Zager v. Comm'r of Internal Revenue

• Citation: 72 T.C. 1009
• Decision Date: 05 September 1979
• Docket Number: Docket No. 11051-78.
• Parties: MAX ZAGER and GOLDIE R. ZAGER, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

72 T.C. 1009

MAX ZAGER and GOLDIE R. ZAGER, PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 11051-78.

United States Tax Court

Filed September 5, 1979.

Held: The dominant stockholders (who were also officers and employees) of a corporation did not realize taxable income by reason of interest-free loans to them by the corporation. Dean v. Commissioner, 35 T.C. 1083 (1961), followed. The principle of stare decisis is applicable in the light of the history of this issue. William L. Tankersley III, for the petitioners.

Edwina L. Link, for the respondent.

OPINION

RAUM, Judge:

The Commissioner determined deficiencies and wife, in the amounts of $6,179.75 and $6,627.18, for the calendar years 1975 and 1976, respectively. After concessions by petitioners as to certain adjustments made by the Commissioner, there remains in controversy only whether petitioners realized taxable income in respect of their interest-free use of funds borrowed from a corporation in which they were the dominant stockholders. The case was submitted on the basis of a stipulation of facts.

Petitioners, residents of North Miami Beach, Fla., when they filed their petition herein, filed joint income tax returns for 1975 and 1976 on the cash basis of accounting. During 1975 and 1976, and at all other times relevant to this case, petitioners owned 80 percent of the outstanding stock of Standard Enterprises, Inc., a North Carolina corporation. In addition, they were officers and salaried employees of the corporation during this period. The remaining 20 percent of the stock was owned by their children. The last 8 months of petitioners' calendar year 1976, but was not a personal holding company during 1975 or the first 4 months of 1976.

Prior to 1975 and 1976, the corporation made interest-free loans to petitioners on open accounts receivable. The outstanding balance of such loans was in excess of $100,000 in the years prior to 1975, but such balance was $88,988.30 in each of the years 1975 and 1976. Petitioners have since repaid the full amount thus outstanding. The Commissioner determined that “The economic benefit to you from free use of $88,988.30 of the corporation's funds,” measured by the 7 percent prime interest rate being charged by area banks in those years, was $6,229.18 for each year, and he increased petitioners' taxable income accordingly.

The Government recognizes that its position is contrary to Dean v. Commissioner, 35 T.C. 1083 (1961), but it argues that the decision in Dean was wrong and asks that it be overruled. We adhere to the result

To be sure, the principle of stare decisis is not the embodiment of an inexorable rule of law. Cf. Helvering v. Hallock, 309 U.S. 106, 119 (1940). But the circumstances relating to the issue now before us are of such character as to call for the application of the doctrine of stare decisis rather than the exception thereto that was found appropriate in Hallock. A review of the history of the problem is important in the context of the course which the Government is asking us to follow here.

Our modern income tax laws have been in effect continuously since 1913, and the various applicable statutes, using one form of words or another, have characterized the income subject to tax in broad and sweeping terms. Yet, at the time Dean was presented to this Court, there was no indication that there had previously ever been even a single instance in which the Government had taken the position, either in litigation (successfully or unsuccessfully) or by rule, regulation, or administrative practice in any manner, that an interest-free loan by a corporation to its stockholder-officers resulted in the realization of income which the statute sought to reach. Indeed, the position advocated in this respect by the Government in Dean would appear to have been nothing more than an afterthought. No such issue was raised in the deficiency notice or even in the answer as originally filed in response to the taxpayers' petition therein. The point was first raised in an amended answer and appears to have had its origin in a fortuitous dictum in a then-recent Memorandum Opinion of this Court involving gift taxes of the same taxpayers which had been promulgated several months prior to the filing of the amended answer. (See 35 T.C. at 1089.) The theory was further refined in the Government's brief.

The problems gave us much difficulty because there appeared superficially to be but little difference between the interest-free use of corporate funds and the rent-free officer that had been held to constitute a tax benefit the fair value of which was includable in gross income. Conceptually, it did seem that the same result should be reached in both types of cases. Yet, the fact that the Treasury had not theretofore—-for some 48 years—-attempted to treat as income the benefits attributable to such interest-free loans was highly troublesome. We searched for a distinction that would support the administrative practice which had endured for so long a period. And we found a difference in that if the taxpayer had undertaken to pay interest or rent, he would generally have been entitled to a deduction for the payment of interest but not for rent. Thus, the tax benefit resulting from the exclusion from gross income of any amount attributable to such an interest-free loan would be matched dollar for dollar by the tax benefit attributable to the interest deduction in the case of an interest-bearing loan, assuming of course that the interest were fixed at a fair rate. To be sure, there were peripheral situations general, the neutralizing effect of the interest deduction did seem to afford a basis for supporting the differing treatment which the Government itself had long accorded to interest-free loans and rent-free use of property. In reaching our conclusion, we recognized that “the question may not be completely free from doubt,” (35 T.C. at 1089) and our opinion, although reflecting the views of a majority of the Court, was not unanimous.

Notwithstanding the potential importance of Dean, the Government failed to pursue an appeal from our decision and accepted the result for a period of some 12 years thereafter. It was not until 1973 that the Commissioner announced his “nonacquiescence,” 1973-2 C.B. 4, and mounted a campaign to have Dean overruled. The matter was squarely presented in Suttle v. Commissioner, 37 T.C.M. 1638, 47 P-H Memo T.C. par. 78,393 (1978), but the Court reaffirmed its holding in Dean. Cf. Greenspun v. Commissioner, 72 T.C. 931 (1979). in the present case, and has filed a strong brief in support of its position. We recognize that we perhaps made too sweeping a statement in Dean when we said without qualification that “an interest-free loan results in no taxable gain to the...