Hirst v. Comm'r of Internal Revenue

• Decision Date: 09 December 1974
• Docket Number: Docket No. 2865-72.
• Citation: 63 T.C. 307
• Parties: EDNA BENNETT HIRST, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

63 T.C. 307

EDNA BENNETT HIRST, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 2865-72.

United States Tax Court

Filed December 9, 1974.

Michael Mulroney and John P. Lipscomb, for the petitioner.

Robert E. Dallman, for the respondent.

Transaction in which donee agreed to pay donor's gift taxes held not to result in realization of taxable income by donor measured by the excess of such gift taxes over donor's basis in the donated property. Richard H. Turner, 49 T.C. 356,affirmed410 F.2d 752 (C.A. 6), followed; Joseph W. Johnson, Jr. 59 T.C. 791,affirmed495 F.2d 1079 (C.A. 6), certiorari denied419 U.S. 1040, distinguished.

The Commissioner determined a deficiency of $16,502.04 in petitioner's income tax for the calendar year 1968. The principal issue is whether petitioner realized gain by transferring property subject to the requirement that the recipients pay the State and Federal gift taxes arising from the transfers.

FINDINGS OF FACT

Most of the facts have been stipulated. The stipulation, supplemental stipulation, and accompanying exhibits are incorporated herein by this reference. Petitioner filed her Federal income tax return for the calendar year 1968 with the district director of internal revenue at Richmond, Va., and resided in Alexandria, Va., at the time she filed her petition herein. She reported her income according to the cash receipts and disbursement method of accounting.

Petitioner is an 80-year-old widow. In 1967 she had only one living child, her son Omer Hirst, who was married and had three children, Thomson M. Hirst, Deborah H. Nager, and Edna Robin Hirst. At that time petitioner owned the house in which she lived, a one-half interest in a six-room house being used as an office building, and one-half interest in 3 tracts of undeveloped land. The remaining interests in the ‘office building’ and tracts were in her husband's estate. Petitioner did not have any other substantial assets, except for about $25,000 on deposit in savings accounts.

Not only were the 3 tracts unproductive of any income but they subjected petitioner to real estate tax liabilities each year. To eliminate this burden on her limited liquid assets and to benefit the natural objects of her bounty, petitioner decided to give her interest in these tracts to her son and his family. Because such gifts would require the payment of substantial gift taxes, far in excess of petitioner's liquid assets, she and her son orally agreed that he would pay the resulting gift taxes. On April 11, 1967, petitioner transferred her interest in 1 tract to Omer and his wife Ann, and her interest in another to two of the grandchildren and to her son as trustee for the third grandchild, a minor. On July 19, 1967, she transferred her interest in the third tract to two of the grandchildren and to the trust for the minor grandchild. All of the transfers were subject to the condition that Omer and Ann Hirst pay the applicable gift taxes. None of the tracts was subject to any mortgage, lien, or other encumbrance.

In April 1968, petitioner filed a United States gift tax return listing the three parcels with adjusted basis and appraised value for each as follows:

+--------------------------------------+
                ¦       ¦Donor's adjusted  ¦           ¦
                +-------+------------------+-----------¦
                ¦       ¦basis             ¦Value      ¦
                +-------+------------------+-----------¦
                ¦       ¦                  ¦           ¦
                +-------+------------------+-----------¦
                ¦Tract 1¦$4,654            ¦$291,832.50¦
                +-------+------------------+-----------¦
                ¦Tract 2¦3,723             ¦119,404.50 ¦
                +-------+------------------+-----------¦
                ¦Tract 3¦0                 ¦33,351.50  ¦
                +--------------------------------------+
                

The total Federal gift tax liability arising from these transfers was $68,277. In computing this amount the total amount of the taxable gifts was reduced by the amount of the State and Federal gift taxes paid by the donees. ¹ Ann and Omer Hirst paid the Federal gift tax by check dated April 8, 1968, and made payable to the Internal Revenue Service.

The Virginia gift tax was paid with three checks, one dated April 22, 1968, for $15,440, one dated July 15, 1968, for $253, and one dated June 6, 1969, for $1,499.55, all drawn by Omer Hirst. The checks were mailed on or about their respective dates and in each instance received shortly thereafter by the Virginia Department of Taxation, the payee. A computational error in the amount of the first check made the second check necessary, while the third was tendered when petitioner decided not to contest the refusal of the Virginia authorities to agree that the value of the gifts should be reduced by the amount of the gift taxes paid by the donees. The first two checks were not presented by the payee for payment until some time in February 1969, at which time the drawee bank refused to honor them because of their stale dates, although sufficient funds were available. After learning that the checks had been dishonored, Omer Hirst instructed the bank to honor them when presented again. Soon thereafter the checks were presented and paid.

