Gudmundsson v. United States

09-4869-cv
Gudmundsson v. United States

UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT

August Term 2010

Argued: September 20, 2010 Decided: February 11, 2011

Docket No. 09-4869-cv

OLAFUR GUDMUNDSSON, SALLY A. RUDRUD,

Plaintiffs-Appellants,

v.

UNITED STATES OF AMERICA,

Defendant-Appellee.

Before: CALABRESI, KATZMANN, and CHIN, Circuit Judges.

Appeal from a judgment of the United States District

Court for the Western District of New York (David G. Larimer, J.)

dismissing plaintiffs-appellants' claim for a tax refund.

Plaintiffs-appellants argued that they prematurely recognized and

significantly overvalued property received in connection with the

performance of services. The district court disagreed and

granted summary judgment to the government.

AFFIRMED.
 ARNOLD R. PETRALIA, Petralia, Webb &
O'Connell, P.C., Rochester, New
York (Kenneth L. Greene, on the
brief), for Plaintiffs-Appellants.

ELLEN PAGE DELSOLE, Attorney, United
States Department of Justice, Tax
Division (William J. Hochul, Jr.,
United States Attorney for the
Western District of New York, of
counsel), for John A. DiCicco,
Acting Assistant Attorney General,
for Defendant-Appellee.

CHIN, Circuit Judge

In 2000, plaintiffs-appellants Olafur Gudmundsson

("Gudmundsson") and Sally Rudrud (together, "plaintiffs")1

jointly filed their 1999 federal tax return, reporting income

earned on stock Gudmundsson received as compensation from his

employer, Aurora Foods, Inc. ("Aurora"), on July 1, 1999. The

stock was subject to several contractual and legal restrictions

that impeded its marketability for one year -- by which point the

company's stock value had plummeted. Plaintiffs sought to amend

the tax return and obtain a refund, asserting that they had

prematurely reported the stock and significantly overvalued it as

income under § 83 of the Internal Revenue Code (the "I.R.C.").

After exhausting their administrative remedies, they brought this

1
Plaintiffs were married at all relevant times. They
are now divorced but have pursued this claim together.

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action against the government in the Western District of New

York. In a thoughtful and thorough decision, the district court

(Larimer, J.) granted summary judgment in favor of the

government. We affirm.

STATEMENT OF THE CASE

A. The Facts

The parties stipulated to the following facts before

the district court.

At all relevant times, Gudmundsson was an officer of

Aurora, which marketed food products under brand names such as

Aunt Jemima, Duncan Hines, and Van de Kamp. Shortly after a

corporate reorganization, Aurora made an initial public offering

of 14,500,000 registered shares of common stock on July 1, 1998

(the "IPO"). Gudmundsson became entitled to 73,105 unregistered

shares (the "Stock") by virtue of his participation in Aurora's

incentive compensation plan. The plan provided for the Stock to

be distributed to him one year from the date of the IPO, on July

1, 1999. Gudmundsson received the Stock as planned.

Aurora subsequently provided Gudmundsson a W-2 that

calculated his income from the distribution to be a little less

than $1.3 million. This figure reflected the mean price of

unrestricted shares of Aurora stock trading on the New York Stock

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Exchange (the "Exchange Price") on July 1, 1999: $17.6875.

Gudmundsson reported this amount as income under I.R.C. § 83 --

which governs the taxation of property transferred in connection

with the performance of services -- in the federal tax return he

filed jointly with his then-wife, on or before April 15, 2000.

Gudmundsson held the Stock subject to several

constraints. First, these were "restricted securities" under

Securities and Exchange Commission ("SEC") Rule 144, 17 C.F.R.

§ 230.144(a)(3)(i), meaning they were acquired directly from the

issuer and not in a public offering, id. Under Rule 144, the

Stock could not be sold on a public exchange until the expiration

of a holding period that, in Gudmundsson's case, ended on July 1,

2000. See Berckeley Inv. Grp., Ltd. v. Colkitt, 455 F.3d 195,

213 (3d Cir. 2006) (discussing the operation of Rule 144). The

Stock could, however, be disposed of in a private placement sale

or pledged as security or loan collateral. See McDonald v.

Comm'r, 764 F.2d 322, 323 n.3 (5th Cir. 1985) (citing 17 C.F.R.

