Fisher v. Commissioner

August 20, 1993
[NOT FOR PUBLICATION]

UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT

No. 92-2457

JOHN S. AND LORRAINE M. FISHER,

Petitioners, Appellants,

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent, Appellee.

APPEAL FROM THE UNITED STATES TAX COURT

[Hon. Lawrence Wright, U.S. Tax Court Judge]

Before

Breyer, Chief Judge,

Selya and Stahl, Circuit Judges.

John S. Fisher and Lorraine M. Fisher on brief pro se.

Michael L. Paup, Acting Assistant Attorney General, Gary R.

Allen, Ann B. Durney, and Randolph L. Hutter, Tax Division, Department

of Justice, on brief for appellee.

Per Curiam. John Fisher is an employee of Digital

Equipment Corporation. From 1982-87 he was on a disability

leave of absence from the company. In 1986, he exercised

certain stock options, which resulted in a distribution to

him of stock with a net value of $50,726.55. Fisher and his

wife reported that sum as nontaxable long-term disability

income on their 1986 tax return. The Internal Revenue

Service ("IRS") disagreed and assessed a deficiency which the

Fishers challenged in Tax Court. The Tax Court concluded

that Digital's distribution of stock to John Fisher in 1986

was a taxable transfer of property under 26 U.S.C. ("IRC")

83 rather than tax-free income received through accident or

health insurance under IRC 104(a)(3) or an accident or

health plan under IRC 105(e)(1), as the Fishers claimed.

It also deemed proper the assessment by the IRS of certain

additions to tax against the Fishers for their failure to

report the distribution as taxable income. The Fishers now

appeal. Because the record shows that the Tax Court's

understanding of the law and facts was correct, we affirm.

I. The Characterization of the 1986 Distribution

The tax provisions at issue are IRC 83, 104, and

105. Section 83(a) provides for the taxation of property

transferred to a person "in connection with the performance

of services." The person liable for the tax is the person

who performed the services, and the amount taxed is the

excess of the fair market value of the property over the

amount paid for the property. A transfer of property is

subject to section 83 if made "in respect of past, present,

or future services." Treas. Reg. 1.83-3(f). Section 83

applies at the time a stock option is exercised where, as

here, the option does not have a readily ascertainable fair

market value at the time the option is granted, provided the

stock is transferable or no longer subject to substantial

risk of forfeiture at that time (as defined in the

regulations). Id. 1.83-7(a); IRC 83(a)(1); see Treas.

Reg. 1.83-(c) & (d).1 In general, section 104(a)(3)

excludes from taxable income "amounts received through

accident or health insurance for personal injuries or

sickness . . . ." For section 104 purposes, amounts received

under "an accident or health plan for employees" are treated

as amounts received through accident or health insurance.

IRC 105(e)(1). Generally speaking, an accident or health

plan is "an arrangement for the payment of amounts to

employees in the event of personal injuries or sickness."

Treas. Reg. 1.105-5(a).

1. Under the terms of Digital's Restricted Stock Plan, the
restrictions on an employee's ability to transfer option
shares were to lapse each year for a certain percentage of
the shares. By the time Fisher exercised his option in 1986,
all such restrictions on all of Fisher's remaining option
shares had lapsed, and so the option shares at issue would
have been transferable or no longer subject to substantial
risk of forfeiture within the meaning of IRC 83(a)(1).

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The pertinent facts and our assessment of them in

light of this law are as follows. In 1986, John Fisher

exercised his option to buy 690 shares of stock as to which

the restrictions on transferability had lapsed. The fair

market value of the stock was $58,132.55, and Fisher paid

$7,406 to exercise his option. Fisher had been granted his

stock option rights in 1976 in two stock option agreements,

one of which is included in the record. The option agreement

in the record makes no reference to Digital's disability

plan, but explicitly states that it is subject to Digital's

Restricted Stock Purchase Plan ("the Restricted Stock Plan"),

and it incorporates the terms of the Restricted Stock Plan by

reference. The option agreement, which was to terminate on

July 28, 1986, states that Fisher could exercise the option

only while "employed" by Digital. Similarly, the Restricted

Stock Plan states its intent to provide incentives to certain

employees "who are presently making and are expected to

continue to make substantial contributions" to the company to

ensure that they would "continue in the service of the

Company . . ., thereby advancing [its] interests . . . ."

