
USCA1 Opinion

	




          August 20, 1993                                [NOT FOR PUBLICATION]                            UNITED STATES COURT OF APPEALS                                FOR THE FIRST CIRCUIT                                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).                                          -3-                      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                                         -4-            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,                                         -5-            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                                         -6-            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.                                         -7-            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.                                          -8-                      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                                         -9-            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                                         -10-            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.                                          -11-                 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                                         -12-                      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.                                         -13-            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.                                         -14-            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.                                          -15-            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                                         -16-            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.                                         -17-
