PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
UNITED STATES OF AMERICA,
Plaintiff-Appellee,
v.
No. 08-2054
ROBERT L. BERGBAUER; MARIE T.
BERGBAUER,
Defendants-Appellants.
Appeal from the United States District Court
for the District of Maryland, at Baltimore.
Richard D. Bennett, District Judge.
(1:05-cv-02132-RDB)
Argued: January 28, 2010
Decided: April 16, 2010
Before MOTZ, SHEDD, and AGEE, Circuit Judges.
Affirmed by published opinion. Judge Agee wrote the opin-
ion, in which Judge Motz and Judge Shedd joined.
COUNSEL
ARGUED: Julian Spirer, Bethesda, Maryland, for Appellants.
Francesca Ugolini Tamami, UNITED STATES DEPART-
MENT OF JUSTICE, Washington, D.C., for Appellee. ON
BRIEF: Mark L. Rosenberg, Bethesda, Maryland, for Appel-
2 UNITED STATES v. BERGBAUER
lants. John A. DiCicco, Acting Assistant Attorney General,
Kenneth L. Greene, Tax Division, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C.; Rod J.
Rosenstein, United States Attorney, Baltimore, Maryland, for
Appellee.
OPINION
AGEE, Circuit Judge:
Robert and Marie Bergbauer appeal from the grant of sum-
mary judgment to the Government establishing their federal
income tax liability. The district court held that Robert Berg-
bauer’s sale of his interest in a subsidiary of Ernst & Young
LLP ("Ernst & Young") was a fully taxable event in the year
2000. For the reasons set forth below, we affirm the judgment
of the district court.
I.
A.
In 1999, Ernst & Young LLP ("Ernst & Young") entered
into a letter of intent to sell its consulting business to Cap
Gemini, S.A. ("Cap Gemini"). The parties agreed that Ernst
& Young would transfer the assets of the consulting division
of its business to a newly-formed subsidiary, Cap Gemini
Ernst & Young US LLC ("CGE&Y"), and thereafter distrib-
ute membership interests in CGE&Y primarily to those part-
ners in Ernst & Young, like Robert Bergbauer, who worked
in the consulting division ("the consulting partners"). Immedi-
ately following the distribution, Ernst & Young and the con-
sulting partners would sell their CGE&Y membership
interests to Cap Gemini in exchange for Cap Gemini common
stock. As a result, Cap Gemini would own all the equity inter-
UNITED STATES v. BERGBAUER 3
ests of CGE&Y and operate the former Ernst & Young con-
sulting practice through that entity.1
Ernst & Young distributed a Partner Information Document
("PID") to the consulting partners which described the pro-
posed transaction.2 The PID indicated that the exchange of
CGE&Y membership interests for Cap Gemini stock would
be structured as a "taxable capital gains transaction," in which
the "partners are treated as though they receive all of the gain
and are taxed on it." J.A. 285. The PID also provided that
"[a]ll partners will vest in their shares immediately upon clos-
ing. However, the shares . . . will be subject to forfeiture"
under certain circumstances. J.A. 280. The Cap Gemini shares
received would not be directly distributed to the consulting
partners, but would "be held in an individual account in an
institution such as . . . Merrill Lynch and [would] be subject
to resale restrictions." J.A. 278.
Twenty-five percent of each consulting partner’s Cap Gem-
ini shares would be released for sale shortly after the transac-
tion closed, so the consulting partner could cover the 2000 tax
liability incurred as a result of recognizing the receipt of all
the Cap Gemini stock as income that year. The remaining
seventy-five percent of a partner’s shares would be held in a
restricted brokerage account for that partner and could be
"monetized," that is sold, in installments of up to fifteen per-
cent of the partners’ shares on each of the next five anniver-
sary dates of the sale. A consulting partner could not "directly
or indirectly, sell, assign, transfer, pledge, [or] grant any
option with respect to or otherwise dispose of any interest" in
non-monetized shares. J.A. 785. While non-monetized shares
1
The consulting partners would then sever their relationship with Ernst
& Young by divesting their partnership interests in Ernst & Young, cash-
ing out their capital accounts, and becoming employees of CGE&Y.
2
The PID was not a contract document to be executed by the parties, but
an informational document somewhat akin to a prospectus for security
investments.
4 UNITED STATES v. BERGBAUER
were held in the restricted brokerage accounts, those shares
were subject to forfeiture "for breach of [partners’] individual
Cap Gemini agreements, early departures or termination for
cause." J.A. 280. Upon monetization all restrictions on those
shares lapsed.