Although the option agreement and the Restricted Stock Plan

describe what Fisher's rights to exercise the option would be

if Fisher retired with the company's consent, died, or

terminated his employment with Digital, neither makes any

reference to what Fisher's rights would be if he were unable

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to work because of sickness or disability. Presumably,

however, if he remained "employed" by Digital, his rights

under the option agreement and the Restricted Stock Plan

would continue, whereas if he terminated his employment

because of disability, his rights would be as provided in the

Restricted Stock Plan for employees whose employment with

Digital terminates. As a postscript to the option agreement,

Fisher signed a pledge affirming his obligations to Digital

under the employment agreement he signed when he first joined

Digital, and agreeing, among other things, to preserve the

confidentiality of Digital's trade secrets, inform Digital of

new ideas conceived by him while at Digital, and refrain from

inducing others to violate their employment agreements with

the company. On the basis of these documents, it is clear

that Digital's grant of stock options to its employees was

intended to reward present good performance and to encourage

future services of like quality. Thus, transferring stock to

an employee exercising an option under the option agreement

would transfer property "in connection with the performance

of services" as defined in the regulations. See Treas. Reg.

1.83-3(f) (section 83(a) taxes property transferred "in

respect of past, present, or future services"). Accordingly,

such a transfer would subject the performer of the services

to taxation with respect to that stock under section 83(a),

and the Restricted Stock Plan states, without qualification,

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that the option holder would receive taxable income under

section 83(a) upon exercise of the option with respect to

shares as to which the restrictions have lapsed.

We see nothing in Digital's personnel or disability

policies or in the way in which John Fisher was treated while

on leave that would alter that result with respect to

Digital's transfer of stock to Fisher in 1986. At the time

Fisher was granted his option, he was performing services for

Digital. In 1978, before he went on a leave of absence, an

internal company memorandum explained that, for employees on

a leave of absence, "[stock] options continue to lapse as

though [the] employees were not on leaves of absence." This

memorandum made explicit the inference to be drawn from the

proviso in Fisher's option agreement that the option was

exercisable only as long as he was "employed" by Digital --

that is, that employees on leave are still employed by

Digital and have full rights under their option agreements

and under the Restricted Stock Plan.

Digital's leave of absence policy, stated in

Section 4.23 of its "Personnel Policies and Procedures," is

consistent with the 1987 memorandum. The benefits subsection

of the policy describes the extent to which benefits continue

for employees on a leave of absence. The entry "Qualified

and Restricted Stock Plans" provides that "[i]f the employee

is a participant in either the Qualified or Restricted Stock

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Plan, restrictions on these options continue to lapse while

the employee is on a leave of absence." A separate entry

"Medical, Dental, Life and Disability Insurance" states that

employees on a leave of absence can continue their

"disability income protection" by paying their premiums in

advance. Thus, Personnel Policy 4.23 makes clear that some

benefits continue for employees on leave; it also treats an

absent employee's rights under the Restricted Stock Plan and

under a long-term disability plan separately, and does not

make the exercise of stock options a component of the

disability benefits provided employees on a disability leave

of absence.

Nor do Digital's disability policies do this. In

Section 5 of its benefits booklet, Digital discusses its

disability plans.2 The preface explains that Digital offers

one sickness and three disability plans "to help provide you

with all or a portion of your income if you are sick or

disabled and unable to work." (Emphasis in original.)

