opinion. On this issue this is a case of first

impression and never before has a court ruled that the “Safe

Harbor” procedure is a prerequisite to the taking of a

compensation deduction.

The next issue involves yet another matter of first impression

when the Tax Court ruled that the failure of an employee to

report the receipt of the compensatory stock would in turn

prevent Venture from taking a compensation deduction in the

year the deduction should have been taken and reported by the

employee. Venture properly took the deduction in 1988 and the

amount of the deduction is not in dispute, nor is it in dispute that

the employees were legally obligated to report the income in the

year of receipt, 1988. The Tax Court in essence ruled that a

mistake by an employee in reporting income prevents Venture

from taking a corresponding deduction even though Venture was

legally entitled to the deduction.

The Tax Court did not cite to any authority for the proposition

other than comparing and contrasting the words “include,

includable, includible and included” as determining when Venture

was entitled to the deduction and ignored every existing case to

date that has uniformly held that transfers of stock to employees

is taxable and deductible in the year of transfer. A major point of

contention between the Majority opinion and the Dissent is that

the Majority opinion was greatly influenced by the fact that the

statute of limitations had expired to include the receipt of income

in the employees’ 1988 tax returns. The Internal Revenue Service

failed to timely audit the employees’ returns to properly adjust

the employees’ returns for 1988.

The Dissenting opinion pointed out that the motivation of the

Majority was inspired by a desire to cure a perceived “inequity”

since the statute of limitations to adjust the employee’s return had

expired. Thus, the Dissent revealed the ruminations of the Judges

as they discussed the case. The Dissenting opinion noted that

denying the employer's deduction simply because the statute of

limitations had lapsed against the employees would not only

create a conflict between the Internal Revenue Code and

Regulations, but it would undermine all case law to the contrary

to cure a perceived “inequity.” For this reason, Venture requests

that the Sixth Circuit's decision be reversed and the deduction be

permitted as taken on the tax return in the year the transfer took

place, 1988.

ARGUMENT

I. THE TAX COURT AND SIXTH CIRCUIT

ERRED AS A MATTER OF LAW IN HOLD-

ING THAT THE TRANSFER OF PROPERTY

OF AN EMPLOYER TO AN EMPLOYEE

WAS NOT A TAXABLE TRANSACTION IN

THE YEAR OF TRANSFER IN CONTRA-

VENTION TO THE STATUTE AND ALL

EXISTING PRECEDENT

It is undisputed that the employees of Venture should have

reported the receipt of the lettered stock in 1988, the year of

receipt. It is equally irrefutable that, under the Tax Court's

analysis, both the Majority and Dissenting opinions agreed that

had the employees reported the receipt of income on their tax

returns in 1988, Venture would have been entitled to the

compensation deduction without any adjustment. Thus, the real

issue is whether an employee can control the legal obligation of an

employer to deduct the transfer of lettered stock by a mistaken

failure of the employee to report the receipt in the proper year.

Then by analogy, can the employees’ failure to report the income

they were legally obligated to report cause the employer to be

denied a deduction (that it was admittedly entitled to by the Tax

Court), except for the sole fact that the employees’ reporting was

improper and the employer's reporting was proper.

After a thorough and exhaustive research, not one single case

was uncovered to support this conclusion of the Tax Court.

Rather, the court ignored all precedent holding the transaction

was to be reported in the year of transfer. The Majority embarked

upon an incredibly strained exercise of statutory construction

whereby the meaning of the word “include” was interpreted by

the Majority as modified by a variety of suffixes. This concept shall

be referred to as the “suffix issue”. The Dissent pointed out that

the Majority’s opinion was result oriented rather than based upon

existing precedent. The “equitable” result was achieved by

comparing and contrasting the words included, includible and

includable as used in the statutes and regulation. The Majority

reached its desired result in finding that the employer was denied

a deduction because the employee had not “included” the income

in its 1988 individual income tax return. Therein lies the confusion

between the word “included” and “reported.”

This distinction is imperative to understand to maintain the

harmony between the statutes, regulations and case law. The

Majority opinion constructing substituted the word “reported” as

synonymous with the word “included”. This conflict can be

highlighted and contrasted by applying the law through a series of

rhetorical questions.

First, as a matter of law, was Venture required to deduct the

transfer in 1988? Unequivocally yes.

Second, as a matter of law, was the 1988 transfer taxable

income to the employees in 1988? Unequivocally yes.

Third, as a matter of law, does the employee's failure to

REPORT the transfer in 1988 permit the employee to

include the income in any year other than 1988? NO!

The income is included in 1988 irrespective of whether it is

REPORTED in 1988. Because the transfer was included in the

employee's income in 1988, the employee was required to

“recognize and report” the income attributable to the stock

transfer. An employer is entitled to a corresponding deduction for

income transferred to an employee who was required to recognize

and report of income as a matter of law.

In Judge Ruwe’s Dissent, which was adopted by the Dissenting

Judges, he debated with the Majority the “suffix issue” of -ible,

-able and -ed, but managed to point out that the employees had

no choice but to include the value of the receipt of stock in their

income. Right from the face of I.R.C. §83(a) it states that the

transfer SHALL BE INCLUDED IN THE GROSS INCOME

of Venture’s employees and under I.R.C. §83(h) an employer is

entitled to a deduction in THE AMOUNT INCLUDED

UNDER L.R.C. §83(A).

The clear language of the code is absolute. There are no

disclaimers regarding an employee’s failure to report the income

in the year it SHALL be included under I.R.C. §83.

Judge Ruwe also pointed out that the legislative history of the

employer's deduction was equal to the amount the employee was

REQUIRED TO RECOGNIZE and the employer was entitled

to the deduction when the employee was required to recognize

the income. “The allowable deduction is the amount which the

employee is REQUIRED TO RECOGNIZE as income. The

deduction is to be allowed in the employer's accounting period

which includes the close of the taxable year in which the

employee RECOGNIZES the income. S. Rept. 91-552, supra at

123, 1969-3 C.B. at 502; emphasis added.”

The applicable statutory language is contained in subsections

(a) and (h) of section 83. Subsection (a) provides that the value

of transferred 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 transferable or are not subject

to a substantial risk of forfeiture * ° ° Emphasis added.

Subsection (h) provides:

(h) Deduction by Employer. — In the case of a transfer of

property to which this section applies ° ° ° there shall be

allowed as a deduction under section 162, to the person for

whom were performed the services in connection with

which such property was transferred, an amount equal to

THE AMOUNT INCLUDED UNDER SUBSECTION (a),

(b) or (d)(2) IN THE GROSS INCOME of the person who

performed such services. Such deduction shall be allowed

for the taxable year of such person in which or with which

ends the taxable year in which SUCH AMOUNT IS

INCLUDED IN THE GROSS INCOME of the person

who performed such services. Emphasis added.

The Majority interprets the term “included” as used in section 83

as if it means actually “reported” on each service provider's

income tax return or otherwise used to compute the service

provider's income tax liability. n3 The Majority simply describes

this as the clear, plain, and unambiguous meaning of the statute.

No precedent is cited.

n3 The alternative to reporting as gross income on the

employee's or independent contractor's return would be an

adjustment to gross income in a deficiency determination.

The word “included” is used three times in subsections (a) and (h)

of section 83. Section 83(a) provides that the value of the property

received as compensation for services “shall be included in the

gross income” of the recipient. This means that such property is

required to be included in gross income as a matter of law. n4

n4 In Adair v. Commissioner, T.C. Memo. 1985-392, we

stated:

Section 83(a) provides that property transferred “in

connection with the performance of services” IS included in

the gross income of the transferee in an amount equal to the

—_—

excess of the fair market value over the amount paid for the

property transferred. * * * Fn. ref. omitted; emphasis added.

Section 83(h) provides that “there shall be allowed as a deduction

under section 162 * * ° the amount included under subsection

(a)”; ie., the amount included under subsection (a) as a matter of

law. As explained in the Senate Finance Committee report: “The

allowable deduction is the amount which the employee is

REQUIRED TO RECOGNIZE as income”. S. Rept. 91-552, at

123 (1969), 1969-3 C.B. 423, 502. (Emphasis added.) The next

sentence of section 83(h) provides that the employer’s deduction

“shall be allowed” for the taxable year of the employer that

coincides with the taxable year of the person who performed

services “in which such amount is included in the gross income”

of such person. A natural interpretation of this last phrase, and

the one that is consistent with the previous use of the term

“included”, is that it refers to included in gross income as a matter

of law. The Majority makes no argument that these three instances

wherein the term “included” was used were intended to convey

different meanings of that single word. The Majority, however,

concludes that when Congress used the word “included” it meant

something other than “includible” as a matter of law. I disagree.

Venture Funding v. Commissioner, 110 T.C. No. 19, 34-36 (1998).

Judge Halpern noted in his Dissent these conflicts and

ambiguities created by the Tax Court's decision can only be

resolved if the Court held, as it has in all its past decisions, “that

the year the employer takes the deduction of the transfer is

determined when the transfer is included as income as a matter

of law; not when the employee gets around to it.”

The term ‘gross income’ has the general definition set

forth in section 61(a), and, unless the word ‘included’ is used

in an unusual sense, it is a question of law whether or not

any particular receipt is included or excluded in from gross

income. If context is to govern meaning, then, relying on the

‘plain and common meaning of the text sec. 83(h)’, I

conclude that the meaning of the phrase ‘included in the

gross income of the service provider’ means included as a

matter of law. .

Venture Funding v. Commissioner, 110 T.C. No. 19, 52 (1998).

Eight judges uniformly held that the transfer of stock to

Venture’s employees was, as a matter of law, included in their

income in 1988, and as a result, Venture was entitled to the

deduction as taken on the 1988 return. The Majority never

addressed this issue and ignored the legislative history behind

1.R.C. §83 as well as the clear language of I.R.C. §83(a) that the

transfer “SHALL BE INCLUDED” in the employee's income

and the corresponding deduction; hence, deductible by the

employer..

Il. THE TAX COURT AND THE SIXTH CIRCUIT

COURT OF APPEALS ERRED IN RULING

THAT TREAS. REG. §1.83(A)(6)(2) IMPOSED

A REQUIREMENT THAT AN EMPLOYEE IS

ENTITLED TO COMPENSATION ONLY IF

IT ISSUES A FORM W-2 OR FORM 1099 TO

THE RECIPIENT.

In this case, Venture Funding employees performed services

and in exchange received what is commonly known as “lettered

stock” from Endotronics. Lettered stock is stock issued pursuant

to the Securities and Exchange Act of 1933, §144, whereby it is

“restricted stock” that cannot be transferred for two years and is

not registered with the Securities and Exchange Commission.

This is a common method for compensating employees in “turn

around” reorganization and recapitalization of troubled businesses.

Venture Funding was such a company that was engaged in the

process of rebuilding Endotronics.

Issuing lettered stock to employees as compensation for services

serves as an incentive for employees committed to salvaging a

financially distressed company. If the employees are successful

their efforts will then increase the value of the stock they

received. This is also beneficial to the troubled company because

it can compensate the new employees without having any impact

on the cash flow of the business. Thus, the employees have the

potential of reaping windfall benefits, while the company

reorganizes without any cash flow burdens attributable to payroll.

Although the employees may have believed that they should

not have included the receipt of stock in their income because it

was “restricted” and bore a substantial risk of forfeiture as defined

by I.R.C §83(b), this mistake or failure is of no consequence to

Venture Funding because the transfer of “lettered stock” is

immediately taxable upon transfer. A review of applicable case law

reveals that the employees did not properly include the receipt of

stock in their income in 1988 but Venture properly deducted the

transfer of the stock in 1988, the year in question.

Under current case law, SEC restrictions towards the transfer-

ability of stock are not to be considered a substantial risk of

forfeiture under I.R.C §83(b) and, in fact, are immediately taxable

upon receipt by the employees and deductible by the employer.

Pledger v. Commissioner, 641 F.2d 287 (5th Cir.), Robinson v.

Commissioner, T.C. Memo 1985-275 (1985) (Robinson _ III),

Cassetta v. Commissioner, T.C. Memo 1979-284 (1979).

In fact, in the only reported case where an employer failed to

include a transfer of property in the employee's income, the Tax

Court ruled that the proper remedy was not to deny the employer

the deduction, but rather, the Tax Court ruled that both the

employer and employee were to match the recognition of income

and corresponding deduction in the year the employee should

have included the property transfer in income. Robinson_v.

Commissioner, 82 T.C. 444 (1984) (Robinson I), Robinson _v.

Commissioner, 82 T.C. 467 (1984) (Robinson II).

The Robinson cases involved many issues regarding the

valuation and taxation of property transfers. However, one point

was made abundantly clear regarding the timing of the employer

deduction and the employee’s inclusion of income. Robinson |

involved a taxpayer who failed to include into income the exercise

of an option for lettered stock. In that case, the individual

taxpayer (Robinson) exercised an option to acquire lettered stock

on March 4,.1974 from Centronics (Robinson’s employer,

transferor of the property and co-Appellant). Robinson I, 82 T.C.

at pg. 451.

