60 T.C. 469 (1973), 8176-71, Estate of Bell v. C.I.R.

Docket Nº:8176-71.
Citation:60 T.C. 469
Opinion Judge:QUEALY, Judge: SCOTT, Judge:
Party Name:ESTATE OF LLOYD G. BELL, DECEASED, WILLIAM BELL, EXECUTOR, AND GRACE BELL, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Attorney:Donald D. Lamp, for the petitioners. Thomas N. Tomashek, for the respondent. Paul R. Trigg, Donald S. Young, and Joel J. Morris, for the petitioner. Ralph F. Keister and Chauncy W. Tuttle, Jr., for the respondent.
Case Date:June 26, 1973
Court:United States Tax Court
 
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Page 469

60 T.C. 469 (1973)

ESTATE OF LLOYD G. BELL, DECEASED, WILLIAM BELL, EXECUTOR, AND GRACE BELL, PETITIONERS

v.

COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

No. 8176-71.

United States Tax Court

June 26, 1973

Page 470

          Donald D. Lamp, for the petitioners.

         Thomas N. Tomashek, for the respondent.

         Held: 1. Where property is exchanged for a secured contract to pay an annuity, the recoverable ‘ investment in the contract’ as defined in sec. 72(c), I.R.C. 1954, is the fair market value of the property transferred.

         2. Where the fair market value of the property transferred substantially exceeds the commuted value of the annuity, in the absence of any proof to the contrary, such excess is deemed to be a gift. Under such circumstances, the taxpayer's ‘ investment in the contract’ is limited to the commuted value of the annuity.

         3. The gain attributable to the excess or difference between the fair market value of the annuity contract and the taxpayer's adjusted basis for the property transferred in exchange for such contract is realized in the year of such exchange.

          QUEALY, Judge:

         Respondent determined the following deficiencies in petitioners' income tax:

