US v. Bergbauer

602 F.3d 569

UNITED STATES of America, Plaintiff-Appellee, v. Robert L. BERGBAUER; Marie T. Bergbauer, Defendants-Appellants.

No. 08-2054.

United States Court of Appeals, Fourth Circuit.

Argued: January 28, 2010.

Decided: April 16, 2010.

ARGUED: Julian Spirer, Bethesda, Maryland, for Appellants. Francesca Ugolini Tamami, United States Department of Justice, Washington, D.C., for Appellee. ON BRIEF: Mark L. Rosenberg, Bethesda, Maryland, for Appellants. John A. DiCicco, Acting Assistant Attorney General, Kenneth L. Greene, Tax Division, United States Department of Justice, Washington, DC; Rod J. Rosenstein, United States Attorney, Baltimore, Maryland, for Appellee.

Before MOTZ, SHEDD, and AGEE, Circuit Judges.

Affirmed by published opinion. Judge AGEE wrote the opinion, in which Judge MOTZ and Judge SHEDD joined.

OPINION

AGEE, Circuit Judge:

Robert and Marie Bergbauer appeal from the grant of summary judgment to the Government establishing their federal income tax liability. The district court held that Robert Bergbauer'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 U.S. LLC ("CGE & Y"), and thereafter distribute membership interests in CGE & Y primarily to those partners in Ernst & Young, like Robert Bergbauer, who worked in the consulting division ("the consulting partners"). Immediately following the distribution, Ernst & Young and the consulting 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 interests of CGE & Y and operate the former Ernst & Young consulting practice through that entity.¹

Ernst & Young distributed a Partner Information Document ("PID") to the consulting partners which described the proposed 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 "all partners will vest in their shares immediately upon closing. 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 Gemini shares would be released for sale shortly after the transaction 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 percent of the partners' shares on each of the next five anniversary 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 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 valuation and related issues consistently for U.S. federal income tax purposes.. . .

For all . . . partners . . . the 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 vesting." 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 Cap Gemini stock, the consulting partners must recognize the value of all the shares as taxable income in 2000, thereby setting 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 consummate 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 transaction 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 monetized in the Initial Offering would be valued for tax purposes 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 of their non-monetized shares. The percentage of Cap Gemini stock subject to forfeiture depended upon the triggering forfeiture event.⁴

B.

Robert Bergbauer executed the required transaction documents 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 closing 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 restricted brokerage account, Bergbauer received the dividend income attributable to those shares.

In December 2002, CGE & Y terminated Robert Bergbauer'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' expectations, the Cap Gemini share price had dropped precipitously.⁷ Bergbauer and other former Ernst & Young colleagues discussed the prospect of filing amended year 2000 tax returns based on "what had happened to the value of the Cap Gemini stock." J.A. 92.

The Bergbauers filed an amended year 2000 federal income tax return in 2003, taking the position that only the twentyfive percent of Cap Gemini shares, those which were monetized 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 Bergbauer "did not receive the stock," but should have been recognized 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.

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....