Arnes v. Comm'r of Internal Revenue

Decision Date05 April 1994
Docket NumberNo. 23291–91.,23291–91.
Citation102 T.C. No. 20,102 T.C. 522
PartiesJohn A. ARNES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtU.S. Tax Court


Darrell D. Hallett, Seattle, WA, for petitioner.

Lisa M. Oshiro, Santa Fe, NM, for respondent.

FAY, Judge:

H and W were married and jointly owned 100 percent of M, which owned and operated a McDonald's restaurant. H and W separated. Subsequently, H and W surrendered their jointly held M shares in exchange for separate certificates reflecting equal ownership. H, W, and McDonald's agreed that M would redeem W's stock, and that H would guarantee M's obligation to pay W. The agreement was part of the property settlement agreement of H and W, which was subsequently incorporated in their divorce decree.

W claimed and sued in the District Court for a tax refund on the grounds that gain from the redemption should not be recognized under sec. 1041, I.R.C. In Arnes v. United States, 981 F.2d 456 (9th Cir.1992), affg. 91–1 USTC par. 50,207 (W.D.Wash.1991), the Court of Appeals for the Ninth Circuit affirmed the District Court's decision, which granted summary judgment in W's favor.

1. Held: No constructive dividend resulted to H from M's redemption of W's stock, because H did not have a primary and unconditional obligation to purchase W's stock. See Edler v. Commissioner, 727 F.2d 857 (9th Cir.1984), affg. T.C.Memo. 1982–67.

2. Held, further, respondent's argument that Golsen v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir.1971), applies here is rejected.

This case is before the Court on the parties' cross-motions for summary judgment pursuant to Rule 121.1

By notice of deficiency dated October 8, 1991, respondent determined deficiencies in petitioner's Federal income taxes as follows:

                ¦Year  ¦Deficiency   ¦
                ¦1987  ¦$42,725      ¦
                ¦1988  ¦27,337       ¦


John A. Arnes (petitioner) resided in Ellensburg, Washington, when he filed the petition.

Petitioner and his former wife, Joann Arnes (Joann), were married in 1970. After having worked for a number of years in McDonald's Restaurants and for McDonald's Corporation (McDonald's), petitioner developed an interest in operating his own McDonald's franchise.

On October 8, 1979, petitioner and Joann entered into a license agreement with McDonald's granting them a McDonald's franchise in Ellensburg, Washington. After about a year, they formed Moriah Valley Enterprises, Inc. (Moriah), to own and operate the franchise, and 5,000 shares of Moriah stock were issued to petitioner and Joann jointly.

The articles of incorporation of Moriah include a right of first refusal, which states in relevant part as follows:

In the event any one or more of the shareholders of this corporation should desire to sell or transfer all or any part of his stock in the corporation and retire from the said business, * * * then the corporation shall have the option to purchase and acquire the whole of the stock interest of such party * * * so desiring to sell or transfer his interest. In the event the corporation does not exercise this option, the shareholders shall have a secondary option to purchase said shares at the same price contained in the corporation's options; said secondary option of the shareholders to be computed on a basis of number of shares held on a pro rata basis. Nothing in this paragraph shall prevent the corporation and the shareholders from agreeing to terms and conditions relating to the exercise of the foregoing option as to time within which to exercise the option, terms of payment, security for payment, methods of effecting transfer, and related matters. [Emphasis added.]

On August 5, 1981, McDonald's executed a memorandum entitled Change of Unit Ownership recognizing and approving the assignment of the McDonald's franchise to Moriah and also noting that petitioner and Joann were both 50–percent owners of Moriah.

Petitioner and Joann permanently separated in January 1987. McDonald's wrote a letter dated January 14, 1987, to petitioner, which states in pertinent part:

In conjunction with your pending divorce, we would like to explain McDonald's position concerning dissolution of the marriages of McDonald's operators.

As you know, we are primarily concerned with the operation of the McDonald's restaurant, and an essential element of good operations is 100% ownership of the equity and profits by the owner/operator on premises. Since all divorces include some sort of property settlement, we want to be assured that there is no joint ownership of the McDonald's restaurant business by you and your wife after you divorce and the spouse who ends up with the business is operationally and financially qualified.

We have the right to consent to such a property settlement because it results in a change in the equity ownership of the business and changes the status of the former husband and wife to that of a partnership of unrelated parties. As you know, it has been a longstanding franchising policy of this company to refuse to franchise partnerships.

