## Facts

- John E. Reed, a cash-method taxpayer, owned shares of Reed Electromech Corporation acquired in 1963.
- Reed and other shareholders granted Joseph Cvengros an option (later amended) to buy their shares, with the closing set for December 27, 1973, at $3,300 per share (aggregate $808,500).
- Cvengros exercised the option on November 23, 1973.
- Reed wanted the transaction’s gain recognized in 1974 to offset anticipated 1974 capital losses; Cvengros wanted a 1973 closing.
- At the December 27, 1973 closing, the stock sale was completed, and Cvengros deposited the purchase price into escrow under a written escrow agreement.
- The escrow agreement required the escrowee to disburse the proceeds to Reed on January 3, 1974.
- Reed had no right to withdraw the escrowed funds in 1973 and no right to any “incidental benefits” (e.g., interest or earnings) while the funds were in escrow.
- Reed reported the gain in 1974; the Commissioner asserted the gain was taxable in 1973 and determined a 1973 deficiency of $71,412.68.
- The Tax Court sustained the deficiency; Reed appealed.

## Issues

1. For a cash-basis taxpayer, does a purchaser’s deposit of sale proceeds into escrow constitute taxable receipt in the year of deposit or in the year of escrow disbursement?
2. Should the escrow arrangement be disregarded under constructive receipt or economic benefit doctrines, causing the gain to be recognized in the year of deposit?

## Decision

- The First Circuit reversed the Tax Court.
- Reed did not realize the sale proceeds in 1973 when they were deposited into escrow.
- Reed realized income in 1974 when the escrowee disbursed the funds to him.
- The escrow arrangement was a bona fide deferred-payment agreement and did not trigger constructive receipt or economic benefit in 1973.

## Legal Principles

- A cash-method taxpayer generally recognizes income upon actual or constructive receipt.
- Escrowed sale proceeds are not constructively received when the taxpayer lacks an unconditional right to demand or obtain the funds during the escrow period.
- Lack of entitlement to interest or other earnings on escrowed funds weighs against constructive receipt and against treating the arrangement as providing a current economic benefit.
- Funds held by an independent escrowee are not treated as received by the taxpayer merely because they are set aside, particularly where the escrowee is not the taxpayer’s agent.
- When escrow restrictions prevent current dominion and control and do not confer a present, cash-equivalent benefit, income is recognized upon disbursement, not upon deposit.

## Conclusion

The court held that a properly structured escrow under a bona fide deferred-payment agreement can defer income recognition for a cash-basis taxpayer until the taxpayer actually receives the proceeds, where the taxpayer lacks a present right to the funds, receives no current benefits from them, and the escrow holder is not the taxpayer’s agent.


Reed v. Commissioner, 723 F.2d 138 (1st Cir. 1983)