DIEDRICH v. COMMISSIONER
Legal provision: Internal Revenue Code
ORAL ARGUMENT OF NORMAN E. BEAL, ESQ., ON BEHALF OF THE PETITIONERS
Chief Justice Burger: We will hear arguments next in Diedrich against the Commissioner of Internal Revenue.
Mr. Beal, I think you may proceed whenever you are ready.
Mr. Beal: Mr. Chief Justice, and may it please the Court, this is an income tax case involving a commonly used estate planning device called a net gift.
The issue presented is whether or not the donor of a gift made subject to the condition that the donee pay the resulting gift taxes realizes taxable gain to the extent the gift taxes paid by the donee exceed the donor's adjusted basis in the property transferred.
For the purposes of our brief and in this argument, I will define a net gift as a transfer by gift of property subject to a condition that the donee make payment of the resulting gift taxes.
The term net gift does not refer to any other conveyance of property subject to an indebtedness or an obligation.
The sole obligation assumed by the donee is the discharge of the gift taxes.
There are two cases before the Court at the present time, both here on a writ of certiorari to the Eighth Circuit Court of Appeals.
Both cases had been decided by the United States Tax Court favorably to the taxpayer.
The Eighth Circuit reversed both taxpayer... both decisions in favor of the taxpayer, and found for the government.
I was personally responsible for the Grant case.
There are no material factual variances between the two cases, and I will state the facts with reference to that particular case.
In 1970 and 1971, Frances G. Grant made separate gifts of BMA Corporation securities to her son, subject to the condition that he pay the resulting gift taxes.
The first gift was made in December of 1970, the second in January of 1971.
The total value of the property covered by the two transactions was approximately $1 million, and the total gift taxes involved on the transfers was $232,000.
That payment was made by Mrs. Grant's son in April, 1971.
The securities that were transferred in Mrs. Grant's hands had a basis of approximately $9,000 for federal income tax purposes.
Upon audit of Mrs. Grant's return, the Commissioner of Internal Revenue asserted that the transfers, the net gift transfers that she had made resulted in a taxable gain in that they constituted a part sale and part gift transfer, that she was entitled to capital gain treatment on the transaction, and that her gain was the difference between the gift taxes paid of $232,000 and her basis of $9,000, or approximately a $223,000 capital gain.
Her taxable income was increased by $110,000, and an additional $70,000 or so of income taxes were assessed against her.
Unidentified Justice: Suppose at the time of the gift, Mr. Beal, the father said, here's this gift I am going to give you, and with gifts of that size he is likely to have very good legal counsel, and he says to his son, our lawyers tell us the gift tax on this is going to be $232,000 or whatever, and in addition to the gift, here is a check for $232,000 to pay the gift tax when it comes due.
What about that?
Mr. Beal: In that instance, Your Honor, there would be a gift of $232,000 of corporate securities, and there would be an additional gift... I'm sorry.
There would be a gift of corporate securities of whatever value, and there would be an additional gift of the $232,000.
Unidentified Justice: What is the legal difference between the hypothetical and the case before us?
Mr. Beal: --Well, in... I don't believe there is any difference.
The using of the $232,000 in cash by the donee to pay off the gift taxes wouldn't, I don't think, even under the Commissioner's theory, result in any income tax consequences to the donor.
It is only in the instance where adequate cash to pay off the gift taxes is not transferred that the government asserts that there has been an income tax consequence incurred on the gift.
If we had $1 million of cash paid over subject to that same condition, without question, there would be no assertion of an income tax consequence, and in our view, it is not because there is no gain to the taxpayer upon the transfer of the money, but it is simply because it was not a taxable transaction from an income tax standpoint to start with.
Preliminarily, I would like to point out that the Tax Court in both cases specifically found that the aggregate of the property in Mrs. Grant's case, the $90,000, was conveyed to her son xx gift.
That factual finding is included in the record.
The case did go on a motion.
The finding was made by the court in ruling upon the motion.
The government's contention is that the intent of Mrs. Grant to make or not make a gift is completely beside the point, and that in effect a rule of law must be imposed that when the gift taxes are discharged by the donee without regard to the other circumstances, an income tax may be payable.
The net gift transfer as it relates to income tax consequences came up in the court of appeals for the first time in 1969, in a decision by the Sixth Circuit, Turner versus Commissioner.