Of particular import for the timing-of-income issue in the
case at bar, the PID stated:
The fair market value of the stock received that
cannot be sold immediately will be calculated at 95
percent of the closing price of Cap Gemini stock on
the day of the exchange for [CGE&Y] shares. This
discount will slightly reduce tax due on the Cap
Gemini shares received at closing. . . . Ernst &
Young, its partners, and Cap Gemini will treat valua-
tion and related issues consistently for [U.S.] federal
income tax purposes. . . .
For all . . . partners . . . [t]he gain on the sale of
the distributed [CGE&Y] shares is reportable on
Schedule D of your U.S. federal income tax return
for 2000.
J.A. 285-86.
The consulting partners, including Robert Bergbauer, had
the opportunity to review the PID before they met on March
7-8, 2000 to discuss and vote on the proposed transaction.
During its presentation of the proposed transaction, Ernst &
Young’s management answered questions regarding the tax
implications of the receipt of Cap Gemini stock, particularly
the decision to structure the sale "as a taxable transaction on
day one" in contrast to "creeping vesting" or "structured vest-
ing." J.A. 495, 500, 501. It was widely anticipated among the
parties that the value of Cap Gemini stock would substantially
appreciate after closing. Management explained that in order
to obtain long-term capital gains treatment on future sales of
UNITED STATES v. BERGBAUER 5
Cap Gemini stock, the consulting partners must recognize the
value of all the shares as taxable income in 2000, thereby set-
ting the shares’ cost basis (Internal Revenue Code ("I.R.C.")
§ 1012) and the required capital gains holding period (I.R.C.
§ 1223).3 Ultimately, ninety-five percent of the consulting
partners, including Robert Bergbauer, voted to approve the
transaction.
After the consulting partners’ vote of approval, Ernst &
Young distributed the necessary contract documents to con-
summate the transaction. These documents included, inter
alia, the Consulting Partner Transaction Agreement
("CPTA"), the Master Agreement, and a brokerage agreement
as to the non-monetized shares (collectively "the transaction
documents").
In executing the CPTA, the consulting partners warranted
their receipt of Cap Gemini shares would "be a taxable trans-
action for U.S. federal income tax purposes," but the specific
timing language about the year 2000 was not included as it
was in the PID. J.A. 782. Certain provisions of the Master
Agreement (1) reflected that the Cap Gemini shares "not mon-
etized in the Initial Offering [would] be valued for tax pur-
poses at 95% of the otherwise-applicable market price," J.A.
1047, (2) instructed the parties to treat the transaction as a sale
and not to take a contrary position in any tax return without
the written consent of Cap Gemini, and (3) stated that neither
Cap Gemini nor its affiliates were the legal or beneficial
owner of the shares received by the consulting partners.
The CPTA also contained a liquidated damages clause,
which provided that consulting partners could be terminated
for cause, voluntarily leaving CGE&Y, or breaching the non-
compete or confidentiality provisions of their Cap Gemini
employment agreements, and be required to forfeit some or all
3
Internal Revenue Code sections directly correspond to those found in
Title 26 of the United States Code.
6 UNITED STATES v. BERGBAUER
of their non-monetized shares. The percentage of Cap Gemini
stock subject to forfeiture depended upon the triggering for-
feiture event.4
B.
Robert Bergbauer executed the required transaction docu-
ments on May 1, 2000, and received, in exchange for his
CGE&Y membership interest, 10,740 shares of Cap Gemini
stock subject to the limitations and restrictions noted above.5
The Bergbauers timely filed their year 2000 federal income
tax return consistent with the PID and transaction documents.
On Schedule D of their 2000 return, the Bergbauers reported
the value of all the Cap Gemini shares as taxable income.
Twenty-five percent of the shares were valued at the full clos-
ing price of $155.30 and the remaining seventy-five percent
at ninety-five percent of that value, $148.52.6
On each successive anniversary date of the closing,
2,013.75 shares were monetized, that is released, from the
restricted brokerage account and made available to Bergbauer
for sale. While the non-monetized shares were held in the
4
If an event occurred triggering the forfeiture provision, partners could
lose: (a) 100% of their stock before December 31, 2000; (b) 75% of their
stock before the first anniversary of the closing; (c) 56.7% of their stock
on or after the first anniversary of the closing and before the second anni-
versary of the closing; (d) 38.4% of their stock on or after the second anni-
versary of the closing and before the third anniversary of the closing; (e)
20% of their stock on or after the third anniversary of the closing and
before the fourth anniversary of the closing; and (f) 10% on or after the
fourth anniversary of the closing and prior to the end of the 4-year, 300-
day restricted period. If a consulting partner was terminated for "poor per-
formance," up to fifty percent of the prescribed percentage could be for-
feited at the discretion of CGE&Y. J.A. 787.