§ 230.144(a)(3)).

Second, the Stock was subject to an agreement among

Aurora's various corporate entities and employee "members,"

including Gudmundsson (the "Agreement"). The Agreement

prohibited, inter alia, the public disposition of the Stock

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before the second anniversary of the IPO, July 1, 2000. Until

then, transfers could be made only to a group of "permitted

transferees," which included family members and relatives.

Permitted transferees were bound by the Agreement and had to

agree in writing to abide by its terms. Aurora would treat any

transfers other than to permitted transferees as null and void,

and in some instances it could intervene to stop a forbidden

transfer. Forfeiture of the Stock, however, was not one of the

penalties contemplated for violations of the Agreement, whether

by Gudmundsson or a permitted transferee.

Finally, Gudmundsson was subject to Aurora's Insider

Trading Policy (the "Policy"). Among other things, the Policy

required compliance with certain waiting periods and consent

procedures prior to trading Aurora stock. Violation of the

Policy could result in disciplinary action, including termination

of employment.

Conditions at Aurora deteriorated in the year between

Gudmundsson's receipt of the Stock and expiration of the

restrictions imposed by the Agreement and Rule 144. Unrestricted

shares of Aurora stock -- which had been worth $17.6875 per share

on July 1, 1999 -- lost a quarter of their value over three days

that November following the company's announcement that it would

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not meet estimated fourth quarter earnings. By December 31,

1999, the Exchange Price had fallen to $9.25.

In February 2000, Aurora's auditors discovered

irregularities in the company's financial statements, and the

board of directors announced the formation of a committee to

investigate Aurora's accounting practices and the possibility of

fraud. Several senior-level executives resigned.2 The Exchange

Price tumbled another fifty percent. That April, Aurora

announced an $81 million downward adjustment in pretax earnings

previously reported for most of 1998 and 1999. By the time the

Stock was freely marketable on July 1, 2000, the Exchange Price

had fallen to $3.8375, a decline of almost $14 in one year.

B. Prior Proceedings

In 2003, plaintiffs filed an amended tax return,

claiming a refund of $301,834 plus interest based on the mean

Exchange price of Aurora stock on December 31, 1999,3 rather than

the price on July 1, as originally reported. The Internal

2
Eventually, the executives responsible for the
wrongdoing were indicted and pled guilty to securities fraud and
related charges. Gudmundsson was not involved, and there is no
evidence that he had knowledge of the misconduct.
3
This amount was based on a mistaken Exchange Price of
$7.5625. The Exchange Price on December 31, 1999 was actually
$9.25.

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Revenue Service (the "IRS") disallowed the claim in 2006. On

March 20, 2008, plaintiffs filed this refund action below,

pursuant to 28 U.S.C. § 1346(a)(1) and 26 U.S.C. § 7422.

In the proceedings before the district court, the

parties agreed that the transaction was governed by I.R.C. § 83

and that the Stock was "transferred" to Gudmundsson within the

meaning of that provision on July 1, 1999. They disagreed as to

when the Stock became taxable income. The government argued that

the original tax return had properly reported the Stock on July

1, 1999, and properly used the Exchange Price that day as the

measure of value. Plaintiffs contended that they had been

premature to treat the Stock as income on July 1, 1999, given the

restrictions still encumbering it at the time. Alternatively,

they argued that if July 1, 1999 was the correct recognition

date, then the Stock should not be treated as if it could be sold

at the same price as Aurora's unrestricted shares.

The parties cross-moved for summary judgment. On

October 27, 2009, the district court (Larimer, J.) entered

summary judgment in favor of the government, holding that the

Stock was reportable as of July 1, 1999 and that the day's

Exchange Price was an appropriate basis for measuring the income

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received. See Gudmundsson v. United States, 665 F. Supp. 2d 227,

236-39 (W.D.N.Y. 2009). This appeal followed.

DISCUSSION

A. Standard of Review

This Court reviews a decision granting summary judgment

de novo. Beth Israel Med. Ctr. v. Horizon Blue Cross & Blue

Shield of N.J., Inc., 448 F.3d 573, 579 (2d Cir. 2006). Summary

judgment is appropriate "if there is no genuine issue as to any

material fact, and if the moving party is entitled to a judgment

as a matter of law." Allianz Ins. Co. v. Lerner, 416 F.3d 109,

113 (2d Cir. 2005) (citing Fed. R. Civ. P. 56(c)). The facts of

this case were stipulated and therefore only questions of law are

presented.

