Blatt v. Comm'r of Internal Revenue

Decision Date31 January 1994
Docket NumberNo. 12456–92.,12456–92.
Citation102 T.C. 77,102 T.C. No. 5
PartiesGloria T. BLATT, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

Lawrence P. Schweitzer, for petitioner.

Tanya M. Marcum, for respondent.

LARO, Judge:

This case is before the Court pursuant to a petition filed by Gloria T. Blatt (petitioner) for a redetermination of respondent's determination of a deficiency of $96,787 in petitioner's 1987 Federal income tax.1 The sole issue for decision is whether a payment made to petitioner in redemption of all her stock is taxable to her in 1987, the year of redemption, or is nontaxable to her under section 1041.2 The redemption was made by a corporation owned equally by petitioner and her former husband, Frank J. Blatt (Blatt), and was made pursuant to a court decree entered incident to their divorce. We hold that the stock redemption payment is taxable to petitioner in 1987.

FINDINGS OF FACT

Pursuant to Rule 122(a), the parties submitted this case to the Court without trial; the record in this case consists of the pleadings and the facts recited in a joint stipulation with accompanying exhibits. These facts and exhibits are incorporated herein by this reference. At the time she filed her petition, petitioner resided in East Lansing, Michigan.

Petitioner married Blatt on September 1, 1946. In 1977, petitioner and Blatt organized Phyllograph Corporation (Corporation) in the State of Washington; petitioner and Blatt each owned 50 percent of Corporation.3 Petitioner filed a divorce complaint on October 4, 1985, and the divorce was finalized on July 21, 1987.

On July 16, 1987, Corporation redeemed all petitioner's stock in exchange for $45,384. The redemption was incident to the divorce decree.4 Petitioner did not report any of these proceeds on her 1987 Federal income tax return. Respondent determined that petitioner realized a long-term capital gain of $39,184 on the redemption, and that petitioner should have recognized this gain in 1987; respondent further determined that the redemption did not involve a transfer between spouses or former spouses under section 1041.

OPINION

Gross income includes gains derived from dealings in property, sec. 61(a)(3); gains derived from the redemption of stock are generally includable in the gross income of the redeemed taxpayer, see generally sec. 302 (rules governing redemptions of stock). Petitioner asserts that the proceeds she received from Corporation's redemption of her stock are excludable from her gross income under section 1041.

Section 1041 provides a broad rule of nonrecognition for sales, gifts, and other transfers of property between spouses or former spouses incident to divorce.5 In part, Congress enacted section 1041 to replace the holding in United States v. Davis, 370 U.S. 65 (1962), that a divorce-related transfer of property in exchange for the release of marital claims resulted in recognition of gain to the transferor. H.Rept. 98–432 at 1491–1492 (1984). Before the enactment of section 1041, as a result of Davis, the transferring former spouse was taxable on a divorce-related transfer of appreciated property to his or her former spouse, and the recipient received a basis in the transferred property equal to its fair market value on the date of transfer. United States v. Davis, supra. Thus, the Government was whipsawed if such a transferor did not report any gain on a transfer of appreciated property. Accordingly, in 1984, Congress enacted section 1041 to remedy this whipsaw.6 H.Rept. 98–432 at 1491–1492 (1984).

Consistent with the legislative history, section 1041 only addresses transfers between spouses or former spouses; it generally does not include transfers to third parties,7 such as corporations.8 The basic policy of section 1041 is to treat a husband and wife as one economic unit, and to defer, but not eliminate, the recognition of any gain or loss on interspousal property transfers until the property is conveyed to a third party outside the economic unit. To that end, no gain or loss is recognized upon the transfer of property from one spouse to another, and the property takes a transferred (“carryover”) basis in the hands of the recipient spouse; the carryover basis preserves the gain (or loss) until the recipient spouse transfers the property to a third party in a taxable transaction.

The regulations prescribed under section 1041 apply the tax-free treatment under section 1041 to certain transfers to third parties on behalf of a spouse or former spouse incident to divorce. More specifically, section 1.1041–1T, Q & A 9, Temporary Income Tax Regs., 49 Fed.Reg. 34453 provides that:

Q–9. May transfers of property to third parties on behalf of a spouse (or former spouse) qualify under section 1041?

