USCA1 Opinion
August 20, 1993
[NOT FOR PUBLICATION]
UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
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No. 92-2457
JOHN S. AND LORRAINE M. FISHER,
Petitioners, Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent, Appellee.
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APPEAL FROM THE UNITED STATES TAX COURT
[Hon. Lawrence Wright, U.S. Tax Court Judge]
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Before
Breyer, Chief Judge,
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Selya and Stahl, Circuit Judges.
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John S. Fisher and Lorraine M. Fisher on brief pro se.
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Michael L. Paup, Acting Assistant Attorney General, Gary R.
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Allen, Ann B. Durney, and Randolph L. Hutter, Tax Division, Department
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of Justice, on brief for appellee.
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Per Curiam. John Fisher is an employee of Digital
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Equipment Corporation. From 1982-87 he was on a disability
leave of absence from the company. In 1986, he exercised
certain stock options, which resulted in a distribution to
him of stock with a net value of $50,726.55. Fisher and his
wife reported that sum as nontaxable long-term disability
income on their 1986 tax return. The Internal Revenue
Service ("IRS") disagreed and assessed a deficiency which the
Fishers challenged in Tax Court. The Tax Court concluded
that Digital's distribution of stock to John Fisher in 1986
was a taxable transfer of property under 26 U.S.C. ("IRC")
83 rather than tax-free income received through accident or
health insurance under IRC 104(a)(3) or an accident or
health plan under IRC 105(e)(1), as the Fishers claimed.
It also deemed proper the assessment by the IRS of certain
additions to tax against the Fishers for their failure to
report the distribution as taxable income. The Fishers now
appeal. Because the record shows that the Tax Court's
understanding of the law and facts was correct, we affirm.
I. The Characterization of the 1986 Distribution
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The tax provisions at issue are IRC 83, 104, and
105. Section 83(a) provides for the taxation of property
transferred to a person "in connection with the performance
of services." The person liable for the tax is the person
who performed the services, and the amount taxed is the
excess of the fair market value of the property over the
amount paid for the property. A transfer of property is
subject to section 83 if made "in respect of past, present,
or future services." Treas. Reg. 1.83-3(f). Section 83
applies at the time a stock option is exercised where, as
here, the option does not have a readily ascertainable fair
market value at the time the option is granted, provided the
stock is transferable or no longer subject to substantial
risk of forfeiture at that time (as defined in the
regulations). Id. 1.83-7(a); IRC 83(a)(1); see Treas.
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Reg. 1.83-(c) & (d).1 In general, section 104(a)(3)
excludes from taxable income "amounts received through
accident or health insurance for personal injuries or
sickness . . . ." For section 104 purposes, amounts received
under "an accident or health plan for employees" are treated
as amounts received through accident or health insurance.
IRC 105(e)(1). Generally speaking, an accident or health
plan is "an arrangement for the payment of amounts to
employees in the event of personal injuries or sickness."
Treas. Reg. 1.105-5(a).
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1. Under the terms of Digital's Restricted Stock Plan, the
restrictions on an employee's ability to transfer option
shares were to lapse each year for a certain percentage of
the shares. By the time Fisher exercised his option in 1986,
all such restrictions on all of Fisher's remaining option
shares had lapsed, and so the option shares at issue would
have been transferable or no longer subject to substantial
risk of forfeiture within the meaning of IRC 83(a)(1).
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The pertinent facts and our assessment of them in
light of this law are as follows. In 1986, John Fisher
exercised his option to buy 690 shares of stock as to which
the restrictions on transferability had lapsed. The fair
market value of the stock was $58,132.55, and Fisher paid
$7,406 to exercise his option. Fisher had been granted his
stock option rights in 1976 in two stock option agreements,
one of which is included in the record. The option agreement
in the record makes no reference to Digital's disability
plan, but explicitly states that it is subject to Digital's
Restricted Stock Purchase Plan ("the Restricted Stock Plan"),
and it incorporates the terms of the Restricted Stock Plan by
reference. The option agreement, which was to terminate on
July 28, 1986, states that Fisher could exercise the option
only while "employed" by Digital. Similarly, the Restricted
Stock Plan states its intent to provide incentives to certain
employees "who are presently making and are expected to
continue to make substantial contributions" to the company to
ensure that they would "continue in the service of the
Company . . ., thereby advancing [its] interests . . . ."
