United States of America v. William D. Frazell and Martha T. Frazell
335 F.2d 487 (1964)
Premium Feature
Subscribe to Lexplug to listen to the Case Podcast.
Rule of Law:
When a taxpayer receives an interest in a corporation or partnership as compensation for services, the fair market value of that interest is taxable as ordinary income at the time the interest is transferred and no longer subject to substantial restrictions.
Facts:
- In 1951, geologist William Frazell entered into a contract with two investors, N. H. Wheless Oil Company and W. C. Woolf, to locate and acquire oil and gas properties.
- In return for his services, Frazell was to receive a monthly salary plus a specified interest in the properties acquired.
- The contract stipulated that Frazell's interest in the properties would not vest until Wheless and Woolf had recovered their full costs and expenses from the venture.
- Frazell also contributed valuable oil maps, which were his personal property, to the venture.
- In April 1955, just before the investors were expected to recover their costs, the original contract was terminated.
- The properties were transferred to a newly formed entity, the W.W.F. Corporation.
- As part of this new arrangement, Frazell received 13% of the W.W.F. Corporation's stock, which had a fair market value of $91,000.
Procedural Posture:
- William Frazell did not include the $91,000 fair market value of the W.W.F. stock on his 1955 income tax return.
- The Commissioner of Internal Revenue determined a deficiency, asserting the stock was taxable income.
- Frazell paid the deficiency under protest and filed a suit for a refund against the United States in the U.S. District Court for the Western District of Louisiana (a federal trial court).
- The district court ruled in favor of Frazell, holding that the transaction was a tax-free exchange under IRC § 351(a).
- The United States (the Government), as the appellant, appealed the district court's decision to the U.S. Court of Appeals for the Fifth Circuit.
Premium Content
Subscribe to Lexplug to view the complete brief
You're viewing a preview with Rule of Law, Facts, and Procedural Posture
Issue:
Does the receipt of corporate stock constitute taxable income to the extent its value is attributable to services rendered, even if the transaction is structured as a corporate formation intended to be tax-free under § 351(a)?
Opinions:
Majority - Tuttle, Chief Judge
Yes, the receipt of stock for services constitutes taxable income. Under the Internal Revenue Code, compensation for services is taxable as ordinary income, regardless of the form of payment. The court reasoned that Frazell's interest in the original venture was contingent and would have become taxable income upon vesting, which was scheduled to occur when the investors recovered their costs. The termination of the original contract and the subsequent issuance of stock was merely a substitute for the compensation he was due to receive for his services. The court viewed the transaction's substance over its form, holding that changing the payment from a partnership interest to corporate stock did not alter its character as taxable compensation. However, the court also found that a portion of the stock may have been received in exchange for property—namely, Frazell's maps. Therefore, the case was remanded to determine the value of the maps, as only the portion of the stock's value exceeding the value of the contributed maps would be taxable as ordinary income for services rendered.
Dissenting - Hutcheson, Circuit Judge
No. The dissenting opinion argues that the district court's judgment should be affirmed. The author considers the trial judge's opinion to be 'incontrovertible' and characterizes the government's appeal as 'technical and unsubstantial.' The dissent offers no independent legal analysis, instead asserting that the majority's opinion is not a correct statement of the law and that the initial finding of a tax-free exchange was correct.
Analysis:
This decision is significant for establishing that the non-recognition provisions for corporate formation under § 351 cannot be used to shield compensation for services from taxation. It reinforces the 'substance over form' doctrine in tax law, preventing taxpayers from converting ordinary income into a tax-free exchange through strategic restructuring. The case clarifies that a contingent future interest received for services becomes taxable upon vesting, and a last-minute substitution of corporate stock does not change this outcome. It also mandates an allocation between services and property in mixed-contribution cases, requiring valuation of any property contributed to determine the non-taxable portion of the exchange.
