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April 09, 2013 The Tax Lawyer

Fitting a Square Peg in a Round Hole: Calloway v. Commissioner’s Analytical Shortcomings

Vol. 66, No. 1 - Fall 2012

Caroline Owens Van Wagoner


    Certain property transactions, particularly those involving the exchange of securities, are not always obvious taxable dispositions. The Tax Court and Eleventh Circuit recently faced such a problem in Calloway v. Commissioner, which involved the taxpayer’s “loan” of his stock to Derivium Capital, LLC (Derivium) in exchange for 90% of the value of the securities. To determine whether the transaction was a sale or loan, the courts applied a “benefits and burdens” test that was developed for nonfungible, tangible property. The Tax Court concluded, and the Eleventh Circuit affirmed, that the transaction was a sale that required the taxpayer to recognize gain. This Note argues that, although the Tax Court and Eleventh Circuit ultimately reached the correct result, the courts’ analytical approach unnecessarily clouds jurisprudence and creates uncertainty for practitioners.

    In 2001, Albert Calloway (Calloway) and Derivium entered into a nonrecourse loan agreement in which Calloway transferred 990 shares of IBM stock to Derivium as collateral for a loan equivalent to 90% of the value of the shares. At the loan’s maturity in 2004, Calloway satisfied his debt by surrendering the stock. Calloway never reported any results of the transaction on his 2001, 2002, 2003, or 2004 tax returns. The Service claimed over $40,000 in deficiencies and penalties as a result of the transaction.

    In July 2010, the Tax Court held that the transaction was a sale of property in 2001, the gain from which should have been included in Calloway’s 2001 tax return. The court first concluded that the 90% loan was a sale because the transaction transferred the benefits and burdens of stock ownership to Derivium. Second, the court determined that the transaction did not qualify for nonrecognition treatment as a securities lending agreement under section 1058. Calloway’s inability to reacquire the stock during the loan term limited his opportunity for gain, which violated a requirement of the section 1058 safe harbor. Finally, the Tax Court upheld the penalties imposed on the taxpayer. The Eleventh Circuit subsequently affirmed the Tax Court’s holding by applying the same benefits and burdens test.

    This Note agrees that Calloway should have recognized gain in 2001 but argues that the courts applied an inappropriate analytical framework to resolve the realization and recognition questions. The courts’ use of a test that was designed to determine ownership of tangible property introduces irrelevant and inapplicable factors to the analysis. Such a broad, inexact test is unhelpful to practitioners who structure and advise on the tax treatment of transactions involving securities. The courts could have applied a more precise benefits and burdens test, clarifying the law and reducing practitioner confusion. The courts’ opinions also would benefit from a comparison of the 90% loan to other stock transactions. The characteristics of the 90% loan are unlike those in other securities transactions, a difference that supports recognition treatment. Furthermore, this Note suggests that a court could end its analysis after resolving the sale or loan question. A section 1058 analysis is unnecessary because the 90% loan is not a legitimate securities lending agreement.

    Part II provides an overview of the body of law developed to determine whether a transaction is a sale or loan. Part II also explains the specific tax treatment of securities lending transactions. Part III outlines the Calloway transaction and the courts’ opinions. Part IV examines the flaws in the courts’ analyses and provides alternative approaches to resolving the case’s questions.

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