In 2007, Andrew McKelvey, the founder of Monster Worldwide, Inc., entered into variable prepaid forward contracts (“VPFC”) with Bank of America (“B of A”) and Morgan Stanley. Under these contracts, the banks paid Mr. McKelvey an agreed upon sum of money. The B of A contract can be used to illustrate the issue in the case. Mr. McKelvey received the cash sum of $51 million from B of A and in return agreed to deliver a variable number of shares of Monster stock on ten separate future delivery dates from September 11, 2008, through September 22, 2008. The actual number of shares to be delivered was to be based on the stock price on each delivery date. On each delivery date, Mr. McKelvey had the choice of delivering the number of shares based on the price of the stock on that date, or he could deliver an equivalent amount of cash. The uncertainty over how many shares the taxpayer had sold for $51 million, or whether he had even sold any shares, resulted in the sale being an open transaction since his tax gain could not be computed on the date the contract was entered into. The IRS previously confirmed this result in Rev. Rul. 2003-7, holding that a taxpayer does not have a taxable sale on receipt of the cash from the buyer, but instead when it delivers shares or cash to close the contract.
On July 24, 2008, prior to the first delivery date in September, Mr. McKelvey paid B of A an additional $3.5 million to extend the delivery dates to dates ranging from February 1 through February 12, 2010. This created the tax issue in the case, as the IRS took the position on audit that the extension of the VPFCs amounted to an exchange of the original contracts for new contracts and that was a taxable event for Mr. McKelvey under IRC Section 1001. The Tax Court addressed the question in Estate of Andrew J. McKelvey v. Commissioner (148 TC No. 13, 4/1917). Mr. McKelvey died in 2008 after completing the extensions of the contracts.
The estate’s first argument was that contracts were not property and therefore Section 1001 could not apply. The essence of the argument was that once the taxpayer had received the cash payment from B of A, he had only obligations under the contracts to deliver either shares of Monster stock or cash, at the option of the taxpayer. The IRS argued that the right to choose between delivering shares of stock or cash was in essence a property right. The court disagreed and determined that the contracts were not property because the taxpayer had only obligations under them.
The court nevertheless went on to evaluate whether the extensions of the contract were exchanges of the original contracts for new contracts. It reviewed the rationale behind the open transaction treatment accorded VPFCs by Rev. Rul. 2003-7. At the inception of the contract, the sale price is known. It is the amount of cash the taxpayer receives from the buyer. What is not known is how many shares are sold, or if any shares are even sold. Without knowing the number of shares sold, the taxpayer’s basis in the sold shares cannot be determined so his gain or loss cannot be computed. Further, his gain or loss would be entirely different if he settled the contract by delivering cash. The extension of the delivery dates did nothing to remove any of the uncertainty over the tax basis to be used to compute the taxpayer’s gain or loss because it could still not be determined how many shares would be delivered or if the taxpayer would settle the contracts with a cash payment. Thus the rationale for open transaction treatment was still the same and the court did not think imposing a tax event at this point was appropriate.