B. Taxation of Property under I.R.C. § 83

At the heart of this case is I.R.C. § 83, which governs

the taxation of property transferred in connection with the

performance of services.5 Section 83 was enacted as part of the

5
Section 83(a) provides:

If, in connection with the performance of
services, property is transferred to any
person other than the person for whom such
services are performed, the excess of--

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Tax Reform Act of 1969, Pub. L. No. 91-172, 83 Stat. 487 (1969).

It was designed to "curb the use of sales restrictions to defer

taxes on property given in exchange for services," Robinson v.

Comm'r, 805 F.2d 38, 41 (1st Cir. 1986), which had become a

popular practice among corporations and their employees. The

provision's general rule, set forth in § 83(a), has both a timing

element and a valuation element. As a matter of timing, property

received as compensation is to be recognized as income as soon as

the recipient's rights therein are "transferable" or no longer

"subject to a substantial risk of forfeiture," whichever happens

(1) the fair market value of such
property (determined without regard to any
restriction other than a restriction which by
its terms will never lapse) at the first time
the rights of the person having the
beneficial interest in such property are
transferable or are not subject to a
substantial risk of forfeiture, whichever
occurs earlier, over

(2) the amount (if any) paid for such
property,

shall be included in the gross income of the
person who performed such services in 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 substantial risk of forfeiture,
whichever is applicable.

I.R.C. § 83(a).

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first. I.R.C. § 83(a); see also Treas. Reg. § 1.83-3(b). The

value of the income received is the property's "fair market

value," measured without regard to any restriction, "other than

[a] restriction which by its terms will never lapse," I.R.C.

§ 83(a) -- also known as a "nonlapse" restriction, as

distinguished from one that will "lapse," see Treas. Reg.

§ 1.83-3(h), (i).

Both the timing and valuation components are at issue

in this case, which presents two questions: (1) when was it

appropriate to recognize the Stock as taxable income?, and (2)

what was its fair market value on that date? We address these

issues in turn.

1. The Recognition Date

Plaintiffs argue that the district court erred in

recognizing the Stock as income on July 1, 1999. They contend

that the restrictions still in force on that date rendered it

both non-transferable and subject to a substantial risk of

forfeiture.4 To survive summary judgment, plaintiffs needed to

4
Plaintiffs argue for alternative recognition dates --
e.g., December 31, 1999, July 1, 2000 -- that we need not address
because we agree with the district court that the Stock was
reportable on July 1, 1999. This date was stipulated to be the
date of the Stock transfer, and it was the one reported on
plaintiffs' original tax return. We note, however, that it was

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show the existence of both these conditions, as § 83(a)

recognizes property as soon as either is lifted. The district

court, however, concluded that the Stock was both transferable

and not subject to a substantial risk of forfeiture on July 1,

1999. For the reasons that follow, we agree.

a. Transferability and Substantial Risk of Forfeiture

Section 83(c)(1) provides that property is subject to a

"substantial risk of forfeiture" when the "rights to full

enjoyment of such property are conditioned upon the future

performance of substantial services by any individual." I.R.C.

§ 83(c)(1). The regulations further explain that the existence

of such a risk "depends upon the facts and circumstances" of each

case. Treas. Reg. § 1.83-3(c)(1). It exists where rights "are

conditioned, directly or indirectly, upon the future performance

(or refraining from performance) of substantial services by any

person, or the occurrence of a condition related to a purpose of

the transfer, and the possibility of forfeiture is substantial if

such condition is not satisfied." Id. For example, where the

property is received "subject to a requirement that it be

returned if the total earnings of the employer do not increase,

not necessarily the first day on which the Stock was reportable
under § 83. See Gudmundsson, 665 F. Supp. 2d at 232 n.2.

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such property is subject to a substantial risk of forfeiture."

Id. § 1.83-3(c)(2). On the other hand, circumstances that do not

constitute a substantial risk of forfeiture include the risk that

the property's value will decline, as well as a requirement that

the property be returned if the recipient is discharged for cause

or for committing a crime. Id. § 1.83-3(c)(1), (2).