Although the option agreement and the Restricted Stock Plan
describe what Fisher's rights to exercise the option would be
if Fisher retired with the company's consent, died, or
terminated his employment with Digital, neither makes any
reference to what Fisher's rights would be if he were unable
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to work because of sickness or disability. Presumably,
however, if he remained "employed" by Digital, his rights
under the option agreement and the Restricted Stock Plan
would continue, whereas if he terminated his employment
because of disability, his rights would be as provided in the
Restricted Stock Plan for employees whose employment with
Digital terminates. As a postscript to the option agreement,
Fisher signed a pledge affirming his obligations to Digital
under the employment agreement he signed when he first joined
Digital, and agreeing, among other things, to preserve the
confidentiality of Digital's trade secrets, inform Digital of
new ideas conceived by him while at Digital, and refrain from
inducing others to violate their employment agreements with
the company. On the basis of these documents, it is clear
that Digital's grant of stock options to its employees was
intended to reward present good performance and to encourage
future services of like quality. Thus, transferring stock to
an employee exercising an option under the option agreement
would transfer property "in connection with the performance
of services" as defined in the regulations. See Treas. Reg.
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1.83-3(f) (section 83(a) taxes property transferred "in
respect of past, present, or future services"). Accordingly,
such a transfer would subject the performer of the services
to taxation with respect to that stock under section 83(a),
and the Restricted Stock Plan states, without qualification,
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that the option holder would receive taxable income under
section 83(a) upon exercise of the option with respect to
shares as to which the restrictions have lapsed.
We see nothing in Digital's personnel or disability
policies or in the way in which John Fisher was treated while
on leave that would alter that result with respect to
Digital's transfer of stock to Fisher in 1986. At the time
Fisher was granted his option, he was performing services for
Digital. In 1978, before he went on a leave of absence, an
internal company memorandum explained that, for employees on
a leave of absence, "[stock] options continue to lapse as
though [the] employees were not on leaves of absence." This
memorandum made explicit the inference to be drawn from the
proviso in Fisher's option agreement that the option was
exercisable only as long as he was "employed" by Digital --
that is, that employees on leave are still employed by
Digital and have full rights under their option agreements
and under the Restricted Stock Plan.
Digital's leave of absence policy, stated in
Section 4.23 of its "Personnel Policies and Procedures," is
consistent with the 1987 memorandum. The benefits subsection
of the policy describes the extent to which benefits continue
for employees on a leave of absence. The entry "Qualified
and Restricted Stock Plans" provides that "[i]f the employee
is a participant in either the Qualified or Restricted Stock
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Plan, restrictions on these options continue to lapse while
the employee is on a leave of absence." A separate entry
"Medical, Dental, Life and Disability Insurance" states that
employees on a leave of absence can continue their
"disability income protection" by paying their premiums in
advance. Thus, Personnel Policy 4.23 makes clear that some
benefits continue for employees on leave; it also treats an
absent employee's rights under the Restricted Stock Plan and
under a long-term disability plan separately, and does not
make the exercise of stock options a component of the
disability benefits provided employees on a disability leave
of absence.
Nor do Digital's disability policies do this. In
Section 5 of its benefits booklet, Digital discusses its
disability plans.2 The preface explains that Digital offers
one sickness and three disability plans "to help provide you
with all or a portion of your income if you are sick or
disabled and unable to work." (Emphasis in original.)
