Geftman v. C.I.R.

Decision Date10 August 1998
Docket NumberNo. 97-7313,97-7313
Citation154 F.3d 61
Parties-5617, 98-2 USTC P 50,630 Jonathan B. GEFTMAN, Appellant, v. COMMISSIONER OF INTERNAL REVENUE.
CourtU.S. Court of Appeals — Third Circuit

Steven M. Kwartin (argued), Raoul G. Cantero, III, Adorno & Zeder, P.A., Miami, FL, for Appellant.

Loretta C. Argrett, Teresa E. McLaughlin (argued), Ellen Page Delsole, Tax Division, Department of Justice, Washington, DC, for Appellee.

Before: SLOVITER and GREENBERG, Circuit Judges, and POLLAK, * Senior District Judge.

OPINION OF THE COURT

GREENBERG, Circuit Judge.

I. INTRODUCTION

Appellant Jonathan Geftman ("Geftman") appeals from a decision of the United States Tax Court entered March 17, 1997, holding him liable for an income tax deficiency and for additions to tax due to his failure to report as taxable income a distribution he received from a trust established by his late father Raymond Geftman. The Tax Court entered its decision pursuant to its opinion filed September 30, 1996, as amended by an order of December 23, 1996. The Tax Court had jurisdiction under 26 U.S.C. §§ 7442, 6213(a) and 6214 based on Geftman's timely filing of a petition contesting a Notice of Deficiency issued to him on July 3, 1991, pursuant to 26 U.S.C. § 6212. Appellate jurisdiction rests on 26 U.S.C. § 7482(a)(1). Venue is proper pursuant to 26 U.S.C. § 7482(b)(1)(A), as Geftman resided within this Circuit when he filed his petition contesting the notice of deficiency. For the reasons that follow, we will reverse the Tax Court's decision, thus vacating the tax deficiency and the additions to tax imposed on Geftman.

II. FACTUAL AND PROCEDURAL HISTORY
A. The Trusts

Raymond Geftman died on February 28, 1983, leaving a will which provided that its "primary purpose" was "to provide for the benefit of " his son Jonathan Geftman, the taxpayer-appellant in this case, who was 14 years old at the time of his father's death. The will further provided that "[n]o action should be taken ... which would unreasonably detract from [Geftman's] ability to receive the maximum income and principal to which he is entitled." The will established three trusts, designated A, B, and C, to be funded from the residuary estate with Trust A receiving 40 percent of the residuary estate and Trusts B and C each receiving 30 percent.

As specified in the will, Geftman was the sole beneficiary of Trust C and the decedent's fiancee, Edith Kermer, was the sole income beneficiary of Trust B, while the income beneficiaries of Trust A included the decedent's accountant Steven Love, his real estate agent Warren Welt, his bookkeeper Paul Creedy, and several of their relatives. The will named Love, Welt and Creedy, along with the decedent's attorneys, Terrence Russell and Jonathan Beloff, as personal representatives of the estate ("representatives"), trustees of the trusts, and directors of Berkley Mortgage Corporation ("Berkley") and BOP, Inc. ("BOP"), real estate development enterprises the estate owned.

The will authorized the trustees to make distributions to Geftman from Trust C's current income or from its principal, to the extent "necessary for his health, support, maintenance and education," including higher education and the cost of establishing him in a business or profession. Geftman then would receive the remaining principal of Trust C in installments beginning at age 30 or upon his admission to the bar, if earlier.

In contrast to these terms governing distributions to Geftman from Trust C, the will prohibited distributions from the principal of Trusts A or B, and provided that Trusts A and B were to make the specified distributions to their beneficiaries only to the extent that the trusts had current net income after expenses. 1 The remainders of Trusts A and B after these trusts had made all specified distributions were to be added to the principal of Trust C for Geftman's benefit. See app. at 127-30.

B. The Margin Transactions

In August 1983 the estate funded the trusts by transferring tax-exempt municipal bonds worth approximately $3 million to brokerage accounts held in the name of the trusts through the E.F. Hutton and PaineWebber brokerage firms. See app. at 130-32. Because the estate had not settled all of its liabilities, the personal representatives required all beneficiaries of the trusts to execute consents permitting the estate to recall all trust assets to the estate as necessary to satisfy the estate's obligations, even if the recall completely depleted the trusts. 2

In December 1983 the estate entered into a Settlement Agreement resolving lawsuits pending against it. During the same month, the trusts began brokerage borrowing on margin at rates of 11.50% to 13.25% using their municipal bond assets as collateral and transferring the funds borrowed to the estate. See app. at 178-92; 131. The trusts borrowed $74,950.97 in December 1983, see app. at 154, $870,000 on January 5, 1984, see app. at 192, and $300,000 on January 9, 1984, see app. at 152, for a total of $1,244,950.97 by January 9. On January 17, 1984, the representatives met and issued the following memorandum of their meeting:

The Settlement Agreement ... was ratified....

