1971 U.S. Tax Ct. LEXIS 52">*52
Petitioner paid certain sums to his employer because his sale and purchase of stock constituted an apparent violation of sec. 16(b) of the Securities Exchange Act of 1934.
56 T.C. 1370">*1370 Respondent determined a deficiency of $ 21,897.64 in the petitioners' income tax for the taxable year ending December 31, 1966. The only issue for our consideration is whether payments made by petitioner James E. Anderson to his employer, pursuant to an alleged violation of section 16(b) of the Securities Exchange Act of 1934, constitute an ordinary and necessary expense of petitioner James E. Anderson's business.
FINDINGS OF FACT
A stipulation of1971 U.S. Tax Ct. LEXIS 52">*54 facts filed by the parties is incorporated herein as part of our findings of fact.
Petitioners James E. Anderson and Alice Anderson, husband and wife, filed their 1966 joint Federal income tax return with the district 56 T.C. 1370">*1371 director of internal revenue at Chicago, Ill. They resided in Elmwood Park, Ill., at the time the petition herein was filed. Alice Anderson is a petitioner herein only by virtue of having joined in filing the aforesaid joint return. All references herein to petitioners shall be deemed to refer to James E. Anderson.
In 1942, petitioner joined Zenith Radio Corp. (hereinafter referred to as Zenith) as a purchasing agent. He became vice president, director of purchasing, in 1947 and continued in that capacity until his retirement on September 1, 1968. He was responsible for the procurement of the raw materials, machinery, and labor necessary for the manufacture of Zenith's products, including radios, television sets, and hearing aids. In 1966, purchases made by petitioner on behalf of Zenith totaled approximately $ 350 million.
On January 30, 1956, petitioner entered into an employment agreement which covered the period from January 1, 1955, through December1971 U.S. Tax Ct. LEXIS 52">*55 31, 1964. This agreement was extended by mutual consent through December 31, 1965. It provided, in part, that, upon its expiration, Zenith agreed to employ petitioner in an advisory capacity for a length of time equal to his full-time employment since January 1, 1955, at an annual salary of $ 20,000, in return for which petitioner agreed to perform services for Zenith for no more than 60 days per year. As of December 31, 1965, petitioner had accrued 11 years of full-time employment.
On May 11, 1966, petitioner and Zenith executed a second employment contract, confirming their agreement that petitioner would be employed on a full-time basis effective January 1, 1966, through December 31, 1968. Under this agreement, petitioner received an annual salary of $ 50,000 plus a bonus based upon Zenith's annual net income. Zenith retained the right to terminate petitioner's employment at any time, in which case petitioner would commence serving Zenith in the aforementioned advisory capacity. In 1966, petitioner reported income of $ 173,332.14 as a result of his employment with Zenith.
In 1962 and 1963, petitioner, pursuant to an employee stock purchase agreement dated November 25, 1958, 1971 U.S. Tax Ct. LEXIS 52">*56 purchased a total of 1,000 shares of Zenith common stock for $ 14,038.90. In April of 1966, petitioner sold these shares on the open market for $ 162,923.21 and reported a long-term capital gain of $ 148,884.31. On April 11, 1966, following the sale of the aforementioned shares and pursuant to a second employee stock purchase agreement, dated August 5, 1964, petitioner purchased 750 shares of Zenith common stock for $ 49,312.50.
On May 2, 1966, petitioner filed a "Statement of Changes of Beneficial Ownership of Securities" with the Securities and Exchange Commission (SEC), reporting the details of the aforementioned sale and purchase of Zenith stock. Prior to May 11, 1966, petitioner was advised 56 T.C. 1370">*1372 by Zenith that the aforementioned sale and subsequent purchase of Zenith stock violated section 16(b) of the Securities Exchange Act of 1934. 1 Petitioner responded that he did not think this was the case and, upon receiving a demand for payment from Zenith's legal department, referred the matter to his attorneys. They informed him that Zenith had no alternative but to demand payment from him.
1971 U.S. Tax Ct. LEXIS 52">*57 Although he believed (and still believes) that he had done nothing wrong, petitioner reasonably assumed that if he failed to comply with Zenith's demand, his position would be in jeopardy and his business reputation would be damaged. On May 19, 1966, petitioner's attorneys, acting on his behalf, informed Zenith of petitioner's intent to comply with its demand. Accordingly, petitioner paid Zenith $ 51,259.14, exclusive of interest, in connection with the alleged section 16(b) violation and deducted this sum as an ordinary and necessary business expense.
Petitioner remained a full-time employee of Zenith until September 1, 1968, at which time he refused an offer of 3 additional years of full-time employment and voluntarily retired. Zenith had no mandatory retirement age for its employees and it was not until July of 1968 that petitioner decided to retire.
In his notice of deficiency, respondent determined that the payments made to Zenith should be treated as long-term capital losses and recalculated the petitioners' tax for 1966 accordingly.