On her 1968 income tax return petitioner did not report these transfers. In his deficiency notice to petitioner the Commissioner determined that:

As the result of the gift of your one-half interest in three tracts of real estate with a fair market value of $444,588.50, subject to the condition that the recipients would pay both the Federal and State gift tax, you have received taxable income as shown below :

+-------------------------------------------------------------+
                ¦Federal gift tax                                  ¦$68,277.00¦
                +--------------------------------------------------+----------¦
                ¦Virginia gift tax                                 ¦17,192.55 ¦
                +--------------------------------------------------+----------¦
                ¦Total gift tax paid                               ¦85,469.55 ¦
                +--------------------------------------------------+----------¦
                ¦Less adjusted basis of 1/2 interest in real estate¦$8,377.00 ¦
                +--------------------------------------------------+----------¦
                ¦Realized gain                                     ¦77,092.55 ¦
                +--------------------------------------------------+----------¦
                ¦Recognized gain-50%                               ¦38,546.28 ¦
                +-------------------------------------------------------------+
                

He also made other adjustments which petitioner concedes are correct except to the extent that they reflect automatic changes attributable to the inclusion of the $38,546.28 long-term capital gain in her taxable income.

OPINION

RAUM, Judge:

Whether a donor realizes taxable income upon payment of the resulting gift taxes by the donee or out of the transferred assets is a matter that has been the subject of a tortuous course of decision, characterized by subtleties and fine distinctions. If we accept the decisions in this field, it is our judgment that petitioner did not realize any taxable income as a consequence of the payment of the gift taxes by her son and daughter-in-law.

At the outset, there can be no reasonable dispute that liability for the gift tax is placed by statute primarily upon the donor, section 2502(d) of the 1954 Code, and that payment of the tax by the donee must be regarded as discharging that liability of the donor. Moreover, the discharge of a solvent taxpayer's liability is ordinarily regarded as conferring a benefit upon him which may furnish the basis for taking it into account in the computation of taxable income. Cf. Douglas v. Willcuts, 296 U.S. 1. Bearing these considerations in mind we proceed to consider the development of the case law in this area.

Our earliest concern with this general problem appears in cases involving gifts to trusts. Typically, these cases dealt with arrangements whereby trust income was used to pay the gift tax, and it was held that such trust income that was required to be used for that purpose or was available for such use was taxable to the donor as ordinary income. Where the income was distributable directly to the donor to enable him to pay the gift tax, the result appears to have been based on the theory that he had ‘reserved’ such income from the gift or that he had made himself a ‘preferred beneficiary’ of the trust. That, in substance, was the holding of Estate of A. E. Staley, Sr., 47 B.T.A. 260 (1942), affirmed 136 F.2d 368 (C.A. 5), certiorari denied 320 U.S. 786, which also rejected the taxpayer's contention that the transfers there involved were part-gift and part-sale, thereby precluding the treatment of the amount paid to the donor as a nontaxable return of capital.

Staley was followed by a series of cases beginning with Estate of Craig R. Sheaffer, 37 T.C. 99, affirmed 313 F.2d 738 (C.A. 8), certiorari denied 375 U.S. 818, in which the trustees paid the gift tax out of income of the transferred assets, and the donor was held chargeable therewith under section 677 of the Code as income for the benefit of the grantor.² The Court emphasized the fact that the primary liability for the gift tax was that of the donor and that the trustee was ‘clearly satisfying * * * (that) liability, ‘ 37 T.C. at 105.

However, the matter of the use of trust income to pay the gift tax did not end with Staley and Sheaffer. In Estate of Annette S. Morgan, 37 T.C. 981, affirmed 316 F.2d 238 (C.A. 6), certiorari denied 375 U.S. 825, the trustees borrowed the money for the gift tax and repaid the loan out of trust income of subsequent years. The Court held that since the donor's gift tax liability had already been discharged in the year the loan was taken out, the repayment of the loan in later years did not confer any benefit upon the donor, with the consequence that section 677 was inapplicable and the donor realized no taxable income of any kind in such later years. Apparently, no effort was made to charge the donor with income on some other theory in the earlier year when the gift tax liability...