Appendix — Bergbauer v. United States

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APPENDIX A — OPINION OF THE UNITED STATES

COURT OF APPEALS FOR THE FOURTH CIRCUIT

DECIDED APRIL 16, 2010

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

No. 08-2054

UNITED STATES OF AMERICA,

Plaintiff-Appellee,

v.

ROBERT L. BERGBAUER;

MARIE T. BERGBAVER,

Defendants-Appellants.

Appeal from the United States District Court

for the District of Maryland, at Baltimore.

Richard D. Bennett, District Judge.

(1:05-ev-02132-RDB)

Argued: January 28, 2010

Decided: April 16, 2010

Before MOTZ, SHEDD, and AGEE, Circuit Judges.

Affirmed by published opinion. Judge Agee wrote the

opinion, in which Judge Motz and Judge Shedd joined.

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2a

Appendix A

OPINION

AGEE, Circuit Judge:

Robert and Marie Bergbauer appeal from the grant

of summary judgment to the Government establishing

their federal income tax liability. The district court held

that Robert Bergbauer’s sale of his interest in a

subsidiary of Ernst & Young LLP (“Ernst & Young”)

was a fully taxable event in the year 2000. For the

reasons set forth below, we affirm the judgment of the

district court.

A.

In 1999, Ernst & Young LLP (“Ernst & Young”)

entered into a letter of intent to sell its consulting

business to Cap Gemini, S.A. (“Cap Gemini”). The

parties agreed that Ernst & Young would transfer the

assets of the consulting division of its business to a

newly-formed subsidiary, Cap Gemini Ernst & Young

US LLC (“CGE&Y”), and thereafter distribute

membership interests in CGE&Y primarily to those

partners in Ernst & Young, like Robert Bergbauer, who

worked in the consulting division (“the consulting

partners”). Immediately following the distribution,

Ernst & Young and the consulting partners would sell

their CGE&Y membership interests to Cap Gemini in

exchange for Cap Gemini common stock. As a result,

Cap Gemini would own all the equity interests of CGE&Y

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Appendix A

and operate the former Ernst & Young consulting

practice through that entity.!

Ernst & Young distributed a Partner Information

Document (“PID”) to the consulting partners which

described the proposed transaction.” The PID indicated

that the exchange of CGE&Y membership interests for

Cap Gemini stock would be structured as a “taxable

capital gains transaction,” in which the “partners are

treated as though they receive all of the gain and are

taxed on it.” J.A. 285. The PID also provided that “[a]ll

partners will vest in their shares immediately upon

closing. However, the shares .. . will be subject to

forfeiture” under certain circumstances. J.A. 280. The

Cap Gemini shares received would not be directly

distributed to the consulting partners, but would “be

held in an individual account in an institution such as ..

. Merrill Lynch and [would] be subject to resale

restrictions.” J.A. 278.

Twenty-five percent of each consulting partner’s

Cap Gemini shares would be released for sale shortly

after the transaction closed, so the consulting partner

could cover the 2000 tax liability incurred as a result of

1 The consulting partners would then sever their

relationship with Ernst & Young by divesting their

partnership interests in Ernst & Young, cashing out their

capital accounts, and becoming employees of CGECY.

2. The PID was not a contract document to be executed by

the parties, but an informational document somewhat akin to a

prospectus for security investments.

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Appendix A

recognizing the receipt of all the Cap Gemini stock as

income that year. The remaining seventy-five percent

of a partner’s shares would be held in a restricted

brokerage account for that partner and could be

“monetized,” that is sold, in installments of up to fifteen

percent of the partners’ shares on each of the next five

anniversary dates of the sale. A consulting partner could

not “directly or indirectly, sell, assign, transfer, pledge,

for] grant any option with respect to or otherwise

dispose of any interest” in non-monetized shares.

J.A. 785. While non-monetized shares were held in the

restricted brokerage accounts, those shares were

subject to forfeiture “for breach of [partners’] individual

Cap Gemini agreements, early departures or

termination for cause.” J.A. 280. Upon monetization all

restrictions on those shares lapsed.

Of particular import for the timing-of-income issue

in the case at bar, the PID stated:

The fair market value of the stock received

that cannot be sold immediately will be

calculated at 95 percent of the closing price

of Cap Gemini stock on the day of the

exchange for [CGE&Y] shares. This discount

will slightly reduce tax due on the Cap Gemini

shares received at closing. ... Ernst & Young,

its partners, and Cap Gemini will treat

valuation and related issues consistently for

|U.S.] federal income tax purposes. ...

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Appendix A

For all... partners... [t]he gain on the

sale of the distributed [CGE&Y] shares is

reportable on Schedule D of your U.S. federal

income tax return for 2000.

J.A. 285-86.

The consulting partners, including Robert

Bergbauer, had the opportunity to review the PID before

they met on March 7-8, 2000 to discuss and vote on the

proposed transaction. During its presentation of the

proposed transaction, Ernst & Young’s management

answered questions regarding the tax implications of

the receipt of Cap Gemini stock, particularly the decision

to structure the sale “as a taxable transaction on day

one” in contrast to “creeping vesting” or “structured

vesting.” J.A. 495, 500, 501. It was widely anticipated

among the parties that the value of Cap Gemini stock

would substantially appreciate after closing.

Management explained that in order to obtain long-term

capital gains treatment on future sales of Cap Gemini

stock, the consulting partners must recognize the value

of all the shares as taxable income in 2000, thereby

setting the shares’ cost basis (Internal Revenue Code

(“T.R.C.”) § 1012) and the required capital gains holding

period (I.R.C. § 1223).’ Ultimately, ninety-five percent

of the consulting partners, including Robert Bergbauer,

voted to approve the transaction.

3. Internal Revenue Code sections directly correspond to

those found in Title 26 of the United States Code.

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Appendix A

After the consulting partners’ vote of approval,

Ernst & Young distributed the necessary contract

documents to consummate the transaction. These

documents included, inter alia, the Consulting Partner

Transaction Agreement (“CPTA”), the Master

Agreement, and a brokerage agreement as to the non-

monetized shares (collectively “the transaction

documents”).

In executing the CPTA, the consulting partners

warranted their receipt of Cap Gemini shares would “be

a taxable transaction for U.S. federal income tax

purposes,” but the specific timing language about the

year 2000 was not included as it was in the PID.

J.A. 782. Certain provisions of the Master Agreement

(1) reflected that the Cap Gemini shares “not monetized

in the Initial Offering [would] be valued for tax purposes

at 95% of the otherwise-applicable market price,”

J.A. 1047, (2) instructed the parties to treat the

transaction as a sale and not to take a contrary position

in any tax return without the written consent of Cap

Gemini, and (3) stated that neither Cap Gemini nor its

affiliates were the legal or beneficial owner of the shares

received by the consulting partners.

The CPTA also contained a liquidated damages

clause, which provided that consulting partners could

be terminated for cause, voluntarily leaving CGH &Y, or

breaching the non-compete or confidentiality provisions

of their Cap Gemini employment agreements, and be

required to forfeit some or all of their non-monetized

shares. The percentage of Cap Gemini stock subject to

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Appendix A

forfeiture depended upon the triggering forfeiture

event.‘

B.

Robert Bergbauer executed the required

transaction documents on May 1, 2000, and received, in

exchange for his CGE&Y membership interest, 10,740

shares of Cap Gemini stock subject to the limitations

and restrictions noted above.’ The Bergbauers timely

filed their year 2000 federal income tax return consistent

with the PID and transaction documents. On Schedule

D of their 2000 return, the Bergbauers reported the

value of all the Cap Gemini shares as taxable income.

Twenty-five percent of the shares were valued at the

4. If an event occurred triggering the forfeiture provision,

partners could lose: (a) 100% of their stock before December

31, 2000; (b) 75% of their stock before the first anniversary of

the closing; (c) 56.7% of their stock on or after the first

anniversary of the closing and before the second anniversary

of the closing; (d) 38.4% of their stock on or after the second

anniversary of the closing and before the third anniversary of

the closing; (e) 20% of their stock on or after the third

anniversary of the closing and before the fourth anniversary of

the closing; and (f) 10% on or after the fourth anniversary of

the closing and prior to the end of the 4-year, 300-day restricted

period. If a consulting partner was terminated for “poor

performance,” up to fifty percent of the prescribed percentage

could be forfeited at the discretion of CGEY. J.A. 787.

5. Shortly after the closing, Robert Bergbauer sold twenty-

five percent of his Cap Gemini stock and the proceeds were

distributed to him.

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Appendix A

full closing price of $155.30 and the remaining seventy-

five percent at ninety-five percent of that value,

$148.52.°

On each successive anniversary date of the closing,

2,013.75 shares were monetized, that is released, from

the restricted brokerage account and made available to

Bergbauer for sale. While the non-monetized shares

were held in the restricted brokerage account,

Bergbauer received the dividend income attributable

to those shares.

In December 2002, CGE&Y terminated Robert

Bergbauer’s employment as part of a reduction in force

following the “dot com bubble burst.” J.A. 81.

Bergbauer, however, did not forfeit any of his Cap

Gemini shares and received a cash severance payment.

He later found employment at KPMG where he became

a full equity partner.

By 2003, in contrast to the consulting partners’

expectations, the Cap Gemini share price had dropped

precipitously.’ Bergbauer and other former Ernst &

6. The Bergbauers’ 2000 return reported total capital gain

income of $1,515,814, total taxable income of $2,473,832, and a

federal income tax liability of $676,493.

7. The drop in share price was reflected by Bergbauer’s

sale of his monetized Cap Gemini shares: (1) 555 shares at

$76.77 in April 2002, netting proceeds of $42,607.06; (2) 4,278

shares at $33.09 in May 2003, netting proceeds of $141,569.00;

(3) 2,148 shares at $46.45 in September 2003, netting proceeds

of $99,792.51; and (4) 1,074 shares at $24.68 in October 2004,

netting proceeds of $26,505.67.

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Appendix A

Young colleagues discussed the prospect of filing

amended year 2000 tax returns based on “what had

happened to the value of the Cap [Gemini] stock.”

J.A. 92.