In that particular case, gifts had been made on a net basis into trusts, and also outright to an individual, and the Commissioner conceded that the transfers to the trusts were not part sale transactions, but asserted that the gifts to the individuals were part sales and partly in gift, and attempted to assess an income tax on the payment of the gift taxes by the individual.
The Sixth Circuit found for the taxpayer in that particular case.
The next decision from the courts of appeals was Estate of Davis versus Commissioner, decided by the Fifth Circuit in 1974.
Again, the Commissioner's theory was part gift, part sale, and again it was rejected by the Tax Court, and the Tax Court's decision was affirmed on a per curium by the Fifth Circuit.
The next decision in the courts of appeals was rendered by the Fourth Circuit in 1978, in Hirst v. Commissioner.
A three-judge panel of the court initially decided the issue in favor of the government.
A motion for rehearing was filed, granted, and in a four to three decision the Fourth Circuit again determined that there was no net gift... there was no income tax consequence to the donor of a net gift.
The decision in that case was written for the majority by Chief Judge Hainesworth.
The Diedrich decision, which is the case before us, is the first instance in which a court has found that the net gift transfer results in an income tax consequence... results in a taxable gain upon the payment of the gift taxes.
There has been a subsequent ruling made by the Sixth Circuit in Owen v. Commissioner.
In that instance, a three-judge panel found for the taxpayer on the basis of the Turner decision by the Sixth Circuit earlier.
A motion for rehearing in that case was granted, and the opinion has been vacated, and that case along with several others are being held in abeyance by the Sixth Circuit pending a decision in this case.
Unidentified Justice: Mr. Beal, would you agree with the Solicitor General that for some 25 years the Commissioner has consistently said that such a transaction is subject to income tax--
Mr. Beal: No, I do not.
In 1953, Estate of Staley was tried, I believe in the Fifth Circuit, and in that particular case, property had been transferred into a trust with a reservation by the donor of sufficient income to pay the gift taxes.
The Commissioner asserted that he had retained an income interest in the trust that was taxable to him under the trust provisions of the Internal Revenue Code as ordinary income.
The taxpayer, on the other hand, said, I did not retain an income interest in that trust, I made a sale in part of the property into the trust, exactly the theory that is now the basis of the claim in this case.
And the government opposed that theory, and it was decided that the part gift, part sale rationale did not apply.
In 1957, the--
Unidentified Justice: --What case was that?
Mr. Beal: --That was Estate of Davis.
Unidentified Justice: Davis, yes.
Mr. Beal: No, I am sorry, Estate of Staley.
Unidentified Justice: Staley.
Mr. Beal: And I don't have the cite.
I can give it to you--
Unidentified Justice: No, that's all right.
What is the next one you were going to talk about?
Mr. Beal: --The next one that I am going to refer to is a revenue ruling by the Commissioner which is cited in the amicus brief, Revenue Ruling 57-564, and in that instance, the Commissioner himself responded to the following request.
Advice has been requested with respect to the federal income tax consequences to a donor pursuant to a trust instrument requiring the donee to pay the federal gift tax on a gift of such stock.
He was replying to a request for an opinion on the federal income tax consequences.
Again the Commissioner ruled that there was a retention under these circumstances of an income interest which was taxable, and there is no suggestion whatsoever that there is another tax consequence, that there is perhaps also or in lieu of the reservation of an interest a capital gain consequence.
In the Turner case itself, the Commissioner made the part gift, part sale argument, and insofar as we can tell, I was able to check, there was no petition for cert filed requesting a review of that decision.
Unidentified Justice: Let me ask you about my understanding of the present situation.
If the donee pays the gift tax, the amount that the donee pays for the tax is added onto the basis of the property in the hands of the donee.
Is that correct?
Mr. Beal: That is correct.
Unidentified Justice: And to that extent no capital gains tax or other income tax would ever be levied on that incremental add-on to the basis.
Mr. Beal: That is correct.
Unidentified Justice: Okay.
What is the consequence if the donor pays the gift tax?
Is that same amount added to the donee's basis when the donee gets it?
Mr. Beal: Yes, it is.
The step-up in basis for the amount of gift taxes paid occurs in both instances.
Unidentified Justice: Yes.
