Eisenberg v. C.I.R., Docket No. 97-4331

• Decision Date: 18 August 1998
• Docket Number: Docket No. 97-4331
• Parties: -5757 Irene EISENBERG, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Second Circuit

Page 50

155 F.3d 50

82 A.F.T.R.2d 98-5757

Irene EISENBERG, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Docket No. 97-4331.

United States Court of Appeals, Second Circuit.

Argued May 19, 1998.

Decided Aug. 18, 1998.

Martin A. Stoll, New York, New York, for Petitioner-Appellant.

David I. Pincus, Tax Division, Department of Justice, Washington D.C., (Loretta C. Argrett, Assistant Att. Gen., Tamara W. Ashford, Attorney), for Respondent-Appellee.

Before: WINTER, Chief Judge, JACOBS, Circuit Judge, and CARMAN, Chief Judge. ¹

CARMAN, Chief Judge:

BACKGROUND ²

Appellant, Irene Eisenberg, owned all 1,000 shares of the issued and outstanding In 1991, 1992 and 1993 appellant gifted shares of the Corporation to her son and two grandchildren. When valuing the stock for gift tax purposes, appellant reduced the value of the stock by the full amount of the capital gains tax ⁴ that she would have incurred had the Corporation liquidated, or sold or distributed its fixed asset. Appellant computed the potential capital gains tax by assuming hypothetical annual sales of the property, and the parties stipulated to the amount of capital gains that would have been realized from the hypothetical sales. ⁵

common stock of Avenue N Realty Corporation (the Corporation), its only class of stock. The Corporation, a C corporation ³ for tax purposes during 1991, 1992 and 1993, the years in issue, was organized under the laws of the State of New York. The Corporation's only fixed asset was a commercial building located at 4901-4911 Avenue N, Brooklyn, New York, which it owned and leased to third parties. The Corporation's only active trade or business was the rental of the building. The Corporation did not have plans to liquidate, or to sell or distribute the building.

On July 18, 1995, appellant received a notice of deficiency from the Commissioner identifying deficiencies in gift tax of $20,157.99, $38,257.15 and $3,319.55 for the years 1991, 1992 and 1993, respectively. The deficiencies were based solely on the Commissioner's determination that the values reported on appellant's tax return should not have included reductions in the stock's value to account for potential capital gains tax liabilities. On September 5, 1995, appellant filed a petition in the United States Tax Court contesting the Commissioner's determination she was not entitled on her federal tax returns to reduce the fair market value of the gifted stock by the amount of capital gains tax the Corporation would have incurred if it were to liquidate, or to distribute or sell its commercial building.

The parties filed cross motions for summary judgment in August and September, 1996. The parties agreed that the net-asset-value method ⁶ was appropriate for valuing the gifted stock in this case, stipulated to a 25% minority discount, ⁷ agreed on the fair market value of the property and agreed on the valuation of the shares of stock as reported on petitioner's gift tax returns. The only issue between the parties, therefore, was the valuation reduction for the capital gains tax liabilities. ⁸

On October 27, 1997, the Tax Court granted appellee's motion for summary judgment and denied appellant's motion, holding appellant On October 31, 1997, the Tax Court entered an order and decision finding deficiencies in gift tax due from appellant for the taxable years 1991, 1992 and 1993 in the amounts of $20,157.99, $38,257.15 and $3,319.55, respectively. Appellant challenges this order and decision.

was not entitled on her federal tax returns to reduce the fair market value of the shares of stock she gifted to her relatives by the amount of capital gains tax the Corporation would incur if it were to liquidate, or to sell or distribute its sole asset. The Tax Court held firmly-established precedent dictated no reduction in the value of closely held stock may be taken to reflect the potential capital gains tax liability where evidence fails to establish a liquidation or sale of the corporation or its assets is likely to occur, reasoning the tax liability is purely speculative. The Tax Court also found there was no showing that a hypothetical buyer would purchase the Corporation with a view toward liquidating the Corporation or selling its asset, such that the potential tax liability would be considered a material or significant concern.

This Court must decide whether, for gift tax purposes, appellant is entitled to reduce the fair market value of her C corporation stock to take into account potential capital gains tax liabilities that may be incurred if the Corporation liquidated, or distributed or sold its sole asset where no liquidation, sale or distribution was contemplated as of the stock transfer dates.