On December 16, 1987, petitioner and Joann surrendered their jointly held shares of Moriah stock and were each issued separate stock certificates representing 2,500 shares of Moriah stock. On December 17, 1987, petitioner and Joann entered into an Agreement Regarding Property Custody and Support (the property settlement agreement), providing in part as follows:

The parties hereto shall cause the corporation owned by the parties known as Moriah Valley Corporation to redeem from wife 2,500 shares of stock (Certificate # 4) that she owns, said shares being one-half of the issued stock. That the obligations of the corporation to pay wife in accordance with the provisions hereinafter set forth, shall be and are personally guaranteed by husband and the corporation shall execute any security documents and/or other instruments necessary to secure and perfect the security granted to wife for said obligation. The corporation shall pay to wife the sum of FOUR HUNDRED FIFTY THOUSAND DOLLARS ($450,000.00) for wife's stock in the corporation. Of said sum, ONE HUNDRED TEN THOUSAND NINE HUNDRED EIGHTY–THREE AND 56/100ths DOLLARS ($110,983.56) shall be paid by the corporation by forgiving that certain Promissory Note dated April 17, 1987 in the principal sum of ONE HUNDRED FIVE THOUSAND DOLLARS ($105,000.00) that has accurred [sic] interest of FIVE THOUSAND NINE HUNDRED EIGHTY–THREE AND 56/100ths DOLLARS ($5,983.56). That on the 2nd day of January, 1988, the corporation shall pay to wife the sum of TWENTY–FIVE THOUSAND DOLLARS ($25,000.00) and a like sum on the 1st day of May, 1988. That the balance of TWO HUNDRED EIGHTY–NINE THOUSAND SIXTEEN AND 44/100ths DOLLARS ($289,016.44) shall be paid by the corporation to wife and shall bear interest from January 1, 1988 at the rate of nine percent (9%) per annum and shall be paid through monthly installments of THREE THOUSAND SIX HUNDRED SIXTY–ONE AND 84/100ths DOLLARS ($3,661.84) per month commencing February 1, 1988. That said obligation shall be paid in full no later than January 1, 1998.

On December 28, 1987, Moriah and Joann entered into an Agreement as to Corporate Stock providing for a redemption by Moriah of Joann's stock, with Moriah's obligation guaranteed by petitioner.

The property settlement agreement was filed with the Superior Court of Washington for Kittitas County and incorporated in the Decree of Dissolution of Marriage by the court, entered on January 7, 1988.

On January 18, 1988, Joann, petitioner, and McDonald's executed an Assignment and Consent to Redemption of Stock (the McDonald's consent agreement). The McDonald's consent agreement provided that Moriah would redeem Joann's stock in accordance with the payment schedule set forth in the property settlement agreement and that petitioner would be the guarantor of Moriah's payment obligations thereunder.

At all times during the divorce proceeding and during the negotiations relating to the redemption of Joann's stock in Moriah, petitioner and Joann were each represented by an attorney.

On her Federal income tax return for 1988, Joann reported and paid the tax on capital gain arising out of the redemption. Joann subsequently claimed a refund of income tax on the ground that under section 1041 she was not required to recognize gain on the redemption because it should be deemed a nontaxable transfer of property from Joann to Moriah on behalf of petitioner, and then she initiated a refund suit in the U.S. District Court for the Western District of Washington. The District Court granted summary judgment in Joann's favor in Arnes v. United States, 91–1 USTC par. 50,207 (W.D.Wash.1991), concluding that section 1041 governed the income tax consequences of the transaction to Joann.

On February 10, 1992, petitioner filed his motion for partial summary judgment in this case. On March 9, 1992, respondent filed a Motion to Stay Proceedings and also a response to petitioner's motion for partial summary judgment, in part contending that the stay would conserve this Court's time because the Court of Appeals for the Ninth Circuit decision in Joann's case would be dispositive of this case. On March 19, 1992, petitioner filed his objection to respondent's motion. By order dated July 8, 1992, we granted respondent's motion. On August 12, 1992, petitioner filed a Motion for Reconsideration of Order Staying Proceedings and also a memorandum in support of such motion, in part stating that it would be beneficial for the Court of Appeals for the Ninth Circuit to consider both Joann's and petitioner's cases simultaneously if respondent were to lose this case. On September 21, 1992, respondent filed a Response to Petitioner's Motion for Reconsideration of Order Staying Proceedings, objecting to petitioner's motion. By order dated October 2, 1992, this Court denied petitioner's...

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