Hirst v. C. I. R.

• Decision Date: 04 January 1978
• Docket Number: No. 75-1543,75-1543
• Citation: 572 F.2d 427
• Parties: 78-1 USTC P 9166 Edna Bennett HIRST, Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Appellant.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 427

572 F.2d 427

78-1 USTC P 9166

Edna Bennett HIRST, Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Appellant.

No. 75-1543.

United States Court of Appeals Fourth Circuit.

Argued Nov. 9, 1976.

Decided Jan. 4, 1978.

Jonathan S. Cohen, Atty., Tax Division, Dept. of Justice, Washington, D.C. (Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, Louis A. Bradbury, Attys., Tax Division, Dept. of Justice, Washington, D.C., on brief), for appellant.

Michael Mulroney, Washington, D.C. (John P. Lipscomb, Lee, Toomey & Kent, Washington, D.C., on brief), for appellee.

Before HAYNSWORTH, Chief Judge, BRYAN, Senior Circuit Judge, and WINTER, CRAVEN, ^* BUTZNER, RUSSELL, WIDENER and HALL, Circuit Judges, sitting en banc.

PER CURIAM:

After a hearing by a panel of this court, Judge Roszel C. Thomsen, United States District Judge for the District of Maryland, sitting by designation, prepared an opinion for a majority of the panel reaching a conclusion that the judgment of the Tax Court should be reversed. Senior Judge Albert V. Bryan prepared a dissenting opinion. After these opinions had been circulated but before they had been filed, a majority of the judges in regular active service voted for rehearing en banc.

For the reasons stated in the dissenting opinion of Senior Judge Bryan prepared for the panel (see, infra, p. 431), as supplemented in an opinion prepared by Chief Judge Haynsworth for a majority of the en banc court, Chief Judge Haynsworth, Senior Circuit Judge Bryan, and Circuit Judges Russell, Widener and Hall join in an affirmance of the decision of the Tax Court.

Circuit Judges Winter and Butzner dissent for the reasons stated in the opinion of Judge Thomsen.

HAYNSWORTH, Circuit Judge:

The primary issue in this case is whether a parent is liable for the payment of income taxes as the result of transactions in which she gave to her son, his wife and their children three tracts of land upon the son's agreement to pay any applicable state and federal gift taxes. We affirm the decision of the Tax Court, Edna Bennett Hirst, 63 T.C. 307 (1974), and hold that, under the circumstances of these gifts, Hirst did not realize any taxable income.

The facts are accurately and adequately stated in Judge Thomsen's opinion (see page 434, infra).

Any analysis of Mrs. Hirst's income tax liability as a result of these transactions must focus on two cases, Turner v. Commissioner of Internal Revenue, 49 T.C. 356 (1968), aff'd per curiam, 410 F.2d 752 (6th Cir. 1969); and Johnson v. C. I. R., 495 F.2d 1079 (6th Cir. 1974) aff'd 59 T.C. 791 (1973); cert. den. 419 U.S. 1040, 95 S.Ct. 527, 42 L.Ed.2d 317. Basically, the government argues that Johnson is controlling, while the taxpayer contends Turner is still viable precedent. In our view, Johnson is distinguishable. Turner is the basis of our decision, as it was the basis of decision in the Tax Court.

In Turner, the donor made nine separate gifts of low basis securities, three to her children outright, and six to trusts for the benefit of her grandchildren. Each of these transfers was made on the condition that the recipient pay the resulting gift tax liability. The three individual donees contributed their respective shares of the gift taxes either from available cash or the sale of some of the donated securities. The six trust donees contributed their respective shares primarily from the sale of some of the donated securities, supplemented in two cases by loans, and in four by comparatively small amounts of current income. Aside from these small amounts of current income, there was apparently no basis for invoking Internal Revenue Code sections 671 and 677 which deal only with income The taxpayer in Johnson ⁴ owned securities the fair market value of which exceeded $500,000. His basis was only $10,812.50. Two days prior to his establishment of an irrevocable trust for his children's benefit, Johnson obtained $200,000 from a bank on a thirty-day note "without personal liability." The note was secured by stock. When Johnson created the trust, he transferred to it all of his interest in the stock. Apparently one month later, the trustees replaced Johnson's note with their own, ⁵ secured by the same shares of stock.

from trusts. ¹ The Commissioner contended that each transfer was part sale and part gift and that the excess of the gift tax paid by each donee over the basis of the securities transferred to such donee constituted capital gain chargeable to the donor. In the Tax Court, and again on appeal to the Sixth Circuit, the Commissioner conceded that the transfers in trust were not sales. Thus, the principal problem confronted by the courts was whether the transfers to the three individuals could be classified as part gifts, part sales, resulting in the realization of capital gain, the same issue presented by the Hirst litigation. ² The Tax Court in Turner regarded the transaction as a "net gift" ³ in the amount of the value of the shares less the gift tax, a transaction which the court held had no income tax consequences to the donor. 49 T.C. at 363. The Sixth Circuit affirmed. 410 F.2d 752.