Substantial risks of forfeiture are also built into the

definition of transferability. Property is "transferable" under

§ 83(c)(2) "only if the rights in such property of any transferee

are not subject to a substantial risk of forfeiture." I.R.C.

§ 83(c)(2). The regulations explain that "transferable" property

can be sold, assigned, or pledged "to any person other than the

transferor" without that person also incurring a substantial risk

of forfeiture. Treas. Reg. § 1.83-3(d). Transferability is not

a demanding standard, as the ability to transfer to even one

transferee free of that substantial risk is presumed to

constitute "transferability," even though it may not also mean

full marketability. See Horwith v. Comm'r, 71 T.C. 932, 939-40

(1979).

Finally, § 83 contains a "[s]pecial rule[]" for

"[s]ales which may give rise to suit under section 16(b) of the

Securities Exchange Act of 1934," providing that if the sale of

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property given as compensation at a profit could subject a person

to suit under § 16(b), that person's rights in the property are

deemed to be subject to a substantial risk of forfeiture and not

transferable. I.R.C. § 83(c)(3).5

b. Application to the Stock

(1) Substantial Risk of Forfeiture

We are not persuaded by plaintiffs' arguments that the

Stock was subject to a substantial risk of forfeiture on July 1,

1999. Plaintiffs first argue that under the circumstances, the

risk of termination Gudmundsson faced if he failed to comply with

the Policy constituted a substantial risk of forfeiture. Section

83 is concerned with the forfeiture of interests in property,

however, not in employment, and a substantial risk of forfeiture

requires that those property interests be capable of being lost.

5
The parties agree that at all relevant times
Gudmundsson was an "insider" within the meaning of § 16(b). See
Morales v. Quintel Entm't, Inc., 249 F.3d 115, 121 (2d Cir. 2001)
("An 'insider' is . . . a beneficial owner of more than ten
percent of any class of the company's non-exempt, registered
equity securities, or a director or officer of the company
issuing the stock." (citing 15 U.S.C. § 78p(a), (b)). In the
district court, plaintiffs asserted that the Stock came within
§ 83(c)(3) on July 1, 1999 because Gudmundsson could have been
subject to a § 16(b) suit at that time. The district court
disagreed. See Gudmundsson, 665 F. Supp. 2d at 230, 234-35.
Because plaintiffs do not appeal this aspect of the decision, we
do not address it.

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See Merlo v. Comm'r, 492 F.3d 618, 622 (5th Cir. 2007);

Theophilos v. Comm'r, 85 F.3d 440, 447 n.18 (9th Cir. 1996)

(inquiring into "the chances [that] the employee will lose his

rights in property transferred by his employer" to determine

substantial risk of forfeiture (emphasis omitted)). Therefore,

the risk of termination of employment is relevant under § 83 only

if it has a causal connection to the loss or potential loss of

rights in the property given as compensation. See Merlo, 492

F.3d at 622 (termination for violating insider trading policy

"was not enough to cause [taxpayer] to forfeit the shares"). No

such connection exists here. The Agreement did not provide that

termination for violation of the Policy -- or termination for any

reason at all -- would or could result in the forfeiture of the

Stock. We therefore reject plaintiffs' argument.

Second, plaintiffs argue that Gudmundsson would be

exposed to a suit under § 10(b) of the Securities Exchange Act of

1934, 15 U.S.C. § 78j(b),6 if he transferred the Stock on July 1,

6
Under § 10(b), it is unlawful to "use or employ, in
connection with the purchase or sale of any security . . . , any
manipulative or deceptive device or contrivance" in violation of
SEC rules, including rules against insider trading and fraud. 15
U.S.C. § 78j(b); see 17 C.F.R. § 240.10b-5. Because we hold that
liability under this provision does not create a substantial risk
of forfeiture under § 83, we need not decide whether Gudmundsson
could have been the subject of such a suit.

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1999, and that this created "facts and circumstances" evidencing

a substantial risk of forfeiture, Treas. Reg. § 1.83-3(c),

analogous to the risk of suit under § 16(b), see I.R.C.

§ 83(c)(3).