5
Shortly after the closing, Robert Bergbauer sold twenty-five percent of
his Cap Gemini stock and the proceeds were distributed to him.
6
The Bergbauers’ 2000 return reported total capital gain income of
$1,515,814, total taxable income of $2,473,832, and a federal income tax
liability of $676,493.
UNITED STATES v. BERGBAUER 7
restricted brokerage account, Bergbauer received the dividend
income attributable to those shares.
In December 2002, CGE&Y terminated Robert Berg-
bauer’s employment as part of a reduction in force following
the "dot com bubble burst." J.A. 81. Bergbauer, however, did
not forfeit any of his Cap Gemini shares and received a cash
severance payment. He later found employment at KPMG
where he became a full equity partner.
By 2003, in contrast to the consulting partners’ expecta-
tions, the Cap Gemini share price had dropped precipitously.7
Bergbauer and other former Ernst & Young colleagues dis-
cussed the prospect of filing amended year 2000 tax returns
based on "what had happened to the value of the Cap [Gem-
ini] stock." J.A. 92.
The Bergbauers filed an amended year 2000 federal income
tax return in 2003, taking the position that only the twenty-
five percent of Cap Gemini shares, those which were mone-
tized and then sold in 2000, were taxable income for that year.
Citing the "lack of control over the remaining Seventy-Five
(75%) of the stock in the trust," the Bergbauers contended
those shares were not taxable in 2000 because Robert Berg-
bauer "did not receive the stock," but should have been recog-
nized as income only in the years of monetization and valued
at the much lower market rates. J.A. 914. The amended return
correspondingly reduced the amount of 2000 taxable income,
resulting in a claim for a refund of $253,490 plus accrued
interest.
7
The drop in share price was reflected by Bergbauer’s sale of his mone-
tized Cap Gemini shares: (1) 555 shares at $76.77 in April 2002, netting
proceeds of $42,607.06; (2) 4,278 shares at $33.09 in May 2003, netting
proceeds of $141,569.00; (3) 2,148 shares at $46.45 in September 2003,
netting proceeds of $99,792.51; and (4) 1,074 shares at $24.68 in October
2004, netting proceeds of $26,505.67.
8 UNITED STATES v. BERGBAUER
The Internal Revenue Service ("IRS") reviewed the
amended return and agreed to abate the Bergbauers’ year
2000 tax liability by the requested $253,490. The IRS applied
$100,000 as a credit to the Bergbauers’ 2001 tax liability and
cut a check to them for the remainder plus accrued interest.
Upon further examination, the IRS later determined that the
abatement and refund had been made in error. As a result, a
civil action was brought against the Bergbauers under I.R.C.
§ 7405, seeking payment to the Government of the erroneous
tax refund. After the parties conducted discovery, the Govern-
ment filed a motion for summary judgment contending the
undisputed facts proved the value of all the Cap Gemini stock
was taxable income in 2000 and the tax refund was in error.
The Bergbauers responded with a cross-motion for summary
judgment, arguing the abatement and refund were not errone-
ous because only twenty-five percent of the stock was taxable
income in 2000.8
The district court observed that, when determining the tax
treatment of a transaction, the Fourth Circuit "applies a two-
pronged test which examines (1) the intent of the parties; and
(2) the economic substance of the transaction," United States
v. Bergbauer, No. 05-2132, 2008 WL 3906784, at *8 (D. Md.
Aug. 18, 2008) (citing Gen. Ins. Agency, Inc. v. Comm’r, 401
F.2d 324, 327 (4th Cir. 1968)), commonly termed the "eco-
nomic reality" test. The court determined that the intent prong
of the economic reality test showed an intent to recognize the
value of all the Cap Gemini stock as taxable income in 2000.
Id. at *10. The district court also concluded that the parties
8
The district court initially postponed a decision until other district
courts considering the same question concerning former Ernst & Young
consulting partners had an opportunity to rule. See United States v. Berg-
bauer, No. 05-2132, 2008 WL 3906784, at *4 (D. Md. Aug. 18, 2008). To
date, there are more than 200 cases pending in the lower courts or admin-
istratively with the IRS in which former Ernst & Young consulting part-
ners have sought to defer their recognition of income from the sale of their
CGE&Y interests to Cap Gemini in 2000.
UNITED STATES v. BERGBAUER 9
bargained at arms-length for, and received, real economic
benefit from treating all the Cap Gemini stock as received for
income tax purposes in 2000. Id. Accordingly, the district
court awarded summary judgment to the Government and
denied the Bergbauers’ motion. Id. at *11.
