Linder v. Comm'r of Internal Revenue

• Citation: 68 T.C. 792
• Decision Date: 30 August 1977
• Docket Number: Docket No. 294—75.
• Parties: JOSEPH LINDER, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

68 T.C. 792

JOSEPH LINDER, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 294—75.

United States Tax Court

Filed August 30, 1977.

Petitioner a New Jersey resident, executed gratuitous promises under seal to pay certain sums to his sister. He paid and deducted interest on the promised amounts. Held, under New Jersey law the sealed promises are unenforceable and interest and with respect thereto is nondeductible. Joseph Linder, pro se.

Marwin A. Batt, for the respondent.

HALL, Judge:

Respondent determined the following deficiencies in petitioner's income tax:

+--------------------+
                ¦Year  ¦Deficiency   ¦
                +------+-------------¦
                ¦      ¦             ¦
                +------+-------------¦
                ¦1971  ¦$1,792.50    ¦
                +------+-------------¦
                ¦1972  ¦1,433.20     ¦
                +--------------------+
                

Another issue having been disposed of by mutual agreement, the remaining issue for decision is whether petitioner is entitled to interest deductions under section 163¹ for certain payments made to his sister.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

Joseph Linder resided in Bayonne, N.J., at the time he filed his petition.

Petitioner was an actuary, employed on a consulting basis by various insurance companies. In November 1950 petitioner purchased a lot in Bayonne and had a house constructed on it. Petitioner's two sisters, Rose Linder and Tillie Linder, shared this house with him.

In 1951 petitioner wished to make a substantial gift to his sister Rose but lacked sufficient liquid assets to make a gift in cash or securities. Instead, on September 15, 1951, he gave her what he termed a bond, payable in 20 years, in the face amount of $34,000, which in essence embodied petitioner's purported obligation to make Rose a gift of this amount. To secure this bond, he gave Rose what he termed a mortgage on his Bayonne residence. The mortgage documents indicated that petitioner would pay Rose annual interest of 5 percent on the bond. The mortgage was recorded in Hudson County, N.J. Rose transferred nothing of value to petitioner for the bond given to her on September 15, 1951.

At various times thereafter petitioner gave Rose additional bonds of $3,000, securing each bond by an additional mortgage. Each additional bond bore the same interest rate and expiration date as the original bond. All of the bonds petitioner gave Rose were signed by him, were payable in a sum certain, and were executed under seal. Each additional mortgage was filed in Hudson County, N.J. Rose transferred nothing of value to petitioner for these additional gifts.

As of May 15, 1971, the total face value of the bonds and securing mortgages executed by petitioner and held by Rose totaled $46,000. On that date petitioner decided to consolidate these bonds and mortgages and also decided to increase his overall gift to Rose to $49,000. Therefore Rose canceled his prior bonds and mortgages, and petitioner signed and executed under seal a new bond to Rose, in the face amount of $49,000, payable on May 15, 1981, with annual interest of 7 percent. He also executed a new mortgage of $49,000 on his Bayonne residence and had it recorded. In 1972 petitioner signed and executed under seal an additional bond for $3,000 to Rose, payable on May 15, 1981. He also executed an additional mortgage in the same amount. Both the 1971 and 1972 bonds were payable to Rose Linder or her assigns.

The 1971 bond reads as follows (the 1972 bond was identical, except for the amount of money involved):²

Know all Men by these Presents, That JOSEPH LINDER, of the City of Bayonne in the County of Hudson and State of New Jersey held and firmly bound unto ROSE LINDER the City of Bayonne in the County of Hudson and State of New Jersey in the penal sum of Forty-Nine Thousand ($49,000.00) Dollars lawful money of the United States of America, to be paid to the said ROSE LINDER HER EXECUTORS, ADMINISTRATORS OR assigns: for which payment well and truly to be made, JOSEPH LINDER bind himself, his heirs, executors and administrators, firmly by these presents. Sealed with his seal the 15th day of May One Thousand Nine Hundred and seventy-one.

The Condition of the above obligation is such that if the above bounden JOSEPH LINDER HIS heirs, executors or administrators, shall well and truly pay, or cause to be paid unto the above named ROSE LINDER, HER executors, administrators or assigns, the just and full sum of Forty-Nine Thousand ($49,000.00) Dollars on the fifteenth day of May which will be in the year One Thousand Nine Hundred and eighty-one, and the interest thereon, to be computed from May 15, 1971 at and after the rate of seven per cent. per annum, and to be paid annually, in advance. Without any fraud or other delay, then the above Obligation to be Void, otherwise to remain in full force and virtue.