But Mr. Beal, the step-up occurs, but isn't it true that in your case... what is the basis?
I will ask you.
What do you understand the basis in the donee's hands of the... in this case?
Mr. Beal: In our case, the basis of the stock in the donee's hands would be the donor's basis increased by the amount of the gift taxes.
Unidentified Justice: So in other words it would be $9,000 plus $232,000.
Mr. Beal: That's correct.
Unidentified Justice: Under the government's view, as I understand it, it is 232 plus another 232.
Is that right?
Mr. Beal: That's correct.
Unidentified Justice: So there's a difference between you as to... between the two of you as to what the proper basis is in the donee's hands.
Mr. Beal: Right, and that is because the government wants to--
Unidentified Justice: Because they treat that as a sale to the extent of 232.
Mr. Beal: --Exactly.
Unidentified Justice: And then... but you agree that under their view, you get both the 232 as purchase price plus the 232 in the form of gift tax.
Mr. Beal: Yes, Your Honor, I do.
Unidentified Justice: I understand.
Counsel, be sure to stay as near to the microphones as you can.
Mr. Beal: I am sorry.
I want to at this point... I had better make another point before I slip by it.
I have been accusing the government of the part gift, part sale rationale, and in all fairness, the government no longer makes that contention.
The government no longer asserts that the essence of the transaction is a sale in part of the securities but claims that the payment of the gift taxes, that particular aspect of the transaction is the taxable event for federal income tax purposes.
We have a potential, it seems to me, of three points in time at which we could find there to be a taxable event: when the agreement is made, when the condition is imposed and the donee says, I agree to that; when the property itself is conveyed subject to the obligation to pay the gift taxes; or at the time of payment of the gift taxes, and it is this latter point in time that the government now asserts results in a gift tax... or an income tax consequence, based upon the decision of this Court in Old Colony, in Old Colony Trust Company versus Commissioner in 1929, in which the payment of an individual's income tax by his employer was found to be additional compensation.
Unidentified Justice: And straight income.
Mr. Beal: Yes.
Ordinary income to him, just as though his salary had been paid... in fact, his salary was partly paid in the form of money paid over to the Treasury.
Unidentified Justice: Why shouldn't that have been the result here, under the government's theory?
Mr. Beal: Because in that... in the Old Colony case, there is a taxable transaction for income tax purposes.
And the decision in that... in that case only is that the manner in which the compensation is paid is immaterial.
In this particular instance, we submit that there has not been--
Unidentified Justice: I know you submit, but how about the... on the government's theory that paying off somebody's obligation results in income.
That is their--
Mr. Beal: --I... I--
Unidentified Justice: --Why shouldn't it be ordinary income?
Mr. Beal: --The government's theory that it is not ordinary income is that it is a gain from dealing in property, and therefore subject to the favorable treatment of capital gains--
Unidentified Justice: Well, then, what if it were cash?
Mr. Beal: --Oh, if it were cash, the government would let us go free, without--
Unidentified Justice: Why?
Why would that... if they rely on Old Colony?
Mr. Beal: --The statement--
Unidentified Justice: You would think it wouldn't be a dealing in property, it would be a dealing in money.
Mr. Beal: --The statement in--
Unidentified Justice: And it should be ordinary income.
Mr. Beal: --The statement--
Unidentified Justice: Under the government's theory.
I understand your theory, but--
Mr. Beal: --Mr. Smith would have the answer to that.
Unidentified Justice: --Well, I will have to ask Mr.... I will ask Mr. Smith.
He is very good at explaining it.
Mr. Beal: In his brief, he only states that it is tantamount to giving the tax money to the taxpayer and having him tender it, which is tantamount to the same transaction we are dealing with.
I would like to--
Unidentified Justice: Mr. Walter, normally when a person is said to realize a taxable gain, when someone else pays off his debt or discharges his liabilities, now, how does this differ from that?
Mr. Beal: --Okay.
Unidentified Justice: Except that you have the Turner case and its progeny.
However, this Court has never ruled on that.
Mr. Beal: The discharge of indebtedness in connection with a transfer of property really is based upon Crane versus Commissioner, in which a sale of property was made subject to a non-recourse mortgage, and the taxpayer received some boot.
The Supreme Court held in that case that the mortgage which was on the property at the time she acquired it was not deducted in determining her basis in the property.
