The U.S. Tax Court today released an opinion concerning the tax treatment of variable prepaid forward contracts (VPFCs), and concluded modifications made in 2008 to the VPFCs did not result in taxable exchanges pursuant to section 1001.
The case is: Estate of McKelvey v. Commissioner, 148 T.C. No. 13 (April 19, 2017). Read text of the Tax Court’s opinion [PDF 139 KB]
The taxpayer (now deceased) entered into VPFCs with two investment banks in 2007. Under the original VPFCs, the investment banks made upfront cash payments to the taxpayer, who was obligated to deliver variable quantities of shares of stock on specified future settlement dates in 2008 (original settlement dates). The taxpayer treated the execution of the original VPFCs as open transactions under Rev. Rul. 2003-7.
In 2008, before the original settlement dates, the taxpayer paid the investment banks to extend the settlement dates until 2010 (VPFC extensions). The taxpayer did not report any gain or loss on the execution of the VPFC extensions, continuing the open transaction treatment. The taxpayer died in 2008 after the execution of the VPFC extensions.
The IRS asserted that the VPFC extensions were sales or exchanges of the VPFCs under section 1001, concluded that the taxpayer should have reported gain in 2008 from the extensions, and determined a deficiency of over $41 million.
The Tax Court today noted that the only issue was whether the modifications made in 2008 to the VPFCs resulted in taxable exchanges under section 1001. The court concluded that because the taxpayer had only obligations under the VPFCs to deliver shares of stock, the VPFCs were not property under section 1001, making section 1001 inapplicable to the extensions. Furthermore, because the extensions did not alter the original reasons for open transaction treatment under Rev. Rul. 2003-7 (the tax consequences of settling the VPFCs could not be determined until settlement because the taxpayer’s VPFCs obligations could be satisfied by delivering the cash equivalent of the quantity of shares required to be delivered or, if he physically settled, the basis and holding period of the particular shares delivered at settlement would not be fixed until delivered), that open transaction treatment continued until the transactions were closed by the future delivery of stock or cash. The court further held that the taxpayer did not engage in constructive sales of stock in 2008 under section 1259.
© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.