The Bergbauers noted a timely appeal, and we have juris-
diction pursuant to 28 U.S.C. § 1291.
II.
We review an award of summary judgment de novo. Des-
mond v. PNGI Charles Town Gaming, L.L.C., 564 F.3d 688,
691 (4th Cir. 2009). Summary judgment is appropriate only
"if the pleadings, the discovery and disclosure materials on
file, and any affidavits show that there is no genuine issue as
to any material fact and that the movant is entitled to judg-
ment as a matter of law." Fed. R. Civ. P. 56(c)(2); Erwin v.
United States, 591 F.3d 313, 327 (4th Cir. 2010). Because the
Bergbauers’ claims were rejected on summary judgment, we
view the factual evidence in the light most favorable to them.
See Walker v. Prince George’s County, 575 F.3d 426, 427
(4th Cir. 2009) (citing Anderson v. Liberty Lobby, Inc., 477
U.S. 242, 255 (1986)).
III.
This case presents the issue of the timing of the receipt of
income: Were the Bergbauers the taxable recipients of all the
Cap Gemini shares in 2000 or only the twenty-five percent
monetized and available for sale? The Bergbauers do not con-
test the valuation of the shares, the adequacy of consideration,
or challenge the validity of the transaction. They simply con-
tend that the 8,055 non-monetized Cap Gemini shares were
not "received," for income tax purposes, in 2000 and therefore
should not be "recognized" as income in that year. Citing
I.R.C. § 451(a), the Bergbauers argue that cash method tax-
payers, like them, should report income in the tax year in
10 UNITED STATES v. BERGBAUER
which they actually or constructively receive it. See I.R.C.
§ 451(a) ("The amount of any item of gross income shall be
included in the gross income for the taxable year in which
received by the taxpayer . . . .").
The Bergbauers posit that Robert was not in actual receipt
of the non-monetized shares in 2000 because those shares
were held in a restricted account and subject to transfer prohi-
bitions. Citing the regulations under § 451 in 26 C.F.R.
§ 1.451-2(a), the Bergbauers also argue there was no "con-
structive receipt" of the non-monetized shares in 2000
because of both the restrictions on transfer and the risk of forfei-
ture.9 Br. of Appellant at 20. As further support, the Berg-
bauers reference I.R.C. § 83(a)(2), which they claim sets the
timing of recognition of income as "the first taxable year in
which the rights of the person having the beneficial interest in
such property are transferable or are not subject to a substan-
tial risk of forfeiture." Br. of Appellant at 28.
Thus, if Robert Bergbauer did not "receive" the non-
monetized shares in 2000, the Bergbauers argue they were not
required to recognize and report the value of those shares as
taxable income that year. Br. of Appellant at 23. Instead, the
Bergbauers contend that the non-monetized shares were
received, for income tax purposes, seriatim in each year after
2000 when the forfeiture restrictions lapsed and the shares
were released and available for transfer. Br. of Appellant at
14-15. The Bergbauers conclude that their intention, and that
of the other parties, that the "shares be deemed to have been
9
26 C.F.R. § 1.451-2(a) provides in relevant part:
Income although not actually reduced to a taxpayer’s possession
is constructively received by him in the taxable year during
which it is credited to his account, set apart for him, or otherwise
made available so that he may draw upon it at any time, . . . .
However, income is not constructively received if the taxpayer’s
control of its receipt is subject to substantial limitations or restric-
tions. . . .
UNITED STATES v. BERGBAUER 11
received sooner for tax purposes could not hasten the taxabil-
ity of the shares" because § 451 or § 83 foreclose that result.
Br. of Appellant at 23.
The Government responds by citing the unanimous deci-
sions from courts in other circuits addressing the claims of
similarly situated former Ernst & Young consulting partners,
all of which have determined that the value of all the Cap
Gemini shares was fully taxable in 2000. See, e.g., United
States v. Fletcher, 562 F.3d 839 (7th Cir. 2009). Recognizing
that decisions from outside this Circuit use different standards
in evaluating the recharacterization of a taxable transaction,
the Government also argues the district court correctly applied
our Court’s economic reality test and that the Bergbauers’
statutory argument is misplaced. Br. of Appellee at 26-27.
We note that the Bergbauers do not contend the economic
reality test is invalid. Instead, the bottom line of their position
is that the provisions of § 451 and § 83 supersede any applica-
tion of that test and mandate their proposed tax treatment of
the Cap Gemini stock. We disagree and find the district court
properly applied our precedent and committed no error in
awarding summary judgment to the Government.