The Bergbauers filed an amended year 2000 federal

income tax return in 2008, taking the position that only

the twenty-five percent of Cap Gemini shares, those

which were monetized and then sold in 2000, were

taxable income for that year. Citing the “lack of control

over the remaining Seventy-F ive (75%) of the stock in

the trust,” the Bergbauers contended those shares were

not taxable in 2000 because Robert Bergbauer “did not

receive the stock,” but should have been recognized as

income only in the years of monetization and valued at

the much lower market rates. J.A. 914. The amended

return correspondingly reduced the amount of 2000

taxable income, resulting in a claim for a refund of

$253,490 plus accrued interest.

The Internal Revenue Service (“IRS”) reviewed the

amended return and agreed to abate the Bergbauers’

year 2000 tax liability by the requested $253,490. The

IRS applied $100,000 as a credit to the Bergbauers’ 2001

tax liability and cut a check to them for the remainder

plus accrued interest.

Upon further examination, the IRS later

determined that the abatement and refund had been

made in error. As a result, a civil action was brought

against the Bergbauers under I.R.C. § 7405, seeking

payment to the Government of the erroneous tax

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Appendix A

refund. After the parties conducted discovery, the

Government filed a motion for summary judgment

contending the undisputed facts proved the value of all

the Cap Gemini stock was taxable income in 2000 and

the tax refund was in error. The Bergbauers responded

with a cross-motion for summary judgment, arguing the

abatement and refund were not erroneous because only

twenty-five percent of the stock was taxable income in

2000."

The district court observed that, when determining

the tax treatment of a transaction, the Fourth Circuit

“applies a two-pronged test which examines (1) the

intent of the parties; and (2) the economic substance of

the transaction,” United States v. Bergbauer, No. 05-

2132, 2008 U.S. Dist. LEXIS 66681, 2008 WL 3906784,

at *% (D. Md. Aug. 18, 2008) (citing Gen. Ins. Agency,

Inc. v. Comm’r, 401 F.2d 324, 327 (4th Cir. 1968)),

commonly termed the “economic reality” test. The court

determined that the intent prong of the economic reality

test showed an intent to recognize the value of all the

Cap Gemini stock as taxable income in 2000. /d. at *10.

8. The district court initially postponed a decision until

other district courts considering the same question concerning

former Ernst & Young consulting partners had an opportunity

to rule. See United Stutes v. Bergbauer, No. 05-2132, 2008 U.S.

Dist. LEXIS 66681, 2008 WL 3906784, at “4 (D. Md. Aug. 1,

200%). To date, there are more than 200 cases pending in the

lower courts or administratively with the IRS in which former

Ernst & Young consulting partners have sought to defer their

recognition of income from the sale of their CGE&Y interests

to Cap Gemini in 2000.

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Appendix A

The district court also concluded that the parties

bargained at arms-length for, and received, real

economic benefit from treating all the Cap Gemini stock

as received for income tax purposes in 2000. /d.

Accordingly, the district court awarded summary

judgment to the Government and denied the

Bergbauers’ motion. /d. at *11.

The Bergbauers noted a timely appeal, and we have

jurisdiction pursuant to 28 U.S.C. § 1291.

I].

We review an award of summary judgment de novo.

Desmond v. PNGI Charles Town Gaming, LL.C., 564

i3d 688, 691 (4th Cir. 2009). Summary judgment is

appropriate only “if the pleadings, the discovery and

disclosure materials on file, and any affidavits show that

there is no genuine issue as to any material fact and

that the movant is entitled to judgment as a matter of

law.” Fed. R. Civ. P 56(¢)(2); Hrwin v. United States, 591

3d 313, 327 (4th Cir. 2010). Because the Bergbauers’

claims were rejected on summary judgment, we view

the factual evidence in the light most favorable to them.

See Walker v. Prince George’s County, 575 F.3d 426, 427

(4th Cir. 2009) (citing Anderson v. Liberty Lobby, Inc.,

477 U.S. 242, 255, 106 S. Ct. 2505, 91 L. Ed. 2d 202 (1986)).

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Appendix A

IT].

This case presents the issue of the timing of the

receipt of income: Were the Bergbauers the taxable

recipients of all the Cap Gemini shares in 2000 or only

the twenty-five percent monetized and available for sale?

The Bergbauers do not contest the valuation of the

shares, the adequacy of consideration, or challenge the

validity of the transaction. They simply contend that the

&,055 non-monetized Cap Gemini shares were not

“received,” for income tax purposes, in 2000 and

therefore should not be “recognized” as income in that

year, Citing [.R.C. § 451(a), the Bergbauers argue that

cash method taxpayers, like them, should report income

in the tax year in which they actually or constructively

receive it. See I.R.C. § 451(a) (“The amount of any item

of gross income shall be included in the gross income

for the taxable year in which received by the taxpayer

”),

The Bergbauers posit that Robert was not in actual

receipt of the non-monetized shares in 2000 because

those shares were held in a restricted account and

subject to transfer prohibitions. Citing the regulations

under § 451 in 26 C.IR. § 1.451-2(a), the Bergbauers

also argue there was no “constructive receipt” of the

non-monetized shares in 2000 because of both the

restrictions on transfer and the risk of forfeiture.’

9. 26 CIR. § 1.451-2(a) provides in relevant part

Income although not actually reduced to a taxpayer’:

possession ts con tructively received by him in the

(Clont’d)

Idi

ippendix A

sr. of Appellant at 20. As further support, the

serybauers reference 1R.C. § 48(a)(2), which they claim

sets the timing of recognition of income as “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.”

Br. of Appellant at 28.

Thus, if Robert Berybauer did not “receive” the non

monetized shares in 2000, the Bergbauers argue they

were not required to recognize and report the value of

those shares as taxable income that year. Br. of Appellant

at 24. Instead, the Bergbauers contend that the non

monetized shares were received, for income tax

purposes, servatim in each year after 2000 when the

forfeiture restrictions lapsed and the shares were

released and available for transfer. Br. of Appellant at

14.15. The Bergbauers conclude that their intention,

and that of the other parties, that the “shares be deemed

to have been rececived sooner for tax purposes could not

hasten the taxability of the shares” because 4 451 or

5838 foreclose that result. Bro of Appellant at 2%

The Government responds by citing the unanimou

decisions from courts in other circuits addressinge the

(Clont’d)

taxable year during which it is credited to his aecount

set apart for him, or otherwise made available so that

hemay draw Uponitatany tine However, income

is not constructively received if the taxpayer's control

Of its receipt is subseet lo substantial limitations on

restimetion

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Appendix A

claims of similarly situated former Ernst & Young

consulting partners, all of which have determined that

the value of all the Cap Gemini shares was fully taxable

in 2000. See, e.g., United States v. Fletcher, 562 F.3d 839

(7th Cir. 2009). Recognizing that decisions from outside

this Circuit use different standards in evaluating the

recharacterization of a taxable transaction, the

Government also argues the district court correctly

applied our Court’s economic reality test and that the

Bergbauers’ statutory argument is misplaced. Br. of

Appellee at 26-27.

We note that the Bergbauers do not contend the

economic reality test is invalid. Instead, the bottom line

of their position is that the provisions of § 451 and § 83

supersede any application of that test and mandate their

proposed tax treatment of the Cap Gemini stock. We

disagree and find the district court properly applied our

precedent and committed no error in awarding summary

judgment to the Government.

In Commissioner v. National Alfalfa Dehydrating

and Milling Co., 417 U.S. 134, 94S. Ct. 2129, 40 L. Ed.

2d 717 (1974), the Supreme Court stated:

(While a taxpayer is free to organize his

affairs as he chooses, nevertheless, once

having done so, he must accept the tax

consequences of his choice whether

contemplated or not, and may not enjoy the

benefit of some other route he might have

chosen to follow but did not.

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Appendix A

417 U.S. at 149 (internal citations omitted); Signet

Banking Corp. v. Comm’r, 118 F.3d 239, 241 (4th Cir.

1997) (same); see also Frank Lyon Co. v. United States,

435 U.S. 561, 583-84, 98 S. Ct. 1291, 55 L. Ed. 2d 550

(1978) (holding that “the Government should honor the

allocation of rights and duties effectuated by the parties”

when “there is a genuine multiple-party transaction with

economic substance .. . compelled or encouraged by

business or regulatory realities, ... imbued with tax-

independent considerations, and ... not shaped solely

by tax-avoidance features that have meaningless labels

attached”); 7d. at 584 (“Expressed another way, ... the

form of the transaction adopted by the parties governs

for tax purposes.”); accord Gray v. Powell, 314 U.S. 402,

414, 62 S. Ct. 326, 86 L. Ed. 301 (1941) (“The choice of

disregarding a deliberately chosen arrangement for

conducting business affairs does not lie with the creator

of the plan.”).

In embracing National Alfalfa’s principle, “courts

have established very strict standards,” Furman v.

United States, 602 F. Supp. 444, 456 (D.S.C. 1984), for a

taxpayer who elects “a specific course of action and then

when finding himself in an adverse situation [seeks to]

extricate himself by applying the age-old theory of

substance over form.” Cornelius v. Comm’r, 494 F.2d

465, 471 (5th Cir. 1974) (quotation omitted). We have

recognized that “[g]Jenerally, taxpayers are liable for the

tax consequences of the transaction they actually

execute and may not reap the benefit of recasting the

transaction into another one substantially different in

economic effect that they might have made.” K'state of

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Appendix A

Leavitt v. Comm’r, 875 F.2d 420, 423 (4th Cir. 1989); see

also Signet, 118 F.3d at 242 (“[T]he bank simply cannot

structure the terms of the cardholder agreement to its

advantage and then rely on an indeterminate question

of Virginia law to evade the federal tax implications

thereof.”); Snowa v. Comm’r, 123 F.3d 190, 198 n.11 (4th

Cir. 1997) (observing that § 1034(g) of the Internal

Revenue Code “provide[d] a legislative exception to the

general rule that a taxpayer cannot recharacterize a

transaction to avoid the tax consequences of the form

of the transaction actually chosen”).

To put it plainly, we have bound taxpayers to “the

‘form’ of their transaction” when they attempt to

recharacterize an otherwise valid agreement bargained

for in good faith. Estate of Leavitt, 875 F.2d at 423. We

have also refused to entertain arguments “that the

‘substance’ of their transaction triggers different tax

consequences.” Jd. This precept not only maintains the

vital public policy of enforcing otherwise valid contracts,

but also assures the reliability of agreed tax

consequences to the public fise.

