## Facts

- Albert J. Henry, a senior IMED Corporation officer (including CFO and director), received nonqualified IMED stock options as compensation subject to I.R.C. § 83.
- Henry and other executives filed § 83(b) elections reporting the options’ fair market value at grant as zero, resulting in a zero basis.
- In 1982, Warner-Lambert acquired the IMED options, and Henry realized substantial proceeds from the disposition.
- The Henrys’ return reported the transaction as long-term capital gain, disclosed the acquisition and disposition dates, sales price, gain, and zero basis, and identified the instruments as options (not stock).
- The IRS determined the proceeds should be treated as ordinary income under § 83 upon disposition and asserted a deficiency exceeding $2 million.
- The IRS also asserted additions to tax for negligence under former § 6653(a)(1) (about $105,000) and substantial understatement under former § 6661 (about $525,000).
- In the Tax Court, Henry did not contest that controlling law required ordinary-income treatment; the dispute centered on whether the § 6661 penalty was avoided by “adequate disclosure” on the return and whether negligence applied.
- Henry offered expert testimony (a former IRS employee) that the return’s reporting would have alerted the IRS to the issue and likely triggered examination; the Commissioner argued disclosure did not meet the regulatory standard and the position lacked substantial authority.

## Issues

1. Whether the former I.R.C. § 6661 addition to tax for substantial understatement was avoided because the Henrys “adequately disclosed” on the return the relevant facts concerning their stock-option tax treatment.
2. Whether the Henrys were liable for the former I.R.C. § 6653(a)(1) negligence/disregard addition for reporting the option proceeds as long-term capital gain rather than ordinary income.

## Decision

- The Tax Court sustained the § 6661 substantial-understatement addition to tax.
- The court held the Henrys’ return reporting did not satisfy the regulatory “adequate disclosure” requirements and did not excuse the penalty, particularly where the position lacked substantial authority.
- The Tax Court sustained the § 6653(a)(1) negligence/disregard addition to tax, finding Henry, as a sophisticated financial executive, knew or should have known the reporting position was improper.
- The Commissioner’s asserted additions were upheld along with the deficiency.

## Legal Principles

- For former § 6661 purposes, “adequate disclosure” requires more than complete numerical reporting of a transaction; it must clearly identify the potentially controversial tax position in the manner contemplated by the statute and regulations (often through a specific disclosure statement or comparable explicit notice).
- A taxpayer does not avoid § 6661 merely because the return’s labels and figures might allow the IRS to infer the existence of a legal controversy.
- Expert testimony about audit-selection likelihood or agent awareness does not control whether a return meets the legal standard for “adequate disclosure.”
- Under former § 6653(a)(1), sophisticated taxpayers may be found negligent when they take a reporting position contrary to the governing statutory and regulatory scheme without reliable support.

## Conclusion

The Tax Court held that detailed reporting of a stock-option transaction on the face of a return did not, by itself, meet former § 6661’s adequate-disclosure standards, and it sustained both the substantial-understatement and negligence additions where the taxpayer’s capital-gain characterization lacked sufficient legal support.


Henry v. Commissioner, 73 T.C.M. (CCH) 1769 (T.C. 1997)