The 11th Circuit Court in Lizzie W. Calloway et vir v. Commissioner (No. 11-103965 (11th Cir., (2012)) affirmed the Tax Court's decision (135 T.C. 3 (2010) that a taxpayer sold his stock upon entering into an agreement that purported to be a nonrecourse loan.
In Calloway, an individual (Calloway) had purchased 990 common shares of IBM (the shares) while employed at IBM. The shares had appreciated in value since being acquired by Calloway. In early August 2001, Calloway entered into an agreement with Derivium Capital LLC (Derivium), which provided that Derivium would lend an amount of cash to Calloway equal to 90 percent of the market value of the shares (the loan). The terms provided that the loan (i) accrued interest equal to 10.5 percent, which compounded annually; (ii) was nonrecourse and (iii) had a three-year maturity term.
On Aug. 16, 2001, Calloway transferred the shares to Derivium as collateral for the loan and agreed that Derivium had the right to sell some or all of the shares without providing notice to Calloway. Calloway did not have to maintain margin requirements other than transferring the shares. Dividends that Derivium received from the shares would be applied against the interest due from Calloway.
On Aug. 17, 2001, Derivium sold the shares on the open market and subsequently transferred the loan to Calloway based on the amount it received from the sale (i.e., 90 percent of the market value of the shares). Thus, the amount of the loan was not determined until after Derivium sold the shares. Calloway could not prepay the loan, and Derivium could not require Calloway to repay the loan prior to maturity.
At the end of the three-year maturity term of the loan, Calloway had the option to (i) pay cash equal to the outstanding principal and interest related to the loan and receive the shares, (ii) extend the term of the loan in exchange for a fee equal to a percentage of the balance due or (iii) surrender the shares with no additional obligation.
On July 27, 2004, immediately prior to the loan's maturity, Calloway stated that he relinquished his right to the shares in satisfaction of the loan, and he never made any payments of principal or interest on the loan.
The primary issue in Calloway was whether the loan constituted a sale of the shares in 2001 or a nonrecourse debt Calloway owed to Derivium.
The Tax Court held that the loan constituted a sale of the shares by Calloway in 2001 rather than a nonrecourse debt Calloway owed to Derivium; some of the Tax Court judges, however, had divergent rationales. The Tax Court's analyses are summarized as follows:
- The court's majority analyzed the loan under the factors provided in Grodt & McKay Realty, Inc. v. Commissioner (77. T.C. 1221 (1981)) relating to the benefits and burdens of ownership (the majority opinion).
- Judge James S. Halpern asserted that Derivium's possession of the shares, coupled with its ability to sell the shares, was most relevant in determining that the loan constituted a sale of the shares (the Halpern opinion).
- Judge Mark V. Holmes cited Treas. Reg. Sec. 1.1001-2(a)(4)(i) and Commissioner v. Tufts (461 U.S. 300 (1983)) to support that Calloway sold the shares to Derivium upon Derivium's sale of the shares on the open market (the Holmes opinion).
The 11th Circuit held that the loan constituted a sale of the shares by Calloway in 2001 rather than a nonrecourse debt Calloway owed to Derivium. The court, however, disputed the Halpern and Holmes opinions, and adopted the rationale set forth in the majority opinion.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