“[Ajllowing the government to adopt as conclusive

a result agreed to by the parties . . . provide[s] a more

efficient system that... greatly reduce|s| the possibility

of litigation ... aimed at revising the parties’ bargained

agreement.” Sullivan v. United States, 618 F.2d 1001,

1004 (3d Cir. 1980); see also Furman, 602 F. Supp. at

455 (“To allow a taxpayer to unilaterally reform one end

of a bargain could encourage taxpayers to ignore

agreements as written in the hope that the courts will

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Appendix A

give them more advantageous tax treatment.”). To do

otherwise would allow situations to be created where

the alteration of tax benefits, as a result of inconsistent

reporting, “whip-saws” the Government and results in

disastrous and unfair effects on our tax system.

Sullivan, 618 F.2d at 1004 (recounting the previous

practice of parties “advocat{ing] mutually conflicting tax

characterizations of their agreement[s],” which

“frequently” would compel the Commissioner “to assess

inconsistent deficiencies” and to pursue litigation

against both parties “in separate suit[s],” wherein the

Commissioner was forced to take “divergent positions

so as to avoid two adverse judgments”).

There is no “disparity” in allowing “the

Commissioner alone to pierce formal” agreements as

“taxpayers have it within their own control to choose in

the first place whatever arrangements they care to

make.” Comm ’r v. Danielson, 378 F.2d 771, 775 (3d Cir.

1967) (en bane). The Government’s interest lies “in

having the transaction reported consistently by” the

parties to the sale. Throndson v. Comm’r, 457 F.2d 1022,

1024 n.2 (9th Cir. 1972). In this case, the Government

never challenged the Bergbauers’ recognition of the

value of all 10,740 Cap Gemini shares as taxable income

in 2000. All the other parties to the transaction,

including Cap Gemini, reported the stock transfer

consistent with the Bergabuers’ treatment on the 2000

return and the Commissioner has not challenged those

actions.

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Appendix A

With the foregoing in mind, our Circuit has applied

a two-pronged “economic reality” test when reviewing

a taxpayer’s attempt to recharacterize the tax

consequences of a transaction." Gen. Ins. Agency, Inc.,

10. Other circuits have fashioned their own standards for

determining whether a taxpayer may challenge his prior

treatment of the tax consequences of a transaction. As these

standards do not apply in the Fourth Circuit, we mention them

only for informational purposes. Twe such standards are the

Danielson rule and the “strong proof” rule. In Commissioner

v. Danielson, 378 F.2d 771 (3d Cir. 1967) (en bane), the Third

Circuit held that a taxpayer could recharacterize the terms of a

transaction only if those terms were unenforceable due to

“mistake, undue influence, fraud, [or] duress, etc.” Danielson,

378 F.2d at 775; see also Bradley v. United States, 730 F.2d 718,

720 (Lith Cir. 1984) (“A party can challenge the tax consequences

of his agreement as construed by the Commissioner only by

adducing proof which in an action between the parties would

be admissible to alter that construction or to show its

unenforceability because of mistake, undue influence, fraud,

duress, et cetera.”) (quotations omitted) (emphasis in original);

Smith v. Comm’r, 65 F.3d 37, 40 (5th Cir. 1995) (“[A] taxpayer

may argue substance over form when necessary to prevent

unjust results, and when proof is offered which in an action

between the parties would be admissible to alter that

construction or to show its unenforceability because of mistake,

undue influence, fraud, duress, etc.”) (quotations and internal

citation omitted).

The “strong proof” rule requires a party to adduce “strong

proof” that the parties intended an allocation different than

that included in the contract. See N. Am. Rayon Corp. v. Comm’r,

12 F.3d 583, 588 n.6 (6th Cir. 1993) (“The ‘strong proof’ rule

requires a party seeking to disregard the express price

(Cont’d)

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Appendix A

401 F.2d at 329-30; see also Volvo Cars of N. Am., LLC

v. United States, 571 F.3d 373, 379 (4th Cir. 2009) (“[Wle

have long held that the parties’ intent and the relevant

facts are critical in construing contracts for federal tax

purposes.”); Thomas v. Comm’r, T.C. Memo 2002-108,

83 T.C.M. (CCH) 1576 (2002) (recognizing and applying

the “economic reality” test). The economic reality test

examines (1) the intent of the parties, and (2) the

economic substance of the transaction. The

determination of the parties’ intent and the economic

substance of the transaction are questions of fact, with

the taxpayer bearing the burden of proof. Gen. Ins.

Agency, Inc., 401 F.2d at 329.

The district court concluded that the provisions in

the transaction documents, particularly the CPTA and

Master Agreement, “strongly demonstrate[d]” that it

was the parties’ understanding that all Cap Gemini

shares would be immediately taxable at the

transaction’s closing. Bergbauer, 2008 U.S. Dist. LEXIS

66681, 2008 WL 3906784, at *5. However, the court

recognized that other sections of the transaction

documents, namely the forfeiture and stock transfer

(Cont'd)

allocations in an agreement to adduce strong proof that the

parties actually intended to attribute different values than

those stated in the agreement.”); Rogers’ Estate v. Conum’r, 445

EF2d 1020, 1021 (2d Cir. 1971) (“In this Circuit, the rule is, that

when the parties to a transaction ... have specifically set out

the covenants in the contract and have there given them an

assigned value, strong proof must be adduced by them in order

to overcome that declaration.”) (quotation omitted).

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Appendix A

restriction provisions, could be in conflict with immediate

taxation of the non-monetized shares. /d. at *8-9.

Without a definitive answer from the plain language

of the transaction documents, the district court turned

its analysis to the extrinsic evidence, particularly the

PID, and found that this evidence “shed[ ] light on the

terms of the transaction documents,” and demonstrated

that “the parties’ original intent was for the [c]onsulting

[pJartners to be immediately taxed on the entirety of

the shares they received at the transaction’s closing on

May 23, 2000.” Jd. at *10.

We conclude that the district court did not clearly

err in this finding. Indeed, the Bergbauers conceded

the intent prong of the economic reality test on appeal,

i.e., that the parties intended the value of all the Cap

Gemini shares exchanged for the CGE&Y membership

interests be fully taxed in 2000. Even without such a

concession, the district court’s determination of intent

was strongly supported by the record evidence.

Several provisions of the PID demonstrate that the

parties plainly intended for Robert Bergbauer to be

immediately taxed on all 10,740 Cap Gemini shares in

2000. Not only did the PID provide that the transaction

would be structured as a “taxable capital gains

transaction,” J.A. 285, but it also stated that “Ernst &

Young, its partners, and Cap Gemini [would] treat

valuation and related issues consistently.” J.A. 285-86.

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Appendix A

But, most importantly, the PID unequivocally stated

that “[aJll partners [would] vest in their shares

immediately upon closing,” J.A. 280, and “[t]he gain on

the sale of the [CGE&Y interests] [would be] reportable

on Schedule D of [their] U.S. federal income tax return

for 2000.” J.A. 286.

Further, Arthur Gordon, Ernst & Young’s director

of tax in 2000, testified that the consulting partners

knew the intent of the parties was to close the

transaction so they would own all the Cap Gemini shares

outright that year, thus establishing a cost basis and

holding period for long-term capital gain treatment of

future sales of the stock. As the district court observed,

“even if Robert Bergbauer did not immediately

appreciate the operative tax language contained within

the PID, after attending the March 7-8, 2000 meeting

he was well aware that all parties to the agreement”

intended for the consulting partners to be “immediately

taxed” on all their Cap Gemini shares in 2000. Bergbauer,

2008 U.S. Dist. LEXIS 66681, 2008 WL 3906784, at *9.

Finally, the Bergbauers’ initial 2000 tax return, wherein

they reported as income the value of all 10,740 Cap

Gemini shares, demonstrates that the Bergbauers

understood the intention to be taxed on the entirety of

those shares in 2000.

While the parties intended immediate taxation on

all the Cap Gemini shares in 2000, the “economic reality”

test requires that there be economic substance to that

decision. See Halle v. Comm’r, 83 F.3d 649, 655 (4th Cir.

1996) (explaining that “we must look beyond the parties’

22a

Appendix A

terminology to the ‘substance and economic realities’

of the [transaction], gleaned from the totality of the

circumstances surrounding the transaction”). In other

words, the “economic realities surrounding the

transaction in this case [must] confirm” that the parties’

agreement to treat the shares as immediately taxable

“accurately portrayed their intentions.” Jd.; see also

Wrangler Apparel Corp. v. United States, 931 F. Supp.

420, 426 (M.D.N.C. 1996) (“The second prong of the

General Insurance test requires that the covenant

bargained for have some independent value grounded

in economic reality.”).

All parties to the transaction, bargaining at arms-

length, had economic reasons to subject the entirety of

the consulting partners’ Cap Gemini stock to full and

immediate taxation in 2000. For consulting partners, like

Robert Bergbauer, immediate taxation in 2000 was the

means to both start the holding period for capital gains

treatment under I.R.C. § 1223, and at the same time

establish a high cost basis under I.R.C. § 1012. Both

elements were key for Bergbauer and his colleagues to

achieve their goal of minimizing tax when they later

disposed of the Cap Gemini stock after its anticipated

high rise in value.

Cap Gemini, on the other hand, sought to fix its

cost basis for the acquired assets in CGE&Y, and, in

turn, its amortization deductions under I.R.C. § 197. This

course of action also enabled all of the parties to avoid

future litigation over conflicting opinions of value if

anything other than the agreed value of the Cap Gemini

stock was used for tax reporting purposes.

23a

Appendix A

While the stock transfer restrictions and forfeiture

provisions presented a potential risk to the consulting

partners during the non-monetization period, these

provisions were mutually beneficial, in part, to all

parties’ economic interests. The forfeiture provision

clearly benefitted Cap Gemini as a retention mechanism

to preserve the consulting partners’ client relationships,

goodwill, and expertise. But other economic benefits

accrued to Cap Gemini and the consulting partners as

well. As Arthur Gordon testified:

The purpose of the restricted account was

to protect the value of the stock. In one

moment of time we doubled the number of

issued and outstanding shares of Capgemini,

the public company. The feeling was if

everybody was allowed to go to the market at

once, the stock would plummet because you

had too many shares without enough buyers.

So in order to protect everybody’s value, the

partners agreed that they would voluntarily

restrict their shares with the consideration

being that everybody else will restrict their

shares. ...