Robinson I was factually identical to this case. In Robinson I

the employee received a transfer of property for services in 1974.

Similarly, the employee did not report the transaction as taxable

income on his 1974 U.S. 1040. The case involved the exercise of

an option to acquire lettered stock at a below-market bargain

price. In the year of transfer, Mr. Robinson failed to include into

income for the tax year 1974 the excess of the fair market value

over the purchase price of the lettered stock he received upon the

exercise of the option. Robinson’s employer, Centronics, did not

take a deduction for that year but took the deduction in a

subsequent year, 1975. The Court then addressed the issue of the

timing of the recognition of income and the corresponding

deduction on the transfer of the lettered stock.

In that case, timing of the compensation deduction for the

employer did not rest upon the employee's failure to include the

transfer in income in 1974; rather, the timing of the recognition of

income and corresponding deduction was established by the date

the lettered stock was transferred and not by the year the

employee chose to recognize income. In essence, the Court ruled

that the timing and recognition of the compensation deduction

was established when the taxable event took place; not when the

employee chose to recognize income.

The Court ruled that Robinson’s failure to include the transfer

into income in 1974 was incorrect and held that both the

corporation and Robinson were to report the income and

corresponding deduction in 1974:

For the foregoing reasons, we hold that Appellants

Robinson MUST INCLUDE IN INCOME FOR

THEIR 1974 CALENDAR YEAR the difference

between the value of the Option Stock on March, 4, 1974

and the price paid for it. As stipulated by Centronics and

respondent CENTRONICS IS ENTITLED TO A

DEDUCTION IN ITS TAXABLE YEAR ENDED

JUNE, 30 1974, in the amount ultimately determined to

be includable in gross income by the Robinsons.

Robinson I, 82 T.C. at 466 (Emphasis added).

From this opinion, it is abundantly clear that the recognition of

income and corresponding deduction is not determined by the

year the employee improperly reported the income on the

employee's return; but rather, the recognition of income and

deduction is determined by when the employee should have

reported the property in income because it was included in 1974

as a matter of law. It has been uniformly held that the transfer of

lettered stock is immediately deductible upon transfer and that it

should be reported as income by the employee. Accord, Pledger

and Cassetta supra. There is no authority to the contrary that

Venture’s employees should have reported income for the year

of transfer, 1988, because it was, as a matter of law, included in

their 1988 income or that Venture properly deducted the transfer

in 1988.

This result can be gleaned from the plain language of the code

which requires the immediate recognition of income for transfers

of property for services that are not subject to substantial forfeiture:

I.R.C. §83 (a) and (h) state in pertinent part:

§ 83. Property 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,

(h) Deduction by employer. In the case of a transfer of

property to which this section applies or a cancellation of a

restriction described in subsection (d), there shall be allowed as

a deduction under section 162, to the person for whom were

preformed the services in connection with which such property

was transferred, an amount equal to the amount included

under subsection (a), (b), or (d)(2) in the gross income of the

person who performed such services. Such deduction shall be

allowed for the taxable year of such person in which or with

which ends the taxable year in which such amount is included

in the gross income of the person who performed such services.

Thus, the employees’ mistake or failure to include the taxable

income on their 1988 tax returns is of no consequence to

Venture’s compensation deduction. An employer is entitled to

deduct transfers of property to a service provider when income to

the service provider should be recognized. Rotolo v. Commissioner,

88 T.C. No. 85 (1987), Halligan, et al v. Commissioner, T.C.

Memo 1986-243 (1986).

It is obvious that under existing case law and the plain language

of I.R.C. §83 that as a matter of law, the income from the transfer

of Endotronics stock was included in the employee's income,

albeit not reported, in 1988, and Venture was entitled to the

deduction on its 1988 return.

The Majority never addressed the issue regarding when the

income was recognized as a matter of law. However, all eight

Dissenting judges who addressed this issue all agreed as a matter

of law that the recognition of income and Venture’s corresponding

deduction took place in 1988.

ONY TIAN. peo o0 me pte

Ill. THE TAX COURT AND THE SIXTH

CIRCUIT COURT OF APPEALS ERRED IN

- RULING THAT AN EMPLOYER CANNOT

TAKE THE DEDUCTION UNDER THE

ACCRUAL METHOD OF ACCOUNTING |

PURSUANT TO TREAS. REG. §1.83(a)(6)(3). |

_——

Further, even if the employees did recognize income for the :

property transfer in a year other than 1988, the Regulations

provide that because Venture utilized the accrual method of

accounting, Venture is entitled to the deduction under Treas. Reg.

§1.83(a)(6)(3) in accordance with the accrual method of

accounting:

(3) Exceptions. Where property is substantially vested upon

transfer, the deduction shall be allowed to such person in

accordance with his method of accounting (in conformity

een

with sections 446 and 461). In the case of a transfer to on

employee benefit plan described in §1.162-10(a) or a transfer

to an employees’ trust or annuity plan described in section

404(a)(5) and the regulations thereunder, section 83(h) and

this section do not apply. (Emphasis added)

Not only is it very clear from existing case law that the receipt

of lettered stock is “substantially vested” to the recipient and

deductible by the employer, but it is equally clear that an accrual

basis taxpayer can accrue and deduct Section 83 property transfers

under the accrual method of accounting. Schmidt v. Commissioner,

107 T.C. 271 (1996), Chalmette General Hospital v. United

States, 90-2 U.S. Tax Cas. (CCH 1990). Both of these decisions

stand for the proposition that an accrual basis taxpayer can deduct

property transfers, that are taxable pursuant to I.R.C. §83, in a

year different than the year it is recognized by the recipient of the

property.

Internal Revenue Service's construction and interpretation of

the safe harbor special rule, Treas. Reg. §1.83(a)(6)(2), is in

conflict with the general provisions of Treas. Reg. §1.83(a)(6)(1)

and the Code section itself, I.R.C. §83, and would in essence

preclude the recognition of income for all property transfers that

are not included on a Form W-2 by both the employer and

employee in the same year. This was clearly not the intent of the

regulation and this overreaching construction of the regulation

proposed by Internal Revenue Service, is an anomalous extension

of statutory interpretation rendering the recognition of income on

all taxable property transfers contingent upon the issuance of a

Form W-2 or Form 1099. Treas. Reg. §1.83(a)(6)(3) is designed to

permit a deduction when the year of deduction and recognition

do not match. Internal Revenue Service's construction of Treas

Reg. §1.83(a)(6)(2) infers that the timing of the deduction and

recognition of income must match the same year as the recipient

even for accrual basis taxpayers. This interpretation would render

Treas. Reg. §1.83(a)(6)(3) a nullity.

Additionally, Internal Revenue Service's interpretation conflicts

with Treas. Reg. §1.83(a)(6)(3) clear and express language which

permits an “employer to deduct the transfer of property in

exchange for services in a different year than the employee

includes the transfer in income in accordance with this method of

accounting.” Venture Funding, Ltd. is an accrual basis taxpayer

and is certainly entitled to take the deduction in the year of

transfer under the accrual method of accounting pursuant to

Treas. Reg. §1.83(a)(6)(3). Internal Revenue Service's

interpretation of the application of §1.83(a)(6)(2) would obviate

the exception provided by Treas. Reg. §1.83(a)(6)(3) because it

would never permit an accrual basis taxpayer to deduct a property

transfer under the accrual method.

IV. THE SIXTH CIRCUIT COURT OF APPEALS

CREATED AN IMPERMISSIBLE CONFLICT

BETWEEN THE FEDERAL CIRCUITS IN

RULING THAT THE TRANSFER OF LETTER-

ED STOCK IS NOT IMMEDIATELY DEDUC-

TIBLE TO AN EMPLOYER UPON TRANS-

FER TO AN EMPLOYEE IF AN EMPLOYEE

DOES NOT REPORT THE RECEIPT OF

THE TRANSFER IN THE SAME YEAR.

As previously noted in this petition, when an employer and an

employee did not report the transfer of stock in the same year, the

Tax Court's remedy was to match the timing of the employer

deduction and the employee's inclusion of income in the year the

transaction should have been reported. Robinson v. Commissioner,

82 T.C. 444 (1984) (Robinson I), Robinson v. Commissioner, 82

T.C. 476 (1984) (Robinson II) If the Sixth Circuit's ruling in this

case is followed it will completely invalidate the Robinson decisions

and the clear mandates of I.R.C. 83, that specifically require that

the tax attributes of the transfer be included in the year of

transfer as well as reported in the same year.

It is quite clear from the Robinson decisions that the failure of

an employee to report the receipt of the transfer did not affect the

employer's deduction whatsoever. Although Treas. Reg. §1.83(a)(6)

has been in existence for many years, and at the time of the

Robinson decision, this is nevertheless a case of first impression in

applying the regulation in the method suggested by Internal

Revenue Service as a basis for the denial of Petitioner's

compensation deduction. Internal Revenue Service interprets

Treas. Reg. §1.83(a)(6)(2) as prohibiting an employer from taking

the compensation deduction for the transfer of property to its

employees if the employer does not report the transfer on a W-2

or 1099.

Internal Revenue Service reaches this conclusion by interpreting

Treas. Reg. §1.83(a)(6)(2) as requiring an employer to include the

value of property transfers on a Form W-2 or Form 1099 as a

prerequisite for the employer to take an income tax deduction

and also for an employee to include the transfer in income.

Internal Revenue Service labels this concept the “deemed inclusion

rule.” The more accurate title would be the “deemed fair market

value rule” equally valuing both the employee's income and

employer's deduction. The “deemed inclusion” analysis actually

creates a loophole for permitting an employer to transfer property

to an employee tax free by simply omitting the transfer from the

employee's W-2. This result directly conflicts with the whole

intent of Code Section 83 to tax transfers of property in exchange

for services by creating a “mechanism of manipulation” to thwart

I.R.C. §83’s requirement of recognition upon transfer.

For example, under Internal Revenue Service's analysis, an

employer could give an employee a new car as compensation for

services, not report it on the employee's W-2, and thereby transfer

the car tax-free to the employee and forfeit the deduction for the

car on the employer's tax return. Obviously, this interpretation of

Treas. Reg. §1.83(a)(6)(2) directly conflicts with the intention of

Section 83 to make such property transfers taxable to the employee

and deductible by the employer pursuant to I.R.C. §83(a) and (h).

The proper way to interpret Treas. Reg. §1.83(a)(6)(2) is to

note that the rule is essentially a “Safe Harbor Rule.” It is

important to note that this section is entitled “Special Rule”

whereby this regulation provides a safe harbor for including the

fair market value of the compensation and corresponding

deduction if all requirements of I.R.C. §6041 are complied with;

namely, including the value of the property transferred on the

service provider's W-2 or Form 1099.

This Treasury Regulation provides a safe harbor mechanism for

establishing the timing of the amount recognition of income, and

the corresponding deduction. It does not, however, go so far as to

suggest there is no recognition of income and no deduction for

the transfer of property if it is not included on a W-2 as the

Internal Revenue Service contends in this case. This interpretation

would nullify all existing precedent and I.R.C. §83 which imposes

recognition without regard to reporting the transfer on a W-2.

This interpretation, as Internal Revenue Service suggests,

would totally undermine the application of Section 83 and

undermine the long and distinct theories of taxation regarding

transfers of property. After exhaustive research, Appellant was

unable to find any case law to support this interpretation. Indeed,

all case law is to the contrary. This suggested extension of the

“Special Rule” of Treas. Reg. §1.83-6(a)(2) would create an

impermissible conflict between Treas. Reg. §1.83-6(a)(1) and (3)

rendering these sections a nullity if a W-2 is not filed.

§1.83-6 Deduction by employer

(a) Allowance of deduction — (1) General Rule. In

the case of a transfer of property in connection with the

performance of services, or a compensatory cancellation

of a rps restriction described in section 83(d) and

§1.83-5, a deduction is allowable under section 162 or 212

to the person for whom the services were performed. The

amount of the deduction is equal to the amount included

as compensation in the gross income of the service

provider under section 83(a), (b), or (d) (2), but only to

the extent the amount meets the requirements of section

162 or 212 and the regulations thereunder. The deduction

is allowed only for the taxable year of that person in which

or with which ends the taxable year of the service provider

- in which the amount is included as compensation. For

purposes of this paragraph, any amount excluded from

gross income under section 79 or section 1O1(b) or

subchapter N is considered to have been included in gross

income.

(2) Special Rule. For purposes of paragraph (a) (1) of this

section, the service provider is deemed to have included the

amount as compensation in gross income if the person for whom

the services were performed satisfies in a timely manner all

requirements of section 6041 or section 6041(A), and the

regulations thereunder, is determined without regard to

§1.6041-3(c) (exception for payments to corporations). In the case

of a disqualifying disposition of stock described in section 421 (b),

an employer that otherwise satisfies all requirements of section

6041 and the regulations thereunder will be considered to have

done so timely for purposes of this paragraph (a) (2) if Form W-2

or Form W-2c, as appropriate, is furnished to the employee or

former employee, and is filed with the federal government, on or

before the date on which the employer files the tax return

claiming the deduction relating to the disqualifying disposition.

