Smith v. Comm'r of Internal Revenue
| Decision Date | 12 May 1971 |
| Docket Number | Docket Nos. 5330-68,3489-69. |
| Citation | 56 T.C. 263 |
| Parties | HAROLD W. SMITH AND CAROLINE H. SMITH, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENTHELEN C. SMITH, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Harold S. Voegelin and Richard F. Oetting, for the petitioners.
Michael J. Christianson, for the respondent.
In 1961 the taxpayers (husband and wife) sold their controlling stock interest in American Gas to Union Oil under an installment sale contract payable over a 5-year period. They properly elected to report their gain on the installment method under sec. 453, I.R.C. 1954. In 1964, when over $700,000 in gain remained yet to be reported, the taxpayers and their advisers devised a plan whereby the taxpayers undertook to transfer the installment contract to their two children, the children undertook to pay annuities to the parents, and each child executed an instrument establishing a trust designed to fund the annuities. The sole corpora of both trusts consisted of the funds representing the entire balance of the installment contract, which Union Oil had meanwhile paid.
1. Held, the taxpayers disposed of the installment contract ‘otherwise than by sale or exchange’ and must therefore include in their 1964 gross income that portion of their gain which had not theretofore been recognized to the extent required by sec. 453(d)(1)(B). Held, in the alternative, the taxpayers actually received payment in full of the outstanding installment obligation in 1964 and must therefore account in that year for the remaining unreported gain on the sale of their stock in accordance with sec. 453(a) and (b).
2. Held, the taxpayer's daughter made no deductible interest payments to them under her annuity contracts with them. Sec. 163, I.R.C. 1954.
The Commissioner determined deficiencies in petitioners' income tax as follows:
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¦ ¦Calendar ¦ ¦
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¦Petitioner ¦year ¦Deficiency ¦
+---------------------------------------------------+----------+------------¦
¦Harold W. and Caroline H. Smith, docket No. 5330-68¦1964 ¦$178,543.76 ¦
+---------------------------------------------------+----------+------------¦
¦Helen C. Smith, docket No. 3489-69 ¦1967 ¦4,708.21 ¦
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These cases involve the tax consequences of certain transactions in 1964 whereby (1) Harold W. and Caroline H. Smith, the owners of an installment obligation, undertook to transfer it to their son and to their daughter, petitioner Helen C. Smith, (2) the sone and daughter each undertook the pay annuities to their parents, and (3) the proceeds of the installment obligation, which had meanwhile been paid by the obligor, were placed in trusts in which the son and daughter appeared as settlors, and in which the trustees were instructed to pay the annuities to the parents out of the assets of the trusts. Particularly in question is whether the parents are chargeable with taxable income in 1964 under section 453(d)(1), I.R.C. 1954, in respect of the theretofore unreported gain reflected in the installment obligation, which they had elected to report on the installment basis in an earlier year. Also in issue is whether petitioner Helen C. Smith may deduct as interest a portion of the payments made to her parents by the trustees of her trust purportedly in discharge of her obligation under the so-called annuity agreements.
The parties have stipulated certain facts, which, together with the attached exhibits, are incorporated herein by this reference.
Petitioners Harold W. and Caroline H. Smith (Harold and Caroline) are husband and wife. They filed a joint Federal income tax return for the calendar year 1964 with the district director of internal revenue at Los Angeles, Calif., and resided at 2449 Ridgeway Road, San Marino, Calif., at the time their petition herein was filed. Their return was prepared on the basis of a cash method of accounting. Petitioner Helen C. Smith (Helen) is the daughter of petitioners Harold and Caroline Smith. She filed an individual Federal income tax return for the calendar year 1967 with the district director of internal revenue at Los Angeles, Calif., and resided at 2449 Ridgeway Road, San Marino, Calif., at the time her petition herein was filed.
Harold was born on April 20, 1901, and Caroline was born on October 22, 1913. They are the parents of one daughter, Helen, and one son, Harold W. Smith, Jr. (Harold, Jr.).
Helen was born on November 3, 1944. From September 1962 until June 8, 1966, she was a full-time student at the University of California at Santa Barbara. During the years in question her home address was the same as that of her parents. However, during the first, second, and fourth years of her college career, she resided at Santa Barbara during the school year. From the latter part of August of 1964 until July of 1965, Helen studied at the University of California ‘Extension, junior year abroad program,‘ at Goettingen, Germany. From February 20, 1967, to November 30, 1968, she was employed as a librarian. During this latter period she lived ‘at home’ for approximately 4 or 5 months and then moved into an apartment in Pasadena, Calif. Helen was married in November of 1969 and acquired the married name of Helen C. (Smith) Hurst.