Although Digital automatically enrolls all employees in its

short-term disability plan, employees must purchase their

long-term disability plan from an insurance company, as

Fisher did. In the event of long-term disability, the

2. A copy of the actual long-term disability insurance
policy at issue here is not included in the record, and so we
rely on the description of the policy given in Digital's
benefits booklet.

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insurance company sends "monthly checks for as long as you

are totally disabled . . . ." The checks amount to two-

thirds of an employee's base salary, and the amounts received

are not taxed.3 Nowhere does Section 5 of the benefits

booklet state that disability payments may be made by way of

distribution of Digital's stock under the Restricted Stock

Plan or an option agreement. Although Section 5 includes a

subsection entitled "What happens to your other Digital

benefits if you're disabled", that subsection does not refer

to the Restricted Stock Plan or employee option agreements

either.4

3. There is no record support for the Fishers' allegation
that John Fisher's base salary included "benefits from
Digital's restricted stock plan." Rather, the Restricted
Stock Plan stated that it was intended to "provide a method
whereby employees . . . may be offered incentives, in

addition to those of current compensation . . ." (emphasis

added). At trial, Robert Dill, Digital's Assistant
Treasurer, confirmed that employees "were paid through their
weekly check as well as through the benefits they got from
th[e] stock option plan." This suggests that the stock
option was not part of Fisher's weekly salary, although it
was an additional component of his overall compensation.
In any event, even if the value of the stock option had
been included in Fisher's base salary, that would not have
made a distribution of stock to him pursuant to his exercise
of his stock option a payment under his disability insurance
policy, but presumably would only have increased the amount
of the monthly check issued to him by his disability
insurance company.

4. Thus, while we have no doubt that Digital's long-term
disability policy bears all the indicia of accident or health
insurance or an accident or health plan as the Fishers argue,
their contention is essentially irrelevant since the stock
distribution at issue here could not have been effected
pursuant to that policy.

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John Fisher was on disability leave from Digital

from 1982-87. At no point during his leave did Fisher or

Digital terminate Fisher's employment with Digital. Although

he performed no services for Digital during that time, he

presumably continued to observe his employment agreement

(reaffirmed in the option agreement), which was a matter of

clear importance to Digital. In addition, Digital carried

him on its employee rolls, extended certain benefits to him,

and undoubtedly anticipated his performance of future

services when his disability ended. (Fisher did return at

the end of his leave and as of the time of trial was still

performing services for Digital.) Consistent with Personnel

Policy 4.23, the restrictions on Fisher's option stock

continued to lapse during his leave, and before his option

agreement expired in July 1986, he exercised his option to

purchase the then remaining shares of stock on which

restrictions had lapsed. As the facts show, that exercise

could only have been pursuant to the option agreement, which

was fully effective at that time since Fisher's employment

with Digital had not terminated, the Restricted Stock Plan

and Personnel Policy 4.23. The option could not have been

exercised pursuant to his rights under the long-term

disability insurance policy he had purchased. That policy

provided only for the receipt of monthly checks from Fisher's

disability insurance company during his disability, which

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Fisher testified he had received and excluded from taxable

income.

On these facts, we have no hesitation affirming the

Tax Court's decision that the distribution of stock to Fisher

was taxable under section 83(a). The purpose of the

Restricted Stock Plan was to encourage the continued services

of certain employees by distributing stock which became more

valuable to those employees as their service to the company

continued. Through its leave of absence policy and the

specific provisions of the option agreement, which required

only that an optionee remain "employed" in order to exercise

his option, Digital ensured that employees whose employment

had not terminated, but who were temporarily unable to

perform services because on a leave of absence, were entitled

to take advantage of the benefits of the Restricted Stock

Plan, thus receiving the same incentive to continue their

employment as employees not on leave. The Restricted Stock

Plan was not intended to provide stock to sick or disabled

employees, and, being entirely silent on the subject, cannot

conceivably be thought to have done so. Likewise, the

disability policy made no mention of distributing stock to

sick or disabled employees, but spoke only of distributing

monthly checks to disabled employees, and so cannot

conceivably be thought to have authorized stock distributions

to disabled employees. Consequently, the Restricted Stock

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Plan was not accident or health insurance under IRC 104 or

an accident or health plan under IRC 105, nor was the 1986

distribution of stock a disability payment to Fisher under

Fisher's long-term disability insurance.