V. WHEN THE APPLICATION OF THE TREAS-

URY REGULATION CONFLICTS WITH

OTHER SECTIONS OF THE CODE AND

REGULATIONS IT IS INVALID

The Commissioner has broad authority to promulgate all

needful regulations. United States v. Correll, 389 U.S. 299,

306-307 (1967). Treasury regulations “must be sustained unless

unreasonable and plainly inconsistent with the revenue statutes.”

Commissioner v. South Texas Lumber Co., 333 U.S. 496, 501

(1948). Regulations, as constructions of the Code by those charged

with its administration, “should not be overruled except for

weighty reasons.” Bingler v. Johnson, 394 U.S. 741, 750 (1969):

Commissioner v. South Texas Lumber Co., supra at 501.

Although regulations are entitled to considerable weight,

“appellee may not usurp the authority of Congress by adding

restrictions to a statute which are not there.” Estate of Boeshore

v. Commissioner, 78 T.C. 656 (1981), affd. 692 F. 2d 128 (D.C.

Cir. 1982). A regulation is not a reasonable statutory interpretation

unless it harmonizes with the plain language, origin, and purpose

of the statute. United States v. Vogel Fertilizer Co., 455 U.S. 16

(1982); Durbin Paper Stock Co. v. Commissioner, 80 T.C. 252,

257 (1983). Where that statute’s provisions are unambiguous, and

its directive specific, the Commissioner has no power to amend it

by regulation. Koshland v. Helvering, 298 U.S. 441, 447 (1936);

Arrow Fastener Co. v. Commissioner, 76 T.C. 423 (1981).

Clearly, Internal Revenue Service's interpretation that Treas.

Reg. §1.83(a)(6)(2) requires the issuance of a W-2 creates an

invalid conflict between the Code and_ regulation. Such

extrapolation extends the application of the safe harbor mechanism

beyond its logical scope. As this is the only logical interpretation

of the regulation that would not invalidate the Code and related

regulations, when a Treasury Regulation is in conflict with the

statutory construction of the Internal Revenue Code, it is invalid

in its application. Weingarden_v. Commissioner, 825 F.2d 1027

(6th Cir. 1987).

CONCLUSION

Based upon the foregoing analysis, Petitioner respectfully

requests that this Honorable Court grant the Petition for Writ of

Certioran.

Respectfully submitted,

Robert J. Zinkel, Jr.

Zinkel & Associates, P.C.

Attorney for Petitioner

NOT RECOMMENDED FOR FULL-TEXT PUBLICATION

No. 98-1719

UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

Venture Funding, Ltd., FILED

NOV 9 1999

Petitioner — Appellant, LEONARD GREEN, Clerk

ON APPEAL FROM THE UNITED

STATES TAX COURT

NOT RECOMMENDED FOR FULL-TEXT

PUBLICATION

Commissioner of Internal

Revenue,

Sixth Circuit Rule 28(g) limits citation to specific

d i situations. Please see Rule 28(g) before citing in a

Respondent — Appellee. proceeding in a court in the Sixth Circuit. If cited,

a copy must be served on other parties and the

Court.

This notice is to be prominently displayed if this

decision is reproduced.

BEFORE: KRUPANSKY, NORRIS, Circuit Judges, and GWIN, District

Judge.°

Per Curiam. Petitioner-Appellant Venture Funding challenges the

determination of the United States Tax Court that the Commissioner of

Internal Revenue correctly found that under 26 U.S.C. § 83 Venture Funding

was not entitled to a deduction for the business expense of compensation for

rsonal services. Venture Funding had claimed such a deduction equal to the

value of stock it had transferred to employees, even though Venture Funding

made no withholding of payroll taxes, did not include the amounts in the

employees’ W-2 or 1099 forms and the employees did not declare the amounts

as income in 1988.

Venture Funding v. Commissioner, No. 98-1719

Venture Funding claims alternatively that either the value of the stock was

included in the gross income of their employees as a matter of law, thus

* The Honorable James S. Gwin, United States District Court for the Northern District of

Ohio, sitting by designation.

entitling it to the deduction in question; that the Commissioner's regulations

implementing 26 U.S.C. § 83 are invalid; or that the regulations actually do

allow it to make the deduction.

The panel, having reviewed the extensive opinions of the tax court, read the

briefs and considered the arguments of the parties, agrees with the opinion

propounded by Judge Laro of the Tax Court.

Therefore, the decision of the Tax Court is AFFIRMED.

110 T.-C. NO. 19

UNITED STATES TAX COURT

VENTURE FUNDING, LTD., PETITIONER V.

COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 4174-95. Filed March 26, 1998.

P transferred stock_to its employees as compensation for services, and it

claimed a deduction in the year of transfer for the value of the stock. None of

P’s employees included the value of the transferred stock in his or her gross

income for the year of transfer.

Held: Sec. 83(h), 1.R.C., does not allow P to deduct the reported amount in

the year of transfer.

Joseph Falcone, Brian H. Rolfe, and Robert J. Zinkel, [r., for petitioner.

Mark IL. Siegel, for respondent.

SERVED MAR 26 199

~ OPINION

LARO, Judge: This case was submitted to the Court fully stipulated. See

Rule 122. Petitioner petitioned the Court to redetermine respondent's

determination of deficiencies of $347,583 and $27,578 in its 1988 and 1989

Federal income taxes. We must decide whether section 83 (h) prevents

petitioner from currently deducting the value of stock that it transferred to its

employees in 1988 as compensation for services. We hold it does.! Unless

otherwise indicated, section references are to the Internal Revenue Code in

effect for the subject years. Rule references are to the Tax Court Rules of

Practice and Procedure.

Background

All facts have been stipulated. The stipulations of fact and the exhibits

submitted therewith are incorporated herein by this reference. Petitioner is an

accrual method corporation whose principal place of business was in Detroit,

Michigan, when it petitioned the Court. It was owned as follows during the

subject years:

Shareholder Ownership Percentage

Eugene Schuster 49.45

Monis Schuster 9.99

Adam Schuster 9.99

Joseph Schuster 9.99

Sarah Schuster 9.99

Jayson Pankin 9.99

Ann Schuster 50

London Arts 10

Total 100.00

All the Schusters are related, and London Arts is a corporation whose stock

is owned by Eugene Schuster.

On March 27, 1987, Endotronics, Inc. (Endotronics), filed a petition for

reorganization in the U.S. Bankruptcy Court for the District of Minnesota. On

April 4, 1988, the court confirmed an amended plan of reorganization under

' The deficiency for 1989 results entirely from respondent's determination that a research

and development credit that petitioner claimed for 1989, as a carryover from 1988, was usable

in full in 1988. We sustain respondent's determination for 1989 as a result of our holding on the

deduction issue.

which petitioner gained a controlling interest in Endotronics. Later that day,

petitioner transferred Endotronics stock to 12 of its employees as compensation

for services. The following chart lists the employees who received Endotronics

stock and the fair market value of the stock that they each received:

Employee Fair Market Value

Eugene Schuster $ 390,625.00

Monis Schuster 56,250.00

Mary Parkhill 58,593.75

Bert Williams 78,125.00

David Dawson 78,125.00

Ira Snider 66,953.13

Christopher Dean 11,718.75

Jayson Pankin 156,250.00

Werner Wahl 7,812.50

W. Kent Clarke 7,812.50

Carolyn Mazurkiewicz 7,812.50

Mary Lore 98,593.75

Total 1,078,671.88

Petitioner did not issue to any of these employees, or to respondent, a Form

W-2, Wage and Tax Statement, or a Form 1099-MISC, Miscellaneous Income,

‘and none of these employees included any of this compensation in his or her

1988 gross income. Petitioner claimed a $1,078,672 deduction for the transfer

on its 1988 Federal income tax return. Petitioner filed its 1988 return based on

the calendar year.

Discussion

Respondent determined that petitioner could not deduct the claimed

amount because it failed to meet the requirements of section 83.” Petitioner

| must prove this determination wrong. Rule 142(a); Welch v. Helvering, 290

U.S. 111, 115 (1933). Petitioner also must prove its entitlement to the

deduction. Deductions are a matter of legislative grace. New Colonial Ice Co.

v. Helvering, 292 U.S. 435, 440 (1934).

Petitioner argues that section 83 (h) and the underlying regulations let it |

deduct the claimed amount in 1988 because petitioner's employees were

* Respondent determined alternatively that petitioner realized a $1,078,672 capital gain on

its distribution of the stock. Because we agree with respondent's primary position, we do not

address the alternative determination.

required to recognize the corresponding income in that year. The fact that the

employees failed to recognize this income in 1988, petitioner argues, has no

bearing on its right to this deduction. Petitioner argues that respondent's

regulations are invalid to the extent that they require an employer to issue an

employee a Form W-2 or Form 1099 as a prerequisite to a deduction under

section 83(h). Petitioner alleges that the income from the transfer of the

Endotronics stock was includable in petitioner's employees’ incomes for the

year of transfer, which is the statutory requirement for a deduction under

section 83(h), and respondent's regulatory requirement that, petitioner also

issue Forms W-2 to its employees to deduct the compensation under section 83

(h) impermissibly adds restrictions to a statute which are not there. Petitioner,

relying mainly on section 1.83-6(a)(3), Income Tax Regs., argues that it may

deduct the claimed amount in 1988 because that amount is deductible in 1988

under petitioner's accrual method.

We disagree with petitioner that it may deduct the claimed amount in 1988.

We start our analysis with the statutory text, construing the language as written

by the legislators with reference to the legislative history primarily to learn the

purpose of the statute and to resolve any ambiguity in the words used in the

text. Trans City Life Ins. Co. v. Commissioner, 106 T.C. 274, 299 (1996).

Section 83, which was added to the Code as section 321(a) of the Tax Reform

Act of 1969, Pub. L. 91-172, 83 Stat. 588, reads in relevant part:

SEC. 83. 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

beneficial interest in such property are transferable or are not subject to a

substantial risk of forfeiture, whichever is applicable.

(h) Deduction by Employer. — In the case of a transfer of property to which

this section applies ° ° °, there shall be allowed as a deduction under section

162, to the person for whom were performed the services in connection with

which such property was transferred, an amount equal to the amount included

under subsection (a) ° ° ° in the gross income of the person who performed

such services. Such deduction shall be allowed for the taxable year of such

person in which or with which ends the taxable year in which such amount is

included in the gross income of the person who performed such services.

The legislative history to section 83 reveals that it was enacted primarily to set

forth rules on the tax treatment of deferred compensation arrangements known

as restricted stock plans; i.e., arrangements under which employers transfer

stock to their employees as compensation for services, where the stock is

subject to restrictions which affect its value. S. Rept. 91-552, at 253, 256-263

(1969), 1969-3 C.B. 423, 500-503. Section 83 was not meant, however, to reach

only restricted stock. The legislators drafted section 83 broadly to reach any

transaction in which “a person ° ° ° receives a beneficial interest in property,

such as stock, by reason of his [or her] performance of services”, id. at 256,

1969-3 C.B. at 501, and, as this Court has observed previously, “Absent specific

provision that a particular transfer [of property to a person in connection with

the performance of services] is excepted from section 83, this section is

applicable”, Alves v. Commissioner, 79 T.C. 864, 876 (1982), affd. 734 F.2d 478

(9th Cir. 1984). Once applicable, section 83 rests an employer's deduction on

its employee's inclusion in income of a corresponding amount. As stated by the

Senate Finance Committee in its report: “The allowable deduction is the

amount which the employee is required to recognize as income. The deduction

is to be allowed in the employer's accounting period which includes the close

of the taxable year in which the employee recognizes the income”. S. Rept.

91-552, supra at 262, 1969-3 C.B. at 502.

From the text of section 83, we understand that it applies to the case at hand

because “in connection with the performance of services, property [was]

transferred to [a] person other than the person for whom such services [were]

performed”. See also sec. 1.83-1(a)(1), Income Tax Regs. (“Section 83 provides

rules for the taxation of property transferred to an employee ° ° ° in connection

with the performance of services by such employee”). See generally sec.