Harold, Jr., was born on October 8, 1937. In June of 1963 he graduated from the University of Colorado at Boulder, and enlisted in the U.S. Air Force for 5 years. From the fall of 1963 until August of 1964 he was engaged in flight training at Craig Air Force Base at or near Selma, Ala. After graduation from flight school in August of 1964, he was stationed at Bunker Hill Air Force Base in Indiana. Upon receipt of his honorable discharge from the Air Force in 1968, he was employed by Continental Air Lines as a commercial airline pilot, flying primarily Pacific and Far Eastern flights. At the time of the trial herein, he resided at Dana Point, Calif., and continued to be employed by Continental Air Lines as a commercial Pilot.
On June 1, 1961, Harold and Caroline entered into a ‘purchase agreement’ with Union Oil Co. of California (Union Oil). Under the agreement, the Smiths agreed to sell to Union Oil 9,839 1/4 shares (out of a total of 10,500 issued and outstanding shares) of the capital stock of American Liquid Gas Corp. (American Gas). The purchase agreement, which identified the Smiths as ‘Sellers' and Union Oil as ‘Buyer,‘ made the following provision with regard to payment for the stock:
1. The purchase price to be paid by Buyer to Sellers for the Stock shall be the sum of ONE MILLION, EIGHT HUNDRED AND THIRTY-NINE THOUSAND, ONE HUNDRED AND EIGHT DOLLARS ($1,839,108.00) subject to adjustment upward or downwards in accordance with the provisions of paragraph 5 hereof. An amount equal to twenty-five per cent (25%) of the purchase price shall be paid not later than Tuesday, June 20, 1961, at 10:00 o'clock A.M. in Los Angeles Clearinghouse funds at the principal offices of the Buyer, Union Oil Center, Los Angeles, California. Such time and date is sometimes referred to herein as the ‘time of closing.’ The balance of the purchase price shall be paid in five equal annual installments commencing on the 1st day of July, 1962, or may be prepaid at the option of Buyer, except that no portion of such balance of purchase price shall be paid prior to January 1, 1962. Buyer agrees to pay interest semi-annually on the unpaid balance at a rate equal to the prime rate of interest being charged by New York City banks (currently 4 1/2 per cent) on the interest payment date. * * *
The purchase agreement was subsequently modified on two occasions in 1961, first on June 20, the closing date, to increase the total purchase price to $1,839,248.50, and finally on December 14, 1961, to reduce the total purchase price to $1,786,994.75.
On June 20, 1961, pursuant to the purchase agreement, Union Oil paid the Smiths $459,812.12 (approximately 25 percent of $1,839,248.50, the total purchase price as modified on that date) as the first installment of the purchase price. At the time of the sale, the Smiths' basis in the American Gas shares which were sold was $170,770.12. The selling expenses incurred by them which were attributable to the sale amounted to $10,102.28. On their joint Federal income tax return for 1961, the Smiths properly elected to report their gain from the sale of the American Gas stock on the installment method under section 453, I.R.C. 1954. Accordingly, in 1961 they reported income of $413,271.79 from the sale of the stock.1
In each of the years 1962 and 1963, Union Oil paid the Smiths the annual installment of principal due in the amount of $265,436.53 (equal to approximately one-fifth of the difference between $1,786,994.75, the final aggregate purchase price, and $459,812.13, the first installment payment made in 1961) as well as the interest due on the unpaid balance. However, the payment due on July 1, 1962, was made on July 23, 1962, approximately 3 weeks late, as the result of Harold's oral request that Union Oil delay such payment. Union Oil did not pay the Smiths the added interest which accrued as the result of the late payment. On their joint Federal income tax returns for 1962 and 1963, the Smiths reported the 1962 and 1963 payments on the installment method in accordance with their election to do so in 1961; the income from the sale of the stock reported each year was $238,570.11 (89.8784 percent of the annual payments of $265,436.53).
Thus, at the end of 1963, the unpaid balance of the total purchase price due from Union Oil was $796,309.56, and of that amount...
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