Theophilos v. Commissioner
67 T.C.M. 2106, 1994 T.C. Memo. 45, 1994 Tax Ct. Memo LEXIS 47 (1994)
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Rule of Law:
For purposes of I.R.C. § 83, a 'transfer' of property in connection with the performance of services occurs not upon an executory contract to convey property in the future, but when the transferee has performed all conditions precedent to acquiring a beneficial ownership interest, including tendering all required consideration.
Facts:
- In February 1985, George Beegle, the sole shareholder of Greater Suburban Mortgage (GSM), began discussions with his attorney, Anthony Theophilos, about Theophilos joining the company.
- On May 3, 1985, Theophilos sent Beegle a letter outlining his understanding that he would purchase and hold options for 40% of GSM's stock, based on its March 31, 1985 value.
- Theophilos began working at GSM on June 1, 1985, and formally withdrew from his law firm partnership on October 1, 1985.
- From late 1985 through mid-1986, the parties and their advisors negotiated and repeatedly changed the structure of the transaction, moving from a direct purchase plan to a corporate recapitalization involving two new classes of stock.
- GSM's amended articles of incorporation, which created the new classes of stock, were not filed with the state of California until October 1, 1986.
- On December 10, 1986, GSM issued the new stock to Beegle, who then endorsed the certificate for 1,020 shares of Class B common stock over to Theophilos.
- On that same day, December 10, 1986, Theophilos tendered a $10,000 promissory note to Beegle as payment for the Class B stock.
- Between May 1985 and December 1986, GSM's revenues and pretax income increased dramatically.
Procedural Posture:
- The Commissioner of Internal Revenue determined deficiencies in the Federal income tax of Anthony and Patricia Theophilos for the 1986 and 1987 tax years.
- The deficiency was primarily based on the Commissioner's determination that Theophilos received $3,516,320 in compensation income in 1986 from the receipt of GSM stock.
- Theophilos petitioned the United States Tax Court for a redetermination of the deficiencies asserted by the Commissioner.
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Issue:
For purposes of I.R.C. § 83, does a 'transfer' of property occur when an employee and employer reach a preliminary agreement for the employee to acquire an equity interest, or does it occur when all conditions precedent, including the tender of payment and the finalization of the transaction's structure, are complete?
Opinions:
Majority - Jacobs
No. For purposes of I.R.C. § 83, a 'transfer' of property occurs not when parties reach a preliminary agreement, but only when the recipient has fully performed all conditions precedent to acquiring a beneficial ownership interest, such as tendering payment and finalizing the transaction's structure. The court reasoned that the May 1985 letter was merely an executory contract to purchase stock in the future, not a present transfer of a beneficial interest. The structure of the transaction was uncertain and evolved for over a year, demonstrating there was no 'meeting of the minds' on the specifics of the transfer until much later. The critical moment of transfer occurred on December 10, 1986, when Theophilos finally performed the condition precedent of tendering payment (the promissory note) for the stock. Until that date, he held, at most, an unfunded and unsecured promise to receive property, which is not taxable under § 83. Therefore, the stock must be valued for tax purposes on the December 10, 1986 transfer date, when its value had significantly appreciated.
Analysis:
This case clarifies that for purposes of I.R.C. § 83, a 'transfer' is not a mere promise or agreement in principle, but requires the completion of all necessary steps to confer beneficial ownership. It establishes that the date payment is tendered is a critical factor in determining the transfer date, especially when the terms of the acquisition remain in flux. This precedent serves as a caution for individuals receiving compensatory equity; delays in finalizing and paying for the interest can result in significant unforeseen tax liability if the company's value increases during the negotiation period. The decision underscores the importance of formalizing and executing such transactions promptly to lock in a valuation date for tax purposes.
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