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Although Digital automatically enrolls all employees in its
short-term disability plan, employees must purchase their
long-term disability plan from an insurance company, as
Fisher did. In the event of long-term disability, the
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2. A copy of the actual long-term disability insurance
policy at issue here is not included in the record, and so we
rely on the description of the policy given in Digital's
benefits booklet.
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insurance company sends "monthly checks for as long as you
are totally disabled . . . ." The checks amount to two-
thirds of an employee's base salary, and the amounts received
are not taxed.3 Nowhere does Section 5 of the benefits
booklet state that disability payments may be made by way of
distribution of Digital's stock under the Restricted Stock
Plan or an option agreement. Although Section 5 includes a
subsection entitled "What happens to your other Digital
benefits if you're disabled", that subsection does not refer
to the Restricted Stock Plan or employee option agreements
either.4
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3. There is no record support for the Fishers' allegation
that John Fisher's base salary included "benefits from
Digital's restricted stock plan." Rather, the Restricted
Stock Plan stated that it was intended to "provide a method
whereby employees . . . may be offered incentives, in
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addition to those of current compensation . . ." (emphasis
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added). At trial, Robert Dill, Digital's Assistant
Treasurer, confirmed that employees "were paid through their
weekly check as well as through the benefits they got from
th[e] stock option plan." This suggests that the stock
option was not part of Fisher's weekly salary, although it
was an additional component of his overall compensation.
In any event, even if the value of the stock option had
been included in Fisher's base salary, that would not have
made a distribution of stock to him pursuant to his exercise
of his stock option a payment under his disability insurance
policy, but presumably would only have increased the amount
of the monthly check issued to him by his disability
insurance company.
4. Thus, while we have no doubt that Digital's long-term
disability policy bears all the indicia of accident or health
insurance or an accident or health plan as the Fishers argue,
their contention is essentially irrelevant since the stock
distribution at issue here could not have been effected
pursuant to that policy.
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John Fisher was on disability leave from Digital
from 1982-87. At no point during his leave did Fisher or
Digital terminate Fisher's employment with Digital. Although
he performed no services for Digital during that time, he
presumably continued to observe his employment agreement
(reaffirmed in the option agreement), which was a matter of
clear importance to Digital. In addition, Digital carried
him on its employee rolls, extended certain benefits to him,
and undoubtedly anticipated his performance of future
services when his disability ended. (Fisher did return at
the end of his leave and as of the time of trial was still
performing services for Digital.) Consistent with Personnel
Policy 4.23, the restrictions on Fisher's option stock
continued to lapse during his leave, and before his option
agreement expired in July 1986, he exercised his option to
purchase the then remaining shares of stock on which
restrictions had lapsed. As the facts show, that exercise
could only have been pursuant to the option agreement, which
was fully effective at that time since Fisher's employment
with Digital had not terminated, the Restricted Stock Plan
and Personnel Policy 4.23. The option could not have been
exercised pursuant to his rights under the long-term
disability insurance policy he had purchased. That policy
provided only for the receipt of monthly checks from Fisher's
disability insurance company during his disability, which
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Fisher testified he had received and excluded from taxable
income.
On these facts, we have no hesitation affirming the
Tax Court's decision that the distribution of stock to Fisher
was taxable under section 83(a). The purpose of the
Restricted Stock Plan was to encourage the continued services
of certain employees by distributing stock which became more
valuable to those employees as their service to the company
continued. Through its leave of absence policy and the
specific provisions of the option agreement, which required
only that an optionee remain "employed" in order to exercise
his option, Digital ensured that employees whose employment
had not terminated, but who were temporarily unable to
perform services because on a leave of absence, were entitled
to take advantage of the benefits of the Restricted Stock
Plan, thus receiving the same incentive to continue their
employment as employees not on leave. The Restricted Stock
Plan was not intended to provide stock to sick or disabled
employees, and, being entirely silent on the subject, cannot
conceivably be thought to have done so. Likewise, the
disability policy made no mention of distributing stock to
sick or disabled employees, but spoke only of distributing
monthly checks to disabled employees, and so cannot
conceivably be thought to have authorized stock distributions
to disabled employees. Consequently, the Restricted Stock
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Plan was not accident or health insurance under IRC 104 or
an accident or health plan under IRC 105, nor was the 1986
distribution of stock a disability payment to Fisher under
Fisher's long-term disability insurance.