Year Deficiency
1968 $1,931.91
1969 2,926.11
         Some of the facts have been stipulated by the parties and are incorporated herein by reference. As a result of concessions made by the parties, the following issues remain for decision:          (1) The determinations of petitioners' ‘ investment in the contract’ in the 1968 and 1969 for purposes of the exclusion ratio provided for under section 72(b); [1]          (2) To the extent that petitioners' ‘ investment in the contract’ exceeds their adjusted basis of the stock transferred, the manner of accounting for such excess.          An adjustment to petitioners' medical deduction for 1968 and 1969 is also involved, but is dependent on the outcome of the issues presented.          FINDINGS OF FACT          Petitioners are the Estate of Lloyd G. Bell, deceased, William Bell as executor, and Grace Bell, the surviving spouse of Lloyd G. Bell. The legal residence of petitioners at the time of the filing of the petition was Rockford, Wash.          Lloyd and Grace Bell filed timely joint Federal income tax returns for the calendar years 1968 and 1969 with the Western Service Center of the Internal Revenue Service at Ogden, Utah. Lloyd Bell died on September 8, 1970.          Pursuant to an ‘ Annuity Agreement’ dated December 6, 1967, Lloyd and Grace Bell transferred community property consisting of 822 1/2 shares of Bell & Bell, Inc., capital stock and 2,034 shares of Bitterroot, Inc., capital stock to William and Beverly Bell and Calvin A. and Betty Bell Reinertson in exchange for a promise by the transferees to pay them $1,000 per month for so long as either shall live. The stock was placed in escrow as security for the promise of the Page 471 transferees. As further security, the agreement provided for a cognovit judgement against the transferees in the event of a default. William Bell and Betty Bell Reinertson are the son and daughter, respectively, of Lloyd and Grace Bell.          Bell & Bell, Inc., and Bitterroot, Inc., are both closely held farming corporations. Neither is traded on a stock exchange. Both corporations were formed in 1965 by Lloyd Bell and his son, William Bell, as successors to an informal partnership carried on between father and son.          Lloyd Bell owned one-third of the stock of Bell & Bell, Inc., and two-thirds of the stock of Bitterroot, Inc. William Bell owned the balance of the stock in these corporations.          At the time of the transfer, Lloyd and Grace Bell's basis in the stock of Bell & Bell, Inc., was $9,559.94, and the basis of their stock in Bitterroot, Inc., was $11,497.63, or a total of $21,057.57. The total fair market value of such stock was $207,600.          Lloyd Bell was 72 years of age and Grace Bell was 68 years of age at the time of transfer. They had a joint life expectancy of 18.7 years. The expected return from the annuity, based upon such life expectancy, was $224,400. The discounted value of the annuity at the time of the transfer was stipulated to be either $142,573 or $126,200.38, depending upon whether the Court finds the correct method of valuation to be the representative cost of a comparable commercial annuity, as petitioners contend, or the tables under section 20.2031-7, Estate Tax Regs., as respondent contends.          Pursuant to the ‘ Annuity Agreement’ of December 6, 1967, Lloyd and Grace Bell received payments totaling $13,000 during 1968 and $12,000 during 1969.          OPINION          Lloyd Bell and his son, William Bell, formed and operated two closely held farming corporations. Lloyd Bell owned two-thirds of the stock of one and one-third of the stock of the other. His son owned the balance. Pursuant to an ‘ Annuity Agreement’ executed December 6, 1967, Lloyd and Grace Bell transferred all their stock in these corporations, owned as community property, to their son and daughter and their respective spouses in exchange for their promise to pay them $1,000 per month for so long as either shall live. The stock transferred was placed in escrow to secure the promise of the transferees. As further security, the agreement provided for a cognovit judgment against the transferees in the event of default. Lloyd and Grace Bell received payments of $13,000 and $12,000, respectively, in the taxable years 1968 and 1969.          The rules for the inclusion in income of said payments are prescribed in section 72. Insofar as material herein, that section provides: Page 472           SEC. 72. ANNUITIES; CERTAIN PROCEEDS OF ENDOWMENT AND LIFE INSURANCE CONTRACTS.          (a) GENERAL RULES FOR ANNUITIES.- Except as otherwise provided in this chapter, gross income includes any amount received as an annuity (whether for a period certain or during one or more lives) under an annuity, endowment, or life insurance contract.          (b) EXCLUSION RATIO.- Gross income does not include that part of any amount received as an annuity under an annuity, endowment, or life insurance contract which bears the same ratio to such amount as the investment in the contract (as of the annuity starting date) bears to the expected return under the contract (as of such date). ***          (c) DEFINITIONS.-          (1) INVESTMENT IN THE CONTRACT.- For purposes of subsection (b), the investment in the contract as of the annuity starting date is-          (A) the aggregate amount of premiums or other consideration paid for the contract, minus          (B) the aggregate amount received under the contract before such date, to the extent that such amount was excludable from gross income under this subtitle or prior income tax laws.          The respondent argues that petitioners' ‘ investment in the contract,‘ as defined in section 72(c), is petitioners' adjusted basis for the stock transferred in consideration of the transferees' promise of an annuity. Rev. Rul. 69-74, 1969-1 C.B. 43. The petitioners argue that their investment in the contract’ is the fair market value of the stock transferred, relying on Rev. Rul. 239, 1953-2 C.B. 53, which applied to a similar computation under section 22(b)(2) of the Revenue Act of 1939. Petitioners further contend that the fair market value of the stock was not less than $207,600.          In our opinion, we need not pass on the applicability of either Rev. Rul. 239 or Rev. Rul. 69-74, supra, since both involve ‘ unsecured’ private annuities. [2] Here, we are dealing with an annuity which is amply secured, not only by the property transferred, but also by a cognovit judgment that would subject all the property of the transferees to attachment without court proceedings.          Section 72(c)(1) defines ‘ investment in the contract’ as ‘ the aggregate amount of premiums or other consideration paid for the contract.’ Section 22(b)(2) of the 1934, 1936, and 1939 Revenue Acts, predecessors to section 72, similar language.[3] Under such Page 473 Acts, this language has uniformly been construed to mean the amount required to purchase the annuity, which in an arm's-length transfer, is the fair market value of the property transferred. F. A. Gillespie, 38 B.T.A. 673 (1938); Hill's Estate v. Maloney, 58 F.Supp. 164 (D. N.J. 1944); Jane J. de Canizares, 32 T.C. 345 (1959). Nothing in the statute, the legislative history, or the regulations interpreting section 72 indicates that ‘ consideration paid’ on our facts should have a different meaning than it had under section 22(b)(2) of the prior Acts. Here the consideration paid consisted of stock of two closely held farming corporations having and aggregate fair market value of $207,600.          In determining the ‘ consideration paid,‘ however, the statute presupposes a transaction between unrelated parties dealing at arm's length. The petitioners claim that the consideration paid for the annuity amounted to $207,600, while at the same time petitioners conceded that the discounted value or cost of a commercial annuity providing for the same payments was $142,573. We can only account for such excess as being attributed to the family relationship between the annuitants and the transferees. Such excess, therefore, whether predicated upon the cost of a commercial annuity, as contended for by the petitioners, or upon the annuity tables under section 20.2031-7(f), Estate Tax Regs., as contended for by the respondent, must be deemed to be a gift. In...

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