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II. Additions to Tax

The IRS assessed certain additions to tax against

the Fishers for failing to report Digital's distribution of

stock to John Fisher as taxable income. Before its change in

1989, section 6653(a)(1), which applies to the Fishers' 1986

tax return, provided for certain additions to tax if a

taxpayer's underpayment of tax was due to negligence.

Section 6653(a)(3) defined negligence to include "any failure

to make a reasonable attempt to comply with the provisions of

this title," and case law defines it to be "lack of due care

or failure to do what a reasonable and ordinarily prudent

person would do under the circumstances." See, e.g., Neely

v. United States, 775 F.2d 1092, 1095 (9th Cir. 1985).

Former section 6661(a), which applies as well, provided for

an addition to tax if a taxpayer substantially understated

his income tax for any taxable year, and section

6661(b)(2)(B) permitted a reduction in the addition to tax if

there was "substantial authority" for the taxpayer's position

or if the taxpayer "adequately disclosed" the relevant facts

in his return. The taxpayer has the burden of showing that

penalties under sections 6653 and 6661 should not have been

assessed. Sandvall v. Commissioner, 898 F.2d 455, 459 (5th

Cir. 1990).5

5. There is no dispute that, if the stock distribution was a
taxable transfer of property, the Fishers had underpaid their
tax within the meaning of section 6653 and had substantially

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John Fisher is a certified public accountant who,

before joining Digital, had performed audits and worked in

the tax department of a Big Eight public accounting firm for

approximately eight years. Before filing their 1986 return,

the Fishers had received a W-2c form showing that the 1986

stock distribution was a taxable transfer of property (the

form corrected a previously received W-2 form which

apparently had not included the distribution). During his

leave, John Fisher had received monthly disability checks

from his disability insurer which (with the exception of one

year apparently) he had excluded from income on his tax

returns. Nevertheless, on their tax return the Fishers

described the stock distribution as "L.T. disability income

from 100 percent employee funded stock option excluded under

section 104(a)(3)." Appropriately emphasizing Fisher's

particular expertise as an accountant with tax and auditing

experience, see Carlins v. Commissioner, 55 T.C.M. 228, 244-

45 (1988) (memorandum decision), the Tax Court found the

Fishers negligent in not reporting the stock distribution as

taxable income. It also found that the Fishers had no

substantial authority for their position and did not make

adequate disclosure on their 1986 return.

In view of what we have said above, we have no

doubt that the Tax Court was right. The Fishers had no

understated their tax within the meaning of section 6661.

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factual basis for describing the stock distribution as being

a payment under John Fisher's disability insurance. The

record shows plainly that Fisher's right to exercise his

stock option was based on the option agreement, the

Restricted Stock Plan and Personnel Policy 4.23, and not on

his long-term disability insurance. Thus, their statement

that the distribution was "L.T. disability income" was

inaccurate and misleading.6 To sufficiently apprise the IRS

of "the nature of the potential controversy" regarding their

tax treatment of the stock distribution so as to make

adequate disclosure, see Treas. Reg. 1.6661-4(b)(1)(iv), at

a minimum the Fishers needed to refer to the existence of the

option agreement, the Restricted Stock Plan, Personnel Policy

4.23 and John Fisher's long-term disability insurance. Cf.

id. (b)(4) ("Disclosure is not adequate . . . if it consists

6. We see no need to discuss the arguments the Fishers make
to support their characterization of the distribution as
being a "100 percent employee funded stock option excluded
under section 104(a)(3)" pursuant to the allocation rules in
regulations enacted under section 105. Because the
distribution in question cannot conceivably be regarded as a
payment pursuant to accident or health insurance or an
accident or health plan, further discussion of the Fishers'
arguments regarding the amount and timing of Digital's
contribution to the stock option plan as an accident or
health plan is pointless.