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II. Additions to Tax
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The IRS assessed certain additions to tax against
the Fishers for failing to report Digital's distribution of
stock to John Fisher as taxable income. Before its change in
1989, section 6653(a)(1), which applies to the Fishers' 1986
tax return, provided for certain additions to tax if a
taxpayer's underpayment of tax was due to negligence.
Section 6653(a)(3) defined negligence to include "any failure
to make a reasonable attempt to comply with the provisions of
this title," and case law defines it to be "lack of due care
or failure to do what a reasonable and ordinarily prudent
person would do under the circumstances." See, e.g., Neely
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v. United States, 775 F.2d 1092, 1095 (9th Cir. 1985).
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Former section 6661(a), which applies as well, provided for
an addition to tax if a taxpayer substantially understated
his income tax for any taxable year, and section
6661(b)(2)(B) permitted a reduction in the addition to tax if
there was "substantial authority" for the taxpayer's position
or if the taxpayer "adequately disclosed" the relevant facts
in his return. The taxpayer has the burden of showing that
penalties under sections 6653 and 6661 should not have been
assessed. Sandvall v. Commissioner, 898 F.2d 455, 459 (5th
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Cir. 1990).5
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5. There is no dispute that, if the stock distribution was a
taxable transfer of property, the Fishers had underpaid their
tax within the meaning of section 6653 and had substantially
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John Fisher is a certified public accountant who,
before joining Digital, had performed audits and worked in
the tax department of a Big Eight public accounting firm for
approximately eight years. Before filing their 1986 return,
the Fishers had received a W-2c form showing that the 1986
stock distribution was a taxable transfer of property (the
form corrected a previously received W-2 form which
apparently had not included the distribution). During his
leave, John Fisher had received monthly disability checks
from his disability insurer which (with the exception of one
year apparently) he had excluded from income on his tax
returns. Nevertheless, on their tax return the Fishers
described the stock distribution as "L.T. disability income
from 100 percent employee funded stock option excluded under
section 104(a)(3)." Appropriately emphasizing Fisher's
particular expertise as an accountant with tax and auditing
experience, see Carlins v. Commissioner, 55 T.C.M. 228, 244-
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45 (1988) (memorandum decision), the Tax Court found the
Fishers negligent in not reporting the stock distribution as
taxable income. It also found that the Fishers had no
substantial authority for their position and did not make
adequate disclosure on their 1986 return.
In view of what we have said above, we have no
doubt that the Tax Court was right. The Fishers had no
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understated their tax within the meaning of section 6661.
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factual basis for describing the stock distribution as being
a payment under John Fisher's disability insurance. The
record shows plainly that Fisher's right to exercise his
stock option was based on the option agreement, the
Restricted Stock Plan and Personnel Policy 4.23, and not on
his long-term disability insurance. Thus, their statement
that the distribution was "L.T. disability income" was
inaccurate and misleading.6 To sufficiently apprise the IRS
of "the nature of the potential controversy" regarding their
tax treatment of the stock distribution so as to make
adequate disclosure, see Treas. Reg. 1.6661-4(b)(1)(iv), at
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a minimum the Fishers needed to refer to the existence of the
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option agreement, the Restricted Stock Plan, Personnel Policy
4.23 and John Fisher's long-term disability insurance. Cf.
