Baker v. Comm'r of Internal Revenue, Docket No. 3914-77.

Citation75 T.C. 166
Decision Date22 October 1980
Docket NumberDocket No. 3914-77.
PartiesJACK and FLORENCE BAKER, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
CourtUnited States Tax Court

OPINION TEXT STARTS HERE

T received interest-free loans from a family corporation of which he was an officer-stockholder. Held: T did not realize any taxable income based upon his use or enjoyment of such tax-free loans. Stare decisis requires that Dean v. Commissioner, 35 T.C. 1083 (1961), be followed in the circumstances of this issue, nor is Dean inapplicable on this record by reason of T's investments in federally tax-exempt securities. Benjamin Lewis, for the petitioners.

Joan Ronder Domike, for the respondent.

OPINION

RAUM , Judge:

The Commissioner determined deficiencies in petitioners' income taxes as follows:

+--------------------+
                ¦Year  ¦Deficiency   ¦
                +------+-------------¦
                ¦      ¦             ¦
                +------+-------------¦
                ¦1973  ¦$1,575       ¦
                +------+-------------¦
                ¦1974  ¦3,462        ¦
                +------+-------------¦
                ¦1975  ¦1,976        ¦
                +--------------------+
                

After concessions, the only issue presented by this fully stipulated case is whether Jack Baker, the husband petitioner, realized taxable income as a consequence of interest-free loans from Sue Brett, Inc., of which he is the president. He, his wife, and their children own all the issued and outstanding common stock of the corporation.

At the time of the filing of their petition herein, petitioners were New York residents.

During the years in issue, Mr. Baker maintained a running loan account with the corporation, and used the money borrowed to make estimated tax payments (Federal, State, and city). The loan account was maintained on the corporation's books as “Loans receivable—-Officers.” There were no notes, no specific plan of repayment, and no interest was charged or paid. During 1973, Mr. Baker made monthly repayments in amounts of $1,000 to $3,000. In 1974, he made one repayment of $50,000, and made no repayments during 1975.

In the notice of deficiency, the Commissioner determined that petitioners realized unreported taxable income with respect to the stipulated average balances of the interest-free loans from the corporation (based on specified interest rates), as shown in the following schedule:

+----------------------------------------------+
                ¦      ¦Average       ¦Interest     ¦Interest  ¦
                +------+--------------+-------------+----------¦
                ¦Year  ¦loan balance  ¦rate         ¦income    ¦
                +------+--------------+-------------+----------¦
                ¦      ¦              ¦     ¦       ¦          ¦
                +------+--------------+-----+-------+----------¦
                ¦1973  ¦$36,870       ¦9    ¦percent¦$3,318    ¦
                +------+--------------+-----+-------+----------¦
                ¦1974  ¦95,834        ¦8 1/2¦percent¦8,146     ¦
                +------+--------------+-----+-------+----------¦
                ¦1975  ¦52,689        ¦7 1/2¦percent¦3,952     ¦
                +----------------------------------------------+
                

The parties have stipulated that at a minimum, Mr. Baker would have had to pay interest at the above rates if he had borrowed from a lending institution.

At all times relevant, Sue Brett's accumulated earnings and profits were in excess of the amounts determined by the Commissioner to be the equivalent of interest on the interest-free loans. Mr. Baker's annual salary from Sue Brett, Inc., was $78,000 in 1973 and 1974, and $79,500 in 1975. The parties have agreed that Mr. Baker's compensation from the corporation was not unreasonable and that additional compensation equivalent to the amounts determined by the Commissioner to be additional income to him would not result in unreasonable compensation if paid by the corporation.

On December 31, 1972, petitioners owned federally tax-exempt securities totaling $129,000, and during the years 1973, 1974, and 1975, they made investments of $45,000 in each year in federally tax-exempt securities. On December 31, 1975, they owned a total of $245,000 in such securities. The record does not show that there was any correlation in time or otherwise between the investments in the tax-exempt securities and the interest-free loans.

In asking us to sustain the deficiencies, the Government recognizes that its position is adverse to Dean v. Commissioner, 35 T.C. 1083 (1961). It contends that Dean was wrongly decided and should be overruled. We reaffirm Dean, and hold further that, on this record, Dean is not rendered inapplicable by reason of petitioners' investments in federally tax-exempt securities.

