Taxation & Estate Planning

SALE RESTRICTIONS AND FORFEITURE RISK DID NOT INHIBIT CONSTRUCTIVE RECEIPT

By Charles Rubin

In a recent District Court case, a taxpayer sold a partnership interest in exchange for shares of stock. The stock had significant restrictions, including limits on the ability to sell the received stock for up to 5 years, and the taxpayer would have to forfeit shares if they went into competition with the buyer of the partnership interests, if they quit working for the buyer, or were fired for cause or poor performance.

The taxpayer claimed that he did not have to recognize gain on the value of the received shares, since he could not realize anything from the shares upon receipt and they could be forfeited in the future.

In analyzing the situation, the court noted that ?constructive receipt? occurs under Section 451 Regulations if as to a taxpayer an amount 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.? Income is not constructively received ?if the taxpayer's control of its receipt is subject to substantial limitations or restrictions.?

The court found that a number of facts combined to indicate there was sufficient ?control? in the taxpayer to find constructive receipt. These facts included that the seller would eventually benefit from any appreciation that occurred in the shares while they were subject to restrictions, the seller would receive the dividends from the shares during the restriction period, and the seller could direct how the shares were voted. The court also took into consideration that the transaction was specifically structured to result in full taxation in the year of sale and not a later year, because the taxpayers anticipated future appreciation (in this case, the taxpayer changed his mind and sought to ?defer? the tax because the stock actually ended up going down in value, so that the taxpayer picked up income in the year of sale that would never have arisen if the stock was taxable only when the restrictions lapsed).

Given the number of factors cited by the court, it is difficult to tell which ones were more critical than the others in the finding of constructive receipt. Further, if the transaction had not been carefully structured with one tax result in mind, but with the taxpayer then adopting the opposite characterization when the stock value went down instead of up, perhaps a more sympathetic hearing by the District Court may have resulted.

U.S. v. Fort, 105 AFTR 2d 2010-XXXX, (DC GA), 05/20/2010

Full post as published by Rubin on Tax on June 02, 2010 (boomark / email).