We hold that the district court correctly rejected the

argument, as we conclude that Congress has already indicated that

§ 10(b) does not create a substantial risk of forfeiture under

§ 83. See Merlo, 492 F.3d at 622 ("For civil suits such as

[§ 10(b)] to be considered within the definition of a substantial

risk of forfeiture, Congress would have to amend § 83."); United

States v. Tuff, 469 F.3d 1249, 1256 (9th Cir. 2006). Congress

inserted directly into the statutory text a "[s]pecial rule[]"

using language that refers only to suits under § 16(b), and by

doing so it indicated "that civil suits are not generically

covered by I.R.C. § 83." Tuff, 469 F.3d at 1256; see I.R.C.

§ 83(c)(3). We therefore reject plaintiffs' effort to use the

regulations' "facts and circumstances" analysis to bootstrap

§ 10(b) liability into § 83.

(2) Transferability

The Stock was not subject to a substantial risk of

forfeiture on July 1, 1999, and although this is enough for

income recognition under § 83, we briefly address plaintiffs'

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arguments regarding the transferability of the Stock, as well.

As a preliminary matter, plaintiffs stipulated -- and the

Agreement was clear -- that Gudmundsson could transfer the Stock

to "permitted transferees," which included his family members and

relatives, any of whom were "person[s] other than [Aurora,] the

transferor," see Treas. Reg. § 1.83-3(d). Plaintiffs assert,

however, that the Stock was not transferable because "in reality,

. . . [t]he various restrictions imposed by law and agreement

made [the Stock] impossible to sell." Pls.' Br. 24. Regardless

of whether this is true, the argument misunderstands what § 83

requires. Transferability is not just a question of

marketability. In fact, even if sales are prohibited for a

period of time, property may be transferable if it can be pledged

or assigned. See Tanner v. Comm'r, No. 02-60463, 2003 WL

21310275, at *2 (5th Cir. Mar. 26, 2003); see also Treas. Reg.

§ 1.83-3(d).

We also reject plaintiffs' effort to analogize the

Agreement's transfer restrictions to those in Robinson v.

Commissioner, 805 F.2d 38 (1st Cir. 1986). In Robinson, the

First Circuit concluded that the stock at issue was not

transferable because it had been received subject to an agreement

that contained a mandatory sell back provision prohibiting any

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disposal of the shares other than to the employer for one year.

Id. at 39. In short, for Robinson to transfer the stock "to any

person other than the transferor," Treas. Reg. § 1.83-3(d), he

would be forced to breach the agreement, Robinson, 805 F.2d at

42. By contrast, here the Agreement permitted at least some

transfers during the restricted period. Further -- as plaintiffs

stipulated below -- the Agreement did not provide for the Stock

to be forfeited if Gudmundsson or a transferee violated its

terms. The agreement in Robinson, however, gave the employer the

power to recoup the stock after an event of noncompliance. Id.

at 39-40; see Hernandez v. United States, 450 F. Supp. 2d 1112,

1119 (C.D. Cal. 2006) (rejecting analogy to Robinson where

agreement did not contain mandatory sell back provision).7

Robinson does not help plaintiffs' case and is not a reasonable

analogue: individuals saddled by more complete transfer

restrictions than was Gudmundsson have been held to have

transferable interests under § 83. See Tanner, 2003 WL 1922926,

at *2 (deeming stock to be transferable despite two-year

7
In concluding that Robinson's stock could not be
recognized under § 83(a) until these restrictions expired, the
First Circuit held that transferability could not depend on "a
hypothetical, back-door transfer in breach of the option
agreement." Robinson, 805 F.2d at 42. Rather, it must operate
"on standard practices" and the "observance of contracts." Id.

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moratorium on sales where taxpayer could and did give the stock

to a relative).

To summarize, the district court was correct to

recognize the Stock as income on July 1, 1999, as the Stock was

transferable and not subject to a substantial risk of forfeiture

on that day. This conclusion was correct under § 83(a) and in

general, as income in whatever form is taxable in the year in

which it is received, Wolder v. Comm'r, 493 F.2d 608, 612-13 (2d

Cir. 1974); see also Sakol v. Comm'r, 574 F.2d 694, 700 (2d Cir.

1978), and stock is usually valued on the day it is issued,

United States v. Roush, 466 F.3d 380, 385 (5th Cir. 2006); cf.

Wolder, 493 F.2d at 612-13.