Under federal estate tax law, she had a fair market value basis.
The mortgage that it was subject to was not deducted, so she had a basis of $260,000 roughly.
When she conveyed that property to another person in a sale transaction, the government asserted and the court found that the basis... I'm sorry, that the non-recourse indebtedness was a part of what she received.
The difference between the cases is this.
Number One, there has been in the mortgage encumbrance case, the pre-existing indebtedness case, a realization by the taxpayer of a portion of the value of the property which the taxpayer is free to use or do with as he or she pleases.
In the net gift case, there never is a pre-existing obligation, and there never is an instance in which the taxpayer has a right to receive any cash to do with as the taxpayer pleases.
When you encumber property, you in effect withdraw a portion of the value of that property, and the cash that you get in that manner can be used for whatever purpose you choose.
That in our opinion is the difference between the Crane type transaction and the net gift involved here.
Unidentified Justice: If the donee were to pay the amount of the gift tax plus $100, how should that $100 additional amount be treated for tax purposes?
Mr. Beal: That would clearly be a taxable amount to the party.
That has... the receipt of that consideration would represent a conversion of that asset into cash, at least to that extent.
Unidentified Justice: Taxable at capital gains rates, presumably?
Mr. Beal: Yes, it would be.
Unidentified Justice: Could you tell me why would a donor structure his gift this way rather than himself making a net gift?
Say he is thinking of depleting his estate by the amount of $1 million, and he says the gift tax on this is going to be $200,000, so I will give the donee $800,000 and pay the tax.
Now, why does he not do it that way rather than give the donee $1 million and ask him to pay the tax?
Mr. Beal: Two reasons.
Unidentified Justice: Yes.
Mr. Beal: The first reason, and the one that applies in the Grant case, is that the donor does not have sufficient cash to pay the gift taxes herself, and she did not want to make a sale.
The family as a unit--
Unidentified Justice: Why didn't she want to make a sale?
Mr. Beal: --Because the--
Unidentified Justice: Because it would precipitate some capital gains tax?
Mr. Beal: --Well, that is not true in the Grant case.
It was because control of BMA Corporation was held, effective control of it was held by the Grant family, and they were not about to let any of that stock out of their hands--
Unidentified Justice: I see.
Mr. Beal: --if possible not to.
Unidentified Justice: So the donee would maybe have the cash.
Mr. Beal: And he could arrange for the cash himself, and he could arrange to service the debt.
The Hirst case involved a farm which the parties didn't... three pieces of land that they didn't want to sell.
Unidentified Justice: So he can raise the money on the farm.
Mr. Beal: Right, and she was not in a position to service the debt.
Unidentified Justice: So what is the other reason?
Mr. Beal: The second reason is that if a sale of the property is going to take place in any event, and the donee, the recipient is in a lower--
Unidentified Justice: Tax bracket.
Mr. Beal: --tax bracket, the sale of that property in his hands results in a lesser tax.
Unidentified Justice: Yes.
Mr. Beal: The overall income tax consequences is lower.
Unidentified Justice: The basis remains... there is no basis difference.
It is just a... it's a bracket difference.
Mr. Beal: Exactly right, and the problem that I have just... that you point out is true of an ordinary gift.
Unidentified Justice: Yes.
Mr. Beal: If the donor has enough cash to pay the tax and gives the stock to a donee who immediately sells it, with the exception of trusts, which are under a certain... a separate rule, they get the advantage of the lower tax bracket.
Unidentified Justice: Well, isn't there a new statute that limits the bracket advantage?
Mr. Beal: For trusts.
For transfers into trusts and sales which are made within two years after the transfer has been made, they in effect tax those as though the sale had been made by the donor.
Unidentified Justice: But not in a situation like this.
Mr. Beal: No, not in an outright... not in a net gift to an individual.
Unidentified Justice: Yes.
Mr. Beal: Or an ordinary gift to an individual, a bracket advantage would not be picked up.
That is... we assert there is Congressional recognition of only a limited necessity of adjusting on the bracket advantage.
I would like to give two examples, very quickly, on how this would operate in practice.
Let's assume that we have two taxpayers, A and B, each with $1 million in corporate securities which they want to transfer to their sons, who are running the businesses, as was the case in Grant; that Taxpayer A has a $300,000 basis in the property, and Taxpayer B has a $100,000 basis in the property; and that the taxes, the gift taxes imposed in each instance are $200,000.