In Commissioner v. National Alfalfa Dehydrating and Mill-
ing Co., 417 U.S. 134 (1974), the Supreme Court stated:
[W]hile a taxpayer is free to organize his affairs as
he chooses, nevertheless, once having done so, he
must accept the tax consequences of his choice
whether contemplated or not, and may not enjoy the
benefit of some other route he might have chosen to
follow but did not.
417 U.S. at 149 (internal citations omitted); Signet Banking
Corp. v. Comm’r, 118 F.3d 239, 241 (4th Cir. 1997) (same);
see also Frank Lyon Co. v. United States, 435 U.S. 561,
583-84 (1978) (holding that "the Government should honor
12 UNITED STATES v. BERGBAUER
the allocation of rights and duties effectuated by the parties"
when "there is a genuine multiple-party transaction with eco-
nomic substance . . . compelled or encouraged by business or
regulatory realities, . . . imbued with tax-independent consid-
erations, and . . . not shaped solely by tax-avoidance features
that have meaningless labels attached"); id. at 584
("Expressed another way, . . . the form of the transaction
adopted by the parties governs for tax purposes."); accord
Gray v. Powell, 314 U.S. 402, 414 (1941) ("The choice of dis-
regarding a deliberately chosen arrangement for conducting
business affairs does not lie with the creator of the plan.").
In embracing National Alfalfa’s principle, "courts have
established very strict standards," Furman v. United States,
602 F. Supp. 444, 456 (D.S.C. 1984), for a taxpayer who
elects "a specific course of action and then when finding him-
self in an adverse situation [seeks to] extricate himself by
applying the age-old theory of substance over form." Corne-
lius v. Comm’r, 494 F.2d 465, 471 (5th Cir. 1974) (quotation
omitted). We have recognized that "[g]enerally, taxpayers are
liable for the tax consequences of the transaction they actually
execute and may not reap the benefit of recasting the transac-
tion into another one substantially different in economic effect
that they might have made." Estate of Leavitt v. Comm’r, 875
F.2d 420, 423 (4th Cir. 1989); see also Signet, 118 F.3d at
242 ("[T]he bank simply cannot structure the terms of the
cardholder agreement to its advantage and then rely on an
indeterminate question of Virginia law to evade the federal
tax implications thereof."); Snowa v. Comm’r, 123 F.3d 190,
198 n.11 (4th Cir. 1997) (observing that § 1034(g) of the
Internal Revenue Code "provide[d] a legislative exception to
the general rule that a taxpayer cannot recharacterize a trans-
action to avoid the tax consequences of the form of the trans-
action actually chosen").
To put it plainly, we have bound taxpayers to "the ‘form’
of their transaction" when they attempt to recharacterize an
otherwise valid agreement bargained for in good faith. Estate
UNITED STATES v. BERGBAUER 13
of Leavitt, 875 F.2d at 423. We have also refused to entertain
arguments "that the ‘substance’ of their transaction triggers
different tax consequences." Id. This precept not only main-
tains the vital public policy of enforcing otherwise valid con-
tracts, but also assures the reliability of agreed tax
consequences to the public fisc.
"[A]llowing the government to adopt as conclusive a result
agreed to by the parties . . . provide[s] a more efficient system
that . . . greatly reduce[s] the possibility of litigation . . .
aimed at revising the parties’ bargained agreement." Sullivan
v. United States, 618 F.2d 1001, 1004 (3d Cir. 1980); see also
Furman, 602 F. Supp. at 455 ("To allow a taxpayer to unilat-
erally reform one end of a bargain could encourage taxpayers
to ignore agreements as written in the hope that the courts will
give them more advantageous tax treatment."). To do other-
wise would allow situations to be created where the alteration
of tax benefits, as a result of inconsistent reporting, "whip-
saws" the Government and results in disastrous and unfair
effects on our tax system. Sullivan, 618 F.2d at 1004 (recount-
ing the previous practice of parties "advocat[ing] mutually
conflicting tax characterizations of their agreement[s]," which
"frequently" would compel the Commissioner "to assess
inconsistent deficiencies" and to pursue litigation against both
parties "in separate suit[s]," wherein the Commissioner was
forced to take "divergent positions so as to avoid two adverse
judgments").