... And it was an agreement that we would

all lose certain rights for the benefit of the

whole and for us individually.

J.A. 431-32. Thus, it was in each consulting partner’s

economic interest to agree to restrict every other

consulting partner’s transfer and sale of shares.

24a

Appendix A

Flooding the market with Cap Gemini shares would only

depress the price of the stock, thereby damaging every

party’s economic interest in the transaction.

We therefore conclude that the district court did not

err in its conclusion that the terms of the transaction

contained “some economic substance beyond the parties’

subjective intent.” Bergbauer, 2008 U.S. Dist. LEXIS

66681, 2008 WL 3906784, at *10. The district court

properly determined that the second prong of the

economic reality test was met because the terms of the

transaction were grounded in “business reality such that

reasonable men, genuinely concerned with their

economic future, might bargain for such an agreement.”

Gen. Ins. Agency, Inc., 401 F.2d at 330.

Thus, the value of all the Cap Gemini shares should

have been recognized as taxable income in 2000, as

agreed to and reported by all parties, unless the

Bergbauers’ statutory arguments mandate a different

result. We conclude those arguments are without merit.

The Bergbauers’ argument as to § 83 is readily

rejected. The restrictions under that statute on the

recognition of income for property not “transferable”

or “subject to a substantial risk of forfeiture” applies

only if the property is transferred “in connection with

the performance of services.” I.R.C. § 83(a). The CGE&Y

for Cap Gemini equity interest exchange was clearly not

related to the performance of services and the

Sergbauers do not contend to the contrary. Thus, the

plain terms of § 83 verify that statute has no application

to this case.

25a

Appendix A

The argument as to I.R.C. § 451 is similarly

unavailing. If Robert Bergbauer had received the Cap

Gemini stock in the absence of an agreement, but

subject to the forfeiture and restricted transfer

provisions, his timing argument for the year of income

recognition might have more credence. Of course, he

did not receive the Cap Gemini stock in the abstract or

in a vacuum, Neither are the tax consequences to be

adjudicated in that context, but upon the totality of the

circumstances. As the legion of caselaw set forth above

clearly iJlustrates, a taxpayer’s choice of tax treatment

under a binding contract is not an optional commitment.

“(TJaxpayers are liable for the tax consequences of the

transaction they actually execute and may not reap the

benefit of recasting the transaction into another one

substantially different in economic effect that they might

have made.” state of Leavitt, 875 2d at 423.

In this case, the parties bargained for mutually

beneficial tax consequences with the consulting

partners receiving a high basis for future capital gains

treatment in exchange for immediate taxation in 2000.

At the same time, Cap Gemini received a set

amortization basis in exchange for foregoing the

opportunity (or risk) of a different basis if a structured

stock-distribution schedule were used. This allocation

fixed the tax consequences for both parties and enabled

the Government to receive the benefit of higher taxable

income from the consulting partners in 2000, offset over

time by Cap Gemini’s higher-based amortization

deductions in later years, as well as the potential

reduced tax when the consulting partners sold Cap

Gemini stock at long-term capital gains rates.

26a

Appendix A

The Berghauers point to no statute or caselaw which

would permit them to unilaterally change the agreed

upon tax treatment of the transaction, years after the

fact, because their prior choices no longer serve their

economic interests. Nothing in § 451 or any other

provision of the Internal Revenue Code permits a

taxpayer to whipsaw the Government and the other

parties to the transaction by unilaterally altering the

agreed tax treatment, which has economic substance

and reflects his intent, after the fact when the winds of

change foment delayed seller’s remorse. The principle

established in National Alfalfa is as valid now as when

pronounced nearly four decades ago and settles the

issue raised by the Berybauers:

[While a taxpayer is free to organize hi

affairs as he chooses, nevertheless, once

having done so, he must accept the tas

consequences of his choice, whether

contemplated or not, and may not enjoy the

benefit of some other route he might have

chosen to follow but did not.

417 U.S. at 149 (internal citations omitted); Signe

Banking Corp., 118 b.3d at 241 (same).

We therefore reject the Bergbauers’ contention that

§ 401 grants them the authority to rewrite the tax

treatment of the Cap Gemini stock which they agreed

upon, and did, treat as fully taxable income in 2000 and

for which there were reasons of bona fide economic

substance

28a

APPENDIX B— MEMORANDUM OPINION OF THE

UNITED STATES DISTRICT COURT FOR THE

DISTRICT OF MARYLAND

DATED AUGUST 18, 2008 AND

FILED AUGUST 19, 2008

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MARYLAND

Civil Action No. RDB-05-2132

UNITED STATES OF AMERICA

Plaintiff

v.

ROBERT L. BERGBAUER et ux.

Defendants

MEMORANDUM OPINION

Pursuant to 26 U.S.C. $7405, the Government has

brought this suit against Robert and Marie Bergbauer

to reclaim an erroneous tax refund of $276,510, plus

statutory interest on that amount, accruing from August

4, 2003. The parties have filed cross motions for

summary judgment under Rule 56 of the Federal Rule

of Civil Procedure. At a motions hearing held on July

16, 2008, the parties presented legal arguments in

support of the pending motions and agreed that no

material facts remain in dispute. Under the two-prong,

“economic reality” test of the United States Court of

29a

Appendix B

Appeals for the Fourth Circuit, this Court finds that the

parties intended to treat the underlying transaction as

a fully and immediately taxable event. Accordingly, for

the reasons set forth below, the Defendants’ Cross-

Motion for Summary Judgment (Paper No. 38) is

DENIED and the Government’s Motion for Summary

Judgment (Paper No. 28) is GRANTED.

BACKGROUND

The material facts governing this case are not in

dispute. In autumn 1999, Ernst & Young LLP (“Ernst

& Young “) and Cap Gemini, S.A. (“Cap Gemini “) began

discussing the sale of Ernst & Young’s consulting

business. These discussions materialized when Cap

Gemini acquired Ernst & Young’s consulting business

on May 238, 2000 (“the transaction”). Under the terms

of the transaction, Cap Gemini purchased Ernst &

Young’s consulting business by issuing shares of its

stock, subject to certain restrictions, to Ernst & Young’s

accredited consulting partners (“Consulting Partners”).

There is no dispute that Robert Bergbauer was a

Consulting Partner. When the transaction closed, Robert

Bergbauer left Ernst & Young and joined the newly-

formed Cap Gemini Ernst & Young (““CGE&Y”), the Cap

Gemini affiliate established to take over Ernst & Young’s

consulting division. (Gov’t’s Mem. Supp. Summ. J. Ex.

1 at 8:19-9:12.)

30a

Appendix B

I. The Cap Gemini - Ernst & Young Transaction

On March 2, 2000, pursuant to their ongoing

negotiations with Cap Gemini, but before the

transaction’s consummation, Ernst & Young distributed

to its Consulting Partners a Partner Information

Document and related appendices (collectively, the

“PID”), dated March 1, 2000. (/d. Exs. 2 and 7.) In

pertinent part, the PID indicated that the agreed

purchase price for Ernst & Young’s consulting business

was structured as a fully taxable asset sale

(approximately $6.71 billion), allocated as follows:

Ernst & Young LLP $2.145 billion, consisting

of ¢ 375 million cash and

Sau ean

remainder in Cap Gemini

stock

Ernst & Young $2,191 billion of Cap

consulting partners Gemini stock

Ernst & Young

non-consulting $2,374 billion of Cap

(audit and tax) partners Gemini stock

(/d. Ex. 2, at CG000026.) The PID also indicated that

the Consulting Partners would receive Cap Gemini stock,

recognize gain, and incur federal and state income tax

at the 25 percent capital gains rate. Under the PID,

the Consulting Partners’ would be permitted to

immediately sell 25 pereent of Cap Gemini shares

3la

Appendix B

received to meet their year 2000 tax burden, but the

remainder would be “monetized” for insiallment sales

over the next four years and 300 days. (/d. Ex. 2, at

CG000034.) The PID stated that the Consulting

Partners would vest in their Cap Gemini shares

immediately upon the closing of the transaction. It also

stated that the shares would “be held in an individual

account in an institution such as Merrill Lynch or

Citigroup and [would] be subject to resale restrictions

imposed by Cap Gemini... and under the U.S. securities

laws.” The PID disclaimed that its contents were “not

to be construed as business, legal, or tax advice” and

that each Consulting Partner “must rely ...on the terms

of the transaction.” Ud. at CG000055.)

The PID explained that consent to the transaction

was required by a 75 pereent super-majority of

Consulting Partners. (/d. at CG000058.) At a March 7-

8, 2000 meeting, the Consulting Partners (including

Bergbauer) voted overwhelmingly (approximately 95

percent) to move forward with the transaction. (/d. Ex.

6, Arthur Gordon Dep., at 53:19-54:20.) Prior to the

meeting, Bergbauer had the opportunity to review the

PID, including the portion entitled “Tax Implications.”

At the meeting, Ernst & Young’s management made a

presentation to the Consulting Partners, including

Bergbauer, and answered questions regarding the

proposed transaction and its tax implications. (/d. at 26:1-

26:19; 46:10-48:11; 49:7-49:16; 144:10-147:22.) One

presenter, a former Ernst & Young partner, later offered

testimony explaining that he explicitly fielded questions

32a

Appendix B

regarding the immediate taxability of the shares. He

reported that a vesting schedule was disfavored because

the parties viewed the transaction as a sale of assets

and not an installment sale. Furthermore, he explained

that the transaction was structured for immediate

taxation on shares received by the Consulting Partners

to both avoid compensation issues for the newly formed

CGE@GY and to ensure favorable tax treatment for the

Consulting Partners’ future sale of their Cap Gemini

shares. (/d. at 149:2-151:17.)

Subsequently, on April 7, 2000, the Consulting

Partners received a “Partner Transaction Agreement

Kit” with copies of legal documents that the Consulting

Partners were required to execute pursuant to the

transaction. U/d. Ex. 1, at 52:20-22.) Upon signing the

Consulting Partner Transaction Agreement (“CPTA”)

on May 1, 2000, Bergbauer became a party to the

Master Agreement and all tax related provisions within

both the Master Agreement and the CPTA. (/d. Ex. 10,

at CG4069-4070, 4011, 4068.) Together, the Master

Agreement and the CPTA constitute the operative

transaction documents to the sale. (Jd. Ex. 2, at

CG000032.)

