Lazarus v. C. I. R.

• Decision Date: 02 April 1975
• Docket Number: Nos. 73-2737,s. 73-2737
• Citation: 513 F.2d 824
• Parties: 75-1 USTC P 9387 Simon M. LAZARUS, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. Mina LAZARUS, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. Simon M. and Mina LAZARUS, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. to 73-2739.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 824

513 F.2d 824

75-1 USTC P 9387

Simon M. LAZARUS, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Mina LAZARUS, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Simon M. and Mina LAZARUS, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Nos. 73-2737 to 73-2739.

United States Court of Appeals Ninth Circuit.

April 2, 1975.

Ben Margolis (argued), Los Angeles, Cal., for petitioners-appellants.

Donald Olson (argued), I.R.S., Washington, D. C., for respondent-appellee.

OPINION

Before CHAMBERS and KOELSCH, Circuit Judges, and JAMESON, ^* District Judge.

JAMESON, District Judge:

Three actions are consolidated on this appeal. In Cause No. 73-2739, the petitioners, Simon and Mina Lazarus, husband and wife, seek review of a judgment of the United States Tax Court sustaining an income tax deficiency assessment in connection with an alleged "private annuity" transaction in which petitioners transferred stock to an irrevocable trust in return for a joint and survivor "annuity". In Causes Nos. 73-2737 and 73-2738, companion cases involving the same transaction, petitioners challenge the gift tax assessed against them individually as a result of the transfer of stock to the trust. ¹

Background

In 1955, petitioners acquired title to a parcel of real property in Los Angeles. A shopping center was built by petitioners on the land in 1958-1959. Because of numerous factors, including their age and the illness and marital problems of members of their family, petitioners began considering possible estate and tax-planning techniques. Their attorney, Harry Margolis, suggested a plan whereby the land and shopping center would be placed in trust for members of the petitioners' family and the petitioners in turn would receive an annuity.

Pursuant to the directions of Margolis, the petitioners entered into a trust agreement on April 30, 1963 establishing an irrevocable trust with Arawak Trust Company Limited, a Bahamian corporation, serving as trustee. ² Petitioners' children and numerous relatives were named as beneficiaries of the trust, which was initially funded with $1,000. Meanwhile, on April 15, 1963, petitioners had formed the N & V Realty Corporation and on October 1, 1963 transferred the shopping center to it in exchange for N & V stock. ³

On December 1, 1963, Arawak was replaced as trustee by Aruba Bonaire Curacao Trust Company Limited (ABC), another Bahamian corporation. Pursuant to the overall estate plan devised by Margolis, petitioners on December 18, 1963 entered into what was labeled an "Annuity Agreement" with ABC. The agreement recited that petitioners, contemporaneously with the execution of the agreement, transferred to ABC all the capital stock of N & V Realty in return for ABC's agreement to pay to petitioners the sum of $75,000 per year. The payments were to be made on or before June 30 of each year, beginning in 1964, for the period of petitioners' lives, including the full life of the survivors. Petitioners had a joint and survivor life expectancy of about 21 years. The fair market value of the stock of N & V Realty, and of its shopping center property, was $1,575,000. Petitioners' basis in the stock of N & V Realty at the time of transfer to the trust was $718,406. The actuarial value of the $75,000 annuity was $864,533. The agreement recited that no gift was intended to be given to ABC and that no security of any kind had been reserved for the annuity agreement. ABC was given full power to dispose of the stock as it saw fit.

On January 2, 1964, ABC sold the stock of N & V Realty to a Bahamian corporation entitled World Entertainers Limited. ⁴ As consideration for the transfer of the stock, World Entertainers executed a non-assignable promissory note, ⁵ agreeing to pay to ABC as trustee, the sum of $1,000,000 on January 1, 1984. The note also provided that ABC was to receive annual interest payments of $75,000. ⁶ The payments were to be made on June 1 of each year, beginning in 1964, and continue until the principal was paid. The sale to World Entertainers had apparently been contemplated during 1962-1963 while petitioners and their attorney were in the process of negotiating the trust with Arawak. It was stipulated that during this time "Arawak determined that a Bahamian corporation that it represented and managed, World Entertainers Limited, would be interested in purchasing the shopping center when incorporated". (Emphasis added).

