Taxpayer not allowed to defer income on sale of partnership interest.

• Author: Beavers, James

A partner in a consulting partnership who received restricted stock in the sale of her interest in the partnership to a corporation and agreed by contract to report the full value of the stock in income in the year the stock was transferred could not defer including part of the value of the stock in income until the year the restrictions on the stock were lifted.

Background

In 2000, the public accounting firm Ernst & Young sold its information-technology consulting group to a French corporation, Cap Gemini. In exchange for their partnership interests in Ernst & Young, the consulting partners in the group (the ex-partners) received shares in Cap Gemini. The ex-partners agreed to take the shares of Cap Gemini stock subject to restrictions that lasted for almost five years in order to ensure their loyalty to Cap Gemini. Under these restrictions, if an ex-partner quit, was fired for cause, or went into competition with Cap Gemini, some or all of the shares the ex-partner received could be forfeited.

Ernst & Young, Cap Gemini, and the consulting partners agreed by contract to report the transaction as a partnership-for-shares swap in 2000, fully taxable in that year. This agreement, which the IRS accepted, ensured consistent tax treatment of all the parties. Approximately 25% of the shares were sold in 2000 to generate cash that was distributed to the partners to pay their taxes on the transaction. Merrill Lynch held the remainder of the shares in separate accounts for each ex-partner subject to instructions from Cap Gemini until the restrictions lapsed.

Cynthia Fletcher, one of the ex-partners, voted for the transaction, signed the contract, and went to work for Cap Gemini. She and her husband reported the value of all the shares she received in the transaction as income in 2000, as required by the contract. Fletcher quit cap Gemini in 2003. Although she left before the five years required by the contract to avoid forfeiture of her Cap Gemini shares, the company waived its rights and directed Merrill Lynch to lift all restrictions on the stock in her account. At this point, the price of the stock had fallen dramatically, which in hindsight made Fletcher's agreement to be subject to tax on the transfer of all the shares in 2000 a very costly decision.

To avoid the results of this decision, in 2003 Fletcher filed an amended tax return for 2000, taking the position that only the value of the shares that were sold in 2000 was includible in income...