1.61-2(d)(6), Income Tax Regs. (rules of section 1.61-2(d), Income Tax Regs.,

relating to compensation paid other than in cash, apply to transfers of property

“to the extent such rules are not inconsistent with section 83”). We also

understand that petitioner may deduct the value of the transferred property

when the corresponding value is “included in the gross income of the [persons]

who performed such services.” Because none of petitioner's employees included

the corresponding amount in his or her 1988 income, it follows that petitioner

may not deduct any of the claimed amount in that year. Whereas petitioner

would have us read section 83 (h) to allow it a deduction in 1988 for the

amount of income that was includable in its employees’ income for 1988, we

decline to do so. An amount is deductible under section 83(h) in the year that

the corresponding income is “included” in the recipient employee's income,

which means to us that the amount is taken into account in determining the tax

liability of the employee for that year. See S. Rept. 91-552, supra at 262, 1969-3

C.B. at 502 (“The deduction [under section 83(h)] is to be allowed in the

employer's accounting period which includes the close of the taxable year in

which the employee recognizes the income”); see also Lenz v. Commissioner,

101 T.C. 260, 265 (1993) (“‘Allowable deduction’ generally refers to a deduction

which qualifies under a specific Code provision whereas ‘allowed deduction’,

on the other hand, refers to a deduction granted by the Internal Revenue

Service which is actually taken on a return and will result in a reduction of the

taxpayer's income tax”). See generally Bittker & McMahon, Federal Income

Taxation of Individuals, par. 28.2, at 28-2 (2d ed. 1995) (the word “recognized”

means “taken into account in computing taxable income”).®

3 We also note that the drafters of section 83 knew the difference between the suffixes

“able” and “-ible”, on the one hand, and “-ed” on the other. Section 83 includes both

“transferable” and “transferred” in many places, and it is clear that those words are not

interchangeable. Moreover, sec. 83 was added to the Code by sec. 321 (a) of the Tax Reform Act

of 1969 (the Act), Pub. L. 91-172, 83 Stat. 588, and sec. 321(b)(3) of the Act, 83 Stat. 591, which

provides similar but not identical rules for nonexempt trusts and nonqualified annuities,

amended sec. 404(a)(5) to provide for deductibility “in the taxable year in which an amount

attributable to the contribution is includible in the gross income”. (Emphasis added.) When we

find, as we do here, that different words are used in the same section of the same act, we do not

impute to Congress the intent to express the same meaning through the different words. See

United States v. Olympic Radio & Television, 349 U.S. 232 (1955); Estate of Cuddihy v.

Commissioner, 32 T.C. 1171, 1176 (1959); Root Glass Co. v. Commissioner, 1 T.C. 475, 477

(1943). “[L]egal documents are for the most part nonemotive, [and] it is presumed that the

author's language has been used, not for its artistic or emotional effect, but for its ability to

convey ideas. Accordingly, it is presumed that the author has not varied his terminology unless

Neither party references the legislative history of section 83(h), and we do

not resort to it to alter the plain meaning of the words used in the statute. A

statute speaks for itself, and its legislative history is sought to embellish the text

only when the meaning of the words therein are “inescapably ambiguous”.

Garcia v. United States, 469 U.S. 70, 76 n.3 (1984); see also Ex parte Collett,

337 U.S. 55 (1949). When read in view of the legislative intent for section 83,

the text of section 83 (h) is unambiguous. As stated in section 83(h), an

employer who transfers property to an employee as compensation for services

rendered to it may generally deduct “an amount equal to the amount included

° ¢ ° in the gross income of the person who performed such services ° ° ° {and

the] deduction shall be allowed for the taxable year of * ° * [the employer] in

which or with which ends the taxable year in which such amount is included

in the * * * [employee's] gross income”. Given the clarity of this text, our

inquiry starts and ends with the statutory text, and we apply the plain and

common meaning of that text. TVA v. Hill, 437 U.S. 153 (1978); United States

v. American Trucking Associations, Inc., 310 U.S. 534, 543-544 (1940); see also

Connecticut Natl. Bank v. Germain, 503 U.S. 249, 253-254 (1992). The

statutory prerequisite to petitioner's deduction under section 83 (h) is that the

corresponding amount must be “included” in its employees’ income, and, given

the fact that petitioner's employees did not include any of the subject income

in their 1988 incomes, we conclude that petitioner is not entitled to a

corresponding deduction for that year.

We recognize that Congress’ insistence that an amount be included in an

employee's income as a precursor to an employer's deduction under section 83

(h) may present difficulties to some employers attempting to ascertain whether

their employees included an amount in income. We decline to second-guess

the wisdom of the Congress in promulgating such a requirement, or to rewrite

section 83 (h) in a way that is more employer friendly by substituting the word

“includable” for the word “included”. As the Court has noted many times

before in similar settings, we apply section 83 according to its terms, although

such an application could result in an inequity in a particular case. See Alves

v. Commissioner, 79 T.C. at 878, and the cases cited therein, for prior cases in

which the Court has applied section 83 literally, notwithstanding the inequities

that could occur from such an application. Although the Congress has given the

he has changed his meaning, and has not changed his meaning unless he has varied his

terminology”. Zuanich v. Commissioner, 77 T.C. 428, 443 n.26 (1981) (quoting R. Dickerson,

- The Interpretation and Application of Statutes 224 (1975)) .

—"

Commissioner broad authority under section 7805 (a) to prescribe rules aed

regulations to implement provisions, including provisions such as the ome at

hand which could otherwise be difficult to meet in practice, the duty aed

province of this and other courts are to interpret the statute as written. As the

Supreme Court has repeatedly instructed the lower courts for almost 200 years

“where * * * the statute's language is plain, ‘the sole function of the courts

to enforce it according to its terms.” United States v. Ron Pair Enters... tne

489 U.S. 235, 241 (1989) (quoting Caminetti_v. United States, 242 US. 470

485 (1917)); see also United States v. Goldenberg, 168 U.S. 95, 102-109 ( 187

Oneale v. Thornton, 10 U.S. (6 Cranch) 53, 68 (1810). “[Cjourts must presse

that a legislature says in a statute what it means and means in a statute whet

it says there.” Connecticut Natl. Bank v. Germain, supra at 253-24

In the case at hand, the Commissioner has prescribed an employer-fnemdly

regulatory rule with respect to section 8h). The Commissioners regylations

however, do not help petitioner under the facts herein. The apphewtie

regulations are found in section 1.83-6, Income Tax Regs. These regulations

which are generally effective for transfers of property after June 30, 1968, TD

7554, 1978-2 C.B. 71, 82, read:

§1.83-6. Deduction by employer.

(a) Allowance of deduction — (1) General rule. In the case of a transter

of property in connection with the performance of servicers © °°. «

deduction is allowable under section 162 or 212, to the person for wher

such services were performed. The amount of the deduction i equal fe

the amount includible as compensation in the gross income of the sence

provider, under section 83 (a) * * *, but only to the extent such amount

meets the requirements of section 162 or 212 amd the teygtulaticome

thereunder. Such deduction shall be-allowed only for the taaable year of

such person in which or with which ends the taxable year od the were

provider in which such amount is includible as compensation. * * *

(2) Special Rule. — If the service provider is an employee of the

person for whom services were performed, such deduction @ allowed for

the taxable year of the employer in which or with which emeis the tanehle

year of the employee in which such amount is inchadible as compensation

but only if the employer deducts and withholds upon such amoeet i

accordance with section 3402. A deduction will pot be disallowed ender

the preceding sentence if the employer does sot withhold and docket

10a

upon amounts excluded from gross income, such as amounts excluded

under section 79, section 101(b), or subchapter N. ° ° °

(3) Exceptions. — Where property is substantially vested upon transfer,

the deduction shall be allowed to such person in accordance with his

method of accounting (in conformity with section 446 and 461). °° °

Under these interpretative regulations, the Commissioner has allowed an

employer such as petitioner to deduct compensation paid to an employee

through a transfer of property in the year that the corresponding income is

includable in the employee's income if the employer deducts and withholds

income tax on the payment under section 3402. See sec. 1.83-6(a)(2), Income

Tax Regs.; see also sec. 7805 (a) (the Commissioner authorized to “prescribe all

needful rules and regulations for the enforcement of this title”). Petitioner does

not benefit from these regulations because it did not withhold income tax on

any of the payments underlying the claimed deduction. Although petitioner

attempts to avoid this result by arguing that these regulations are invalid, we do

not agree. The statutory text allows a deduction when the corresponding

amount is included in income, and the Commissioner's regulations merely

establish a “safe harbor” for concluding that the corresponding amount was

included in income. The Commissioner's regulatory implementation of the

congressional mandate set forth in section 83 (h) is reasonable, which, in turn,

means that the regulations are valid. United States v. Vogel Fertilizer Co., 455

U.S. 16, 24 (1982); United States v. Correll, 389 U.S. 299, 307 (1967). The

special rule as to the deduction and withholding of payroll taxes was meant to

alleviate the “difficult[ies] that a service recipient may have in demonstrating

that an amount has actually been included in the service provider's gross

income”, see T.D. 8599, 1995-2 C.B. 12, 12, and its effect that an employer's

deduction is in fact offset by a corresponding inclusion in income comports

with the statute's purpose of matching an employer's deduction with income

inclusion by the employee.

The history of these regulations is noteworthy. When the Commissioner

originally proposed these regulations in 1971, they did not contain a safe harbor

provision under which an employer could deduct the value of property

transferred to an employee as compensation for services, absent the employee's

including the corresponding amount in income. Section 1.83-6, Income Tax

Regs., was originally proposed as follows:

§1.83-6. Deduction by employer. — (a) In general. In the case of a

transfer of property in connection with the performance of services ° ° °,

lla

there is allowed as a deduction under section 162 or 212, to the person

for whom such services were performed, an amount equal to the amount

included, under subsection (a) ° * * of section 83 as compensation, in the

gross income of the person who performed such services, but only to the

extent such amount meets the requirements of section 162 or 212 and the

regulations thereunder. Such deduction shall be allowed only for the

taxable year of such person in which or with which ends the taxable year

for which such amount is included as compensation in the gross income

of the person who performed such services. * * * [Sec. 1.83-6, Proposed

Income Tax Regs., 36 Fed. Reg. 10793 (June 3, 1971).]

After these proposed regulations were published, the Commissioner received

numerous comments expressing concern as to the difficulty that an employer

may have in demonstrating that an amount has actually been included in an

employee’s gross income. Accordingly, the Commissioner, in finalizing the

proposed regulations, opted to allow a deduction at the time that the

corresponding amount was includable in an employee's gross income, even if

the employee did not properly include the includable amount in his or her

income. As a quid pro quo to receiving the deduction at that time, however, the

Commissioner required that the employer deduct and withhold payroll taxes

from the underlying payment.

Most recently, the Commissioner has amended the regulations under section

83 (h) to “more closely [follow] the statutory language of [that] section”. T.D.

8599, supra, 1995-2 C.B. at 13. The current regulations, which are effective for

deductions in taxable years beginning on or after January 1, 1995, but which

may be used by employers claiming deductions for any taxable year not closed

by the period of limitations under section 6501, read:

§1.83-6. Deduction by employer. (a) Allowance of deduction — (1)

General rule. In the case of a transfer of property in connection with the

performance of services * * *, a deduction is allowable under section 162

or 212 to the person for whom the services were performed. The amount

of the deduction is equal to the amount included as compensation in the

gross income of the service provider under section 83 (a) * * *, but only

to the extent the amount meets the requirements of section 162 or 212

and the regulations thereunder. The deduction is allowed only for the

taxable year of that person in which or with which ends the taxable year

of the service provider in which the amount is included as compensation.

12a

(2) Special Rule. For purposes of paragraph (a)(1) of this section, the

service provider is deemed to have included the amount as compensation

in gross income if the person for whom the services were performed

satisfies in a timely manner all requirements of section 6041 or section

6041A, and the regulations thereunder, with respect to that amount of

compensation. * ° °

(3) Exceptions. Where property is substantially vested upon transfer,

the deduction shall be allowed to such person in accordance with his

method of accounting (in conformity with sections 446 and 461). * * °

As stated by the Commissioner in the preamble to these regulations:

Under section 83(h) of the Code, in the case of a transfer of property to

which section 83 (a) applies, the person for whom services were provided may

deduct an amount equal to the amount included in the service provider's gross

income. In light of the difficulty that a service recipient may have in

demonstrating that an amount has actually been included in the service

provider's gross income, the general rule in former §1.83-6(a)(1) permitted the

deduction for the amount “includible” in the service provider's gross income.

Thus, the deduction was allowed to the service recipient even if the service

provider did not properly report the includible amount. Where the service

- provider was an employee of the service recipient, however, the special rule in

§1.83-6(a)(2) provided that a deduction could be claimed only if the service

recipient (employer) deducted and withheld income tax in accordance with

section 3402. The special rule was designed to ensure that the service

recipient's deduction was in .fact offset by a corresponding inclusion in the

service provider's gross income. The special rule was limited to employer-

employee situations because in other situations there was no underlying

withholding requirement upon which the deduction could be conditioned.

Taxpayers expressed concern that it was often difficult to satisfy the

prerequisite that employers must deduct and withhold income tax from

payments in kind as a condition for claiming a deduction. These regulations

address this concern by eliminating this prerequisite, while still ensuring

consistent treatment between service recipients and service providers as

required by the statute. In addition, because the deduction no longer is

conditioned on withholding, there no longer is a need to have different rules

for those who receive services from employees and those who receive services

from others. .

a, TL i i Ae Re te ee A oe

13a

Under these regulations, the former general rule and special rule are

replaced by a revised general-rule that more closely follows the statutory

language of section 83(h). The service recipient is allowed a deduction for the

amount “included” in the service provider's gross income. For this purpose, the

amount included means the amount reported on an original or amended return

or included in gross income as a result of an IRS audit of the service provider.