Under the government's theory of taxation in this case, Taxpayer A, who has a $100,000 basis in that property, realizes a $100,000 capital gain, the difference between the $200,000 gift taxes paid by the donee and her $100,000 basis in the stock.
Taxpayer B, who has a $300,000 basis, realizes a $100,000 capital loss as a result of that transaction, which may or may not be recognizable through her return, but nevertheless it is a realized loss.
We submit that there is no policy of the Internal Revenue Code or the gift tax laws that dictates that that result should occur with two taxpayers who have exactly the same motivation for entering into the transaction.
Unidentified Justice: But the premise of your hypothetical is that the tax law is always a logical structure--
--and that is hardly the case.
It is an arbitrary one, of necessity, isn't it?
Mr. Beal: Yes, it is.
Unidentified Justice: And produces some very odd results sometimes.
Mr. Beal: It can in instances, yes, very definitely so, as Mrs. Grant found out in this instance, when the Commissioner of Internal Revenue said, you owe an income tax for having made a gift to your son.
It does... the interpretation of it does result in strange... The next point I want to go to is the nature of the gift tax, and why--
Unidentified Justice: Suppose... Before you go on, let me try a hypothetical.
I am not sure where this may be relevant.
Suppose in giving the gift to the son, said, now, you pay the... you pay the gift tax, but I can give you reasonable assurance that next year, or very soon I will reimburse you for whatever you paid with another gift.
Mr. Beal: --Well, under our view of the tax--
Unidentified Justice: I don't mean that IRS knew about this conversation, but suppose that was actually what he did.
Mr. Beal: --In that particular instance, the government would tax us on the donee's payment of the gift taxes, and would tax us again when he was reimbursed--
Unidentified Justice: As income?
Mr. Beal: --No, in the second instance there would be another gift tax imposed.
Unidentified Justice: It would be a gift tax, yes.
A gift tax.
And then you would have the same thing in a diminishing pattern, wouldn't you?
Mr. Beal: Exactly.
Unidentified Justice: Under the pattern in this case where the donee pays, on what amount does he pay a gift tax on?
Mr. Beal: The gift--
Unidentified Justice: The net?
Mr. Beal: --That's correct.
The gift tax is imposed upon the net amount.
It is exactly as though she had given only the extent of the difference between the two.
I want to reserve the balance of my time.
Chief Justice Burger: Very well.
ORAL ARGUMENT OF STUART A. SMITH, ESQ., ON BEHALF OF THE RESPONDENT
Mr. Smith: Mr. Chief Justice, and may it please the Court, the question presented in this case involves, as Mr. Beal has pointed out, the income tax consequences to the donor of a gift of low basis property on the condition that the donee pay the resulting gift tax.
In our view of the matter, the question implicates a fundamental principle of tax law deriving from both the statute and this Court's decisions.
Let me refer the Court, if I may, to Section 1001 of the Code, which is set forth at Page 5a of the appendix to our brief.
Subsection (a) defines the computation of gain or loss as,
"The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis."
et cetera, and Section... Subsection (b) of that section says,
"The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property other than money received."
Now, this is very fancy statutory language for the very obvious proposition that if you buy something for a dollar and you sell it for $1,000, your $1,000 is your amount realized under Subsection (b) and your basis is a dollar, and therefore your gain under Subsection (a) is $999.
Now, this case, in our view, is really nothing more than that transaction dressed up in lawyers' language.
Here the taxpayers in both cases had property which... for which they paid a very small amount.
It was family corporation stock.
In one case the basis was just a dollar a share, and in the other case it was also a very small amount.
They decided to give the stock to objects of their bounty, children, what have you, and as the Court knows from the recent opinion yesterday, there is a gift tax that complements the estate tax.
So there is a gift tax due, and the Code is very precise that the obligation to pay the gift tax is on the donor.
Section 2502(d), which is set forth at Page 8a of our appendix, says very explicitly,
"The tax imposed by Section 2501."
--that's the gift tax...
"shall be paid by the donor."
So the donors in this case, in these cases, the taxpayers, had a gift tax obligation.
Now, how is it... how is it arranged?