With respect to the Master Agreement, the relevant

tax provisions in this case are sections 7.7(f) and 7.7(h).

Section 7.7(f)(i) of the Master Agreement provided that.

Bergbauer “agreed to determine the value of and

allocate” the Cap Gemini stock as consideration for its

purchase of Ernst & Young’s consulting business.

Further, it stated that “the determination and allocation

33a

Appendix B

derived ... shall be binding upon [Ernst & Young, the

Consulting Partners and Cap Gemini] for all U.S. federal,

state and local Tax reporting purposes.” (/d. Ex. 3, at

CG000541.) Section 7.7(f) also stated that shares “that

are not monetized in the Initial Offering will be valued

for tax purposes at 95 [percent] of the otherwise-

applicable market price.” (Defs.’ Mem. Supp. Cross Mot.

Summ. J. Ex. A.) To supplement section 7.7(f), section

7.7(h) addressed the manner in which the Consulting

Partners would report the sale of Ernst & Young’s

consulting business to Cap Gemini for tax purposes and

required that “each Accredited Partner agree not to take

any position in any tax return contrary to the foregoing

without the written consent of [Cap Gemini].” (Gov’t’s

Mem. Supp. Summ. J. Ex. 3, at CG000543-CG000544.)

Section 5(b)(xii) of the CPTA provided:

Taxable Transaction; Tax Reporting.

You understand that your receipt to Cap

Gemini shares in the Transaction will be a

taxable transaction for U.S. federal income tax

purposes .... You acknowledge your

obligation to treat and report the Transactions

for all relevant tax purposes in the manner

provided in Sections 7.7(f) and (h) of the

Master agreement (as agreed to by Cap

Gemini, (Ernst & Young], you and the other

Accredited Partners).

(/d. Ex. 9, at CG4023.) Under section 5(b)(x), Bergbauer

warranted that he had read the PID and transaction

34a

Appendix B

agreements, was not relying on any information other

than the PID agreements, and was given an opportunity

to ask questions about the terms and conditions of the

transaction. (Jd. Ex. 9, at CG4023; Ex. 6, at CG66:8-

68:13.) Effectively, Bergbauer’s signature bound him to

the tax provisions in sections 7.7(f) and 7.7(h) of the

Master Agreement.

Section 8 of the CPTA prohibited a Consulting

Partner from selling Cap Gemini stock for a period of

four years and 300 days from the date of the transaction

except in public offerings and certain other “permitted

Divestitures.” (Jd. Ex. 9, at CG4026-CG4027, CG4046-

CG4050.) Additionally, it provided that all Cap Gemini

shares held in the Merrill Lynch Restricted Account

were to be voted by Merrill Lynch’s French affiliate as

instructed by the Consulting Partner. (/d. at CG4027, §

8(d).) Finally, under section 8, the Consulting Partners

were allowed to accumulate dividend income in their

Restricted Accounts. !

The “liquidated damages” clause, section 9 of the

CPTA, provided that Bergbauer was required to forfeit

some or all of his Cap Gemini shares if he was terminated

1. Accordingly, dividends were deposited into Bergbauer’s

Restricted Account and he reported dividend income in the

amounts of $ 8,474 in 2001, $ 5,740 in 2002, and $ 762 in 2003.

(Gov’t’s Mem. Supp. Summ. J. Ex. 16 at Interrogs. 18, 19, and

20.) Later, after the requisite tax was paid on each dividend

disbursement, the net dividend was moved from the Restricted

Account to an accessible, unrestricted account. (See Jd. Exs. 35,

36, 37, 45, 46, 48.)

35a

Appendix B

for cause, voluntarily left CGEGY, or breached the non-

competition or confidentiality provisions of his Cap

Gemini employment agreement. Specifically, section 9

provided as follows:

Timing of Event

Prior to 12/31/2000

Prior to first anniversary of Closing

After first anniversary and prior

to second anniversary of Closing

After second anniversary and prior

to third anniversary of Closing

After third anniversary and prior

to fourth anniversary of Closing

After fourth anniversary and prior

% of Cap Gemini

stock Forfeited

100%

38.4%

20.0%

10.0%

to four years and 300 days after Closing

Wd. at CG4027-CG4028, § 9(a); see also Ex. 2 at CG

000036-CG000040.) Additionally, if Bergbauer was

terminated for “poor performance,” up to 50 percent of

these percentages would also be forfeitable at the

discretion of CGEY officials. /d. at CG4028, § 9(b).)

Finally, under section 10 of the CPTA, Consulting

Partners granted power of attorney to the CKO of Cap

36a

Appendix B

Gemini or his designee. The power of attorney permitted

the CEO to execute transaction documents in connection

with the transaction on behalf of Bergbauer, enforce

restrictions on transfer and liquidated damages

provisions, and implement the resale of Cap Gemini

shares. (/d. at CG4029-CG4030, § 10 (power of attorney).)

Pursuant to section 10, Berghauer executed a Special

Account Instruction with Merrill Lynch agreeing that

an Authorized Signatory would instruct Merrill Lynch

as to (1) voting and transfers of Bergbauer’s Cap Gemini

stock pursuant to section 8 of the CPTA, (2) holding Cap

Gemini stock and other assets in Bergbauer’s

Restricted Account until the restrictions and liquidated

damages provisions ended, and (3) transferring Cap

Gemini stock and other assets from Bergbauer’s

Restricted Account to another account when the

limitations expired. (/d. Ex. 11, Special Account

Instruction Agreement; Ex. 9, at CG4026-CG4029.)

Il. The Transaction’s Applicability to Bergbauer

As part of the transaction, Ernst & Young paid

Bergbauer the value of his partnership interest. In

return, Bergbauer transferred his interest to CGE&Y

for 10,740 shares of Cap Gemini stock subject to the

restrictions imposed by the transaction. (/d. Ex. 1, at

70:6-19.) Around May or June 2000, Bergbauer sold 2,685

shares (25 percent) to pay his year 2000 income taxes.

(/d. Ex. 15, at Resp. To Interrog. 6.) As of December

31, 2000, 8,055 shares (the remaining 75 percent of the

10,740) resided in Bergbauer’s Merrill Lynch Restricted

Account and were subject to all restrictions and

37a

Appendix B

liquidated damages as per the transaction. (/d. Ex. 9,

at CG4026-CG4027, § 8.) The shares were valued for tax

purposes at 95 percent of their market value. (The

market value at the time was $155.30 per share, 95

percent of which was $148,527 per share.)

III. The Bergbauers’ Original and Amended Year

2000 Tax Returns

The Bergbauers filed a joint return on or about July

13, 2001, consistent with the transaction being a fully

taxable event to the Consulting Partners. The initial tax

return was prepared by Ernst & Young. This return

reported $1,613,379 gross sale proceeds from the

transaction in accordance with the Form 1099-B issued

to Bergbauer by Cap Gemini, leading to a total federal

tax liability of $676,493. (id. Ex. 13.) Two years later,

after Cap Gemini’s share value had precipitously

dropped to approximately $16 per share, the

Bergbauers sought alternative means to profit on the

transaction. (See Ex. 47.) Heeding the advice that

similarly situated Consulting Partners received,’ the

2. As will be discussed infra, Bergbauer was not the only

former Consulting Partner that filed an amended return. In

United States v. Culp, No. 05-0522, 2006 U.S. Dist. LEXIS 95030

(M.D. Tenn., December 29, 2006), the first federal case

addressing this issue, the court stated as follows:

This case is the first of twelve cases involving the

Cap Gemini issue that the IRS, to date, has referred

to the Tax Division. Presently, there are in excess of

two hundred (200) actions related to this action

(Cont’d)

38a

Appendix B

Bergbauers filed an amended federal income tax return

for the year 2000 on or about June 3, 2003. (/d., Ex. 14.)

The Bergbauers’ amended return relied on the

proposition that the transaction was not a fully taxable

event to the sellers. (/d. Ex. 1 at 31:4-17.) Based on this

assumption, the Bergbauers reduced the amount of

reported taxable income by $1,232,277 (alleging that the

75 percent of Cap Gemini shares, valued at 95 percent,

had not yet been taken into income) and claimed a total

tax reduction of $253,490. (/d. Ex. 14.) Of this, $153,490

was to be refunded and $100,000 was to be applied to

their 2001 estimated tax. (/d.)

On or about August 4, 2003, the Internal Revenue

Service (“IRS”) abated $253,490 of tax for 2000, applied

a $100,000 credit to the Bergbauers estimated 2001 tax,

and cut a refund check payable to Robert and Marie

Bergbauer in the amount of $176,510, consisting of the

$153,490 refund and $23,020 of interest. (Compl. PP 14,

15, 16.) Later, the IRS alleged error and the Government

brought the instant suit against the Bergbauers to

recover the refund pursuant to 26 U.S.C. $7405.

(Cont'd)

pending in different forums across the country. The

different forums involved include the IRS Appeals

Office, the United States Tax Court, the United

States Court of Federal Claims, and other United

States District Courts. These actions are based on

virtually the identical substantive tax issue involved

with this litigation, the Cap Gemini Issue.

2006 U.S. Dist. LEXIS 95080 at *2 -*3; see also United States v

lletcher, No. 06-6056, 2008 U.S. Dist. LEXIS 3555 (N.D. Tl.,

January 15, 200%).)

39a

Appendix B

The Government filed the initial Complaint on

August 4, 2005. Robert Bergbauer is one of over 200

similarly situated individuals throughout the country

seeking to resolve the tax implications of the Cap Gemini

-- Ernst & Young transaction. As such, this Court

granted a Motion to Stay on May 29, 2007, lasting

approximately 15 months, while other district courts

addressed the issue. After the stay was lifted, both the

Government and the Bergbauers moved for judgment

as a matter of law under Rule 56 of the Federal Rule of

Civil Procedure.

STANDARD OF REVIEW

Rule 56 of the Federal Rules of Civil Procedure

provides that summary judgment “shall be rendered

forthwith if the pleadings, depositions, answers to

interrogatories, and admissions on file, together with

the affidavits, if any, show that there is no genuine issue

as to any material fact and that the moving party is

entitled to a judgment as a matter of law.” Fed. R. Civ.