Petitioners' attorney Harry Margolis represented numerous trusts for which Arawak and ABC served as trustee. It was stipulated that Margolis represented more than 150 ABC trusts, a number greater than any other single attorney.

Between 1964 and 1967, the petitioners received $300,000 from the trust. ⁷ In their 1964 joint income tax return, petitioners reported no income from payments received pursuant to the "Annuity Agreement". They treated the receipts as payments pursuant to a private annuity arrangement. Using an "investment in contract" of $1,575,000, and an "expected return" of the same amount, they determined that the "percentage of income to be excluded" as annuity income was 100 percent. In an explanation attached to their return, they stated:

"On November 18, 1963 (sic), taxpayers transferred all of the stock of N & V Realty Corporation in exchange for a private annuity. The stock had been acquired April 15, 1963, and had a basis of $718,406. The fair market value of the stock was $1,575,000. Taxpayers are to receive $75,000 per year for life on a joint and survivor basis, the actuarial term of which is twenty one years. Taxpayers elect to report only such installments as may be actually received by them and taxpayers herewith report the payments received as being a recovery of basis only at this time."

Petitioners followed the same procedure in 1965.

In his notices of deficiency, the Commissioner of Internal Revenue determined that petitioners were taxable on their receipts from the trust under the annuity provisions and owed an additional $111,192 in income tax for the years in question. He determined also that the petitioners individually owed gift taxes for 1963 amounting to $141,288.62, based on a gift to the trust of the difference between the fair market value of the property transferred to the trust and the value of the annuity when it was created in 1963.

Tax Court Opinion

The contentions of the parties before the Tax Court were summarized in the court's opinion as follows:

"Petitioners contend that they sold their N & V stock to the trust in consideration for a 'private annuity agreement' which did not have an ascertainable fair market value. Consequently, they urge, they realized no taxable gain in the year of the sale and will realize no such gain until they have recovered their adjusted basis ($718,406) in the N & V stock. Moreover, since the transaction took the form of a sale for adequate consideration, petitioners maintain, they incurred no gift tax on the transfer to the trust; and, under the rationale of their position, at the time of their deaths neither of their estates will owe any estate tax with respect to the N & V stock or its proceeds.

"In other words, petitioners contend that they have so arranged the disposition of their shopping center that they will receive $75,000 per year as long as they live, will pay no income tax on the first $718,406 of their receipts, and will pay income tax at capital gain rates on the balance of their receipts, if any. Furthermore, under their analysis, the value of the N & V assets remaining at their deaths will pass to their children and grandchildren without any gift tax or estate tax having been incurred.

"Respondent contends that the substance of the transaction was not a sale but was a transfer of property to the trust for the benefit of petitioners' children and grandchildren, subject to a reservation of the right to have the yearly income of the trust ($75,000) distributed annually to petitioners, or the survivor of them, for life. On this ground, respondent maintains that petitioners are taxable on the payments which they received from the trust during the years in controversy."

Following a thorough review of the facts and the inferences to be drawn therefrom, the Tax Court concluded that the petitioners had, as contended by the Commissioner, transferred rather than sold the shopping center stock to ABC and that petitioners had reserved the right for life to the income from the stock so transferred. The Tax Court therefore held that under § 677(a) of the Internal Revenue Code, 26 U.S.C. § 677(a), the petitioners were the owners of the trust and were taxable on the income therefrom under § 671 of the Code. ⁸ In addition, the Tax Court agreed with the Commissioner that the petitioners in retaining only a life estate in the trust income had made a gift of the remainder interest and were thus subject to a gift tax.

Annuity or Trust

The crucial issue for determination is whether petitioners' transfer of stock to the Bahamian trust was a sale in consideration for an annuity or a transfer to the trust with a reserved life estate in the income. If the transfer were a sale for an annuity promise, the tax savings would be substantial. When the transfer is a sale for an annuity promise, that part of the annuity constituting a recovery of the basis of the assets transferred by the annuitant is not taxable, and any amount received in excess of the adjusted base is taxed as a capital gain. On the other hand, where the transfer is in trust with a reserved life estate, all income received from the trust is taxed to the transferor. In addition, the transfer of property to a trust with a reserved life estate would subject the grantor to a gift tax on any remainder interest. The transfer of property in return for an annuity generally does not involve a gift tax assessment since the transfer is...