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id. (b)(4) ("Disclosure is not adequate . . . if it consists
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6. We see no need to discuss the arguments the Fishers make
to support their characterization of the distribution as
being a "100 percent employee funded stock option excluded
under section 104(a)(3)" pursuant to the allocation rules in
regulations enacted under section 105. Because the
distribution in question cannot conceivably be regarded as a
payment pursuant to accident or health insurance or an
accident or health plan, further discussion of the Fishers'
arguments regarding the amount and timing of Digital's
contribution to the stock option plan as an accident or
health plan is pointless.
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of undifferentiated information . . . .").7 They did not do
so.
Nor did they have substantial authority for their
position that the stock distribution was not taxable. They
say that they relied on BNA Portfolio #389 and certain case
law in treating the distribution as nontaxable income under
section 104(a)(3). The statement they relied on is as
follows:
For purposes of 104(a)(3), insurance benefits
include amounts received from a non-insured fund.
31/ Accident or health benefits from a qualified
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pension, profit-sharing, or stock bonus plan are
also within the scope of 104(a)(3). 32/
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Even if inactive in 1986, as an accountant with tax
experience John Fisher must have known that he could not rely
on so general a statement as this in asserting that the
distribution here was exempt from taxation under section
104(a)(3). Moreover, Footnote 32, which the Fishers
highlight in the appendix to their appellate brief, referred
the reader to a different portion of the portfolio for an
assessment of when the plan in question was "qualified" under
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7. The regulation referred to contains requirements for
disclosures made in a statement attached to the return. The
Fishers did not attach a statement to their return, but noted
the tax position they took directly on the return.
Nevertheless, in their brief they claim that they met all the
requirements of this regulation, and so we use it as a
measure of the adequacy of their disclosure. Judged by
common sense standards as well, however, their disclosure was
unquestionably inadequate given the disparity between the
claim they were asserting and the actual facts.
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section 104(a)(3). The Fishers did not provide that portion
of the portfolio to the Tax Court, and do not state that the
information it contained substantiated their position.
Moreover, Footnote 32 also referred the reader to the second
sentence of section 104(a), which concerns the treatment of
payments to self-employed individuals and so is not
applicable, and to Trappey v. Commissioner, 34 T.C. 407
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(1960). Trappey and the other cases cited by the Fishers are
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all readily distinguishable since all involved payments made
pursuant to contractual or statutory provisions which
expressly authorized the payments to certain employees in
view of their disability. The stock distribution here was
made pursuant to the option agreement, the Restricted Stock
Plan and Personnel Policy 4.23, none of which expressly
provided for the distribution of stock to sick or disabled
employees. Because they are factually distinguishable, none
of the cases which the Fishers relied on in preparing their
return is substantial authority for the tax position they
took. See Treas. Reg. 1.6661-3(b)(1) ("There is
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substantial authority for the tax treatment of an item only
if the weight of the authorities supporting the treatment is
substantial . . . ."); id. (b)(3) ("[T]he weight of
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authorities depends on their persuasiveness and relevance . .
. . For example, a case . . . would not be considered
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particularly relevant if the authority is materially
distinguishable on its facts . . . .").
Nor would any reliance by the Fishers on any
statements by Digital employees suggesting that the
distribution was tax-free under section 104(a)(3) have been
reasonable: the Restricted Stock Plan itself stated
unqualifiedly that exercising the stock option with respect
to transferable option shares would result in a taxable
transfer of property under section 83; the relevant documents
demonstrate that no connection whatever existed between the
option agreement and Restricted Stock Plan, on the one hand,
and John Fisher's disability or long-term disability
insurance, on the other; Digital had issued a W-2c form to
Fisher stating that the distribution was taxable income
before the Fishers filed their return; and John Fisher had
been receiving and deducting monthly checks from a disability
insurer on account of his disability consistent with the
terms of his disability policy. Moreover, any such
statements would not have been substantial authority under
section 6661, even if the employees in question had been tax
professionals. See Treas. Reg. 1.6661-3(b)(2) ("legal
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opinions or opinions rendered by other tax professionals . .
. are not authority").
The judgment of the Tax Court is affirmed.
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