P 56(c) (emphasis added). In Anderson v. Liberty Lobby,

Inc., 477 U.S. 242, 106 S. Ct. 2505, 91 L. Kd. 2d 202

(1986), the Supreme Court of the United States

explained that only “facts that might affect the outcome

of the suit under the governing law” are material. /d. at

248. Moreover, a dispute over a material fact is genuine

“if the evidence is such that a reasonable jury could

return a verdict for the nonmoving party.” /d.

The Supreme Court further explained that, in

considering a motion for summary judgment, a judge’s

40a

Appendi t i

function is limited to determining whether sufficient

evidence supporting a claimed factual dispute exists to

warrant submission of the matter to a jury for resolution

at trial. /d. at 249. In that context, a court is obligated

to consider the facts and all reasonable inferences in

the light most favorable to the nonmoviny party.

Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475

U.S. 574, 587, 106 S. Ct. 1348, &9 L. ed. 2d 588 (1986):

see also B.NLOLC. v. Navy Federal Credit Union, 424

hd 397, 405 (Ath Cir. 2005). Rule 56 mandates summary

judgment against a party “who fails to make a showing

sufficient to establish the existence of an element

essential to that party’s case, and on which that party

will bear the burden of proof at trial.” Celotesr Corp. |

Catrett, 477 U.S. 317, 322 (1986).

When both parties file motions for summary

judgment, as here, the court applies the same standard:

of review. Taft road. Co. v. United States, 929 F.2d 240,

24% (6th Cir. 1991); /7CO Corp. v. Michelin Tire Corp.,

722 F.2d 42, 45 1.3 (Ath Cir. 1983) (The court is not

permitted to resolve genuine issues of material fact on

a motion for summary judgment even where... both

parties have filed cross motions for summuary

judgment.”) (emphasis omitted), cert. denied, 469 U.S

1215, 1055. Ct. 1191, 84 L. ed. 2d 387 (1985). The role

of the court is to “rule on each party’s motion on an

individual and separate basis, determining, in each case,

whether a judgment may be entered in accordance with

the Rule 56 standard.” Towne Mgmt. Corp. v. Hartford

Acct. & Indem. Co., 627 F. Supp. 170, 172 (D. Md.

1985). When cross-motions for summary judgment

tla

[pp ndix B

demonstrate a basic agreement concerning what legal

theories and material facts are dispositive, they “may

be probative of the non existence of a factual dispute

Shook v», United States, 713 k-2d 662, 665 (11th Cir. 1983)

(citation omitted)

DISCUSSION

At the motions hearing conducted on July 16, 200%

the parties ayreed that the dispute between them hinge

on conflicting interpretations of law, thus making the

pending Cross motions ripe for ch pro Ilion at the

summary judgment stage. The disagreement between

the parties, in substance, can be summarized as follow

The Government contends that Robert Bergbauer is an

asset seller and that the 10,740 shares of Cap Gemini

stock were fully tuxable on the closing date undes

26 U.S.C. & 100) and in accordance with the contract

terms apreed by ernst & Young and Cap Gemini and to

Which Bergbauer assented in writing. The Berghbauer

contend, however, that Robert Bergbauer received only

2,685 shares of Cap Gemini stock when the transaction

closed on May 24, 2000, and that the re miainingy S005

hares were not tuxable until the transferability

restrictions and liquidated damayes provisions of the

(PTA lap ed

The Cap Gemini lornst & Youny transaction

involved a preat many Consulting Partnes and

sergbuauer is far from the only Consulting: Partnes

seeking to retain a tax refund after fillny an amended

return with the IRS Indeed, counsel for the

42a

Appendix B

Government indicated at the hearing that, upon

resolution of this case, six cases remain pending in

federal district courts on the same legal issue, although

this estimate has not been confirmed. Additionally, a

presently unknown number of cases also remain pending

in various other forums across the country, including

the IRS Appeals Office, the United States Tax Court,

and the United States Court of Federal Claims.

Two cases, United States v. Culp, No. 05-0522, 2006

U.S. Dist. LEXIS 95030 (M.D. Tenn., December 29,

2006) and United States v. Fletcher, No. 06-6056, 2008

U.S. Dist. LEXIS 3555 (N.D. IL, January 15, 2008), have

already been decided in other federal district courts. In

both cases, the court granted summary judgment to the

Government, finding that the entire transaction was

taxable in 2000.

In Culp, the first case involving the Cap Gemini —

Ernst & Young transaction, the United States District

Court for the Middle District of Tennessee applied

traditional contract principles and discussed whether

the restrictions contained ip the transaction documents

were conditions subsequent or conditions precedent.

Focusing on the contract language used in the

transaction documents, the court found that the

restrictions were conditions subsequent to receiving the

shares. Therefore, under Commissioner v. Danielson,

378 F.2d 771 (3d. Cir. 1967), the defendant could

“recharacterize” the terms of the deal only if they were

unenforceable due to “mistake, undue influence, fraud

or duress.” /d. at 775. The court concluded that the

43a

Appendix B

Danielson rule did not apply and granted summary

judgment for the Government.

In Fletcher, the United States District Court for the

Northern District of Illinois found that the transaction

documents were ambiguous and susceptible to more than

one reasonable interpretation. The court concluded that

the PID, viewed as extrinsic evidence, demonstrated the

parties’ intention to treat the sale as a fully and

immediately taxable event. Addressing the defendant's

argument that immediate taxation was in contravention

of 26 U.S.C. § 451, the court balanced the intention of

the parties, on the one hand, with the public policy

embodied in the Internal Revenue Code (“the Tax

Code”), on the other. The court concluded that under

either the Danielson rule or the “strong proof rule, see

Leshe S. Ray Ins. Agency, Inc. v. United States, 463

hi2d 210, (ist Cir. 1972) (requiring “strong proof that

the parties intended an allocation different than that

included in the contract), the result was the same: the

sale was an immediately and fully taxable event and the

Government was entitled to summary judgment.

The United States Court of Appeals for the Fourth

Circuit, however, has neither adopted the Danielson

rule nor the “strong proof” rule. Instead, the Fourth

Circuit, when faced with a tax recharacterization case,

applies a two-pronged test that examines the tax

consequences contemplated by the parties and the

economic substance of the agreement. Wrangler

Apparel Corp. v. United States, 931 F. Supp. 420, 424

(M.D.N.C. 1996) (citing General Ins. Agency Inc. v.

44a

Appendix B

Comm ’r, 401 F.2d 324 (4th Cir. 1968).) In short, as

outlined by the operative transaction documents and

further clarified by the PID, Cap Gemini, Ernst &

Young, and Robert Bergbauer all sought immediate

taxation on the entire 10,740 shares at the close of the

transaction. Furthermore, both sides received

bargained-for consideration, thereby supporting the

requisite economic substance of the transaction.

I. The Government Has the Statutory Authority to

Seek Refund

As an initial matter, Defendants argue that the

Government’s case is not over a refund, but instead

involves a mere deficiency in amounts owed. See 26

U.S.C. § 6211(a). As such, the appropriate vehicle for

recovery under the Tax Code is an assessment and, if

necessary, actions to foreclose liens or reduce

assessments to judgment. See 26 U.S.C. §§ 6321-6326,

7403. Alternatively, Defendants argue that erroneous

refund suits are limited to situations in which the IRS

makes an erroneous, bona fide error in computation,

such as a “clerical misunderstanding, . . . controlling

decisions overruled or undermined, ... [or] a simple

change of mind by the [IRS] on the substantive law.”

United States v. Russell Mfg. Co., 349 F.2d 138, 17 (2d

Cir. 1965).

The Tax Code permits the Government to recover

an erroneous refund by filing suit under 26 U.S.C.

§ 7405. Section 7405(b) provides that “[a]ny portion of a

tax imposed by this title which has been erroneously

4Sa

Appendix B

refunded (if such refund would not be considered as

erroneous under section 6514) may be recovered by civil

action brought in the name of the United States.”

26 U.S.C. § 7405(b). As the Government notes, there

are two categories of erroneous refunds: rebate and non-

rebate. See O’Bryant v. United States, 49 F.3d 340, 342

(7th Cir. 1995). A rebate refund is issued on the basis of

a substantive recalculation of the tax owed, while a non-

rebate refund arises out of clerical or computer errors

by the IRS. In the instant case, Defendants

undisputedly received a rebate refund because the IRS

abated $276,510 worth of tax on the basis of a substantive

recalculation pursuant to Defendants’ 2003 amended

return. Therefore, the Government appropriately filed

the instant suit, and this Court has jurisdiction over the

matter.

Il. Application Of The Fourth Circuit’s Two-Pronged

Approach Does Not Alter the Outcome Reached

in Culp and Fletcher

In Commissioner v. National Alfalfa Dehydrating

and Milling Co., 417 U.S. 134, 948. Ct. 2129, 40 L. Ed.

2d 717 (1974), the Supreme Court stated as follows:

while a taxpayer is free to organize his affairs

as he chooses, nevertheless, once having done

so, he must accept the tax consequences of

his choice whether contemplated or not

[citations omitted], and may not enjoy the

benefit of some other route he might have

chosen to follow but did not.

46a

Appendix B

Id. at 149; see also Signet Banking Corp. v. Comm’r,

118 F.3d 239, 241 (4th Cir. 1997). Although the Fourth

Circuit has not adopted either the Danielson rule (relied

upon in Culp and Fletcher) or the “strong proof” test

(cited and discussed in Fletcher), the “economic reality”

approach used to determine tax consequences in this

circuit embraces the principles set forth in National

Alfalfa. In Furman v. United States, 602 F. Supp. 444

(D.S.C. 1984), the court wrote as follows:

To allow a taxpayer to unilaterally reform one

end of a bargain could encourage taxpayers

to ignore agreements as written in the hope

that the courts will give them more

advantageous tax treatment. Both parties to

a transaction could enjoy tax benefits due to

inconsistent reporting of the same

transaction. To allow taxpayers to so

“whipsaw” the Commissioner would have

disastrous effects on our tax system.

Id. at 455; see also Pantry Pride v. Stop & Shop Cos.,

Inc., 630 FL Supp. 637, 640 (E.D. Va. 1986) (holding that

allowing a taxpayer to escape an unfavorable outcome

would jeopardize the entire transaction--” Here Pantry

Pride and Richmond freely agreed to the allocation now

complained of. Having made its own bed, Pantry Pride

will have to lie in it.”).

