United States Court of Appeals
Fifth Circuit
F I L E D
IN THE UNITED STATES COURT OF APPEALS
March 27, 2003
FOR THE FIFTH CIRCUIT
_____________________ Charles R. Fulbruge III
Clerk
No. 02-60463
_____________________
PAUL A. TANNER, SR.; BEVERLY N. TANNER,
Petitioners-Appellants,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
__________________________________________________________________
Appeal from the Decision of the United States Tax Court
No. 5738-00
_________________________________________________________________
Before REAVLEY, JOLLY and JONES, Circuit Judges.
PER CURIAM:*
Paul and Beverly Tanner appeal the decision of the Tax
Court holding that they had unreported income of $728,000 in 1994
based on Paul’s exercise of employee nonstatutory stock options for
182,000 shares of Polyphase Corporation. Paul was, at that time,
the president, chief executive officer, and chairman of the board
of Polyphase, and he also held about sixty-five percent of
Polyphase’s outstanding stock. The Commissioner issued a notice of
deficiency for the unreported income several years later, after
*
Pursuant to 5TH CIR. R. 47.5, the Court has determined that
this opinion should not be published and is not precedent except
under the limited circumstances set forth in 5TH CIR. R. 47.5.4.
receiving a Form 1099 from the company. Finding no error in the
Tax Court’s decision, we affirm.
The Tanners first argue that the Commissioner’s decision
to issue the notice of deficiency was arbitrary and erroneous
because the Commissioner based its notice solely on a Form 1099
issued by Polyphase and did not conduct any other investigation to
support its issuance of the notice. Thus, the Tanners argue, the
Tax Court erred in not holding the notice arbitrary and erroneous
under Portillo v. Comm’r, 932 F.2d 1128 (5th Cir. 1991). Unlike
the situation in Portillo, however, the Tanners did not raise any
factual dispute as to the amount of income. In fact, the Tanners
stipulated to all of the relevant factual issues in this case. They
argue only that the $728,000 should not be included in gross income
under the Internal Revenue Code, 26 U.S.C. § 83 (2000). This court
has held that “[t]he Commissioner has no duty to investigate a
third party payment report that is not disputed by the taxpayer.”
Parker v. Comm’r, 117 F.3d 785, 786 (5th Cir. 1997).
The Tanners next contend that the Tax Court erred in not
placing the burden of proof in this case on the Commissioner,
pursuant to I.R.C. §§ 6201(d) and 7491(a)(1). Yet because the
Tanners disputed none of the operative facts, the Tax Court did not
err in not placing the burden of proof on the Commissioner. See
I.R.C. § 7491(a)(1) (2000) (burden shifts to Commissioner only when
taxpayer introduces evidence with respect to any factual issue
relevant to ascertaining the taxpayer’s liability); Gale v. Comm’r,
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83 T.C.M. (CCH) 1270, 2002 Tax Ct. Memo LEXIS 57, at *21 n.8 (2002)
(stating that admission by taxpayer that income was received is
sufficient to satisfy Commissioner’s burden). Furthermore, since
the Tanners’ stipulations allowed the Commissioner to satisfy its
burden of proof with respect to the unreported income, the
Commissioner was entitled to take advantage of the six-year statute
of limitations provided for under I.R.C. § 6501(e)(1)(A) (2000).
Reaching the merits, the Tanners contend that the Tax
Court erred in applying 26 U.S.C. § 83. Under section 83(a), when
property (such as stock options) is transferred to a taxpayer in
connection with the taxpayer’s provision of services, the taxpayer
must generally include in gross income the fair market value of the
property at the first time the taxpayer’s interest in the property
becomes “substantially vested,” less the amount paid for the
property. I.R.C. § 83(a) (2000); Treas. Reg. § 1.83-1(a)(1). For
the taxpayer’s interest in the options to be substantially vested,
the interest must be transferable or not subject to a substantial
risk of forfeiture. Treas. Reg. § 1.83-3(b). Section 83(c)(3)
further provides that a taxpayer’s rights in property are per se
not transferable and subject to a substantial risk of forfeiture
(i.e., not substantially vested) if the sale of the property at a
profit by the taxpayer would subject the taxpayer to suit under
section 16(b) of the Securities Exchange Act of 1934. I.R.C. §
83(c)(3) (2000).
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The Tanners initially argue that Paul’s interest in the
Polyphase stock was not substantially vested upon the exercise of
his option because, at the time of the exercise, if he had sold the
stock he would have been subject to liability under section 16(b)
for six more months after the sale.1 The flaw in this argument was
pointed out, however, by the Tax Court’s recognition that although
Section 16(b) liability can extend beyond six months from the
acquisition of the property, Congress did not make the period in
Section 83(c)(3) coterminous with the period of the taxpayer’s
potential Section 16(b) liability. Section 83(c) applies only when
the “sale of property at a profit could subject a person to suit
under section 16(b).” 15 U.S.C. § 78p(b) (2000). Treasury
Regulation Section 1.83-3(j)(1) incorporates this understanding:
For purposes of section 83 and the regulations
thereunder if the sale of property at a profit
within six months after the purchase of the
property could subject a person to suit under
section 16(b) of the Securities Exchange Act
of 1934, the person's rights in the property
are treated as subject to a substantial risk
of forfeiture and as not transferable until
the earlier of (i) the expiration of such
six-month period, or (ii) the first day on
which the sale of such property at a profit
1
Under section 16(b), corporate insiders, such as Tanner,
must disgorge to the issuing corporation any profit realized as a
result of a purchase and sale, or sale and purchase, of a covered
equity security within a six month period. Securities Exchange Act
of 1934 § 16(b); 15 U.S.C. § 78p(b) (2000). For purposes of
section 16(b), the grant of an option is equivalent to a purchase
and the exercise of an option is a nonevent. Magma Power Co. v. Dow
Chem. Co., 136 F.3d 316, 321-22 (2d Cir. 1998) (citing 17 C.F.R. §
240.16b-6(a) (1997)).
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will not subject the person to suit under
section 16(b).
Treas. Reg. § 1.83-3(j)(1) (emphasis added). The tax statute and
regulations protect a recipient of stock options for the first six
months after their grant, consistent with section 16(b), but do not
afford the rolling protection sought by the Tanners based on every
future event of exercise of the options.
The Tanners finally assert that Paul’s interest in the
options was not substantially vested and the net income realized
upon exercise of the options was not includible in his taxable
income under section 83(a) because a lockup agreement with
Polyphase prohibited Paul from selling his Polyphase stock for a
period of two years. While the lockup agreement did prevent Paul
Tanner from selling his Polyphase stock, it did not prohibit him
from assigning his Polyphase stock to another (he gave some of his
stock to relatives) or pledging it as collateral for a loan. Under
the regulations, Paul’s interest was plainly transferable and thus
substantially vested. Treas. Reg. § 1.83-3(d) (property is
transferable and not subject to a substantial risk of forfeiture if
it can be sold, assigned, or pledged).
Because the Tax Court did not err with respect to its
procedural rulings or in holding the $728,000 to be properly
included as income to the Tanners, the decision of the Tax Court is
AFFIRMED.
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