Fehrs v. United States

• Decision Date: 16 April 1980
• Docket Number: No. 118-72,119-72.,118-72
• Citation: 620 F.2d 255
• Parties: Edward J. FEHRS v. The UNITED STATES. Violette E. FEHRS v. The UNITED STATES.
• Court: U.S. Claims Court

620 F.2d 255

Edward J. FEHRS v. The UNITED STATES.

Violette E. FEHRS v. The UNITED STATES.

Nos. 118-72, 119-72.

United States Court of Claims.

April 16, 1980.

William A. Cromartie, Chicago, Ill., attorney of record, for plaintiffs. Michael M. Conway and Hopkins, Sutter, Mulroy, Davis & Cromartie, Chicago, Ill., of counsel.

Jay G. Philpott, Jr., Washington, D. C., with whom was Asst. Atty. Gen. M. Carr Ferguson, Washington, D. C., for defendant; Theodore D. Peyser, Jr., Washington, D. C., of counsel.

Before NICHOLS, KASHIWA and SMITH, Judges.

OPINION

PER CURIAM:

This case comes before the court on defendant's motion, filed January 30, 1980, requesting that the court adopt, as the basis for its judgment in this case, the recommended decision of Trial Judge John P. Wiese, filed November 27, 1979, pursuant to Rule 134(h), no intention to except or exceptions thereto having been filed by the parties and the time for so filing pursuant to the Rules of the court having expired. Upon consideration thereof, without oral argument, since the court agrees with the trial judge's recommended decision, as hereinafter set forth,^* it hereby grants defendant's said motion and affirms and adopts the recommended decision as the basis for its judgment in this case. Therefore, it is concluded that, in accordance with the trial judge's recommended decision, plaintiffs are entitled to a partial refund of gift taxes paid, together with interest as provided by law and judgment is entered for plaintiffs to that extent with the amount of their recovery to be determined through further proceedings pursuant to Rule 131(c). In all other respects plaintiffs' petitions are dismissed.

OPINION OF TRIAL JUDGE^**

WIESE, Trial Judge: In an earlier tax refund suit involving the present plaintiffs, this court held that the transfer of all of their shares of Fehrs Rental Corporation (a "brother" corporation) to a newly-created Fehrs Finance Company (a "sister" corporation 100 percent owned by the plaintiffs' daughters) in return for perpetual annuities of a fixed yearly value resulted in a redemption that qualified as an "exchange" transaction pursuant to sections 302(b)(3) and 302(c)(2) of the Internal Revenue Code.¹ Accordingly, the plaintiffs were deemed entitled to treat as capital gain, rather than as ordinary income, the amounts received pursuant to their annuities. Fehrs v. United States, 214 Ct.Cl. 74, 556 F.2d 1019 (1977).

In this consolidated action the same background facts are met once again. The question now, however, is whether the plaintiffs' transfer of their shares in return for the annuities represented an exchange of economic equivalents or was, as the Government contends, in part a gift by them to the shareholders of the Fehrs Finance Company to the extent of a claimed excess in the market value of the transferred shares. On the basis of the accompanying findings of fact and for the reasons discussed in this opinion, the court concludes that the transaction was in part a gift.

I. Background Facts

Plaintiffs, husband and wife, were the owners of all 1,380 outstanding shares of the Fehrs Rental Corporation (Rental), a company engaged primarily in the renting, leasing, selling and repairing of heavy road and industrial equipment. On December 21, 1964, plaintiff, Edward J. Fehrs (since deceased²), acting on the basis of tax planning advice given by counsel, implemented the first of a series of steps whose two-fold objectives were: (i) to allow Mr. Fehrs to retire upon a satisfactory income while leaving Rental "in the family" and (ii) to create adequate working capital for a soon-to-be-created Fehrs Finance Company (Finance).

Thus, on the indicated date, December 21, 1964, Mr. Fehrs gave 130 shares of Rental stock to his wife and children; subsequently, on January 11, 1965, he gave them an additional 111 shares. As a result of these initial steps, Mr. Fehrs was left owning 982 shares of Rental stock, his wife's holdings had been increased to 177 shares, and 221 shares were now owned by his two daughters and their respective families. In his United States gift tax return for the calendar years 1964 and 1965, Mr. Fehrs valued his gifts of stock at $600 per share.