Because of the potential difficulty of demonstrating actual inclusion by the

service provider, a special rule provides that, if the service recipient timely

complies with applicable Form W-2 or 1099 reporting requirements under

section 6041 (or 6041A), as appropriate, with respect to the amount includible

in income by the service provider, the service provider is deemed to have

included the amount in gross income for this purpose. Thus, the regulations

allow the deduction without requiring the service recipient to demonstrate

actual inclusion by the service provider. ° ° °

The deemed inclusion rule may be used only by a service recipient whose

compliance with applicable Form W-2 or 1099 reporting requirements is

timely. Thus, for example, under the current reporting requirements, if

amounts attributable to one or more section 83 transfers of property are

includible in an employee's income in year | (and are not eligible for any

reporting exemption), the employer generally is required to furnish the

employee a Form W-2 reflecting that amount by January 31 of year 2 and

generally is required to file a copy of the Form W-2 with the federal

government by the last day of February of year 2. If the employer reports to

the employee and the government in a timely manner, the employer can rely

on the deemed inclusion rule to claim a deduction for the amount in year 1.

If the employee's Form W-2 is not furnished until after January 31 of year 2 or

the government's copy of Form W-2 is not filed until after the last day of

February of year 2, the employer generally is required to demonstrate that the

employee actually included the amount in income in order to support its

deduction of the amount. ° ° °

T.D. 8599, supra, 1995-2 C.B. at 12-13. Petitioner can find no refuge in current

section 1.83-6, Income Tax Regs., because: (1) It has not issued a Form W-2

or Form 1099, and (2) none of its employees has-included the value of the

Endotronics stock in his or her gross income.

Nor can petitioner find refuge in section 1.83-6(a)(3), Income Tax Regs.

Section 1.83-6(a)(3), Income Tax Regs., provides an exception to the general

\4a

timing rule of section 1.83-6(a)(1), Income Tax Regs., in that the deduction

afforded by section 1.83-6(a)(1) and/or (2), Income Tax Regs., is allowed to the

employer in accordance with its method of accounting where the underlying

property is substantially vested upon transfer. Section 1.83-6(a)(3), Income Tax

Regs., does not, as argued by petitioner, provide an independent basis for

deducting an amount under section 83(h). Section 1.83-6(a)(3), Income Tax

Regs., merely sets forth the time that an amount is deductible, where the

employer's right to the deduction has already been established by section

1.83-6(a)(1) and/or (2), Income Tax Regs. The fact that section 1.83-6(a)(3),

Income Tax Regs., is only a timing provision is quickly seen by comparing the

rules contained in that section with the rules contained in section 1.83-6(a)(1),

Income Tax Regs. Section 1.83-6(a)(1), Income Tax Regs., tracks the statutory

text in that they both contain three separate rules, the first of which allows a

deduction under section 162 or 212, the second of which sets forth the amount

of the deduction, and the third of which sets forth the timing of the deduction.

Section 1.83-6(a)(3), Income Tax Regs., by contrast, contains only one rule, and

that rule speaks only to the timing of the deduction.

The following example illustrates the applicability of section 1.83-6(a)(3),

Income Tax Regs. Assume that the respective taxable years of an employer and

an employee end on July 31 and December 31. Assume further that the

employer transfers property to the employee on May 1, 1993, in connection

with services rendered, that this property is substantially vested at the time of

transfer, and that the employer deducts and withholds income tax on this

transfer under section 3402. In such a case, the employee must include the

value of the property in income for his or her taxable year ended December 31,

1993. See sec. 83(a). With respect to the employer, the general rule of section

1.83-6(a)(1) and (2), Income Tax Regs., forces it to deduct the value of the

transfer in its taxable year ended July 31, 1994 (i.e., its taxable year in which

ends the taxable year of the employee in which the amount is included in gross

income), although the employer made the payment in its taxable year ended

July 31, 1993. By virtue of the safe harbor in section 1.83-6(a)(2), Income Tax

Regs., and the exception in section 1.83-6(a)(3), Income Tax Regs., the

employer can take the deduction in its taxable year ended July 31, 1993; i.e.,

the year in which the amount is deductible under the employer's method of

accounting. See Schmidt Baking Co. v. Commissioner, 107 T.C. 271 (1996); see

also Chalmette Gen. Hosp., Inc. v. United States, 71 AFTR 2d 93-3314, 90-2

USTC, par. 50,578 (E.D. La. 1990). See generally Utz, 384-2nd T.M., Restricted

Property — Section 83 A-15-16 (1996) .

\Sa

Petitioner argues that section 1.83-6(a)(3), Income Tax Regs., the two cases

cited immediately above, and Robinson v. Commissioner, 82 T.C. 444 (1984),

support its right to a deduction in 1988, the year in which the amount is

deductible under its accrual method, notwithstanding the fact that its employees

did not include any of the subject amount in income. We do not agree. As

discussed above, section 1.83-6(a)(3), Income Tax Regs., does not independently

bestow a deduction on petitioner with respect to its transfer of the Endotronics

stock. Moreover, petitioner's reliance on Schmidt Baking Co., Chalmette Gen.

Hosp., and Robinson is misplaced. None of the Courts in those cases addressed

or decided the issue that is before us today. Nor did the parties in those cases,

unlike the parties here, dispute that the employers were entitled to a

deduction, challenging only the timing of that deduction.

In summary, petitioner has not met the requirements for deductibility under

section’ 83(h), and it has not met the requirements for deductibility under

section 1.83-6, Income .Tax Regs., either pre— or post-amendment. Thus,

section 83 (h) prevents petitioner from deducting the value of the transferred

stock in 1988. We have considered all arguments made by petitioner for a

contrary holding and, to the extent not discussed above, find them to be

irrelevant or without merit.

To reflect the foregoing,

Decision will be entered

for respondent.

Reviewed by the Court.

CHABOT, SWIFT, JACOBS, GERBER, PARR, COLVIN, FOLEY, and

VASQUEZ, JJ., agree with this majority opinion. COLVIN, J., concurring: |

agree with the reasoning and conclusions stated by the majority. The majority

concludes that section 83 (h) does not allow petitioner to deduct the value of

stock that it transferred to 12 of its employees as compensation for services in

the year of the transfer. The majority denies the deduction because none of the

12 employees included the value of the stock in income, and because petitioner

did not qualify for safe harbors provided in applicable regulations that allow the

employer a deduction if it meets certain withholding or reporting requirements.

I concur to emphasize some points of agreement with the majority.

Judge Ruwe recognizes that his interpretation of section 83 (h) raises

questions about “the ‘equity’ of allowing a corporate deduction for compensation

16a

paid to its controlling shareholders and principal officers, who failed to report

the same items as income.” Judge Ruwe’s dissent p. 50. I agree with the

majority that Congress did not intend and the statute does not require the

inequitable result that follows from the disseat’s reasoning.

“Included”

Section 83 (a) requires that a service provider (e.g., an employee) include

the fair market value of property received from the employer in his or her gross

income in the first taxable year in which the rights of the person having the

beneficial interest in such property are transferable or are not subject to a

substantial risk of forfeiture. Section 83 (h) allows an employer to deduct an

amount equal to the amount “included” under section 83 (a) .

Judge Ruwe’s substitution of the word “includible”, Judge Ruwe’s dissent

pp.36-37, for the word “included” is at odds with our usual understanding of

these and analogous terms. I agree with the majority that the “led” ending and

the “ible” (or “able”) ending have different meanings. The “led” ending refers

to something done in fact, e.g., an expense “deducted”, income “reported”, or

an item “recognized” in computing gross income. Majority op. p. 8. The “ible” |

(or “able”) ending refers to something legally required, such as “reportable”

income, or permitted, such as a “deductible” expense. Id. Consistent with those

usual meanings, the majority properly reads “included” to require that the

amount has in fact been included in income. Majority op. pp. 8-9.

Section 83 (a) says that the fair market value of certain property “shall be

included” in the gross income of a service provider in the first year the property

is not subject to a substantial risk of forfeiture. The majority (majority op. pp.

6-7) and Judge Ruwe’s dissent p. 35 correctly point out that section 83 (a)

imposes a legal obligation on the recipient of property. Congress could also

have imposed that obligation by saying that the fair market value of the

property is “includible” in the recipient's income. See sec. 88 (nuclear

decommissioning costs are “includible” in gross income).

Judge Ruwe’s dissent uses the word “included” in section 83 (a) to construe

the word “included” in section 83(h). Although the choice of “included” or

“includible” in section 83 (a) would not affect our reading of that subsection,

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Judge Ruwe’s dissent'’s substitution of “includible” for “included” in section 83

(h) would dramatically change the meaning of that subsection.

From the fact that Congress might have accomplished its purpose in section

83 (a) equally well by saying “includible” instead of “included”, Judge Ruwe

reasons that Congress meant “includible” in section 83 (h) where it used

“included”. Judge Ruwe’s dissent pp. 36-37. The dissent in essence relies on

the maxim of statutory construction that if Congress uses the same term in two

places in the statute, we should give it the same meaning.

Maxims of construction are useful interpretative tools but are not dispositive.

The dissent overlooks the different purpose and context of sections 83 (a) and

(h). The same word or phrase appearing in different places in the internal

revenue laws may have different meanings depending on the. context and

legislative purpose involved. See Helvering v. Stockholms Enskilda Bank, 293

U.S. 84, 86-88 (1934); Helvering v. Morgan’s Inc., 293 U.S. 121, 128 (1934).

The context of section 83(a), an income inclusion provision, is different than

section 83(h), a deduction provision. While the term “includible” is

interchangeable with “included” in section 83 (a) without affecting the result,

it is definitely not interchangeable in section 83(h). The effect of applying the

maxim regarding consistent use of terms here would be to override the plain

meaning of the term “included” in section 83 (h) and to significantly alter the

meaning of section 83 (h) .

Il.

The 1995 Regulations

Judge Ruwe’'s dissent does not take into account the 1995 amendments to

the section 83 (h) regulations or the accompanying preamble, both of which

shed important light on the issue in dispute here.

The 1995 regulations under section 83 (h) provide a safe harbor under which

a service provider is deemed to have included an amount as compensation in

gross income if the person for whom the services were performed timely meets

Form W-2 or Form 1099 reporting requirements under sections 6041 or

6041A. Sec. 1.83-6(a)(2), Income Tax Regs. The preamble accompanying the

1995 amendments to those regulations states that, absent qualification under

that special rule, the employer must show that the employee “actually

included” the amount in income in order to support its. deduction of the

amount. T.D. 8599, 1995-2 C.B. 12, 12-13.

18a

The 1995 amendments to the section 83 (h) regulations and the preamble

accompanying them show that the Commissioner's interpretation of section 83

(h) is the same as that of the majority. This is shown by the preamble to the

1995 regulations which states in part:

Because of the potential difficulty of demonstrating actual inclusion by

the service provider, a special rule provides that, if the service recipient

timely complies with applicable Form W-2 or 1099 reporting requirements

under section 6041 (or 6041A), as appropriate, with respect to the amount

includible in income by the service provider, the service provider is

deemed to have included the amount in gross income for this purpose.

°° © (T.D. 8599, 1995-2 C.B. 13.]

A safe harbor is needed only if the interpretation of the majority is correct.

This is so because the purpose of the safe harbor is to ease an employer's

potential difficulty of proving that an employee actually included the fair

market value of property in income.

If Judge Ruwe’s reading of the regulations in effect from 1978 to 1995 (ie.,

that an employer may deduct the fair market value of property given to an

employee whether or not the employee includes that property in income) is

correct, then the 1995 regulations are a total reversal in position by the IRS.

The preamble to the 1995 regulations indicates that this interpretation is

incorrect. The IRS did not reverse its position on this fundamental issue. T.D.

8599, 1995-2 C.B. at 12-13. In describing the regulations in effect from 1978

to 1995, the preamble states:

In light of the difficulty that a service recipient may have in demonstrating

that an amount has actually been included in the service provider's gross

income, the general rule in former section 1.83-6(a)(1) permitted the

deduction for the amount “includible” in the service provider's gross

income. [T.D. 8599, 1995-2 C.B. at 12.]

After describing a special rule provided in the regulations in effect from

1978 to 1995 (reasonably characterized as a safe harbor by the majority,

majority op. pp. 11-12), the preamble continues as follows:

The special rule was designed to ensure that the service recipient's

deduction was in fact offset by a corresponding inclusion in the service

provider's gross income. [T.D. 8599, 1995-2 C.B. at 12.]

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19a

The “difficulty” to which the first of these two quotes refers is the service

recipient's task of proving that a service provider included the fair market value

of property in income. The regulations in effect from 1978 to 1995 presented

that “difficulty”, prompting the IRS to provide a safe harbor. Thus, the

preamble accompanying issuance of the 1995 regulations shows that the

meaning of “included” in section 83 (h) was the same before and after 1995,

and is as the majority holds.