There is no "disparity" in allowing "the Commissioner
alone to pierce formal" agreements as "taxpayers have it
within their own control to choose in the first place whatever
arrangements they care to make." Comm’r v. Danielson, 378
F.2d 771, 775 (3d Cir. 1967) (en banc). The Government’s
interest lies "in having the transaction reported consistently
by" the parties to the sale. Throndson v. Comm’r, 457 F.2d
1022, 1024 n.2 (9th Cir. 1972). In this case, the Government
never challenged the Bergbauers’ recognition of the value of
all 10,740 Cap Gemini shares as taxable income in 2000. All
14 UNITED STATES v. BERGBAUER
the other parties to the transaction, including Cap Gemini,
reported the stock transfer consistent with the Bergabuers’
treatment on the 2000 return and the Commissioner has not
challenged those actions.
With the foregoing in mind, our Circuit has applied a two-
pronged "economic reality" test when reviewing a taxpayer’s
attempt to recharacterize the tax consequences of a transaction.10
Gen. Ins. Agency, Inc., 401 F.2d at 329-30; see also Volvo
Cars of N. Am., LLC v. United States, 571 F.3d 373, 379 (4th
10
Other circuits have fashioned their own standards for determining
whether a taxpayer may challenge his prior treatment of the tax conse-
quences of a transaction. As these standards do not apply in the Fourth
Circuit, we mention them only for informational purposes. Two such stan-
dards are the Danielson rule and the "strong proof" rule. In Commissioner
v. Danielson, 378 F.2d 771 (3d Cir. 1967) (en banc), the Third Circuit held
that a taxpayer could recharacterize the terms of a transaction only if those
terms were unenforceable due to "mistake, undue influence, fraud, [or]
duress, etc." Danielson, 378 F.2d at 775; see also Bradley v. United States,
730 F.2d 718, 720 (11th Cir. 1984) ("A party can challenge the tax conse-
quences of his agreement as construed by the Commissioner only by
adducing proof which in an action between the parties would be admissi-
ble to alter that construction or to show its unenforceability because of
mistake, undue influence, fraud, duress, et cetera.") (quotations omitted)
(emphasis in original); Smith v. Comm’r, 65 F.3d 37, 40 (5th Cir. 1995)
("[A] taxpayer may argue substance over form when necessary to prevent
unjust results, and when proof is offered which in an action between the
parties would be admissible to alter that construction or to show its unen-
forceability because of mistake, undue influence, fraud, duress, etc.")
(quotations and internal citation omitted).
The "strong proof" rule requires a party to adduce "strong proof" that
the parties intended an allocation different than that included in the con-
tract. See N. Am. Rayon Corp. v. Comm’r, 12 F.3d 583, 588 n.6 (6th Cir.
1993) ("The ‘strong proof’ rule requires a party seeking to disregard the
express price allocations in an agreement to adduce strong proof that the
parties actually intended to attribute different values than those stated in
the agreement."); Rogers’ Estate v. Comm’r, 445 F.2d 1020, 1021 (2d Cir.
1971) ("In this Circuit, the rule is, that when the parties to a transaction
. . . have specifically set out the covenants in the contract and have there
given them an assigned value, strong proof must be adduced by them in
order to overcome that declaration.") (quotation omitted).
UNITED STATES v. BERGBAUER 15
Cir. 2009) ("[W]e have long held that the parties’ intent and
the relevant facts are critical in construing contracts for fed-
eral tax purposes."); Thomas v. Comm’r, 83 T.C.M. (CCH)
1576 (2002) (recognizing and applying the "economic reality"
test). The economic reality test examines (1) the intent of the
parties, and (2) the economic substance of the transaction.
The determination of the parties’ intent and the economic sub-
stance of the transaction are questions of fact, with the tax-
payer bearing the burden of proof. Gen. Ins. Agency, Inc., 401
F.2d at 329.
The district court concluded that the provisions in the trans-
action documents, particularly the CPTA and Master Agree-
ment, "strongly demonstrate[d]" that it was the parties’
understanding that all Cap Gemini shares would be immedi-
ately taxable at the transaction’s closing. Bergbauer, 2008
WL 3906784, at *5. However, the court recognized that other
sections of the transaction documents, namely the forfeiture
and stock transfer restriction provisions, could be in conflict
with immediate taxation of the non-monetized shares. Id. at
*8-9.
Without a definitive answer from the plain language of the
transaction documents, the district court turned its analysis to
the extrinsic evidence, particularly the PID, and found that
this evidence "shed[ ] light on the terms of the transaction
documents," and demonstrated that "the parties’ original
intent was for the [c]onsulting [p]artners to be immediately
taxed on the entirety of the shares they received at the transac-
tion’s closing on May 23, 2000." Id. at *10.
We conclude that the district court did not clearly err in this
finding. Indeed, the Bergbauers conceded the intent prong of
the economic reality test on appeal, i.e., that the parties
intended the value of all the Cap Gemini shares exchanged for
the CGE&Y membership interests be fully taxed in 2000.