Approximately 2 months later, February 28, 1965, the plaintiffs' daughters formed the Fehrs Finance Company for the purpose of purchasing the commercial paper generated from the sales of construction equipment by Rental. They, the daughters, were the sole shareholders of Fehrs Finance Company. The following day, March 1, 1965, the final steps of the plan were carried out: a transfer to Finance by Mr. and Mrs. Fehrs of all their remaining shares of Rental in return for lifetime annuities and a reacquisition, by Rental, of nearly all of its stock from Finance in return for cash and an unsecured promissory note.

Described in greater detail, the March 1, 1965, transfers involved the following: In return for the remaining 982 shares that it acquired from Mr. Fehrs, Finance promised to pay him $62,000 per year in equal quarterly installments beginning January 1, 1966, and continuing for the remainder of his life; in return for the 177 shares it acquired from Mrs. Fehrs, Finance promised to pay her $8,000 per year — again, in equal quarterly installments beginning January 1, 1966, and also continuing for the remainder of her life.

The two annuity agreements were substantially alike. They provided that, upon default in any payment that continued for 30 days, the entire commuted value of the annuity would be immediately due and payable, such commuted value to be computed in accordance with standard actuarial tables and values taking into account the age of the annuitant as of the date of the default. The agreements permitted the annuitants to waive any default; they also provided that neither the agreements nor the payments to be made under them could be negotiated, assigned or anticipated by the annuitants and that Finance would have no obligation to recognize or give effect to any attempted transfer of such sort.

On its books and records, and in its corporate income tax return for the taxable year ending November 30, 1965, Finance recorded its liability to Mr. and Mrs. Fehrs, as of March 1, 1965, as being in the amount of $725,000 (Mr. Fehrs had been born on December 5, 1894 and Mrs. Fehrs was born on July 9, 1900. Hence, their respective ages as of March 1, 1965, were 70 years and 64 years).

As to the other transfer of March 1, 1965 — that between Finance and Rental — this was carried out pursuant to a formalized redemption agreement under the terms of which Finance transferred to Rental the 1,159 shares of Rental stock then held by Finance, i. e., the same shares which Finance had received from Mr. and Mrs. Fehrs. In exchange for this stock, Rental transferred to Finance $100,000 in cash and an unsecured negotiable promissory note of Rental in the principal amount of $625,000. The note provided for annual payments of principal and interest. Each principal payment was set at 5 percent of the original principal or 25 percent of Rental's annual net income after Federal income taxes, whichever amount was greater; the interest rate was set at 7 percent per annum. Annual payments were to be made on January 2 of each year, commencing with 1966.

Viewed in terms of their net result, the series of transfers described above resulted in the complete divestiture of the plaintiffs' ownership of Rental stock, a significant reduction in the outstanding amount of that stock and control of the shares that did remain outstanding being exclusively in the hands of plaintiffs' children. At the same time, the newly-established Finance company was provided with working capital and it too remained within the exclusive control of the plaintiffs' daughters.

Despite the careful planning that we may assume this realignment of ownership interests to have been based upon, the manner in which the transactions were subsequently reported for tax purposes did not meet with the approval of the Commissioner of Internal Revenue. Finance, for example, for its taxable year ending November 30, 1965, had reported neither a gain nor a loss with respect to the proceeds realized from its sale of the Rental stock. However, in the Commissioner's view, that transaction was seen as giving rise to short-term capital gain that was taxable, in 1965, to the extent of the cash that had then been received, namely, $100,000. Similarly, in regard to the plaintiffs (Mr. and Mrs. Fehrs), the Commissioner took issue with the declared amount of their gift tax liability for the year 1965 and, as a separate and later matter, with their treatment of the annuity payments as long-term capital gain rather than as ordinary income.

Deficiency assessments followed and then, ultimately, litigation. Finance brought suit in the Tax Court and the decision there went in the Government's favor. The gist of that court's decision (of which more shall be said later) was that the sum of the several transfers (as heretofore described) was governed, in the first instance, by section 304 of the Internal Revenue Code (pertaining to redemptions of stock carried out through affiliated corporations) and that, pursuant to that code section, the Rental stock (in Finance's hands) constituted a "contribution to its capital." Further, on the particular facts of the case, that stock was deemed to have a zero basis; hence, Finance was held to have realized a gain upon its subsequent disposition of the stock to Rental.

With regard to the deficiency determinations asserted against Mr. and Mrs. Fehrs, these matters became the subject of separate actions commenced in this court. As mentioned at the outset, plaintiffs' position on the treatment of their annuity income as capital gain was subsequently sustained by this court. Left standing, pending the final resolution of that suit, is the question now before the court: the correctness of the...