And it is hereby expressly agreed, that should any default be made in the payment of the said interest, or of any part thereof, on any day whereon the same is made payable as above expressed, or should any tax, assessment, water rent or other municipal or governmental rate, charge, imposition or lien be hereafter imposed or acquired upon the premises described in the mortgage accompanying this bond, and become due and payable; and should the said interest remain unpaid and in arrear for the space of 120 days, or said tax, assessment, water rent or other municipal or governmental rate, charge, imposition or lien, or any or either of them, remain unpaid and in arrear for the space of 120 or should any default be made in the performance of any of the terms, covenants and conditions contained in the Mortgage accompanying this Bond (the said terms, covenants and conditions and all matters and things contained in said Mortgage being hereby made a part hereof as though set forth at length herein) then and from thenceforth, that is to say, after the lapse or expiration of either of the said periods, as the case may be, the aforesaid principal sum of Forty-Nine Thousand dollars ($49,000.00) with all arrearage of interest thereon, shall, at the option of the said ROSE LINDER, OR legal representatives or assigns, become and be due and payable immediately thereafter, although the period first above limited for the payment thereof may not then have expired, anything hereinbefore contained to the contrary thereof in any wise notwithstanding, and the said Obligee may at option, pay such tax, assessment, or water rent in arrear, and the amount so paid shall be added to and become part of the principal sum secured by the said mortgage and by this Bond, and shall be payable on demand with interest to six per centum per annum.

In 1974 petitioner paid Rose $52,000 and canceled the outstanding bonds and mortgages. Prior to 1974 petitioner had not made any payments to reduce the principal of his bond and mortgage obligations. On August 1, 1974, Rose purchased an annuity contract from an insurance company, paying a single premium of $55,000.

Title to the Bayonne residence at all times remained in petitioner's hands. Petitioner also paid all real estate taxes on the house. The responsibility for day-to-day operation of the house rested with Rose, who used her own income as well as petitioner's interest payments to pay for groceries, cleaning, and other household expenses.

In 1971 petitioner made interest payments totaling $3,430 to Rose on the $49,000 band then outstanding and deducted this amount on his 1971 tax return as interest on a home mortgage. In 1972 he paid Rose $3,640 as interest on the $52,000 of bonds then outstanding and similarly deducted this amount on his return. Respondent disallowed these deductions in their entirety.

OPINION

Over a period of 20 years petitioner made successive promises to his sister Rose to make sizable gifts to her. His promises for the years in issue were memorialized in bonds, executed under seal, secured by mortgages on his home. The issue before us is whether petitioner is entitled to deduct the interest which he paid to his sister on these bonds.

A deduction is generally allowed on ‘all interest paid or accrued within the taxable year on indebtedness.’ Sec. 163(a). Courts have defined indebtedness to mean an unconditional and legally enforceable obligation for the payment of money. Autenreith v. Commissioner, 115 F.2d 856, 858 (3d Cir. 1940), affg. 41 B.T.A. 319 (1940). The determination of whether an obligation is legally enforceable requires an analysis of the law of the State in which the transaction occurred, in this case New Jersey.³ Morton v. Commissioner, 38 B.T.A. 1270, 1273 (1938), affd. 112 F.2d 320 (7th Cir. (1940); Park v. Commissioner, 38 B.T.A. 1118, 1119 (1938), affd. 113 F.2d 352 (3d Cir. 1940).

Since in most jurisdictions⁴ a promissory obligation executed as a gift is not legally enforceable, any interest paid on such an obligation is not deductible. Brown v. Commissioner, 241 F.2d 827 (8th Cir. 1957) (Missouri law), affg. 25 T.C. 920 (1956); Woodward v. United States, 208 F.2d 893, 898 (8th Cir. 1953) (Iowa law); French v. Commissioner, 138 F.2d 254, 258 (8th Cir. 1943) (Iowa law), affg. a Memorandum Opinion of this Court; Gilman v. Commissioner, 53 F.2d 47 (8th Cir. 1931) (Iowa law), affg. 18 B.T.A. 1277 (1930); Day v. Commissioner, 42 B.T.A. 109, 111—112 (1940) (Connecticut law), affd. 121 F.2d 856 (2d Cir. 1941); Sellers v. Commissioner, 22 T.C.M. 1327, 32 P-H Memo. T.C. par. 63,263 (1963) (Virginia law).⁵

In New Jersey, as under the common law generally, a gratuitous promise to make a gift cannot normally be enforced. Jones v. Westcott, 8 N.J. Misc. 312, 150 A. 50 (Sup.Ct. 1930); Cockrell v. McKenna, 103 N.J.L. 166, 134 A. 687 (Ct. Err. & App. 1926). At common law, however, such a promise, if under seal, is enforceable. E.g., Aller v. Aller, 40 N.J.L. 446 (Sup. Ct. 1878); Trustees First Presbyterian Church v. National State Bank, 57 N.J.L. 27, 29 A. 320 (Sup. Ct. 1894), affd. 58 N.J.L. 406, 36 A. 1129 (Ct. Err. & App. 1...