Est. of Kenneth W. Davis v. Commissioner, Docket No. 5703-69.

• Decision Date: 20 December 1971
• Docket Number: Docket No. 5703-69.
• Parties: Estate of Kenneth W. Davis, Deceased, Kenneth W. Davis, Jr., Independent Executor, and Estate of Alice B. Davis, Deceased, Kenneth W. Davis, Jr., Administrator with will annexed v. Commissioner.
• Court: U.S. Tax Court

30 T.C.M. (CCH) 1363 (1971)

T.C. Memo. 1971-318. Estate of Kenneth W. Davis, Deceased, Kenneth W. Davis, Jr., Independent Executor, and Estate of Alice B. Davis, Deceased, Kenneth W. Davis, Jr., Administrator with will annexed v. Commissioner.

Docket No. 5703-69.

United States Tax Court.

Filed December 20, 1971.

Whitfield J. Collins, Cantey, Hanger, Gooch, Cravens & Munn, 1800 1st Nat'l Bank Bldg., Fort Worth, Tex., and Allan Howeth, for the petitioner. Harold L. Cook, for the respondent.

Memorandum Opinion

DAWSON, Judge:

Respondent initially determined a deficiency in petitioner's Federal income tax for the year 1965 in the amount of $315,162.11. In his amended answer filed on March 22, 1971, respondent claimed an increased deficiency of $424,714.06, resulting in a total asserted deficiency of $739,876.17.

The issues presented for decision are: (1) Did the petitioner realize taxable income of any kind in 1965 resulting from the gift of corporate stocks to one of his sons and to two trusts for two other sons expressly conditioned on the payment of the requisite gift tax by the several donees? (2) If the petitioner-donor did, in fact, realize taxable income from the gift tax payment by the donees, what is the character of that income? (3) What basis, if any, in the gift tax income is the petitioner entitled to claim?

All of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.

Kenneth W. Davis and Alice Bond Davis (hereinafter sometimes referred to as Kenneth, Sr. and Alice) were husband and wife during the years 1960 to 1965. Alice B. Davis died on February 27, 1967, and Kenneth W. Davis died on August 29, 1968. The petitioner is their son, Kenneth W. Davis, Jr., who is the Administrator with Will Annexed of his mother's estate, and the Independent Executor of his father's estate. Any reference to petitioner hereinafter will include both Kenneth W. Davis, Alice B. Davis and their estates.

At the time the petition was filed in this proceeding the petitioner had his legal residence at Fort Worth, Texas.

Kenneth W. Davis and Alice B. Davis filed joint Federal income tax returns for 1964 and 1965 with the district director of internal revenue at Dallas, Texas. Additionally, Kenneth W. Davis and Alice B. Davis timely filed individual Federal gift tax returns in 1964 with the district director, each paying a gift tax of $690,659.11.

On December 20, 1941, Kenneth W. Davis and Alice B. Davis executed a trust instrument which established three irrevocable trusts for the benefit of their three sons, Kenneth W. Davis, Jr., Thomas Cullen Davis and William Seldon Davis. Into these trusts Kenneth, Sr., and Alice transferred 1,020 shares of Class A common capital stock and 1,830 shares of Class B common capital stock of Mid-Continent Supply Company in equal amounts to the three trusts. At the time of the filing of the petition herein the Kenneth W. Davis, Jr. Trust had been terminated pursuant to the 1941 trust instrument and the corpus of that trust turned over to the beneficiary, Kenneth W. Davis, Jr. The Thomas Cullen Davis Trust and the William Seldon Davis Trust were still in existence. Thus the gifts of corporate stock made by Kenneth, Sr., and Alice in 1964 were made to Kenneth W. Davis, Jr., as an individual and to the pre-existing trusts of the other two sons.

The first series of gift transfers made in 1964 by Kenneth, Sr., occurred as follows:

(1) On April 27, 1964, Kenneth W. Davis made a transfer of 180,000 shares of Cummins Sales & Service, Inc., stock (hereinafter referred to as Cummins) to the following persons or entities:

                                                   Number of
                                                    shares
                  Kenneth W. Davis, Jr. .........   60,000
                  Thomas Cullen Davis Trust .....   60,000
                  William Seldon Davis Trust ....   60,000
                                                   _______
                    Total .......................  180,000
                

(2) On April 30, 1964, Kenneth W. Davis made a transfer of 24,240 shares of Cummins Sales & Service, Inc., stock to the following persons or entities:

                                                    Number of
                                                     shares
                  Kenneth W. Davis, Jr. ...........   8,080
                  Thomas Cullen Davis Trust .......   8,080
                  William Seldon Davis Trust ......   8,080
                                                     ______
                    Total .........................  24,240
                

The 204,240 shares of Cummins Sales & Service, Inc., stock had a total fair market value of $1,405,171.20 as of April and/or May 1964 and Kenneth, Sr., had a basis in this stock of $13,124.05.