III.

Judge Ruwe’s Dissent’s Concerns About Practicality

Judge Ruwe’s dissent is concerned that the result reached by the majority

leads to a rule compliance with which is “impractical, if not impossible” for

employers and employees or other service providers. Judge Ruwe’s dissent pp.

42, 44. Maybe it is impractical to expect the employer to have this level of

cooperation from its (typically, key) employees to which it has distributed

property. But if we are to consider those impracticalities, we should also

compare the employer's difficulties to those faced by the IRS when, as here,

employers and their key employees play “hide the ball” with the result that the

employer can deduct the fair market value of property under section 83 (h)

which has not been included or reported in income by the recipient of the

property.

IV.

Conclusion

For the foregoing reasons, | agree with the reasoning and conclusions of the

majority that petitioner may not deduct the value of stock that it transferred to

its employees in 1988 under section 83 (h) .

CHABOT, SWIFT, JACOBS, GERBER, PARR, FOLEY, and VASQUEZ,

]J., agree with this concurring opinion.

BEGHE, J., concurring in result and dissenting in part: Judge Ruwe’s

concern (see his dissenting op. p. 50) over the unsatisfactory result his correct

analysis seems to require and my own sense that there must be more to this

fully stipulated case than either side chose to present has led me to review the

20a

record made by the parties. My review of the record raises such troubling

questions that | am impelled to set them forth, with supporting references to

their sources in the record and petitioner's brief, in the face of the views of my

colleagues and the courts that judges must refrain from trying to tell respondent

how to do his job. See, e.g., United States v_ Payner, 447 U.S. 727, 737-738

(1980).

1. Why didn’t respondent issue statutory notices of deficiency to petitioner's

employees who received Endotronics shares as compensation?!

2. Why didn’t respondent summarily assess employment taxes that petitioner

should have withheld and paid over in respect of the Endotronics shares

petitioner caused to be paid to its employees as compensation?”

' Petitioner's brief suggests that the employees may not have reported the receipt of the

shares as income because the shares were “letter stock” under the Federal securities laws and

could not be sold on the public market without a registration statement for a 2-year period

following receipt. The suggestion appears misplaced in two respects: (1) It was clear at-the time

the shares were received that letter stock is not subject to a substantial risk of forfeiture under

sec. 83 (a) and that letter stock restrictions do not postpone the receipt of income, as

demonstrated by the cases cited in petitioner's brief, decided prior to the receipt of the shares,

see Pledger v. Commissioner, 641 F.2d 287 (5th Cir. 1981); Robinson _v. Commissioner, T.C.

Memo. 1985-275; Phillippe v. Commissioner, T.C. Memo. 1982-30; Cassetta v. Commissioner,

TC. Memo. 1979-384, see also Robinson v. Commissioner, 82 T.C. 444, 467 (1984) (sec. 83(c)(3)

is not in issue here); Horwith v. Commissioner, 71 T.C. 932 (1979); Grant v. United States, 15

Cl. Ct. 38 (1988)); (2) Petitioner's chief executive officer, owning 49.95 percent of its stock (the

parties have stipulated that he directed and controlled all aspects of petitioner's activities), signed

petitioner's return, which claimed the corporate deduction as a miscellaneous deduction for

“consulting” and did not report on the officers’ salary schedule on p. 2 of the return the

compensatory shares received by him and petitioner's other officers, even as petitioner was not

reporting on the same retum its compensation income on receipt of a much larger number of

Endotronics shares and he was not reporting on his own return his personal income on the

shares received by him as compensation.

2 The parties have stipulated that petitioner did not issue W-2 Forms or Forms 1099

disclosing the payments of the compensatory shares to its employees. It seems likely that

petitioner omitted the value of the Endotronics shares from the amounts of compensation paid

to its employees from the Forms 941 that it was required to file with respect to employment

taxes under subtitle C, chapter 24 of the Code.

In addition, petitioner may well have caused Endotronics, which became controlled by

petitioner under the terms of the plan of reorganization approved by the bankruptcy court, not

to file a Form 1099 for the 7,650,000 shares that Endotronics issued to petitioner, including the

portion of those shares issued, at petitioner's direction, to petitioner's employees, as compensation

Sse mee

De Vier RDI ATA

Bip bse SdDis De Datehil

2la

3. Why didn’t respondent's statutory notice, rather than asserting, as an

alternative to disallowing the compensation deduction claimed by petitioner,

that petitioner had “taxable capital gain” in the same amount as the claimed

deduction on petitioner's transfer of the Endotronics stock to petitioner's

employees (see majority op. p. 4 note 2), instead determine that petitioner had

ordinary income in the same amount as the claimed deduction upon its own

receipt of those same shares as compensation? As indicated by facts in the

stipulated record disclosed by the explanation of the next question, that

determination would be without regard to whether the deduction claimed by

petitioner were allowed or disallowed.

4. More to the point, why didn’t respondent's statutory notice to petitioner

include in petitioner's gross income the full stipulated value — $5,976,563 —

of the total number of 7,650,000 Endotronics shares that petitioner received as

compensation?? Included in the stipulated record is the plan of reorganization*

under which the bankruptcy court approved the issuance to petitioner of

to petitioner for its commitments to provide management services and necessary financing. The

plan of reorganization discloses that more than 3 months before issuance of the shares

petitioner's treasurer had been named chief financial officer of Endotronics.

* The only clue on petitioner's return to its receipt of the 7,650,000 Endotronics shares is that

line 22 of the yearend consolidated balance sheet Schedule L shows paid-in or capital surplus of

$5,976,563, which did not appear on the corresponding balance sheet for the beginning of the

year. This is the exact fair market value of the 7,650,000 shares that petitioner received on Apr.

4, 1988 (at the stipulated value of $.78125 per share).

* The plan of bankruptcy reorganization to which petitioner and Endotronics were parties

in the transactional sense did not immunize petitioner's receipt of the Endotronics shares from

the recognition of taxable income. The transaction in which petitioner received the Endotronics

shares did not satisfy the definition of a recapitalization reorganization under sec. 368(a)(1)(E)

or of an insolvency reorganization defined by sec. 368 (a) (1) (G) as:

a transfer by a corporation of all or part of its assets to another corporation in a title 11 or

similar case; but only if, in pursuance of the plan, stock or securities of the corporation to

which the assets are transferred are distributed in a transaction which qualifies under section

354, 355, or 356. An operative requirement of both (E) and (G) reorganizations is an

exchange of stock or securities. In this case there was no such exchange. Petitioner received

the stock of Endotronics as compensation for providing services; petitioner did not transfer

any stock or securities in itself or of any other corporation in exchange for the Endotronics

shares.

22a

7,650,000 shares — 51 percent of the new common stock of Endotronics®

as consideration for petitioner's undert rtakings to provide Endotronics with

management services and necessary financing.°

5. If the 3- and 6-year periods of limitation on assessment have expired on

respondent's right to take the actions described in any or all of the foregoing

questions, would respondent still have any arguably valid grounds for taking

any such actions against petitioner and/or petitioner's controlling person or

persons, as might be shown to be appropriate? Cf. Burke v. Commissioner, 105

T.C. 41 (1995), with Zackim v. Commissioner, 91 T.C. 1001 (1988), revd. 887

F.2d 455 (3d Cir. 1989).

This is a fully stipulated case that was submitted without a trial pursuant to

Rule 122, and with only one round of concurrently filed briefs. Included in the

stipulated record, apparently at petitioners request, is the Debtor's

[Endotronics’s}] Amended Disclosure Statement, which contains the plan of

” The premier treatise on venture capital does not discuss the factual situation presented by

the Venture Funding, Ltd. acquisition of control of Endotronics. See Levin, Structuring Venture

Capital, Private Equity, and Entrepreneurial Transactions (1997), especially ch. 8, Structuring a

Turn-Around Investment in an Overleveraged or Troubled Company. The role of the venture

capitalist (VC) in the example described in ch. 8, see Levin, supra at 264-265, is to contribute

$8 million in new money to “Badco” and to receive in exchange (while preexisting creditors and

shareholders are suffering various “haircuts”)

$7.9 million face of new senior preferred stock, mandatorily redeemable 10 years after

issuance, plus

1,000 new common shares (at a stated price of $100 per common share, Le, an aggregate of

$0.1 million). (Levin, supra, sec. 802.1.1 at 264 |

Under the facts of the example, the new common shares received by VC (1,000 out of 3.950)

amount to 25 percent of Badco’s post restructuring common stock. It goes without saying that

the exchange of cash by VC for newly issued preferred and common stock of Badeo is a

nontaxable transaction to both of them. No gain or loss is realized by (nuch less recognized to)

either party to the transaction, and the only obvious tax question presented by the example is

how the $8 million of consideration is to be allocated between the preferred and common stock

’ Petitioner's undertaking to provide necessary financing, as well as management services

would appear to cause the shares allocable to that undertaking to be treated as a commitment

fee, included in the gross income of the recipient as compensation for services at the time of

accrual or receipt. See Rev. Rul. 70-540, 1970-2 C_B. 101 (issue 3), declared obsolete on another

issue by Rev. Proc. 94-29, 1994-1 C.B. 616, 621; see also Chesapeake Fin. Corp. v. Commissioner

78 T.C. 869, 879 (1982); Metropolitan Mortgage Fund, Inc. v. Commissioner, 62 TC. 110, 120

(1974)

Te*Corppary eval tev abun . ve fi ore all te Brubitione 8*. rr ‘. *" 2 - “~~ «

forth in petitioner's brief, are replete with references to the Diwlonee

Statement and the plan, including the adminion (Petitioners Proposed Pledbeg

75) that petitioner was entitled under the plan to treeme TAO eel

issued Endotronics shares

The majority does not adopt any of petitioner's prerapenre! bemedbonyee e+ pertbongs

the background and terms of the plan. inasemuct as thone Reckegse ane meeeleoune

to the majority’s theory of how the case should be decided fe ee ceew

however, petitioner, by including the Disclosure Statewweet and pile we te

stipulated record, has caused the insures raised im quevtions 3 aed 4 dee &

effect to be tried by consent. 1 beliewe that the case chould mot be ceguedied oe

fully submitted for decision until the parties have heew athed te ceopend te

questions 3 and 4, which appear to me to be imehuctably iehewwnt ie he late

of the case as presented by petitioner with revpeomadiend + commene

If respondent on a inmotion for recomaderstion aed lune to amend annwee

should attempt to raise questions 3 and/or 4. and each mutton ohondd be denned!

by the Court on the grounds of lateness of surprine. ot for whatever sunem

then respondent could try to put question 5 ie play neler a: petitioner

concerned, if respondent should comchade that thete ace grormdle for cencing

petitioner a second notice of defickency purmaant to section G21Die) Sew Bevte

\_ Commissioner, supra

There may be facts not in the record that would belie the mlewenewe Gat

have led me to concur in the majority’s result and te cane he feu

questions. There may be explanations that sould promed ont evsore an ney ccudling

of the record and provide anwwers that would condiew that thene + aetthong mene

that respondent can or should do It's wp to reypomdiend> mumagement ae Ge

mercise of its discretion. to decide whether the quevitions marten! am degen

and action at this time

RUWE., |].. dissenting: The neue im this cane ie whether petitioner a te he

denied a deduction for compenution paid i the form of peepee Ne

property was not subyect to risk of forfewere The fae muatet wate of Ge anet

was includible' in the conphoyers icone whew the teaelier ceenwnedl The

hers amrter that operiiange o rteed ctommmetteretiiy Bey sooggeresne Peronaggtiecnen flee andi

24a

transfer meets the deductibility requirements of section 162. The only possible

impediment to the deduction is section 83 and the regulations thereunder?

The applicable statutory language is contained in subsections (a) and (h) of

section 83. Subsection (a) provides that the value of transferred 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 transferable or are not subject

to a substantial risk of forfeiture * * ° [Emphasis added. ]

Subsection (h) provides:

(h) Deduction by Employer. — In the case of a transfer of property to

which this section applies * * * there shall be allowed as a deduction

under section 162, to the person for whom were performed the services

in connection with which such property was transferred, an amount equal

to the amount included under subsection (a) , (b) , or (d) (2) in the gross

income of the person who performed such services. Such deduction shall

be allowed for the taxable year of such person in which or with which

ends the taxable year in which such amount is included in the gross

income of the person who performed such services. [Emphasis added. |

The majority interprets the term “included” as used in section 83 as if it

means actually reported on each service provider's income tax return or

otherwise used to compute the service provider's income tax liability.’ The

majority simply describes this as the clear, plain, and unambiguous meaning of

the statute. No precedent is cited.

The word “included” is used three times in subsections (a) and (h) of section

583. Section 83 (a) provides that the value of the property received as

compensation for services “shall be included in the gross income” of the

* Unless otherwise stated, references to the regulations under sec. 83 are to those in effect

from 1978 through 1995 and which are applicable to the years in issue. The current regulations

promulgated in 1995 are effective for taxable years ending after Jan. 1, 1995, although they may

he used by employers who so choose for any taxable year not closed by the statute of limitations.