ULTIMATE FINDING OF FACT
Petitioner's payment of $ 51,259.14 to Zenith was made to preserve his employment with Zenith and avoid injury to his1971 U.S. Tax Ct. LEXIS 52">*58 business reputation.
OPINION
In April of 1966, petitioner sold 1,000 shares of Zenith stock, from which he realized a long-term capital gain of $ 148,884.31. Several 56 T.C. 1370">*1373 days later, in apparent violation of section 16(b) of the Securities Exchange Act of 1934, petitioner purchased 750 shares of Zenith stock for $ 49,312.50. In response to Zenith's demand for payment under section 16(b), petitioner paid Zenith $ 51,259.14 during 1966.
The sole issue herein relates to the deductibility of such amount. Petitioner urges us to adhere to our decision in
We deal first with the question whether, aside from the impact of the
We now turn to the critical issue herein. Under substantially identical circumstances, we held in
We see no need to restate our reasons for holding that
In the instant case, the situation is quite different. Here, the sale was made by petitioner in his capacity as a stockholder of Zenith. His obligation to make the payment in question arose out of his status as an employee of Zenith. Neither the sale or purchase nor the combination 56 T.C. 1370">*1375 thereof imposed any obligation upon him. Thus,
Other cases relied upon by respondent are also distinguishable. 1971 U.S. Tax Ct. LEXIS 52">*64
1971 U.S. Tax Ct. LEXIS 52">*66 56 T.C. 1370">*1376 Respondent seeks to draw sustenance from the statement in
The rationale for the
We think that respondent has failed to recognize that the Supreme Court was speaking in the narrow context of a situation where the taxpayer, having received money
As we see it, respondent's position in this case comes down to this: If petitioner had not sold his Zenith stock with respect to which he was entitled to long-term capital gain treatment, he would not have been exposed to a demand for the payment in question. Therefore, the petitioner is limited to a long-term capital loss deduction with respect to that payment. We think that respondent paints with too broad a brush in contending for such a simple "but for" test. It is not enough that the relationship between two transactions is merely that "the fruit of the first was the subject of the second." See
A further analogy is to be found in cases dealing with loans to a 56 T.C. 1370">*1377 corporation by its stockholder-employees, wherein it is recognized that if the taxpayer can prove that the making of the loan stemmed from his desire to protect1971 U.S. Tax Ct. LEXIS 52">*69 his status as an employee rather than his status as a shareholder, he is entitled to a business bad debt deduction. Compare
1971 U.S. Tax Ct. LEXIS 52">*70 Finally, our analysis herein is consistent with decisions dealing with the treatment of payments received subsequent to a transaction which is considered closed for tax purposes. E.g.,
Dawson,
As noted in
To bestow upon this petitioner and others similarly situated the "windfall" benefit of deducting in full the amount of a repayment pursuant to section 16(b), while taxing any capital gain previously realized only in part, serves no logical end. As the Supreme Court pointed out in
The taxpayer here, as in
Certainly we would not want to make it possible for a person to intentionally avail himself of this benefit.
Finally, unresolved by the majority opinion is whether different treatment should be accorded directors and shareholders affected by section 16(b). Is a shareholder who, either voluntarily or under some form of compulsion, makes a repayment of his "insider" profit to a corporation entitled only to a capital loss deduction while an officer of the same company is entitled to an ordinary-loss deduction? Is a corporate director who receives minimal directors fees from the corporation entitled to an ordinary-loss deduction under similar circumstances? I think not. It is my view that officers, directors and "10 percent" shareholders should all be treated as investors with respect to trading in the capital stock of their companies (excluding dealers in securities). Any gains or losses from the sale of their stock, 1971 U.S. Tax Ct. LEXIS 52">*74 as well as profits they might be required to restore to their companies under section 16(b), should be consistently treated. No sound reason for bifurcating these transactions has been advanced in the majority opinion.
56 T.C. 1370">*1379 Under these circumstances I would sustain the respondent's determination in denying the deduction as an ordinary and necessary business expense under
1. Sec. 16(b) provides as follows:
For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) within any period of less than six months, unless such security was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security purchased or of not repurchasing the security sold for a period exceeding six months. Suit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer shall fail or refuse to bring such suit within sixty days after request or shall fail diligently to prosecute the same thereafter; but no such suit shall be brought more than two years after the date such profit was realized. This subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase of the security involved, or any transaction or transactions which the Commission by rules and regulations may exempt as not comprehended within the purpose of this subsection. [
2. All references, unless the context indicates otherwise, are to the Internal Revenue Code of 1954, as amended.↩
3. Given the realities of the business world, we refuse to enter into what we think would be an Alice in Wonderland discussion as to whether the proper test is whether petitioner's belief was reasonable or was not unreasonable. See
4. Respondent has conceded that petitioner is entitled to a capital loss and has made no contention that the payment in question herein should be treated as part of the cost of the Zenith stock purchased by petitioner. See concurring opinion of Drennen,
5. See also