2. The Fair Market Value of the Stock

The remaining question is the value of the Stock on

July 1, 1999. Section 83(a) recognizes property at its "fair

market value (determined without regard to any restriction other

than a restriction which by its terms will never lapse) . . .

over . . . the amount (if any) paid for such property." I.R.C.

§ 83(a).8

8
As Gudmundsson did not pay for the Stock, the amount of
income is only a question of its fair market value.

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 Plaintiffs contend that the district court erred in two

ways when it determined the fair market value of the Stock.

First, they assert that, based on an erroneous reading of §

83(a), the court impermissibly departed from the traditional

method of determining fair market value set forth in United

States v. Cartwright, 411 U.S. 546 (1973). Second, they contend

that restrictions imposed by law, rather than by contract, cannot

be considered "lapse" restrictions within the meaning of § 83(a).

We consider these arguments in turn.

a. The Calculation of Fair Market Value under § 83

In general, the term "fair market value" is understood

to mean "the price at which the property would change hands

between a willing buyer and a willing seller, neither being under

any compulsion to buy or to sell and both having reasonable

knowledge of relevant facts." Cartwright, 411 U.S. at 551

(quotation mark omitted); accord United States v. Boccagna, 450

F.3d 107, 115 (2d Cir. 2006). Cartwright articulated the

"general understanding of fair market value used throughout the

[I.R.C.] in the absence of a specific statutory rule." Harrison

v. United States, 475 F. Supp. 408, 413 (E.D. Pa. 1979). For

instance, this definition is used to value a decedent's estate

under I.R.C. § 2031, Cartwright, 411 U.S. at 554-56, and to

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assess economic income for minimum tax purposes under I.R.C.

§§ 56 and 57, McDonald, 764 F.2d at 322, 329; Estate of Gresham

v. Comm'r, 752 F.2d 518, 523 (10th Cir. 1985).

Relying on these cases, plaintiffs contend that the

fair market value of the Stock -- restricted by the Agreement,

unregistered, and not yet publicly marketable -- is determined by

the private market, as that is where the willing buyers exist.

They argue that nothing in § 83 contains the "specific statutory

rule" that requires using a method of computing fair market value

other than Cartwright's. See McDonald, 764 F.2d at 329

(expressing "a strong disinclination to disturb the established

meaning of the term 'fair market value' as it was enunciated" in

Cartwright). This is incorrect. Section 83 is, of course,

different from I.R.C. § 57 or I.R.C. § 2031, because it calls for

fair market value to be "determined without regard to any

restriction other than [one] which by its terms will never

lapse." I.R.C. § 83(a)(1). The methods used to calculate fair

market value under other I.R.C. provisions -- and the

hypothetical value of the Stock under other I.R.C. provisions --

are irrelevant to its value under § 83(a). It is unsurprising

therefore that plaintiffs cite no instances in which Cartwright's

definition of "fair market value" has been used to analyze "fair

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market value" under § 83: we have discussed before that this

language unambiguously breaks from common usage, Sakol, 574 F.2d

at 699-701, and every other court to consider the issue has

agreed, see, e.g., Roush, 466 F.3d at 386 ("[T]he fact that stock

is restricted, or even specifically valued for the purposes of

private sales at less than the fair market value, does not affect

the valuation of the shares for [§ 83] purposes."); McDonald, 764

F.2d at 330, 340-41; Pledger v. Comm'r, 641 F.2d 287, 291, 293

(5th Cir. 1981); see also Kolom v. Comm'r, 454 U.S. 1011, 1016

(1981) (Powell, J., dissenting) ("[Section] 83 . . . modifies

th[e] phrase [fair market value] with a parenthetical indicating

that restrictions that lapse are to be ignored."); Gresham, 752

F.2d at 521-22. We therefore hold that the district court

correctly rejected plaintiffs' argument and determined fair

market value according to the directives of § 83(a).

b. Lapse and Nonlapse Restrictions

On July 1, 1999, the Stock was subject to two transfer

restrictions: one imposed by contract (the Agreement) and one

imposed by law (Rule 144). The question is whether these

restrictions "will never lapse" under § 83; only in that event

would they be considered in determining value. See I.R.C.

