International F. Corp. v. Commissioner of Int. Rev.
30 A.F.T.R. (P-H) 1433, 135 F.2d 310, 1943 U.S. App. LEXIS 3268 (1943)
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Rule of Law:
The transfer of appreciated property by an employer to an employee as compensation for services is a taxable disposition of that property, resulting in a realized gain for the employer equal to the difference between the property's fair market value at the time of transfer and its original cost basis.
Facts:
- A corporate taxpayer purchased shares of stock in another company.
- The value of these shares subsequently increased above the taxpayer's original purchase price.
- In 1936, the taxpayer decided to pay a bonus to some of its employees for services they had already rendered.
- The taxpayer paid this bonus by delivering shares of the appreciated stock to the employees.
- The taxpayer was not under a pre-existing legal obligation to pay this specific bonus.
- The fair market value of the shares at the time of delivery was greater than the taxpayer's original cost to acquire them.
Procedural Posture:
- The Commissioner of Internal Revenue determined a tax deficiency against the taxpayer corporation.
- The taxpayer petitioned the United States Tax Court, a court of first instance for tax disputes, to challenge the deficiency.
- The Tax Court held that the taxpayer's transfer of appreciated stock to its employees as a bonus resulted in a taxable gain.
- The taxpayer, as appellant, appealed the decision of the Tax Court to the United States Court of Appeals for the Second Circuit.
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Issue:
Does an employer realize a taxable gain when it distributes shares of stock that have appreciated in value to its employees as compensation for past services?
Opinions:
Majority - Frank, Circuit Judge
Yes. A disposition of appreciated property for valid consideration, such as compensation for services, constitutes a closed and taxable transaction resulting in a realized gain. The court reasoned that the transfer was not a gift because the taxpayer received a full 'quid pro quo' in the form of employee services. This consideration is deemed to have a value at least equal to the fair market value of the shares transferred. Under § 111 of the Revenue Act of 1936, a taxable gain is realized from the 'sale or other disposition of property' when the 'amount realized' exceeds the property's cost basis. Although the taxpayer did not literally receive 'money' or 'property,' it received 'money's worth' in the form of services, which satisfies the statutory requirement for a taxable event. The transaction is economically equivalent to the taxpayer selling the shares for their fair market value and then paying the cash proceeds to the employees as compensation.
Analysis:
This decision establishes the key principle that using appreciated property to satisfy a business obligation is a 'disposition' that triggers the realization of capital gains. It clarifies that 'amount realized' under tax law is not limited to cash or tangible property but also includes the 'money's worth' of services received. This ruling creates a dual tax consequence for such transactions: the employer must recognize the gain on the property's appreciation while also being entitled to a business expense deduction for the compensation paid (at the property's fair market value). This prevents corporations from avoiding capital gains tax by compensating employees with appreciated assets instead of cash.