(1) The Government's frontal attack upon Dean began in 1973 with the announcement of the Commissioner's “nonacquiescence” in Dean. 1973-2 C.B. 4. Thereafter, the first case to face the issue squarely in this Court in the context of a stockholder-officer relationship to the corporation was Suttle v. Commissioner, 37 T.C.M. 1638, 47 P-H Memo T.C. par. 78,393 (1978), which reaffirmed Dean. Cf. Greenspun v. Commissioner, 72 T.C. 931 (1979), on appeal (9th Cir., Nov. 20, 1979). Suttle has since been affirmed by the Fourth Circuit, 625 F. 2d 1127 (1980). Meanwhile, the issue was again presented to this Court in Zager v. Commissioner, 72 T.C. 1009 (1979), on appeal (5th Cir., Feb. 5, 1980). There, we traced the history of the problem back to the first of our modern revenue acts in 1913, and emphasized our conclusion to apply the principle of stare decisis. Our discussion of the matter in Zager is particularly pertinent and we quote extensively from our opinion in that case (72 T.C. at 1010-1012, 1013):

Our modern income tax laws have been in effect continuously since 1913, and the various applicable statutes, using one form of words or another, have characterized the income subject to tax in broad and sweeping terms. Yet, at the time Dean was presented to this Court, there was no indication that there had previously ever been even a single instance in which the Government had taken the position, either in litigation (successfully or unsuccessfully) or by rule, regulation, or administrative practice in any manner, that an interest-free loan by a corporation to its stockholder-officers resulted in the realization of income which the statute sought to reach. Indeed, the position advocated in this respect by the Government in Dean would appear to have been nothing more than an afterthought. No such issue was raised in the deficiency notice or even in the answer as originally filed in response to the taxpayers' petition therein. The point was first raised in an amended answer and appears to have had its origin in a fortuitous dictum in a then-recent Memorandum Opinion of this Court involving gift taxes of the same taxpayers which had been promulgated several months prior to the filing of the amended answer. (See 35 T.C. at 1089.) The theory was further refined in the Government's brief.

The problems gave us much difficulty because there appeared superficially to be but little difference between the interest-free use of corporate funds and the rent-free occupancy of corporate property by a stockholder or officer that had been held to constitute a tax benefit the fair value of which was includable in gross income. Conceptually, it did seem that the same result should be reached in both types of cases. Yet, the fact that the Treasury had not theretofore—-for some 48 years—-attempted to treat as income the benefits attributable to such interest-free loans was highly troublesome. We searched for a distinction that would support the administrative practice which had endured for so long a period. And we found a difference in that if the taxpayer had undertaken to pay interest or rent, he would generally have been entitled to a deduction for the payment of interest but not for rent. Thus, the tax benefit resulting from the exclusion from gross income of any amount attributable to such an interest-free loan would be matched dollar for dollar by the tax benefit attributable to the interest deduction in the case of an interest-bearing loan, assuming of course that the interest were fixed at a fair rate. To be sure, there were peripheral situations in which the distinction would not hold, but in general, the neutralizing effect of the interest deduction did seem to afford a basis for supporting the differing treatment which the Government itself had long accorded to interest-free loans and rent-free use of property. In reaching our conclusion, we recognized that “the question may not be completely free from doubt” (35 T.C. at 1089), and our opinion, although reflecting the views of a majority of the Court, was not unanimous.

Notwithstanding the potential importance of Dean, the Government failed to pursue an appeal from our decision and accepted the result for a period of some 12 years thereafter. It was not until 1973 that the Commissioner announced his “nonacquiescence,” 1973-2 C.B. 4, and mounted a campaign to have Dean overruled.

the prior practice spanned a period of 60 years—-from 1913 to 1973. There were undoubtedly at least many thousands of instances during this period when the issue could have been raised. We know that there are a great number of corporations that are wholly owned or subject to the control of a dominant stockholder. And we also know from the records in numerous cases that have been before us that the flow of funds—-often on an informal basis—-between such stockholder and his corporation is a very common occurrence. Sometimes, notes are executed; at other times, there are merely book entries; and at still other times, there may be no documentation whatever. Dean gave effect to the administrative practice that had existed for 48 years as of that time in respect of the non-interest-bearing loans in such situations, and that practice continued thereafter for another 12 years until the Commissioner took his present position by publishing his ...

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