Forward contract extension ruled taxable as short-term gain


The Tax Court has ruled in Estate of Andrew J. McKelvey et al. v. Commissioner (161 T.C. No. 9) that an extension of variable prepaid forward contracts (VPFCs) was taxable under Section 1234A as short-term capital gain. The case was decided on remand from the Second Circuit.


The case centered on a transaction undertaken by Andrew McKelvey, who was the founder and CEO of Monster Worldwide, Inc., which operated the job-search website. McKelvey entered VPFCs with counterparties in 2007 to monetize his shares in Monster. Pursuant to the VPFCs, McKelvey received upfront cash payments totaling approximately $193.6 million from the counterparties in exchange for a contingent amount of Monster shares determined over 10 separate settlement dates in September 2008.


The number of shares that McKelvey would be required to deliver on each settlement date was contingent on the closing stock price of Monster stock on that date. McKelvey could also elect to deliver an equivalent amount of cash instead of the required amount of shares. The contract also pledged Monster shares to secure his obligation, but McKelvey could substitute other collateral with the counterparties’ approval.


Before the settlement dates commenced, McKelvey paid the counterparties to extend the settlement dates approximately 16 to 17 months, with all other terms remaining unchanged. Specifically, McKelvey paid a total of approximately $11.7 million to extend the settlement dates until February 2010.


McKelvey passed away before the extended settlement dates and most of the underlying shares were transferred to the respective counterparties in 2009 following his death.


The IRS contended that McKelvey should have a short-term capital gain on the extension dates related to the VPFCs under Section 1001. The Tax Court concluded that Section 1001 did not apply because the VPFCs did not constitute property to McKelvey and the Second Circuit agreed that Section 1001 did not apply. However, the Second Circuit remanded the case to the Tax Court to determine whether the termination of the obligations related to the VPFCs resulted in taxable short-term capital gain under Section 1234A.


Section 1234A requires taxpayers to treat gain or loss from the cancellation, lapse, expiration or other termination of a right or obligation (other than a securities futures contract as defined in Section 1234B) with respect to property as gain or loss from a sale of a capital asset if such property is (or would be) a capital asset in the hands of the taxpayer. The Tax Court held that the extensions of the VPFC resulted in a termination of the obligations under the VPFCs. In addition, the shares of Monster stock were capital assets under Section 1221(a); therefore, Section 1234A applied.


Notwithstanding that McKelvey had a long-term holding period related to the Monster stock, McKelvey had a short-term holding period related to the VPFCs. Therefore, the capital gain determined by the Tax Court was a short-term capital gain.


The Tax Court computed the short-term capital gain based on the total upfront payments of $193.6 million, less the extension payments of $11.7 million, less the value of McKelvey’s obligation under the extended VPFCs, which was determined to be approximately $110.2 million. Thus, the Tax Court concluded that the extensions resulted in a total short-term capital gain of approximately $71.7 million.


Although the Second Circuit had also remanded the calculation of Section 1259 back to the Tax Court, the parties subsequently agreed to an amount of $102.4 million in long-term capital gain. Thus, the Tax Court made no further determination.



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