“(Wihen addressing the tax consequences of a

transaction the [Fourth Circuit] applies a two-prong test

which examines (1) the intent of the parties; and (2) the

47a

Appendix B

economic substance of the transaction.” Wrangler

Apparel Corp., 931 F. Supp. at 424 (citing General Jns.,

401 F.2d at 327). Applying this standard with the

principles of National Alfalfa in mind, the Government

is entitled to judgment as a matter of law.

A. Intent of the Parties

This Court looks first within the four corners of the

operative transaction documents (namely, the Master

Agreement and the CPTA) for the parties’ expressed

intent regarding the tax implications at the transaction’s

closing. As in Fletcher, this Court finds that the terms

within the Master Agreement and the CPTA may be

interpreted two different ways.

Both documents contained provisions that strongly

demonstrate that Bergbauer’s shares were immediately

and fully taxable at the transaction’s closing. For

example, the CPTA provided that the Consulting

Partners would receive their shares “[a]t the Closing,”

and that these shares would “be a taxable transaction

for U.S. federal income tax purposes.” (Gov’t’s Mem.

Supp. Summ. J. Ex. 9, at 000620-26.) Furthermore, the

Master Agreement stated that: (1) Cap Gemini would

deliver the shares allotted to each Consulting Partner

to the restricted account on his or her behalf and

“provide ...to... each [Consulting Partner] a Form

1099-B” with respect to the transaction; (2) the

Consulting Partners would file their tax returns “for the

year in which the Closing occurs;” (3) for federal tax

purposes, “the transactions undertaken pursuant to

48a

Appendix B

[the agreement] will be treated and reported by [all

parties] as ...a sale of the [Consulting Partner’s]

interests in CGE&Y to Cap Gemini; “ and (4) Cap Gemini

did not legally owr the transferred shares, even if the

shares were “held in custodial accounts and/or Trusts”

for the Consulting Partners. Ud. Ex. 3, at 000046-47,

000121-24, 000143.) The Master Agreement explained

further that “neither [Cap Gemini] nor any of its

Affiliates will be a legal or beneficial owner of Transaction

Shares” in the custodial accounts established for the

Consulting Partners. (/d. Ex. 3A, at 000560.)

On the other hand, the CPTA also contained

provisions that placed limitations and/or restrictions on

the Defendant’s use of 8,055 shares. Consequently,

Defendant argues that, as a matter of law, Bergbauer

did not receive the shares subject to the limitations and

restrictions, and therefore could not be taxed on them

under 26 U.S.C. § 451.* Specifically, under the CPTA,

3. The Tax Code requires cash method taxpayers, like

Defendants here, to report income in the tax year in which they

actually or constructively receive it. See 26 U.S.C. § 451(a) (“The

amount of any item of gross income shall be included in the

gross income for the taxable year in which received by the

taxpayer.”); 26 C.E.R. § 1.451-1(a) (“Gains, profits, and income

are to be included in gross income for the taxable year in which

they are actually or constructively received by the taxpayer.”).

Under the regulations interpreting section 45], a taxpayer has

constructively received income when “it is credited to his

account, set apart for him, or otherwise made available so that

he may draw upon it at any time.” 26 C.F.R. § 1.451-2(a). If the

taxpayer’s ability to control the account “is subject. to

substantial limitations or restrictions,” then the income is not

deemed to have been constructively received. /d.

49a

Appendix B

Bergbauer could not “directly or indirectly, sell, assign,

transfer, pledge, grant any option with respect to or

otherwise dispose of any interest in” Cap Gemini Shares,

except in periodic offerings organized by Cap Gemini,

for a period of four years and 300 days after the closing.

(Id. Ex. 9, at 000597-98.) Second, Bergbauer granted

Cap Gemini exclusive authority to invest, transfer and

release the shares in his Merrill Lynch Restricted

Account during that time period. (/d. at 000627-31.)

Third, under the liquidated damages clause of the

CPTA, Bergbauer agreed that he would forfeit some or

all of the Cap Gemini shares if he breached provisions

of the employment agreement with CGEY, voluntarily

ended his employment, or was terminated “for cause”

or “poor performance.’’* (/d. at 000641.)

Because of the conflicting provisions of the

transaction documents, this Court is unable to

determine with any certainty the parties’ intent at the

time the transaction closed. Therefore, this Court will

look to extrinsic evidence (namely, the PID, testimony

of a former Ernst & Young partner, and parties’ actions

after closing) to examine the parties’ intent with respect

to taxation.

4. Both “cause” and “poor performance” were left

undefined by the transaction documents.

50a

Appendix B

1. The PID Explicitly Provided For Immediate

Taxation on The Shares in Their Entirety

As demonstrated by the PID’s provisions, the parties

plainly intended for Bergbauer to immediately receive and

be taxed on all 10,740 Cap Gemini shares. The PID

expressly stated that “(elven though both (Ca, Gemini]

and the {Consulting] partners are sellers in this

transaction, the [Consulting] partners are treated as

though they receive[d] all of the gain and are taxed on it.”

(id. Ex. 2 at 000726-27.) Moreover, the PID further

explained that “(tjhe fair market value of the stock received

that cannot be sold immediately will be calculated at 95

{percent] of the closing price of Cap Gemini stock on the

day of the exchange for [CGE&Y] shares.” (/d. at 000041

(emphasis added).) The PID also stated that “(t]he gain

on the sale of the distributed [CGE GY] shares is reportable

on Schedule D of your U.S. federal income tax return for

2000.” (Id. at CG000042.) Lastly, it emphasizes the parties’

desire to report the transaction consistently, saying that

“{ijt also has been agreed that Ernst & Young, its partners,

and Cap Gemini will treat valuation and related issues

consistently for US feceral income tax purposes.””

(Id. at CG000041-42.)

5. The PID has evidentiary value despite the fact that it

was prepared prior to the transaction’s closing. The fact that

the parties all had the same understanding of the transaction

documents before signing is persuasive. Moreover, the PID

remains persuasive to this Court even though it disclaims that

its “contents... are not to be construed as legal, business, or tax

advice ....[YJou must rely on your own examination of Cap

(Cont'd)

Sla

Appendix B

2. A Former Ernst & Young Partner

Explained The Immediate Taxability to

The Consulting Partners

Supplementing the language contained within the

PID, a former Ernst & Young partner’s testimony

regarding his presentation on the transaction’s tax

consequences at the March 7-8, 2000 meeting affords

additional weight to the Government’s contention that

the parties desired immediate taxation on the received

Cap Gemini shares. In pertinent part, the Ernst & Young

partner testified that there was a discussion at the

meeting concerning immediate vesting upon the

transaction’s closing and that “people were

extraordinarily optimistic that the stock was going to

rise at some exponential rate.” (/d. Ex. 6, at 144:10-

145:7.) Moreover, he testified that “we all wanted to own

the shares outright and all wanted to get the capital

(Cont’d)

Gemini and the terms of the transaction.” (Gov’t’s Mem. Supp.

Summ. J. Ex. 2 at CG000055. (emphasis supplied).)

Defendants also argue that the PID contains “oblique”

language, citing the subsection titled “Subsequent Stock Sales.”

This subsection was part of a larger, four-page section which

addressed the “Tax Implications” of the transaction and that

paints a clear picture evidencing the parties’ intent to be

immediately taxed. (/d. at CG000041, CG000044.) Thus, the

subsection cited by the Bergbauers does not contradict the

parties’ expressed desire for immediate taxability on the

Consulting partners’ received shares, but rather merely

established the basis upon which gains and/or losses on future

sales of Cap Gemini shares would be measured.

52a

Appendix B

gain and, therefore, have this transaction closed”

because “creeping vesting” carried too much risk

(/d. at 149-151.)

Therefore, even if Robert Bergbauer did not

immediately appreciate the operative tax language

contained within the PID, after attending the March 7

8, 2000 meeting he was well aware that all parties to the

agreement intended for the Consulting Partners to be

immediately taxed on the entirety of their received Cap

(;emini shares.

3. The Bergbauers’ Actions After Closing

Reflect Understanding of Immediate

Taxability on The Shares in Their

Entirety

Defendants’ initial tax return provides very strong

evidence that it was mutually understood that the

transaction was fully and immediately taxable. As

contemplated by the transaction documents,

Defendants filed a joint return on or about July 13, 2001.

This return reported $1,613,379 gross sale proceeds

from the transaction (i.e. al] 10,740 Cap Gemini shares)

in accordance with the Form 1099-B issued to Bergbauer

by Cap Gemini, leading to a total federal tax liability of

$676,493. (Ud. ix. 13.) Notably, it was not until Cap

Gemini stock plummeted to approximately $16 per share

in 2002 that Defendants filed their amended return and

now challenge the transaction’s true tax implications.

Indeed, prior to the precipitous drop in the share value,

the Defendants, much like Cathy Culp and Cynthia

S3a

Appendi x B

Kletcher and others similarly situated, showed no

inclination to unilaterally alter the tax consequences of

the transaction.

In sum, the extrinsic evidence in this case sheds light

on the terms of the transaction documents, and this

Court finds that based on the extrinsic evidence the

parties’ original intent was for the Consulting Partners

to be immediately taxed on the entirety of the shares

they received at the transaction’s closing on May 238,

2000.

B. Economic Substance

“The second prong of the General Insurance test

requires that the covenant bargained for have some

independent value grounded in economic reality.”

Wrangler Apparel Corp., 931 F. Supp. at 424 (citing

General Ins., 401 2d at 330). Thus, the transaction

terms must contain some economic substance beyond

the parties’ subjective intent. The Fourth Circuit

explained in General Insurance that a contract's terms

must “have some independent basis in fact or some

arguable relationship with business reality such that

reasonable men, genuinely concerned with their

economic future, might bargain for such an ayreement.”

General Ins., 401 F.2d at 330 (quoting Schulz v. CLLR.,

294 I2d 52, 55 (9th Cir. 1961)). In this case, all partic:

were engaged in arms-length negotiations in which each

party bargained for and received real economic benefit.

