In Uncategorized on 04/19/2017 at 16:14

No, not a ten-foot tall basketball player. These are carefully-structured Variable Prepaid Forward Contracts (VPFC), whereby a stockholder with a basis of zippo cashes out $200 million worth of stock for no current gain.

Estate of Andrew J. McKelvey, Deceased, Bradford G. Peters, Executor, 148 T. C. 13, filed 4/19/17, tells the story.

The late Andy was the founder of Monster Worldwide, Inc., owner/operator of, internet flesh peddler extraordinary. I, even I, once had my resume out there.

The late Andy wanted cash in the years shortly before he became the late Andy. So he made deals with BoA and Morgan Stanley, using as his template Rev. Rul. 2003-7, 2003-1 C.B. 363.

The late Andy pledged a boatload of Monster stock and got $200 million in cash, with which he could do whatever he liked. In exchange, a year later, Andy had to give BoA or MS a certain number either of the pledged shares, or other shares, or pay off in cash.  And he could substitute collateral for the pledged shares, if BoA or MS agreed. The exact number of shares, or amount of cash, was determined by formulas based on Monster stock price over certain dates.

At delivery date, the late Andy’s gain or loss would be known. He might owe more cash than he got. The stock he gave to BoA or MS had a certain basis in his hands, and had a determinable worth when he handed them over.

So far, so good.

But before the year was up, Andy paid for a one-year extension of the delivery date. IRS claimed that was an exchange of a property right in that year, and therefore a constructive sale of the Monster stock.

No, says Judge Ruwe.

“In Rev. Rul. 2003-7, 2003-1 C.B. 363, the IRS recognized that VPFCs are open transactions when executed and do not result in the recognition of gain or loss until future delivery.  The rationale of Rev. Rul. 2003-7, supra, is straightforward:  A taxpayer entering into a VPFC does not know the identity or amount of property that will be delivered until the future settlement date arrives and delivery is made.  In the instant case, the treatment of the original VPFCs is not in dispute.  Both parties agree that when decedent entered into the original VPFCs in 2007, the contracts satisfied the requirements of Rev. Rul. 2003-7, supra, and decedent recognized no current gain or loss.” 148 T. C.  13, at pp. 13-14.

All the late Andy had was an obligation to deliver stock or cash. The extension only put off the date when had to deliver. He had no unlimited right to substitute collateral, and he got no more money when he got the extension. He still didn’t know what his basis might be if he delivered stock (he might deliver the pledged stock or other stock, or mix-and-match), or how much cash he’d have to pay BoA or MS, as the price of Monster stock would fluctuate.

In short, the transaction was still open. Keeping it open was valuable, but the late Andy paid for that. He still had the same obligation. And given the fluctuations in Monster stock, he might be worse off with the extension.

And the late Andy’s right to choose stock, or which specific shares of stock, or cash, or to substitute collateral, weren’t property rights he could sell or hock.

Editorial comment: I ain’t so sure. If I were going to short Monster, I might want to buy into the formula and assume the obligation, figuring I could buy enough stock in the open market to deliver to BoA or MS without the problem of actually borrowing stock to sell short up front, and getting an extended delivery date at the same time. But that’s pure speculation, and who would want to buy that deal (and prove to the late Andy that s/he could deliver) is another story.

Finally, Section 1259 constructive sale doesn’t apply, because the worth of the obligation to deliver or pay is variable, not fixed. And Rev. Rul. 2003-7 went off on that rationale.

Nicely structured.

  1. But 2 Cir. torpedoed Andy, using Black-Scholes probability theory. The extension was a novation, said 2 Cir, a new deal, thus triggering capital gain. And almost no chance of hitting the floor price for the stock per the VPFCs, so amount to tender is fixed. But the point is using VPFCs to grab cash while postponing handing over shares until you’re dead (and your estate gets DOD or DOD + 6 stepped-up basis) is not what Congress intended. Judge Carbanes wants it clear that the probability theory is only for nondebt, not debt, instruments. Here’s the whole story:

    And thanks to my colleague Mr Peter Reilly for the heads-up.


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