The actions necessary to pay or transfer estate assets needed for the settlement was also ratified, however, there was lengthy discussion on the issue as to the ratification of the borrowing from the stockbroker by using trust assets as collateral as opposed to the sale of estate assets to pay the sums due for the settlement. The action which had been taken to borrow was ratified, however it was acknowledged that Paul Creedy had dissented from the decision to borrow for purposes of carrying out the settlement agreement, however Paul Creedy agreed to the ratification of the action.

App. at 135a. The estate received additional transfers from the trusts during 1984 for a total of $2,850,408 as of August 31, 1984, which represented the maximum amount that could be borrowed on margin against the trusts' $3 million municipal bond collateral. See app. at 131.

The trusts' E.F. Hutton account statements reflected the monthly interest which the broker charged on the margin loans. On the statements for the months of April through July 1984, handwritten notations indicated that a portion of the margin interest charges was attributable to the amounts forwarded to the estate while a portion was attributable to funds which the trusts lent to Edith Kermer. See app. at 160-99. The loan to Edith Kermer was secured by a first mortgage in favor of the trusts and was repayable pursuant to the terms of an installment note which provided for monthly payments of principal plus interest at a rate of 1% above the rate charged to the trusts by E.F. Hutton. See app. at 416.

On four occasions the estate paid the trusts an amount equal to the notation on the prior month's statement indicating the amount of margin interest attributable to the estate. During the period from April through August 1984, the handwritten notations and corresponding payments were as follows:

                Statement  Notation of Estate's  Deposit Into
                Date       Share of Interest     Account
                ---------------------------------------------
                4/84       $16,086               --
                5/84       $20,538               $16,086
                6/84       $21,580               $20,538
                7/84       $24,560               $21,580
                8/84       --                    $24,560
                total      $82,764               $82,764
                

See Geftman v. Commissioner, 72 T.C.M. (CCH) 816, 818 (1996); app. at 179, 181, 183, 185, 187.

C. The Mortgage Transactions

The representatives, including those who served as officers and directors of Berkley and BOP, met on September 5, 1984, regarding Berkley's and BOP's condominium development ventures, including ventures known as "La Playa" and "Blue Grass." The representatives determined that because a financing arrangement for the La Playa condominium development had fallen through, it was necessary for the trusts to sell their municipal bonds and transfer the proceeds to Berkley and BOP. The bonds were sold for a capital loss of approximately $100,000 and the proceeds were used to satisfy the margin debt owed to E.F. Hutton. According to the memorandum of the September 5 meeting, the remaining proceeds from the sale of the bonds were transferred to La Playa "as a down payment for the purchase of all new first mortgages ... on the La Playa units." App. at 135a-b.

A memorandum dated February 4, 1985, indicated that the trusts had acquired the La Playa mortgages, although Berkley would hold the title to them. The memorandum stated that,

the prior action[s] taken with regard to Trust A, B and C ... were confirmed.... Approximately $2,000,000 in first mortgages at LaPlaya have been bought outright by the Trust.... Title to the mortgages[was] taken in the name of Berkley Mortgage Corp. as collection agent for the Trust.... The balance of Trust assets for approximately $1,000,000 has been used to buy mortgages from BOP, Inc. which were also taken in Berkley's name as collection agent.

App. at 135c. The trusts' books did not reflect a purchase of the mortgages corresponding to the transaction described in the February 4, 1985 memorandum. However, "adjusting journal entries" recorded on June 11, 1985, after the trusts' tax year ended on February 28, 1985, indicated that the trusts had received $2,029,390 in La Playa condominium mortgages from the estate as a "partial debt settlement." Supp. app. at 40. 3

A document entitled "Berkley Mortgage Corp. Accrued Interest and Principal Collections" set forth cumulative totals of the principal and interest which Berkley received on the La Playa and Blue Grass mortgages for the tax year ended February 28, 1985, and for the "Ten Months Ended 12/31/85." The document indicated that Berkley had collected $90,595.81 in payments on mortgages at the La Playa and Blue Grass developments, and attributed these amounts to the...

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