DISCUSSION

We review de novo a grant of summary judgment. Summary judgment is properly granted where no genuine issue of material fact exists and the movant is entitled to judgment as a matter of law. See, e.g., Briones v. Runyon, 101 F.3d 287, 291 (2d Cir.1996). This Court has jurisdiction pursuant to 26 U.S.C. § 7482(a)(1) (1994) and 28 U.S.C. § 2106 (1994).

Section 2501 of the Internal Revenue Code imposes a gift tax "on the transfer of property by gift during [the] calendar year by any individual." 26 U.S.C. § 2501(a)(1) (1988). Section 2512(a), which addresses the valuation of gifts, states, "[i]f the gift is made in property, the value thereof at the date of the gift shall be considered the amount of the gift." 26 U.S.C. § 2512(a) (1988). In interpreting this provision, section 25.2512-1 of the Treasury Regulations on gift tax provides, "[t]he value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts." 26 C.F.R. § 25.2512-1 (1992).

The value of a gift on which a tax is paid is generally determined by ascertaining the fair market value of the property at the time the gift is transferred. Where, as here, the gift is stock, its value for gift tax purposes is the fair market value of the stock on the date of the transfer, and "[a]ll relevant facts and elements of value as of the time of the gift shall be considered." 26 C.F.R. § 25.2512-1 (1992). For publicly traded stock, valuation can generally be based on market selling prices. See 26 C.F.R. § 25.2512-2(b) (1992). For closely held corporations, such as Avenue N, for which there is no public trading market, valuation of stock is based on of a variety of factors. ⁹ In this case, the parties stipulated to the fair market value of the property and the shares of stock on each of the transfer dates. See supra, note 5.

Valuation Reduction for Unrealized Capital Gains

The Tax Court has consistently held, in valuing closely held stock using the net asset In the past, the denial of a reduction for potential capital gains tax liability was based, in part, on the possibility that the taxes could be avoided by liquidating the corporation. The law in this area, embodied in the Internal Revenue Code of 1954, was loosely based on the Supreme Court decision in General Utilities & Operating Co. v. Helvering, 296 U.S. 200, 56 S.Ct. 185, 80 L.Ed. 154 (1935), which held that a corporation did not recognize gain on a dividend distribution of appreciated property. Id. at 206, 56 S.Ct. 185. The General Utilities doctrine operated as an exception to the double taxation that applied to C corporations and their shareholders, i.e., taxation once at the corporate level and a second time at the shareholder level upon the distribution of corporate earnings to shareholders. See United States v. Cumberland Pub. Serv. Co., 338 U.S. 451, 452 n. 2, 455, 70 S.Ct. 280, 94 L.Ed. 251 (1950) (finding "[n]o gain or loss is realized by a corporation from the mere distribution of its assets in kind in partial or complete liquidation, however they may have appreciated or depreciated in value since their acquisition" and finding "a corporation may liquidate or dissolve without subjecting itself to the corporate gains tax, even though a primary motive is to avoid the burden of corporate taxation"). By employing the General Utilities doctrine, a corporation could liquidate and distribute appreciated or depreciated property to its shareholders without recognizing built-in gain or loss, and thus could circumvent double taxation. See 26 U.S.C. §§ 311, 336, 337 (1958). ¹⁰

value method, that a special reduction of the value of the stock for potential capital gains tax liabilities at the corporate level is unwarranted where there is no evidence that a tax-triggering event, such as a liquidation or sale of the corporation's assets, is likely to occur. See, e.g., Ward v. Commissioner, 87 T.C. 78, 103-04, 1986 WL 22156 (1986) (finding when liquidation only speculative, costs of selling real estate and taxes that would be recognized upon liquidation not taken into account); Estate of Piper v. Commissioner, 72 T.C. 1062, 1087, 1979 WL 3788 (1979) (determining no discount for potential capital gains tax at corporate level where there is no evidence a liquidation of the investment companies was planned or could not have been accomplished without incurring capital gains taxes at corporate level); Estate of Cruikshank v. Commissioner, 9 T.C. 162, 165, 1947 WL 28 (1947) (finding tax on appreciation to be "hypothetical and supposititious" because there was no demonstrated intent to liquidate assets, and in any case, liquidation could occur without taxing the corporation).

Tax Reform Act of 1986

These tax-favorable options ended with the enactment of the Tax Reform Act of 1986(TRA), Pub.L. No. 99-514, § 631, 100 Stat. 2085, 2269 (codified as amended in scattered sections of 26 U.S.C.), which abrogated the General Utilities doctrine for liquidations after 1986 and rejected tax principles that were more than half a century old. ¹¹ The The TRA amended 26 U.S.C. §§...