Cline v. Commissioner

On June 14, 1984, Jewel Companies, Inc. (Jewel) agreed to be acquired by American Stores Company (American Stores) through a merger of Jewel with American Stores. On June 15, 1984, Richard Cline (plaintiff), a senior executive of Jewel, entered an agreement (severance agreement) with Jewel that provided for a severance benefit of three times the sum of Cline’s annual salary and target bonus if his employment was terminated due to the merger. On July 12, 1984, the severance agreement was amended to reduce the severance benefits so that the benefits would not be considered parachute payments under I.R.C. §§ 280G and 4999. Sections 280G and 4999, which had just been enacted and applied to agreements entered after June 14, 1984, provided that parachute payments—payments to a corporation’s officer contingent on a change in control of the corporation equal to three or more times a specified amount of the officer’s compensation level (base amount)—were not tax deductible by the corporation and subjected the officer to a 20 percent excise tax for the portion of the payments above the officer’s base amount (excess parachute payments). Payments of reasonable compensation for services performed after a change in control were exempt from §§ 280G and 4999. American Stores orally promised Cline it would make a good-faith effort to employ him after the merger to make up for the reduction in severance benefits. Pursuant to his severance agreement, Cline received $1,210,000 in severance pay in 1984, which was less than his base amount. Cline was employed by American Stores for a brief, post-merger transition period, from January 1, 1985, to February 3, 1985, for which he received $409,163, $109,163 of which represented salary, unused vacation time, and miscellaneous items, and $300,000 of which was a bonus. The commissioner of internal revenue (commissioner) (defendant) contended that the $300,000 bonus was not reasonable compensation and, when aggregated with the $1,210,000 in severance pay, was an excess parachute payment subject to a 20 percent excise tax. Cline challenged the excise tax in United States Tax Court, which ruled in the commissioner’s favor, holding that the bonus was a disguised parachute payment. The tax court also found that the bonus was not reasonable compensation, noting that American Stores did not consider the compensation paid to other individuals for performing similar services or typically pay bonuses to departing employees. Cline appealed.