A–9. Yes. There are three situations in which a transfer of property to a third party on behalf of a spouse (or former spouse) will qualify under section 1041, provided all other requirements of the section are satisfied. The first situation is where the transfer to the third party is required by a divorce or separation instrument. The second situation is where the transfer to the third party is pursuant to the written request of the other spouse (or former spouse). The third situation is where the transferor receives from the other spouse (or former spouse) a written consent or ratification of the transfer to the third party. * * * In the three situations described above, the transfer of property will be treated as made directly to the nontransferring spouse (or former spouse) and the nontransferring spouse will be treated as immediately transferring the property to the third party. The deemed transfer from the nontransferring spouse (or former spouse) to the third party is not a transaction that qualifies for nonrecognition of gain under section 1041.

Petitioner contends that Q & A 9 encompasses Corporation's redemption of her stock, and, accordingly, the redemption qualifies under section 1041 as a transfer that is nontaxable to her. We disagree; petitioner's transfer of her stock to Corporation was outside the provisions of Q & A 9 because the transfer was not on behalf of Blatt. To illustrate the operation of Q & A 9, assume that H owes a debt to a bank, and W, as part of a divorce settlement, transfers her unencumbered appreciated stock to the bank in discharge of H's debt. This transfer falls within the first “situation” described in Q & A 9; that is, the transfer is required by a divorce instrument and is made by W on behalf of H. Thus, under Q & A 9, the stock is deemed transferred from W to H, in a nonrecognition transaction under section 1041, and, contemporaneously therewith, the stock is deemed retransferred from H to the bank. Under Q & A 9, H receives a carryover basis in the stock on the deemed transfer from W, and realizes (and must recognize) gain on the retransfer equal to the difference between the amount of the discharged debt and H's carryover basis. The effect of Q & A 9 is that the appreciation in the stock at the time of W's transfer is preserved, and the tax consequences relating to the appreciation are shifted from W to H, on behalf of whose benefit W made the transfer to the bank.

As contrasted with the example above, the record in the instant case is devoid of evidence disproving respondent's determination that petitioner's transfer of her stock to Corporation was not on behalf of Blatt within the meaning of Q & A 9. The redemption, in form, was a transaction between petitioner and Corporation; she transferred her stock to Corporation in exchange for its appreciated value in cash.9 The term “on behalf of” means “in the interest of” or “as a representative of”, Webster's Ninth New Collegiate Dictionary (1990); the record does not indicate that petitioner was acting in the interest of Blatt or as a representative of Blatt at the time of the redemption. A transfer that satisfies an obligation or a liability of someone is a transfer on behalf of that person; 10 petitioner does not claim, and the record does not indicate, that the redemption satisfied any obligation of Blatt. In this respect, we note that Blatt did not personally guarantee the obligation of Corporation to redeem petitioner's stock.11

Petitioner relied mainly on Arnes v. United States, 981 F.2d 456 (9th Cir.1992), for her proposition that the redemption was a transfer on behalf of Blatt. For the reasons stated herein, we do not agree with Arnes and respectfully refuse to follow it.12 In Arnes, the taxpayer and her former husband owned jointly a corporation that operated a McDonald's franchise. Pursuant to the divorce decree, the corporation redeemed all the stock owned by the taxpayer for $450,000 of consideration, consisting of cash, relief of debt, and installment payments. The Court of Appeals stated that McDonald's Corporation required complete ownership of the franchise by the owner/operator, and had informed the taxpayer's former husband that there should be no joint ownership of the franchise after the divorce. Id. at 457. The Internal Revenue Service asserted that the $450,000 was taxable to the taxpayer.

In holding for the taxpayer, the Court of Appeals for the Ninth Circuit reasoned that, although the taxpayer transferred her stock directly to the franchisee corporation, the transfer was on behalf of her former husband within the meaning of Q & A 9. Id. at 458. In this regard, the court stated that the taxpayer's former husband (and not the corporation) was obligated to purchase the taxpayer's stock. In addition, the court stated that the taxpayer's former husband benefited from the redemption because he guaranteed the corporation's payments to her and was liable for those payments under State law. Id. at 458–459. Furthermore, the court noted that the trial court found that the transfer benefited the taxpayer's former husband because the transfer limited the taxpayer's future community property claims...

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