Kor instance, Cap Gemini ensured that there would not

be an immediate sell-off, which would seriously harm

hare value, by attaching restrictions and limitation

preventing the immediate sai

(>| hare riven to thie

Consulting Partners. Likewise, the Consulting Partne!

believed that their newly acquired Cap Gemini share

would continue to increase In value and therefore sought

mmediate taxation on their total received shares to

capitalize on anticipated future yains. Again, it was only

after the stock price plummet d that the Berghauet

and many other similarly situated Consulting Partne

ought to unilaterally recharacterize certain aspects ol

tne transaction,

In sum, fulland immediate ta LION Was CONnSe

ehosen DP PNIsts ited partie ror real ¢

IPpose hu t} (,ourt I il medal it tf hour

{ iIrcult LWO pronped CCOMOTHI re iT tf [

demonstrate thut the 1] errones ed th

Defendants a S276,510 1 relund that the ¢ ernment

i ne ) ()

, | r | ' .

ry? | } | '

SSa

Appendix B

CONCLUSION

For the foreyoing reasons, the Defendants’ Cross

Motion for Summary Judgment (Paper No. 33) is

DENIED and the Government's Motion for Summary

Judgment (Paper No. 28) is GRANTED. A separate

Order and Judgment follows.

Dated: Aupust 18, 200%

/s/

Richard D. Bennett

United States District Judpe

S6a

APPENDIX C — ORDER AND JUDGMENT OF THE

UNITED STATES DISTRICT COURT FOR THE

DISTRICT OF MARYLAND

DATED AUGUST 18, 2008 AND

FILED AUGUST 19, 2008

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MARYLAND

Civil Action No. RDB-05-2132

UNITED STATES OF AMERICA

Plaintiff

V.

ROBERT L. BERGBAUER et ux.

Defendants

ORDER AND JUDGMENT

For the reasons stated in the foregoing Memorandum

Opinion, it is this 18th day of August 2008, hereby

ORDERED and ADJUDGED, that:

a. The Motion for Summary Judgment filed by the

United States of America (Paper No. 28) is

GRANTED;

b. The Motion for Summary Judgment filed by

Robert and Marie Berghauer (Paper No. 33) is

DENIED;

S

Appendix C

Judgment is entered in favor of the United

States of America and against Robert and Marie

Bergbauer, in the amount of $276,510.00, plus

statutory interest on that amount, accruing from

August 4, 2003;

The Clerk of the Court transmit copies of this

Order and Judgment and the accompanying

Memorandum Opinion to counsel for the parties;

and

The Clerk of the Court CLOSE THIS CASE.

S

Richard D. Bennett

United States District Judge

58a

APPENDIX D —STATUTE AND REGULATIONS

INVOLVED

26 U.S.C.S. § 451

§ 451. General rule for taxable year of inclusion.

(a) General rule. The amount of any item of

gross income shall be included in the gross

income for the taxable year in which received

by the taxpayer, unless, under the method of

accounting used in computing taxable income,

such amount is to be properly accounted for

as of a different period.

26 C.F.R. § 1.451-1

§ 1.451-1 General rule for taxable year of inclusion.

(a) General rule. Gains, profits, and income are

to be included in gross income for the taxable

year in which they are actually or constructively

received by the taxpayer unless ineludible for a

different year in accordance with the taxpayer's

method of accounting. Under an accrual method

of accounting, income is ineludible in gross

income when all the events have occurred which

fix the right to receive such income and the

amount thereof can be determined with

reasonable accuracy. Therefore, under such a

method of accounting if, in the case of

compensation for services, no determination can

59a

Appendix D

be made as to the right to such compensation

or the amount thereof until the services are

completed, the amount of compensation is

ordinarily income for the taxable year in which

the determination can be made. Under the cash

receipts and disbursements method of

accounting, such an amount is includible in gross

income when actually or constructively received.

Where an amount of income is properly accrued

on the basis of a reasonable estimate and the

exact amount is subsequently determined, the

difference, if any, shall be taken into account for

the taxable year in which such determination is

made. To the extent that income is attributable

to the recovery of bad debts for accounts

charged off in prior years, it is includible in the

year of recovery in accordance with the

taxpayer’s method of accounting, regardless of

the date when the amounts were charged off.

For treatment of bad debts and bad debt

recoveries, see sections 166 and 111 [26 USCS

§§ 166 and 111] and the regulations thereunder

For rules relating to the treatment of amounts

received in crop shares, see section 61 {26 USCS

$ 61] and the regulations thereunder. For the

year ‘n which a partner must include his

distributive share of partnership income, see

section 706(a) [26 USCS § 706(a)] and paragraph

(a) of § 1.706-1. If a taxpayer ascertains that an

item should have been included in gross income

in a prior taxable year, he should, if within the

period of limitation, file an amended return and

60a

Appendix D

pay any additional tax due. Similarly, if a

taxpayer ascertains that an item was improperly

included in gross income in a prior taxable year,

he should, if within the period of limitation, file

claim for credit or refund of any overpayment

of tax arising therefrom.

26 C.E-R. § 1.451-2

§ 1.451-2 Constructive receipt of income.

(a) General rule. Income although not

actually reduced to a taxpayer’s possession is

constructively received by him in the taxable

year during which it is credited to his account,

set apart for him, or otherwise made available

so that he may draw upon it at any time, or so

that he could have drawn upon it during the

taxable year if notice of intention to withdraw

had been given. However, income is not

constructively received if the taxpayer’s

control of its receipt is subject to substantial

limitations or restrictions. Thus, if a

corporation credits its employees with bonus

stock, but the stock is not available to such

employees until some future date, the mere

crediting un the books of the corporation does

not constitute receipt. In the case of interest,

dividends, or other earnings (whether or not

credited) payable in respect of any deposit or

6la

Appendix D

account in a bank, building and loan

association, savings and loan association, or

similar institution, the following are not

substantial limitations or restrictions on the

taxpayer’s control over the receipt of such

earnings:

(1) A requirement that ‘he deposit or

account, and the earnings thereon, must

be withdrawn in multiples of even

amounts;

(2) The fact that the taxpayer would, by

withdrawing the earnings during the

taxable year, receive earnings that are

not substantially less in comparison with

the earnings for the corresponding

period to which the taxpayer wovld be

entitled had he left the account on

deposit until a later date (for example, if

an amount equal to three months’

interest must be forfeited upon

withdrawal or redemption before

maturity of a one year or less certificate

of deposit, time deposit, bonus plan, or

other deposit arrangement then the

earnings payable on premature

withdrawal or redemption would be

substantially less when compared with

the earnings available at maturity);

62a

Appendix D

(3) Arequirement that the earnings may

be withdrawn only upon a withdrawal of

all or part of the deposit or account.

However, the mere fact that such

institutions may pay earnings on

withdrawals, total or partial, made

during the last three business days of

any calendar month ending a regular

quarterly or semiannual earnings

period at the applicable rate calculated

to the end of such calendar month shall

_not constitute constructive receipt of

income by any depositor or account

holder in any such institution who has

not made a withdrawal during such

period;

(4) A requirement that a notice of

intention to withdraw must be given in

advance of the withdrawal. In any case

when the rate of earnings payable in

respect *f such a deposit or account

depends on the amount of notice of

intention to withdraw that is given,

earnings at the maximum rate are

constructively received during the

taxable year regardless of how long the

deposit or account was held during the

year or whether, in fact, any notice of

intention to withdraw is given during

the year However, if in the taxable year

of withdrawal the depositor or account

63a

Appendix D

holder receives a lower rate of earnings

because he failed to give the required

notice of intention to withdraw, he shall

be allowed an ordinary loss in such

taxable year in an amount equal to the

difference between the amount of

earnings previously included in gross

income and the amount of earnings

actually received. See section 165 [26

USCS § 165] and the regulations

thereunder.

26 C.E-R. § 1.1060-1

§ 1.1060-1 Special allocation rules for certain asset

acquisitions.

(e) Reporting requirements — (1) Applicable

asset acquisitions — (i) In general. Unless

otherwise excluded from this requirement by

the Commissioner, the seller and the

purchaser in an applicable asset acquisition

each must report information concerning the

amount of consideration in the transaction and

its allocation among the assets transferred.

They also must report information concerning

subsequent adjustments to consideration.

64a

Appendix D

(ii) Time and manner of reporting —

(A) In general. The seller and the

purchaser each must file asset

acquisition statements on Form 8594,

“Asset Allocation Statement,” with

their income tax returns or returns of

income for the taxable year that

includes the first date assets are

sold pursuant to an applicable

asset acquisition. This reporting

requirement applies to all asset

acquisitions described in this section.

For reporting requirements relating to

asset acquisitions occurring before

March 16, 2001, as described in

paragraph (a)(2) of this section, see the

temporary regulations under section

1060 [26 USCS § 1060] in effect prior

to March 16, 2001 (see 26 CFR part 1

revised April 1, 2000).

(B) Additional reporting requirement.

When an increase or decrease in

consideration is taken into account

after the close of the first taxable year

that includes the first date assets are

suld in an applicable asset acquisition,

the seller and the purchaser cach must

file a supplemental asset acquisition

statement on Form 8594 with the

income tax return or return of income

for the taxable year in which the

65a

Appendix D

increase (or decrease) is properly taken

into account.

(C) Election described in § 1.338-6(¢)(5)

—(1) Availability. The election

described in § 1.338-6(¢)(5) is available

in respect of an applicable asset

acquisition provided that the

requirements of that section are

satisfied. Such election may be made

by the seller, regardless of whether the

purchaser also makes the election, and

may be made by the purchaser,

regardless of whether the seller also

makes the election.

(2) Time and manner of making

election. The election described in

§ 1.338-6(c)(5) is made by taking a

position on a timely filed original tax

return for the taxable year of the

applicable asset acquisition that is

consistent with having made the

election.

(3) Irrevocability of election. The

election described in § 1.338-6(¢)(5) is

irrevocable.

(4) Kffective/applicability date. This

paragraph (e)(1)(Gii)(C) applies to

applicable asset acquisitions occurring

66a

Appendix D

on or after September 11, 2007. For

applicable asset acquisitions occurring

before September 11, 2007 and on or

after September 15, 2004, see § 1.1060-

1T as contained in 26 CFR Part 1 in effect

on April 1, 2007. For applicable asset

acquisitions occurring before September

15, 2004, see §§ 1.388-6 and 1.1060-1 as

contained in 26 CFR Part 1 in effect on

April 1, 2004.

(2) Transfers of interests in partnerships.

Kor reporting requirements relating to

the transfer of a partnership interest,

see § 1.755-1(d).