’ The alternative to reporting as gross income on the employee's or independent contractor's

retum would be an adjustment to gross income in a deficiency deiermination.

i a i nt

eet eee eee ee 6 te ee iy re oe de

sabes

—

recipient. This means that such property is required to be included in gross

income as a matter of law.‘

Section 83(h) provides that “there shall be allowed as a deduction under

section 162 ° * * the amount included under subsection (a)”; i.e., the amount

included under subsection (a) as a matter of law. As explained in the Senate

Finance Committee report: “The allowable deduction is the amount which the

employee is required to recognize as income”. S. Rept. 91-552, at 123 (1969),

1969-3 C.B. 423, 502. (Emphasis added.) The next sentence of section 83 (h)

provides that the employer's deduction “shall be allowed” for the taxable year

of the employer that coincides with the taxable year of the person who

performed services “in which such amount is included in the gross income” of

such person. A natural interpretation of this last phrase, and the one that is

consistent with the previous use of the term “included”, is that it refers to

included in gross income as a matter of law. The majority makes no argument

that these three instances wherein the term “included” was used were intended

to convey different meanings of that single word. The majority, however,

concludes that when Congress used the word “included” it meant something

other than “includible” as a matter of law. I disagree.

The Code sections providing that different types of accessions to wealth

constitute gross income use various forms of the word “include”. Section 61(a)

provides that “grossincome means all income from whatever source derived,

including (but not limited to) the following items:” and then lists 15 items

specifically included in gross income. Sectian 61 (b) provides: “For items

specifically included in gross income, see part II (sec. 7] and following). For

items specifically excluded from gross income, see part III (sec. 101 and

following).” Section 79 uses the same articulation as section 83 in providing

that the cost of employees’ group-term life insurance “shall be included in the

gross income” of employees. The same is true for reimbursed moving expenses

under section 82. Other Code sections convey the same meaning by different

terms such as providing that “gross income includes” alimony (section 71),

annuities (section 72), prizes and awards (section 74), and Social Security

* In Adair v. Commissioner, T.C. Memo. 1985-392, we stated:

Section 83 (a) provides that property transferred “in connection with the performance of

services” is included in the gross income of the transferee in an amount equal to the excess

of the fair market value over the amount paid for the property transferred. * * * (Fn. ref.

omitted; emphasis added. | :

26a

benefits (section 86). Section 80(a) provides that the restoration of value of

certain securities “shall, except as provided in subsection (b), be included in

gross income”. Subsection (b) then provides for reducing “The amount

otherwise includible in gross income under subsection (a)” (emphasis added),

using the term “includible” to refer to what was previously “included” in gross

income. In another variation, section 88 provides that nuclear decommissioning

costs that are built into costs of services for ratemaking purposes “shall be

includible in the gross income of such taxpayer”.° (Emphasis added.) Obviously,

Congress has used the terms “includes”, “included”, and “includible”

interchangeably.

The regulations regarding gross income also use variations of the word

“include” to describe items that constitute gross income. Section 1.61-1(a),

Income Tax Regs., provides that “Gross income includes income realized in any

form, whether in money, property, or services.” That regulation goes on to

provide:

(1) For examples of items specifically included in gross income, see

part IT (section 71 and following), subchapter B, chapter | of the Code.

(2) For examples of items specifically excluded from gross income, see

part IIT (section 101 and following), subchapter B, chapter | of the Code.

(3) For general rules as to the taxable year for which an item is to be

included in gross income, see section 451 and the regulations thereunder.

(Sec. 1.61-1(b), Income Tax Regs. ]

Section 1.61-2T(a), Temporary Income Tax Regs., 50 Fed. Reg. 52281,

52285 (Dec. 23, 1985), provides that “gross income includes compensation for

services”. Section 1.61-6(a), Income Tax Regs., provides: “Gain realized on the

sale or exchange of property is included in gross income, unless excluded by

law.” Section 1.61-9(a), Income Tax Regs., provides:

Except as otherwise specifically provided, dividends are included in

gross income under sections 61 and 301. For the principal rules with

* Congress has used the phrase “shall be includible in gross income” as a legal mandate in

the following Code sections: 101(f(3)(B\ii); 415(b) (O(C\ii); 454(c); 457 (a), (g): 468A(eX 1):

S2WeM SMA); 530 (d\(1); 7TO4(eM 2), T7OAMAINC); TIOZA(eEX INC); and T702B(b) (2C), (dd)

Further, Congress has used the phrase “is includible in the gross income” as a legal mandate in

see. 72(m)(3)(B), and Congress has used the phrase “are includible in gross income” as a legal

mandate in sec. 803(a)(3)

27a

respect to dividends includible in gross income, see section 316 and the

regulations thereunder. ° * * [Emphasis added.]

Section 1.61-9b), Income Tax Regs., provides:

Gross income includes dividends in property other than cash, as well as

cash dividends. For amounts to be included in gross income when

distributions of property are made, see section 301 and the regulations

thereunder. ° ° °

The terms “includes”, “included”, and “includible” in reference to gross

income are used throughout the Code and regulations and, as the above

examples demonstrate, generally refer to the legal status of an item that

constitutes gross income. In a Court-reviewed opinion released on February

19, 1998, this Court also used the terms “included” and “includes” in the same

sense when we stated:

Absent any exclusionary provision, items of income are included in gross

income. See. 61(a). Section 61(a)(12) includes COD income in gross

income. [Nelson v. Commissioner, 110 T.C. ; (1998) (slip op.

at 4).]

The majority, relying on the report of the Senate Finance Committee,

opines that “inchided” means “taken into account in determining the tax

liability” and is synonymous with the term “recognize”. Majority op. pp. 8-9. In

footnote 3 on page 9 of the Majority opinion, the majority argues that because

section 83 (h) uses the term “included” and section 404(a)(5), which was also

added by section 321 of the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat.

487, 588, uses the term “includible”, Congress intended different meanings.°

tlowever, a close analysis of the Senate Finance Committee report indicates

that Congress used the two terms interchangeably. The Senate Finance

Committee report refers to the deduction under section 83 (h) and states:

The allowable deduction is the amount which the employee is required to

recognize as income. The deduction is to be allowed in the employer's

accounting period which includes the close of the taxable year in which

* See. 404(a\(5) provides that contributions to nonexempt plans are deductible in the taxable

year in which an amount attributable to the contribution is “includible in the gross income of

employees” See. 402(to)(1) provides that employer contributions to a nonexempt trust “shall be

included in the gross fincome of the employee in accordance with section 83”.

the employee recognizes the income. * * * [S. Rept. 91-552, supra at 123,

1969-3 C.B. at 502; emphasis added. ]

Section 404(a)(5), which uses the term “includible”, is then explained by the

Senate Finance Committee by using essentially the same terminology:

The committee provided with respect to nonexempt trusts that the

employer will be allowed a deduction for his contribution at the time that

the employee recognizes income * ° * [S. Rept. 91-552, supra at 123,

1969-3 C.B. at 502; emphasis added. ]

The Senate Finance Committee report uses the phrase “required to recognize”

to describe the amount of any deduction under section 83(h). Section 83 (h)

itself describes the amount of the deduction as the “amount included” in the

gross income of the employee. The term “recognizes” is used by the Commit!

to describe the period in which property “is included” in an employee's gross

income in section 83(h). The term “recognizes” is also used by the Committee

to describe the period in which income “is includible” by the employee in

section 404(a)(5). Thus, it is, reasonable to conclude that the timing provisions

of both sections were intended to refer to the year in which income is required

to be “included” or is “includible” in the employee's income.

When Congress wants to require actual reporting of gross income, it knows

how to say so. For example, section 1367(b)(1) provides that:

An amount which is required to be included in the gross income of a

shareholder and shown on his return shall be taken into account under

subparagraph (A) or (B) of subsection (a)(1) only to the extent such

amount is included in the shareholder's gross income on his return ° ° °

Interpreting the word “included” to mean “reported by” or “actually used in

computing the tax liability of” any employee or independent contractor would

establish a statutory requirement that would be impractical and in many cases

impossible for employers to meet. Deductions are a matter of legislative grace,

and a taxpayer is required to meet all of the statutory requirements before

taking a deduction. Employers would not be able to take a deduction until they

first ascertained that their employees and independent contractors had filed an

income tax return and reported the item as gross income. How could

employers know that employees and independent contractors had actually filed

returns and reported the property transfers as income before taking a deduction?

Indeed, in many situations the employer's return would be due before the due

29a

date of the service providers’ returns.’ Even the majority acknowledges that its

interpretation sets up an impractical requirement that the majority believes

justifies “employer friendly” regulations that are at variance with the majority's

own interpretation of the statutory requirements.

When the applicable regulations interpreting section 83 (h) were issued in

1978, neither the preamble in the Treasury decision nor the regulations

contained anything indicating that deductibility under section 83 (h) depends

on an employee or independent contractor's actually reporting the compensation.

on July 11, 1978, final regulations were issued dealing with section 83(h). T.D.

7554, 1978-2 C.B. 71. The general rule for deductions under section 83 (h) was

stated as follows:

(1) General rule. In the case of a transfer of property in connection with

the performance of services, or a compensatory cancellation of a nonlapse

restriction described in section 83 (d) and §1.83-5, a deduction is

allowable under sections 162 or 212, to the person for whom such services

were performed. The amount of the deduction is equal to the amount

includible as compensation in the gross income of the service provider,

under section 83(a), (b), or (d)(2), but only to the extent such amount

meets the requirements of section 162 or 212 and the regulations

thereunder. Such deduction shall be allowed only for the taxable year of

such person in which or with which ends the taxable year of the service

provider in which such amount is includible as compensation. For

purposes of this paragraph, any amount excluded from gross income

under section 79 or section 101 (b) or subchapter N shall be considered

to have been includible in gross income. [Sec. 1.83-6(a)(1), Income Tax

Regs.; emphasis added. ] .

The explanation of the difference between these final regulations and those

previously proposed in 1971 was as follows:

Subject to the requirements of sections 162 and 212, a deduction is

allowed to the person for whom services were performed, in an amount

equal to the amount of compensation includible in the gross income of

* Most individual employees file returns on a calendar year basis, in which case their returns

are due on April 15. Employers are often corporations filing returns on the basis of a fiscal year.

Even those corporations filing returns on a calendar year basis are, absent extensions, required

to file returns on March 15. See sec. 6072.

the person who provided the services, at the time the compensation

becomes includible in the gross income of the person who performed the

services. This timing rule is a change from the regulations as proposed in

1971, which allowed a deduction at the time an amount was actually

included in gross income. This change was suggested by public comments

to the regulations as proposed in 1971. [T.D. 7554, 1978-2 C.B. at 72-73;

emphasis added. |

There is nothing in T.D. 7554, supra, to indicate that these regulatory

provisions allowing the deduction “at the time the compensation becomes

includible” were intended to be anything other than a proper interpretation of

the statutory language of section 83(h). Nothing in T.D. 7554, supra, describes

the use of the word “includible” as a “safe harbor” or an “employer friendly”

variance from the statutory requirement. Indeed, T.D. 7554, supra, states that

the U.S. Treasury Department rejected any suggested regulatory language that

conflicted with the « express statutory language.

Many comments suggested changes that either conflicted with the express

statutory language or would have made the regulations unreasonably long

and complex. Those suggestions were rejected. [Id., 1978-2 C.B. at 73.] It

is clear.that use of the word “includible” in the regulations is used in the

sense that the law requires inclusion. Those regulations remained in

effect for 17 years and apply to the years in issue. I believe that section

1.83-6(a)(1), Income Tax Regs., is a proper interpretation of the

requirements of section 83(h). This interpretation is supported by Duncan

Indus.. Inc. v. Commissioner, 73 T.C. 266, 285 (1979), where we stated:

Section 83(h) expressly allows the person for whom the services were

performed to deduct an amount equal to the amount includable in the

service performer's income under section 83(a). °° ° [Emphasis added. |

The majority’s interpretation of section 83 conflicts with the interpretation

contained in section 1.83-6(a)(1), Income Tax Regs. The majority attempts to

reconcile this conflict by describing the regulations as being an “employer

friendly” “safe harbor”. But such rationalization is only necessary because of

the majority's strained interpretation of the term “included”. If given a choice

between two possible interpretations, we should choose the one that is

reasonable and practical rather than assume that Congress intended to set

3la

standards for deductions — that are impractical, if not impossible, to meet.”

See United States v. American Trucking Associations, Inc., 310 U.S. 534, 543

(1940). The more reasonable and practical interpretation, and the one contained

in the applicable interpretative regulations, is that a deduction under section 83

(h) is allowed for the employer's taxable year that coincides with the taxable

year in which the compensation is “includible” in the service provider's income.