§ 83(a)(1). The regulations define a nonlapse restriction as "a

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permanent limitation on the transferability of property" that

will (1) require the property to be sold "at a price determined

under a formula," and (2) that will apply to all subsequent

transferees. Treas. Reg. § 1.83-3(h).9 The regulations also

provide that "[l]imitations imposed by registration requirements

of State or Federal security laws or similar laws imposed with

respect to sales or other dispositions of stock or securities are

not nonlapse restrictions." Id. Applying these rules, the

district court determined that the Agreement and Rule 144 both

9
We note that § 83 is different from but not
inconsistent with Cartwright's core principle. There, the Court
rejected a regulation that taxed the decedent's mutual fund
shares at the "asked" price -- the price "used by the [mutual]
fund when selling its shares to the public" -- because, "[a]s a
matter of statutory law [under the Investment Company Act of
1940], holders of mutual fund shares cannot obtain the 'asked'
price from the fund." Cartwright, 411 U.S. at 552. In other
words, the regulation "purport[ed] to assign a value to mutual
fund shares that the estate could not hope to obtain and that the
fund could not offer." Id. at 553. The more reasonable value
was the "redemption" price, "the only price that a shareholder
may realize and that the fund -- the only buyer -- will pay,"
which was, also as a matter of statutory law, somewhat less than
the "asked" price. Id. at 552-53.

If the same issue had been considered under § 83(a),
the result likely would have been the same. Section 83(a)
adjusts its method of calculating fair market value when property
is subject to permanent pricing or transfer limitations that
negatively affect its value -- nonlapse restrictions. See I.R.C.
§ 83(a). A statutorily-set price that will run to all potential
transferees is such a restriction. See Treas. Reg. § 1.83-3(h).

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imposed restrictions that lapsed, and so disregarded them in

calculating the fair market value of the Stock on July 1, 1999.

Plaintiffs argue that this was error. They argue that

because § 83 does not explicitly say that securities laws lapse,

these laws do not lapse, and that Treasury Regulation § 1.83-3(h)

therefore unreasonably includes them in the statute's scope. The

regulation contravenes what they claim was Congress's intention

for lapse restrictions to include only contractually imposed

restrictions, and not those imposed by law.

We disagree. The plain text of the statute broadly

requires that "any restriction" be disregarded in valuing the

property, limited only by the permanence of a particular

restriction. Nothing in the statute indicates that Congress

meant to further differentiate a restriction on the basis of its

source.

Nor do we see any legitimate reason to infer such a

distinction. Targeting restrictions was the point of § 83. For

context, before the provision was enacted in 1969, restricted

stock received preferential treatment in the I.R.C.10 It "was

10
Under earlier law, the restrictions were "cooperatively
imposed," allowing the employee to defer the payment of taxes
until the restrictions lapsed while, at the same time, enjoying
the voting and dividend benefits of shareholding. Sakol, 574
F.2d at 698-99. The corporate employer, meanwhile, could pay the

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taxed either when the restrictions lapsed or when the stock was

sold," and the tax was levied "upon the difference between the

purchase price and the fair market value at the time of transfer

or when the restrictions lapsed, whichever was less." Alves v.

Comm'r, 734 F.2d 478, 481 (9th Cir. 1984). At the same time, and

by contrast, contributions to employee pension plans and profit

sharing trusts "were immediately taxable in the year of receipt."

Id. Thus, "Congress's primary intention in enacting § 83 was to

address the disparity created by the favorable treatment of

restricted stock plans vis-a-vis other mechanisms for providing

deferred compensation." Theophilos, 85 F.3d at 444; see also

Grant v. United States, 15 Cl. Ct. 38, 41 (1988). The problem

was essentially one of timing, and therefore Congress drafted a

"blanket rule," Sakol, 574 F.2d at 699, that "ignor[ed] any

value-depressing effect of [temporary] transfer restrictions" in

computing income, id. at 698 n.14.

We previously addressed § 83 and its purpose in Sakol.

At issue there was stock that was held subject to a temporary

transfer restriction imposed by the plaintiff's stock purchase

plan. Id. at 696. The IRS had taxed the stock, under § 83,

employee "with dollars that, because they may be tax-free or
tax-favored, may be fewer." Id. at 699.

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without taking into account any temporary loss of value that

might be caused by the transfer restriction. The plaintiff sued.

