Lawrence J. Alves and Myra L. Alves v. Commissioner of Internal Revenue
54 A.F.T.R.2d (RIA) 5281, 1984 U.S. App. LEXIS 21843, 734 F.2d 478 (1984)
Rule of Law:
Under Internal Revenue Code Section 83(a), the appreciation in value of restricted stock transferred "in connection with the performance of services" is taxable as ordinary income when the restrictions lapse, even if the employee paid full fair market value for the stock at the time of transfer and did not realize a "bargain element." A Section 83(b) election is necessary to avoid this treatment.
Facts:
- In April 1970, General Digital Corporation was formed to manufacture and market micro-electronic circuits.
- Lawrence J. Alves joined General Digital Corporation as vice-president for finance and administration.
- As part of an employment and stock purchase agreement dated May 22, 1970, General Digital Corporation sold Alves 40,000 shares of common stock at ten cents per share.
- A portion of Alves's shares were restricted, subject to repurchase by the company at ten cents per share if Alves left within four or five years, specifically to provide assurance that key personnel would remain with the company.
- On July 1, 1974, the restrictions on 4,667 of Alves's four-year shares lapsed, at which time their fair market value was $6 per share.
- On March 24, 1975, the restrictions on 7,093 of Alves's five-year shares lapsed, at which time their fair market value was $3.43 per share.
- Alves did not report the difference between the fair market value of these shares when restrictions ended and the original purchase price paid as ordinary income on his 1974 and 1975 tax returns.
- The parties stipulated that on the date Alves entered the agreement, General Digital's common stock had a fair market value of 10 cents per share, and Alves did not make an election under Section 83(b) when he received the restricted stock.
Procedural Posture:
- The Commissioner of Internal Revenue found a deficiency in Lawrence J. Alves's tax returns for the years 1974 and 1975, determining that the appreciation of his restricted stock was ordinary income under Section 83(a).
- Alves petitioned the Tax Court to challenge the Commissioner's determination.
- The Tax Court sustained the Commissioner's deficiency determination, finding that the stock was transferred in connection with Alves's performance of services and that Section 83(a) applies even when full fair market value is paid (Alves v. Commissioner, 79 T.C. 864 (1982)).
- Alves, as the appellant, appealed the Tax Court's decision to the United States Court of Appeals for the Ninth Circuit.
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Issue:
Does Internal Revenue Code Section 83(a) apply to an employee's purchase of restricted stock, causing the appreciation in value to be taxed as ordinary income when restrictions lapse, even if the employee paid the full fair market value for the stock at the time of purchase?
Opinions:
Majority - Schroeder, Circuit Judge
Yes, Internal Revenue Code Section 83(a) applies to an employee's restricted stock, making its appreciation taxable as ordinary income upon the lapse of restrictions, even if the employee paid full fair market value at the time of purchase. The court affirmed the Tax Court's decision, finding that the plain language of Section 83(a) applies to all property transferred "in connection with the performance of services" and makes no reference to "compensation" or a requirement that the property's fair market value exceed the purchase price at the time of transfer. The legislative history of Section 83 indicates Congress's intent to create a "blanket rule" to address the disparate tax treatment of restricted stock plans compared to other deferred compensation arrangements and to regulate how employees gain a shareholder's interest, extending beyond mere bargain purchases. The court rejected Alves's argument that Section 83(b) (the election provision) implies Section 83(a) only applies to bargain purchases, noting that Section 83(b) merely adds flexibility and Treasury Regulations explicitly provide for an 83(b) election even when the transferee paid full value (zero excess). Therefore, the appreciation in value of Alves's restricted stock upon the lapse of restrictions in 1974 and 1975 was properly included as ordinary income under Section 83(a) because he failed to make a Section 83(b) election. The court cited Sakol v. Commissioner for the "blanket rule" and the practical nature of the statute.
Analysis:
This case significantly clarified the scope of Internal Revenue Code Section 83, establishing that its application is broad and not limited to instances where an employee receives a "bargain" price for restricted stock. It confirms that the key trigger for Section 83 is the transfer of property "in connection with the performance of services," regardless of the purchase price. This ruling prevents taxpayers from avoiding ordinary income tax on the appreciation of restricted stock by claiming it was an "investment" if full fair market value was paid, reinforcing the critical importance of the Section 83(b) election for those wishing to fix their tax liability at the time of transfer and treat subsequent appreciation as capital gains.