Section 1.83-6(a)(2), Income Tax Regs., provides a “Special rule” for

compensatory transfers of property by “employers” to “employees”. It allows a

deduction in the employer's taxable year that coincides with the year in which

the compensation is “includible” in the employee's income, but “only if the

employer deducts and withholds upon such amount in accordance with section

3402.” Id. This regulatory requirement that there be withholding has no basis

in the statutory language or the legislative history of section 83(h). The majority

nevertheless upholds the validity of this withholding requirement by treating it

as a relaxation of what it believes to be the more explicit and onerous

requirements in the Code. The only basis for this is the majority's restrictive

and erroneous interpretation of the word “included”. .

* Indeed, were we to interpret “included” as meaning reported, an employer could arguably

take the deduction in any amount for any year that matches the employee's reporting position.

® The withholding requirement in sec. 1.83-6(a)(2), Income Tax Regs., is fatally flawed even

if one were to accept respondent's definition of “included”. Under this regulation, deductibility

is totally dependent on whether the employer withheld tax upon the compensatory transfer of

property. An obvious example in which the withholding requirement is unworkable involves its

application to situations where there are significant restrictions on the employee's rights to the

property at the time of transfer such as a substantial risk of forfeiture. In that case, the employee

generally receives no includible gross income under sec. 83 (a) until those restrictions are lifted.

Therefore, there would be no withholding requirement at the time of the initial transfer. Indeed,

the amount of any reportable compensation would not be known at the time of transfer. But any

withholding that might be required when the restrictions are lifted, possibly years later, may be

physically or legally impossible if the employee earned no other compensation in the later year

or was no longer an employee. Withholding would also be inappropriate if the employee's Form

W-4 indicates no withholding was required. Sec. 1.83-6(a),2), Income Tax Regs., would also

disallow a-deduction for a compensatory transfer of property to an employee where there was

no withholding, even where the employee reported the income and paid the tax. Respondent has

acknowledged that “employers that failed to deduct and withhold income tax were denied a

deduction even where the employee reported the income and paid the tax.” T.D. 8599, 19952

C.B. 12, 12. (Emphasis added.) Thus, this part of the regulation was in conflict with respondent's

current position that actual reporting is exactly what sec. 83 (h) requires.

Finally, even if section 1.83-6(a)(2), Income Tax Regs., is considered valid,

section 1.83-6(a)(3), Income Tax Regs., provides an exception to the

requirements of section 1.83-6(a)(2), Income Tax Regs. Despite the statutory

timing provisions of section 83(h), which ‘are also contained in section

1.83-6(a)(1) and (2), Income Tax Regs., section 1.83-6(a)(3), Income Tax Regs.

(hereinafter subparagraph (3)), provides:

(3) Exceptions. Where property is substantially vested upon transfer,

the deduction shall be allowed to such person in accordance with his

method of accounting (in conformity with sections 446 and 461). ° ° °

Pursuant to this exception, when the compensatory transfer consists of property

that is substantially vested upon transfer (which is true in the instant case), the

explicit timing provisions of section 83 (h) and the regulations are not

applicable.'° Petitioner's transfers come within the exception in subparagraph

(3).

The majority suggests that the exception in subparagraph (3) overrides the

explicit statutory timing requirements in section 83 (h) but does not override

the withholding requirements in section 1.83-6(a)(2), Income Tax Regs. This is

a non sequitur. Section 1.83-6(a)(2), Income Tax Regs., imposes a withholding

requirement, but only in connection with the application of its specific timing

provisions. Thus, in the only sentence that has any application to this case, the

regulation provides:

If the service provider is an employee of the person for whom services

were performed, such deduction is allowed for the taxable year of the

’ Sec. 83 (h) requires that any deduction by the service recipient be allowed “for the taxable

year of such person [the service recipient or employer] in which or with which ends the taxable

year in which such amount is included in the gross income of the person who performed such

services.” In light of the explicit timing provisions of sec. 83(h), how can the exception in

subparagraph (3) be justified? The original version of sec. 83 introduced in the House of

Representatives contained no provision regarding deductions for property transferred in retum

for services. What is now sec. 83 (h) was first introduced by the Senate Finance Committee. The

Senate report states:

The committee provided rules for the employer's deduction for restricted property given

to employees as compensation. The allowable deduction is the amount which the employee

is required to recognize as income. * * * [S. Rept. 91-552, at 123 (1969), 1969-3 C.B. 423,

502; emphasis added. |

It is therefore possible that the U.S. Treasury Department concluded that sec. 83(h) was not

intended to affect deductions based on the transfers of unrestricted property.

ne ee eae es

33a

employer in which or with which ends the taxable year of the employee

in which such amount is includible as compensation, but only if the

employer deducts and withholds upon such amount in accordance with

section 3402. ° * ° [Sec. 1.83-6 (a) (2) , Income Tax Regs. |

The literal terms of the withholding requirement in the above-quoted

regulation apply only where the deduction is allowed for the employer's taxable

year in which or with which ends the taxable year in which the compensation

is includible in the employees’ income; i.e., where the timing rules of section

83 (h) apply. The withholding requirement does not purport to apply to other

situations, such as where the deduction is allowed in accordance with the

employer's own accounting method pursuant to subparagraph (3).

The majority states that the regulations under section 83 (h) implement the

following three requirements for deductibility: (1) The requirements of sections

162 or 212; (2) the requirements of section 83 (h) regarding the amount of the

deduction; and (3) the requirements of section 83 (h) regarding the timing of

the deduction. There is no question in this case that the transfer of property

qualifies for deduction under section 162. Deductions under section 162 are

not conditioned on withholding. There is also no question in this case regarding

the amount of any potential deduction pursuant to the formula in the statute.'!

As stated in the Senate Finance Committee report: “The allowable deduction

is the amount which the employee is required to recognize as income.” S. Rept.

91-552, supra at 123, 1969-3 C.B. at 502. (Emphasis added.) As we stated in

Duncan Indus.. Inc. v. Commissioner, 73 T.C. at 285:

Section 83 (h) expressly allows the person for whom the services were

performed to deduct an amount equal to the amount includable in the service

performer's income under section 83(a). * * * [Emphasis added.]

The only other requirement concerns timing.'? The majority argues that

subparagraph (3) is only an exception to the statutory timing provision. But that

is the only statutory requirement that is conceivably in issue.

'' The majority makes no attempt to link the regulatory withholding requirement to the

statutory provisions regarding the amount of any deduction and, indeed, there is no linkage.

'® As stated in Duncan Indus., Inc. v. Commissioner, 73 T.C. 266, 285 (1979):

Section 83 (h) is a modification of section 162 which only affects the time and

amount of deductions otherwise allowable, when property is transferred in

connection with services. * * * [Emphasis added. ]

34a

We recently addressed the exception contained in subparagraph (3). In

Schmidt Baking Co. v. Commissioner, 107 T.C. 271 (1996), the taxpayer-

employer's taxable year ended on December 28. The taxpayer deducted

vacation and severance pay that it had accrued as of December 28, 1991, on its

return for the year ended December 28, 1991. The taxpayer’s employees

received unrestricted property representing the accrued vacation and severance

pay on March 13, 1992, which was during the employees’ calendar year ended

December 31, 1992. If the explicit timing provisions of section 83 (h) and

section 1.83-6(a)(2), Income Tax Regs., applied, the taxpayer would not have

been entitled to take the deduction until its taxable year ended December 28,

1993; i.e., the taxpayer's taxable year in which or with which ends the

employee's taxable year in which the amount was includible in the employee's

income. Nevertheless, based on the exception in subparagraph (3), we allowed

the deduction in the year ended December 28, 1991, in accordance with the

taxpayer's accrual method of accounting.'®

The instant case turns on an interpretation of section 83 and the regulations.

Legal interpretations should not be driven by the facts of a particular case.

While I disagree with the majority's interpretation, I recognize that the

operative facts of this particular case raise questions about the “equity” of

allowing a corporate deduction for compensation paid to its controlling

shareholders and principal officers, who failed to report the same items as

income. However, neither respondent nor the majority relies on equitable

arguments. In any event, such considerations should play no part in how we

interpret statutory and regulatory language.

COHEN, WELLS, BEGHE, CHIECHI, AND GALE, ]]., agree-with this

dissent.

HALPERN, J., dissenting: The majority concludes: “An amount is deductible

under section 83 (h) in the year that the corresponding income is ‘included’ in

the recipient employee's income, which means to us that the amount is taken

into account in determining the tax liability of the employee for that year.” The

majority explains: (1) “When read in view of the legislative intent for section

83, the text of section 83(h) is unambiguous” and (2) “Given the clarity of this

text, our inquiry starts and ends with the statutory text, and we apply the plain

'S In Schmidt Baking Co. v. Commissioner, 107 T.C. 271 (1996), the parties had stipulated

that the taxpayer-employer had not withheld taxes when it transferred the property on Mar. 13,

1992.

Oe ee

35a

and common meaning of that text.” The majority is correct that the word

“include” has the plain, common, and unambiguous meaning ascribed to it by

the majority: i.e., “To consider with or place into a group, class, or total”. The

American Heritage Dictionary of the English Language 913 (3d ed. 1992). The

question, however, is not whether Congress is skilled in rhetoric, or used the

word “included” unambiguously in section 83(h), but what the word “included”

means in the context of section 83(h). The Supreme Court has said: “Ambiguity

is a creature not of definitional possibilities but of statutory context”. Brown v.

Gardner, 513 U.S. 115, 117 (1994) (citing King v. St. Vincent's Hosp., 502 U.S.

215, 221 (1991) (“[T]he meaning of statutory language, plain or not, depends

on context.”) All of the majority, Judge Ruwe, and Judge Colvin have failed to —

give sufficient weight to the contextual relationship between the word “included”

and the phrase “in the gross income”. Gross income is a legal concept and not

a reporting position. The term “gross income” has the general definition set

forth in section 61(a), and, unless the word “included” is used in an unusual

sense, it is a question of law whether or not any particular receipt is included

or excluded from gross income. If context is to govern meaning, then, relying

on the “plain and common meaning of that text [sec. 83(h)]”, I conclude that

the meaning of the phrase “included in the gross income of the [service

provider]” means included as a matter of law. Nothing in the majority's

description of Congressional purpose for section 83 (“primarily to set forth

rules on the tax treatment of deferred compensation arrangements known as

restricted stock plans” leads me to believe that Congress intended the word

“included” in section 83(h) to have an unusual meaning. The majority cites S.

Rept. 91-552, 1969-3 C.B. 423 (S. Rept. 91-552 (1969)), wherein it is stated:

The allowable deduction is the amount which the employee is required to

recognize as income. The deduction is to be allowed in the employer's

accounting period which includes the close of the taxable year in which the

employee recognizes the income. ° * * [1969C.B. at 502; emphasis added. |

On its face, the language of S. Rept. 91-552 is ambiguous. In the income tax

law, the word “recognize” is a term of art, connoting a noncognitive act — gain

or loss being recognized “to” a person, not “by” a person. See, e.g., secs. 361 (a),

731 (a) and (b), 1245(b)(3). Nevertheless, the majority has persuaded me that

we should proceed as if section 83 (h) were ambiguous.

' “Ambiguity exists if reasonable persons can find different meanings in a statute”. Black's

Law Dictionary 79 (6th ed. 1990)

We are not without guidance, however, because we have interpretive

regulations, section 1.83-6(a), Income Tax Regs. (section 1.83-6(a)).? Those

regulations contain both a general rule, in subparagraph (1) (the general rule),

and a special rule, in subparagraph (2) (the special rule). The general rule is as

follows: “[The section 83 (h) deduction] shall be allowed only for the taxable

year of such person [the service consumer] in which or with which ends the

taxable year of the service provider in which such amount is includible as

compensation.” (Emphasis added.) The general rule applies to all service

consumers, whether an employment relationship exists with the service provider

or not. The special rule applies only to service consumers that are employers,

and it differs from the general rule only in that it conditions the deduction on

withholding.

In Chevron, U.S.A., Inc. v_ Natural Resources Defense C Inc... 467

U.S. 837, 842 — 843 (1984), the Supreme Court stated that, when a Court

reviews an agency's construction of a statute that it administers, it is confronted

with two questions:

First, always, is the question whether Congress has directly spoken to

the precise question at issue. If the intent of Congress is clear, that is the

end of the matter; for the court, as well as the must give effect to

the unambiguously expressed intent of Congress.

“The Judiciary is the final authority on issues of statutory construction

and must reject administrative constructions which are contrary to chear

congressional intent. If a court, ¢ traditional tools of

construction, ascertains that _C an intention on the

question at issue, that intention is the law and must be given effect

id. at 842-843 (citations omitted; emphasis added). Second, if section Kh)

is ambiguous, then we must address: “[W]hether the agency's answer is tassel

on, a permissible [reasonable] construction of the statute.” id. at 537-404. If

section 83(h) is not ambiguous, and carries the must-be-reported meaning

ascribed to it by the majority, then the general rule is necessarily invalid

because it conditions a deduction only on inchudability (as a matter of law), and

not on reporting. The majority has not considered that consequence i

reaching its conclusion about the (lack of) ambiguity in section Mh). bnckewed,

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