Even without such a concession, the district court’s determi-
16 UNITED STATES v. BERGBAUER
nation of intent was strongly supported by the record evi-
dence.
Several provisions of the PID demonstrate that the parties
plainly intended for Robert Bergbauer to be immediately
taxed on all 10,740 Cap Gemini shares in 2000. Not only did
the PID provide that the transaction would be structured as a
"taxable capital gains transaction," J.A. 285, but it also stated
that "Ernst & Young, its partners, and Cap Gemini [would]
treat valuation and related issues consistently." J.A. 285-86.
But, most importantly, the PID unequivocally stated that "[a]ll
partners [would] vest in their shares immediately upon clos-
ing," J.A. 280, and "[t]he gain on the sale of the [CGE&Y
interests] [would be] reportable on Schedule D of [their] U.S.
federal income tax return for 2000." J.A. 286.
Further, Arthur Gordon, Ernst & Young’s director of tax in
2000, testified that the consulting partners knew the intent of
the parties was to close the transaction so they would own all
the Cap Gemini shares outright that year, thus establishing a
cost basis and holding period for long-term capital gain treat-
ment of future sales of the stock. As the district court
observed, "even if Robert Bergbauer did not immediately
appreciate the operative tax language contained within the
PID, after attending the March 7-8, 2000 meeting he was well
aware that all parties to the agreement" intended for the con-
sulting partners to be "immediately taxed" on all their Cap
Gemini shares in 2000. Bergbauer, 2008 WL 3906784, at *9.
Finally, the Bergbauers’ initial 2000 tax return, wherein they
reported as income the value of all 10,740 Cap Gemini shares,
demonstrates that the Bergbauers understood the intention to
be taxed on the entirety of those shares in 2000.
While the parties intended immediate taxation on all the
Cap Gemini shares in 2000, the "economic reality" test
requires that there be economic substance to that decision. See
Halle v. Comm’r, 83 F.3d 649, 655 (4th Cir. 1996) (explain-
ing that "we must look beyond the parties’ terminology to the
UNITED STATES v. BERGBAUER 17
‘substance and economic realities’ of the [transaction],
gleaned from the totality of the circumstances surrounding the
transaction"). In other words, the "economic realities sur-
rounding the transaction in this case [must] confirm" that the
parties’ agreement to treat the shares as immediately taxable
"accurately portrayed their intentions." Id.; see also Wrangler
Apparel Corp. v. United States, 931 F. Supp. 420, 426
(M.D.N.C. 1996) ("The second prong of the General Insur-
ance test requires that the covenant bargained for have some
independent value grounded in economic reality.").
All parties to the transaction, bargaining at arms-length,
had economic reasons to subject the entirety of the consulting
partners’ Cap Gemini stock to full and immediate taxation in
2000. For consulting partners, like Robert Bergbauer, imme-
diate taxation in 2000 was the means to both start the holding
period for capital gains treatment under I.R.C. § 1223, and at
the same time establish a high cost basis under I.R.C. § 1012.
Both elements were key for Bergbauer and his colleagues to
achieve their goal of minimizing tax when they later disposed
of the Cap Gemini stock after its anticipated high rise in
value.
Cap Gemini, on the other hand, sought to fix its cost basis
for the acquired assets in CGE&Y, and, in turn, its amortiza-
tion deductions under I.R.C. § 197. This course of action also
enabled all of the parties to avoid future litigation over con-
flicting opinions of value if anything other than the agreed
value of the Cap Gemini stock was used for tax reporting pur-
poses.
While the stock transfer restrictions and forfeiture provi-
sions presented a potential risk to the consulting partners dur-
ing the non-monetization period, these provisions were
mutually beneficial, in part, to all parties’ economic interests.
The forfeiture provision clearly benefitted Cap Gemini as a
retention mechanism to preserve the consulting partners’ cli-
ent relationships, goodwill, and expertise. But other economic
18 UNITED STATES v. BERGBAUER
benefits accrued to Cap Gemini and the consulting partners as
well. As Arthur Gordon testified:
The purpose of the restricted account was to pro-
tect the value of the stock. In one moment of time we
doubled the number of issued and outstanding shares
of Capgemini, the public company. The feeling was
if everybody was allowed to go to the market at
once, the stock would plummet because you had too
many shares without enough buyers. So in order to
protect everybody’s value, the partners agreed that
they would voluntarily restrict their shares with the
consideration being that everybody else will restrict
their shares. . . .