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of undifferentiated information . . . .").7 They did not do

so.

Nor did they have substantial authority for their

position that the stock distribution was not taxable. They

say that they relied on BNA Portfolio #389 and certain case

law in treating the distribution as nontaxable income under

section 104(a)(3). The statement they relied on is as

follows:

For purposes of 104(a)(3), insurance benefits
include amounts received from a non-insured fund.
31/ Accident or health benefits from a qualified

pension, profit-sharing, or stock bonus plan are
also within the scope of 104(a)(3). 32/

Even if inactive in 1986, as an accountant with tax

experience John Fisher must have known that he could not rely

on so general a statement as this in asserting that the

distribution here was exempt from taxation under section

104(a)(3). Moreover, Footnote 32, which the Fishers

highlight in the appendix to their appellate brief, referred

the reader to a different portion of the portfolio for an

assessment of when the plan in question was "qualified" under

7. The regulation referred to contains requirements for
disclosures made in a statement attached to the return. The
Fishers did not attach a statement to their return, but noted
the tax position they took directly on the return.
Nevertheless, in their brief they claim that they met all the
requirements of this regulation, and so we use it as a
measure of the adequacy of their disclosure. Judged by
common sense standards as well, however, their disclosure was
unquestionably inadequate given the disparity between the
claim they were asserting and the actual facts.

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section 104(a)(3). The Fishers did not provide that portion

of the portfolio to the Tax Court, and do not state that the

information it contained substantiated their position.

Moreover, Footnote 32 also referred the reader to the second

sentence of section 104(a), which concerns the treatment of

payments to self-employed individuals and so is not

applicable, and to Trappey v. Commissioner, 34 T.C. 407

(1960). Trappey and the other cases cited by the Fishers are

all readily distinguishable since all involved payments made

pursuant to contractual or statutory provisions which

expressly authorized the payments to certain employees in

view of their disability. The stock distribution here was

made pursuant to the option agreement, the Restricted Stock

Plan and Personnel Policy 4.23, none of which expressly

provided for the distribution of stock to sick or disabled

employees. Because they are factually distinguishable, none

of the cases which the Fishers relied on in preparing their

return is substantial authority for the tax position they

took. See Treas. Reg. 1.6661-3(b)(1) ("There is

substantial authority for the tax treatment of an item only

if the weight of the authorities supporting the treatment is

substantial . . . ."); id. (b)(3) ("[T]he weight of

authorities depends on their persuasiveness and relevance . .

. . For example, a case . . . would not be considered

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particularly relevant if the authority is materially

distinguishable on its facts . . . .").

Nor would any reliance by the Fishers on any

statements by Digital employees suggesting that the

distribution was tax-free under section 104(a)(3) have been

reasonable: the Restricted Stock Plan itself stated

unqualifiedly that exercising the stock option with respect

to transferable option shares would result in a taxable

transfer of property under section 83; the relevant documents

demonstrate that no connection whatever existed between the

option agreement and Restricted Stock Plan, on the one hand,

and John Fisher's disability or long-term disability

insurance, on the other; Digital had issued a W-2c form to

Fisher stating that the distribution was taxable income

before the Fishers filed their return; and John Fisher had

been receiving and deducting monthly checks from a disability

insurer on account of his disability consistent with the

terms of his disability policy. Moreover, any such

statements would not have been substantial authority under

section 6661, even if the employees in question had been tax

professionals. See Treas. Reg. 1.6661-3(b)(2) ("legal

opinions or opinions rendered by other tax professionals . .

. are not authority").

The judgment of the Tax Court is affirmed.

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