As a result of these transactions, the donors had $200,000 in cash, and the trust owned stock worth more than $500,000 but encumbered by a $200,000 note. The next year, Johnson paid approximately $150,000 in gift taxes.

The Tax Court in Johnson found the transactions were part of a plan of the donor to make the gift to the trust and to attempt to realize a substantial portion of the appreciated value of the stock for the donor without tax liability. It found that the donor retained the full amount of the loan obtained by him and used the proceeds for his own personal purposes. The Court held that the transfers were part gift, part sale, that the excess of the fair market value of the stock over the amount of the loan was a gift subject to gift taxes, that portion subject to the loan was a sale on which the taxpayer realized a capital gain to the extent the loan exceeded his basis in the stock.

The Tax Court's reasons for distinguishing Turner included the fact that the transfer in Johnson was not conditioned upon the donee's payment of the gift taxes, the donor reserved no interest in the trust corpus, the amount of the loans significantly exceeded the gift tax paid, and Johnson's transactions were part sale and part gift.

The Tax Court's judgment, but not its reasoning, was affirmed by the Sixth Circuit.

It found the substance of the transactions to be a gift of stock worth $500,000 in exchange for $200,000, $150,000 of which was used to pay the gift taxes of the donor. The court said its result could be reached by any of several routes. First, if viewed under section 61 of the Code the $200,000 was "income from whatever source derived;" the use to which $150,000 of that amount was put was of no moment. Secondly, under § 2502(d) the gift tax is the donor's primary obligation ⁶ and under Old Colony Trust Co. v. Commissioner of Internal Revenue, 279 U.S. 716, 729, 49 S.Ct. 499, 504, 73 L.Ed. 918 (1929) "(t)he discharge by a third person of an obligation to him is equivalent to receipt by the person taxed" so that here, effectively, the donee's payment of the donor's gift tax was income to the donor. Thirdly, under Crane v. Commissioner of Internal Revenue, 331 U.S. 1, 67 S.Ct. 1047, 91 L.Ed. 1301 (1947), the donor shed his $200,000 debt, and realized income in that amount, particularly because Johnson received cash without any liability for repayment of the notes from his own assets.

The Sixth Circuit rejected as merely conclusory the appellation "part sale and part gift" employed by the Tax Court. Also rejected were the features by which the Tax Court distinguished Turner, because those lost their force to the extent the loan proceeds were ultimately used to pay the gift tax. The appellate opinion in Johnson stated that Turner has no precedential value beyond its peculiar fact situation.

We do not quarrel with the oft-stated proposition that the substance of a transaction rather than its form controls an individual's tax liability. ⁷ Indeed, we believe that we adhere to that premise. In the present case, the Tax Court found that a gift was made. ⁸ Surely this finding is not clearly erroneous in the familial and non-commercial context of the transfer of this land.

The predominant circumstance here is that this taxpayer did not intend to sell anything; she intended only to give her property to her progeny. She did not receive anything for herself; there was no economic gain of any kind accruing to her, except release from the normal tax burden of an owner of real estate. ⁹

Unlike Turner or the present case, Johnson involved a pre-transfer draw down of a portion of the appreciated value of the asset transferred, by the donor's borrowing against it immediately prior to its transfer to the donees. The gift to the trust was then made subject to the trust's paying the note. While the donor himself actually paid the gift tax, none of the $200,000 he borrowed As to the argument that the donee's payment of the gift tax was a discharge of the donor's debt, in effect producing income for her, it is no doubt generally true that another's discharge of an obligation is productive of income, but that is not universally the case. It depends upon the relationship between the parties and the existence of other obligations. For example, where a son has borrowed from a bank and his father pays off the son's loan without discharging any obligation to the son, the payment is not taxable income to the son, but a gift. The circumstances of the transaction determine the tax consequences. The predominant circumstances here dispel the notion of any gain accruing to Mrs. Hirst.

was committed to payment of the tax. Thus as a result of his borrowing, and of the donee's repayment of the loan, $200,000 was put in the donor's pocket. Although we may agree with the result in Johnson, that...