It was arranged that the transfer would be made on the condition that the donees would pay the resulting gift taxes.
Now, in our view, this payment of the gift tax by the donees is an amount realized just as if the... in economic terms, the donors sold the property to the donees for the amount of the gift taxes, because indeed it... these transfers were made on the condition... that is very important here, that they were made on the condition that the donees pay the gift taxes, and in fact, really explains Justice White's query as to why these... why this amount is tied in with sale or exchange.
It is tied in with sale or exchange principally because it is really an inextricable part of the transaction.
I am going to give you this property, and you are going to pay a sum of money that I owe X.
In this particular case, X happens to be the Internal Revenue Service, but it could well be the grocer--
Unidentified Justice: That isn't the question I asked, is it?
Mr. Smith: --I thought--
Unidentified Justice: I understand your theory for saying that there is a capital gain in this case, but what about when there is money?
Mr. Smith: --Well--
Unidentified Justice: When there is money, and he says to the donee, please pay the tax, and he does, and theoretically I thought your argument was that when he does that, he is paying off an obligation of the donor.
Mr. Smith: --Well, indeed--
Unidentified Justice: And is he?
Mr. Smith: --He is.
Unidentified Justice: And do you say there is an income consequence then?
Mr. Smith: He is, but the view of the transaction... these transactions that has been developed by the Commissioner over the year... over the years, and indeed it is for a very long time... We take issue with Mr. Beal's protestation that this is some new development.
This is really an old development.
But the view is that the consideration for the transfer was the payment of the gift tax.
Now, indeed, if I were to say, if the transaction would be A just gives the money, gives the stock to B, and then later on there is this gift tax, and no one knew about it at the time, and then A... and then A says, gee, I don't have the money to pay this, and B says, well, I am going to--
Unidentified Justice: I know, but--
Mr. Smith: --I am going to pay it--
Unidentified Justice: --the donor, the donor... As you say, let's remember this very important condition.
Mr. Smith: --Um-hm.
Unidentified Justice: The donor gives some money.
Mr. Smith: Um-hm.
Unidentified Justice: And he says, on condition, however, that you pay the gift tax that is due on this gift.
Mr. Smith: Oh, I see.
Well, that's... that's a variation on the transaction.
Unidentified Justice: Well, then, but Mr. Beal says that you would... you would not say that the donor had any income tax on that.
Mr. Smith: Well, if the donor... if the donor just gives the donee money to pay--
Unidentified Justice: He gives him $1 million on condition that the donee pays the gift tax.
That is what he does.
Just like in this case.
Mr. Smith: --Well, of course, then... then you don't have... well, I think we advert to that in--
Unidentified Justice: Well, is there... does the government there, then say that the donor realizes no income?
Mr. Smith: --No, there would be no... there would be no income if the donee... if the donee... if the donor, excuse me, gives the donee a sum of money and says, here, you pay the gift tax out of it.
Well, of course, that is really equivalent to the donor paying his gift taxes.
It is really just a kind of a circuitous way of... if you give someone $1 million and say, there will be gift taxes--
Unidentified Justice: And you think that... you think that is quite distinguishable from this case?
Mr. Smith: --Oh, absolutely, because here you have a situation where you have appreciated property--
Unidentified Justice: Well, the Tax Court certainly doesn't think so.
Isn't that the key to it, that the basis in the cash is not a very small amount?
Mr. Smith: --Well, there is--
Unidentified Justice: The basis in cash.
Mr. Smith: --The basis in cash is just--
Unidentified Justice: Just the amount of the cash.
Mr. Smith: --is just the amount of the cash.
The way we view this transaction, and I think it is quite appropriate in statutory terms, is that A decides to give appreciated stock to B on the condition that B pay his gift taxes.
He could have said, B, please pay my grocer, and B then dutifully says, well, how much is it, and it is $200,000, and that's an amount realized on the transfer, and that has to be netted out against the donor's basis in the property, and that is in one case $51,000, and the amount realized is the amount of the gift taxes.
That is just like a purchase price, essentially.
Unidentified Justice: You mean, exactly as if he said, I will sell you the $1 million worth of stock for $232,000?
Mr. Smith: Exactly.
It is part, you know... there are a lot of slogans that have--
Unidentified Justice: But that is--
Mr. Smith: --Exactly.
