Taxpayer's Agreement To Treat Receipt Of Income In A Particular Way Is Not Binding On Taxpayer If Substantive Terms Of Agreement Dictate Different Result
UNITED STATES OF AMERICA v. FLETCHER (April 10 , 2009)
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Cap Gemini purchased a consulting business from Ernst & Young in 2000. The Ernst & Young partners received shares in the new business in exchange for their partnership shares. The partners preferred to treat the receipt of shares as income in 2000. The company wanted to put some restrictions on the shares to ensure that the partners would remain with the new organization. They all agreed on a methodology that they thought would serve both purposes. The shares were all transferred and fully taxable in 2000 but were restricted for almost five years. One of the partners, Cynthia Fletcher, received shares with a market value of approximately $2.5 million. She reported this as ordinary income in 2000. Fletcher left the organization and collected the shares remaining in her account. Because the market price of the stock plummeted after the acquisition, it turns out that the partners would have been better off not taking the income in the first year. Fletcher filed an amended tax return for 2000 and took the position that her only income in 2000 was the $650,000 that was actually distributed from her account. Although the Internal Revenue Service processed the refund, the United States filed suit to recover. The district court granted summary judgment to the United States and ordered Fletcher to refund the refund. Fletcher appeals.
In their opinion, Chief Judge Easterbrook and Judges Ripple and Tinder affirmed. The Court first made it clear that Fletcher was not attempting to change the form of the transaction. Instead, she argued that the actual terms of the original transaction had tax consequences that are different than originally reported. The Court disagreed with the substance of her argument, however. Although the stock was restricted, the partners bore the economic risk and were the beneficial owners as of 2000. Even though the partners did not have cash in hand, the economic value of the stock was within their control. Therefore, the income was constructively received in the year 2000 and properly reported as such originally.