We agreed with the Tax Court that the IRS's approach was

constitutionally acceptable and held that restrictions "other

than permanent, nonlapsing restrictions[] may not be considered

in determining fair market value." Id. "Because nonqualified

plans have been the vehicles of tax avoidance," we concluded,

"Congress may clothe the tax incidental to them with a ready-

made, rather than a custom-tailored, suit." Id. at 701.

The decision was addressed to the contract restrictions

as well as the constitutional questions presented, but we did not

hold, as plaintiffs now imply, that contract restrictions

constitute the universe of lapsable restrictions under § 83. Nor

was our holding interpreted that way, as Sakol's reasoning was

extended to legal restrictions shortly thereafter. See, e.g.,

Pledger, 641 F.2d at 293; Grant, 15 Cl. Ct. at 41.

Plaintiffs are correct that contracts were the primary

source of the problem the statute was designed to solve, but its

plain language is not limited to contractual restrictions.

Again, § 83 differentiates only on the basis of a restriction's

permanence, not on its type or source. See Grant, 15 Cl. Ct. at

41. The statute's legislative history reveals that this was

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deliberate. In its proposal for what became § 83, the Treasury

Department recommended that certain securities law restrictions

be given the same treatment as those that never lapse. Koss v.

Comm'r, 57 T.C.M. (CCH) 882, n.14 (Tax Ct. 1989). The proposal

fared poorly:

Both the House Ways and Means Committee and
the Senate Finance Committee ignored the
Treasury's recommendation and in their
respective versions of section 83 provided
that only a nonlapse restriction will affect
a stock's fair market value for the purpose
of income realization. The Treasury, having
no choice but to comply with the wishes of
Congress, provided in the proposed
regulations to section 83 that registration
requirements imposed by federal or state
securities laws do not qualify as either
nonlapse or substantial risk of forfeiture
restrictions . . . .

Ronald Hindin, Internal Revenue Code Section 83 Restricted Stock

Plans, 59 Cornell L. Rev. 298, 332 (1974) (footnotes omitted).

It is clear that the regulation plaintiffs challenge effectuates

Congress's intent, as the regulation provides that "[l]imitations

imposed by registration requirements of State or Federal security

laws or similar laws imposed with respect to sales or other

dispositions of stock or securities are not nonlapse

restrictions." Treas. Reg. § 1.83-3(h).

In sum, we hold that all lapse restrictions -- whether

imposed by contract or by law -- must be disregarded in

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calculating income under § 83. The district court was correct to

disregard Rule 144, which was a restriction on the Stock's

marketability that "by its terms" lapsed on July 1, 2000. See

I.R.C. § 83(a)(1); accord Grant, 15 Cl. Ct. at 41 (holding that

because Rule 144's restrictions will eventually expire, "there

can be no merit to the argument that the shares are burdened by a

nonlapsing restriction"). Stripped of restrictions, the Stock

was like Aurora's unrestricted shares trading on the New York

Stock Exchange on July 1, 1999, and the district court correctly

used the Exchange Price to determine fair market value, which is

how stock is typically valued under § 83(a), see, e.g., Roush,

466 F.3d at 385-86; Sakol, 574 F.2d at 696, as well as in

general, see Boyce v. Soundview Tech. Grp., Inc., 464 F.3d 376,

385 (2d Cir. 2006); E. Serv. Corp. v. Comm'r, 650 F.2d 379, 384

(2d Cir. 1981); Maxim Grp. LLC v. Life Partners Holdings, Inc.,

690 F. Supp. 2d 293, 301 (S.D.N.Y. 2010).

Finally, we acknowledge, as we have before, that in the

course of addressing restricted stock arrangements, Congress

employed a rule that is "reasonably well tailored," but that can

operate unfairly in an individual case. Sakol, 574 F.2d at 699.

This may be such a case, but this is the result § 83(a)

contemplates. As we have previously noted, taxpayers participate

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in stock-based compensation plans voluntarily and "presumably

aware of Section 83(a)'s tax consequences," id., or at least that

the risk of loss is part of any stock acquisition, McDonald, 764

F.2d at 339 n.29; Pledger, 641 F.2d at 291.

CONCLUSION

We have considered plaintiffs' other arguments and

conclude that they are without merit. The judgment of the

district court is AFFIRMED.

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