. . . And it was an agreement that we would all
lose certain rights for the benefit of the whole and
for us individually.
J.A. 431-32. Thus, it was in each consulting partner’s eco-
nomic interest to agree to restrict every other consulting part-
ner’s transfer and sale of shares. Flooding the market with
Cap Gemini shares would only depress the price of the stock,
thereby damaging every party’s economic interest in the
transaction.
We therefore conclude that the district court did not err in
its conclusion that the terms of the transaction contained
"some economic substance beyond the parties’ subjective
intent." Bergbauer, 2008 WL 3906784, at *10. The district
court properly determined that the second prong of the eco-
nomic reality test was met because the terms of the transac-
tion were grounded in "business reality such that reasonable
men, genuinely concerned with their economic future, might
bargain for such an agreement." Gen. Ins. Agency, Inc., 401
F.2d at 330.
Thus, the value of all the Cap Gemini shares should have
been recognized as taxable income in 2000, as agreed to and
UNITED STATES v. BERGBAUER 19
reported by all parties, unless the Bergbauers’ statutory argu-
ments mandate a different result. We conclude those argu-
ments are without merit.
The Bergbauers’ argument as to § 83 is readily rejected.
The restrictions under that statute on the recognition of
income for property not "transferable" or "subject to a sub-
stantial risk of forfeiture" applies only if the property is trans-
ferred "in connection with the performance of services."
I.R.C. § 83(a). The CGE&Y for Cap Gemini equity interest
exchange was clearly not related to the performance of ser-
vices and the Bergbauers do not contend to the contrary.
Thus, the plain terms of § 83 verify that statute has no appli-
cation to this case.
The argument as to I.R.C. § 451 is similarly unavailing. If
Robert Bergbauer had received the Cap Gemini stock in the
absence of an agreement, but subject to the forfeiture and
restricted transfer provisions, his timing argument for the year
of income recognition might have more credence. Of course,
he did not receive the Cap Gemini stock in the abstract or in
a vacuum. Neither are the tax consequences to be adjudicated
in that context, but upon the totality of the circumstances. As
the legion of caselaw set forth above clearly illustrates, a tax-
payer’s choice of tax treatment under a binding contract is not
an optional commitment. "[T]axpayers are liable for the tax
consequences of the transaction they actually execute and
may not reap the benefit of recasting the transaction into
another one substantially different in economic effect that
they might have made." Estate of Leavitt, 875 F.2d at 423.
In this case, the parties bargained for mutually beneficial
tax consequences with the consulting partners receiving a
high basis for future capital gains treatment in exchange for
immediate taxation in 2000. At the same time, Cap Gemini
received a set amortization basis in exchange for foregoing
the opportunity (or risk) of a different basis if a structured
stock-distribution schedule were used. This allocation fixed
20 UNITED STATES v. BERGBAUER
the tax consequences for both parties and enabled the Govern-
ment to receive the benefit of higher taxable income from the
consulting partners in 2000, offset over time by Cap Gemini’s
higher-based amortization deductions in later years, as well as
the potential reduced tax when the consulting partners sold
Cap Gemini stock at long-term capital gains rates.
The Bergbauers point to no statute or caselaw which would
permit them to unilaterally change the agreed upon tax treat-
ment of the transaction, years after the fact, because their
prior choices no longer serve their economic interests. Noth-
ing in § 451 or any other provision of the Internal Revenue
Code permits a taxpayer to whipsaw the Government and the
other parties to the transaction by unilaterally altering the
agreed tax treatment, which has economic substance and
reflects his intent, after the fact when the winds of change
foment delayed seller’s remorse. The principle established in
National Alfalfa is as valid now as when pronounced nearly
four decades ago and settles the issue raised by the Berg-
bauers:
[W]hile a taxpayer is free to organize his affairs as
he chooses, nevertheless, once having done so, he
must accept the tax consequences of his choice,
whether contemplated or not, and may not enjoy the
benefit of some other route he might have chosen to
follow but did not.
417 U.S. at 149 (internal citations omitted); Signet Banking
Corp., 118 F.3d at 241 (same).
We therefore reject the Bergbauers’ contention that § 451
grants them the authority to rewrite the tax treatment of the
Cap Gemini stock which they agreed upon, and did, treat as
fully taxable income in 2000 and for which there were reasons
of bona fide economic substance.
UNITED STATES v. BERGBAUER 21
IV.
As the record reflects, both prongs of the "economic real-
ity" test have been satisfied and the district court did not err
in so finding. Accordingly, we affirm the district court’s grant
of summary judgment to the Government and the court’s
denial of summary judgment to the Bergbauers.
AFFIRMED