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or partnership interest if there would be gain were such position sold, assigned, or otherwise terminated at its fair market value. Furthermore, for purposes of Code Sec. 1259, the term “position” means an interest, including a futures or forward contract, short sale, or option.22
Under Code Sec. 1259(c)(1)(C), a taxpayer is treated as having engaged in a constructive sale of an appreciated nancial position where he (or a related person) enters into a futures or forward contract to deliver the same or sub- stantially identical property. e term “forward contract” is de ned under Code Sec. 1259(d)(1) as a contract to deliver a substantially xed amount of property (including cash) for a substantially xed price. e legislative history indicates that a forward contact that provides for the de- livery of an amount of stock that is subject to “signi cant variation” under the terms of the contract is not within the statutory de nition of a forward contract.
e IRS, in an alternative holding in Rev. Rul. 2003-7, ruled that Code Sec. 1259 did not apply. Since the delivery of the correct number of shares on the event date is based on the FMV of the stock on such date, and such varia- tion in number of shares is “signi cant,” the agreement is not a contract that is for a substantially xed amount for purposes of Code Sec. 1259(d)(1). erefore, the IRS ruled that the agreement did not meet the de nition of a forward contract under Code Sec. 1259(d)(1) and was not a constructive sale under Code Sec. 1259(c)(1)(C).
Anschutz Co.
In this case, the taxpayers, husband and wife, owned stock in an S corporation, Anschutz Corporation. e corpora- tion owned a quali ed Subchapter S subsidiary (“QSUB”), TAC.24 In the late 1990s and early 2000s, the taxpayer and executives of the corporation decided it would leverage TAC’s stock holding by entering into a series of VPFCs and share-lender agreements with a brokerage rm. A master stock purchase agreement (“MSPA”) was entered into on May 9, 2000. Under each of the several VPFCs negotiated, the investment banking rm made an upfront payment to the QSUB for TAC’s promise to deliver a variable number of shares in 10 years. e upfront payment was 75% of the FMV of the shares subject to the VPFCs. e agreement provided that there would be a ceiling on TAC’s entitlement to any appreciation in the stock over the term of the FMV. If the FMV of such stock increased, TAC would be entitled to retain the rst 50% of the resulting appreciation, with any appreciation after the 50% ceiling inuring to the bene t of the brokerage rm. e shares were pledged as collateral.
Under the MSPA (and stock pledge agreement), TAC pledged the shares of stock that were the subject of the
VPFCs as collateral for the upfront cash payments and to guarantee TAC’s performance of the VPFCs. e shares pledged were delivered to Wilmington Trust Co. (“WTC”), the collateral agent and trustee. ere were also three transaction schedules and pledge agreements corresponding to such schedules. ree share-lending agreements were executed corresponding to the three pledge agreements. Share-lending agreements, which are “over-the-counter trades in the nancial markets,” are frequently entered into by equity holders who have a long position with respect to stock and plan on holding it for an extended period. e equity holder agrees to lend the stock to another party, the borrower, who can use the borrowed shares to increase market liquidity and facilitate stock sales. e borrower typically pledges cash collateral, and the lender derives a pro t lending the shares by retaining a portion of the interest earned from this cash collateral. At the end of the lending period, the borrower returns the borrowed shares to the equity owner/lender. “If the borrower fails to return the [shares] then the lender will go to the market to buy the shares of stock with the [cash] collateral.” For each share-lending agreement, TAC received a prepaid lending fee calculated by reference to the value of the lent shares. at lending fee was typically equal to 5% of the fair market value of the shares lent under the share-lending agreements.
e taxpayer Anschutz and the Anschutz Company treated the VPFC portions of the MSPA as open trans- actions and not as closed sales of stock. No gain or loss was reported by Anschutz Corporation in 2000 ( rst and second closings) or in 2001 (third closing) on the taxpay- ers’ returns with respect to the three blocks of shares. e amounts received from the counterparty to the VPFC were substantially in excess of the taxpayers’ stock basis.
e IRS issued a notice of de ciency to the Anschutz Company for 2000 and 2001 and treated the transactions TAC entered into as closed sales of stock, had received 100% of the fair market value for the stock, and thus was liable for the Code Sec. 1374 built-in gains tax in 2000 and 2001 to the extent the value received exceeded Anschutz Company’s basis in the stock. e built-in gains tax was calculated by reference to the shares of stock that were pledged to WTC, then borrowed by the brokerage rm. e de ciencies did not include shares pledged as collateral by TAC but not borrowed by the brokerage rm. e IRS also issued a notice of de ciency to Mr. Anschutz for 2000 and 2001 for the entire amount real- ized less the corporation’s tax on the built-in gain under Code Sec. 1374.
After the petitions to the Tax Court were led by the corporation and the taxpayers were consolidated, a trial
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