On the dates indicated, the following persons or entities issued their checks to Kenneth W. Davis:

                  -------------------------------------------------------------------------------
                      Date Check Cashed         Check Issued By                      Amount
                  -------------------------------------------------------------------------------
                        April 27, 1964    Kenneth W. Davis, Jr. ..............  $  412,800.00
                        April 30, 1964    Kenneth W. Davis, Jr. ..............      55,590.40
                        April 27, 1964    Thomas Cullen Davis Trust ..........     412,800.00
                        April 30, 1964    Thomas Cullen Davis Trust ..........      55,590.40
                        April 27, 1964    William Seldon Davis Trust .........     412,800.00
                        April 30, 1964    William Seldon Davis Trust .........      55,590.00
                                                                                _____________
                            Total ............................................  $1,405,171.20
                  -------------------------------------------------------------------------------
                

The Thomas Cullen Davis Trust and the William Seldon Davis Trust each owned 875 shares of common stock in Dorris Ballew, Inc. In early 1964 this corporation was being liquidated, and cash and other assets were being distributed to the shareholders. Cash of $546,875 was distributed to each of the two trusts on or just prior to April 2, 1964, and a deposit for this amount was made on April 2, 1964, to the checking account of the William Seldon Davis Trust at the First National Bank of Fort Worth and for the same amount on April 2, 1964, to the checking account of the Thomas Cullen Davis Trust at the First National Bank of Fort Worth. On or just prior to April 20, 1964, additional distributions of cash of $54,687.50 were made to both trusts, and on April 20, 1964, deposited to the same accounts. On or just prior to April 20, 1964, cash of $70,028.08 was received by both trusts, resulting from sale of certain equipment received from Dorris Ballew, Inc., and on April 20, 1964, deposited to the same accounts. These funds, deposited in the checking accounts of the two trusts, represented the source of funds used by the two trusts to write the checks dated April 27, 1964, and April 30, 1964. Long term capital gain resulting from the distributions from Dorris Ballew, Inc., was reported by each trust in its 1964 income tax return, Form 1041.

In a letter dated September 14, 1964, Kenneth W. Davis, Sr., informed Kenneth W. Davis, Jr., the Thomas Cullen Davis Trustee and the William Seldon Davis Trustee that the April and May stock transfer had erroneously been handled as sales rather than as gifts. Kenneth Sr. further stated that he intended the Cummins Sales & Service stock to be gifts to the donees subject to the donees' agreement to pay all gift taxes which accrue by virtue of the transactions. The three donees agreed to the terms of the gifts and Kenneth Sr. delivered personal promissory notes to the donees in the aggregate amount of $1,405,171.20 ($468,390.40 per donee) bearing interest at the rate of 4½% per annum. Kenneth Sr. subsequently redeemed all the promissory notes on April 15, 1965, paying the full principal with interest.

On August 6, 1964, Kenneth Sr. made additional gifts to the following persons or entities of certain shares of Class A Mid-Continent Supply Co. stock (hereinafter referred to as Mid-Continent):

                                                   Number of
                                                    shares
                  Kenneth W. Davis, Jr. .........   65,886
                  Thomas Cullen Davis Trust .....   65,886
                  William Seldon Davis Trust ....   65,886
                                                   _______
                    Total .......................  197,658
                

The 197,658 shares of Mid-Continent stock had a total fair market value of $4,546,134 and Kenneth Sr. had a basis in this stock of $107,545.72 on August 6, 1964.

The terms of the Mid-Continent stock transfer were identical to those of the Cummins stock transfer. Kenneth Sr. wrote to the three donees on August 6, 1964, setting forth the conditions:

The gift to each of you is made subject to the condition that you assume and agree to pay whatever gift tax is imposed by reason of the gift of the Mid-Continent Supply Co. shares to you. One third of such tax to be paid by Kenneth Davis, Jr. individually and one third each to be paid by the two trusts.

If you are willing to accept the gift of this Mid-Continent stock subject to this condition and assume and agree to pay all gift taxes which may accrue by virtue of this transaction, so indicate by signing and returning to me a copy of this letter. I will then cause to be delivered to you stock certificates, representing the shares of Mid-Continent Supply Co. Class A stock, which are the subject of this gift.

It is further understood by your acceptance of this agreement that you will undertake to file the gift tax returns which may be due by reason of such gift and pay the tax which may be shown thereon and in addition to pay any additional gift tax which might therefore be assessed by reason of this gift, all such payments to be made proportionately by each of you.

The three donees signed Kenneth Sr.'s letter as requested and the stock was transferred to the donees.

Pursuant to their agreements in the August 6, 1964, and September 14, 1964, letters, the son and the...