Unidentified Justice: --You say the transactions are no different.
Mr. Smith: The transactions are no different, and indeed in economic terms it is exactly what it is.
I have this stock, and I am going to give it to you if you... for $200,000, but please, don't give it to me because the Commissioner of Internal Revenue is waiting here in the wings, and I would like you to give it to him.
Now, the teaching of Old Colony is really a helpful--
Unidentified Justice: But not very relevant to this theory.
Mr. Smith: --Well, it... well, it is... it is relevant.
Unidentified Justice: Well, if it were, you would... you would... in the cash transaction, you would have income tax consequences.
Mr. Smith: Well, that's... that's true, but the point is, the way I would view that cash transaction, it's as if the donor pays the tax.
In fact, if I may refer the Court to Footnote 21 of our brief at Page 30, where we discuss the Krause case, in which the Tax Court stated there that if the donor had transferred cash in the amount of the gift tax, the use of the cash for the discharge of the gift tax liability would have not generated any taxable income.
This is true enough.
But the donor's transfer of tax is tantamount to his paying the gift tax himself.
That is the view.
I think it is a sound view of the transaction.
This is not that transaction.
Unidentified Justice: Mr. Smith, do you concede, though, that the intent of the donors in these cases was to make a gift, not a sale?
Mr. Smith: --Yes, I am sure that the intent of the donors here was to make a gift, but in our view, that intent is irrelevant.
The economic objective, economic consequences of the transaction have to be viewed objectively.
One commentator has put it really quite succinctly in a way that the court of appeals has quoted.
He has said,
"Terming the transaction a net gift does not alter the fact that despite the transferor's intention, he is actually transferring the entire property and receiving something in return."
"His intent that the transferee receive only a portion of the value of the property cannot eliminate that essential fact of economic life."
In our view, subjective intent is simply not relevant here, and I think that... you know, that kind of argument is well known to this Court's jurisprudence.
As long ago as 22 years ago, really, in Commissioner versus Duberstein, a celebrated tax case, the Court said, it scarcely needs adding that the parties' expectations or hopes as to the tax treatment of their conduct in themselves have nothing to do with the matter, and in our view--
Unidentified Justice: But that is not the same question as the parties' intent in engaging in the transaction without respect to tax consequences.
I mean, one can have an intent to make a gift--
Mr. Smith: --Oh, sure, sure, sure.
Unidentified Justice: --quite apart from one's expectations--
Mr. Smith: But I think that in this particular case, to say that, well, gee, all I wanted to do was to give a gift, and I didn't think that I was going to have to have income tax consequences, I didn't think of this as in income taxable transaction, I think that that is a level of unsophistication that really just doesn't wash with respect to... I mean, I don't think that has any relevance in determining what the income tax consequences are of the transaction.
I suspect that Mrs. Crane in the Crane case had no idea when she stepped away from her house for a very small amount of cash and had the buyer assume a mortgagee, and she really didn't have very much, that she in fact wound up having really a large taxable gain.
It's the same sort of thing.
I mean, one can only think of a case that this Court had several years ago, Commissioner versus Gordon, which involved a very complicated spin-off transaction, in which the court of appeals had analyzed it in much those terms.
Well, gee, you know, they just had pieces of paper in one corporation, and then they had them in another, and nothing really very much happened, and this Court very sharply said that these are statutory questions that have to be... these transactions have to be measured against statutory language.
And here, in our view, the concept of amount realized, and here, you have a transaction in which there is a transfer of property with a low basis for an amount realized which is as real as anything.
Paying the donor's gift taxes in this... in these cases is a... confers a very real and substantial benefit that is part of the consideration on the transfer.
Unidentified Justice: --Mr. Smith, why do you think the Tax Court has been so persistently wrong over the years?
Mr. Smith: Well, this... this is--
Unidentified Justice: Whereas in yesterday's case you felt it had been persistently right over the years.
Mr. Smith: --Sometimes they are right, and sometimes they are wrong.
But... Like all of us, I suppose.
Unidentified Justice: Yes, like the Commissioner.
Mr. Smith: Like all of us.
Unidentified Justice: Perhaps the answer is that the Commissioner's duty is to collect taxes, wherever he can get them.
Mr. Smith: Well, that... that is... that is true, but I think there... there are explanations as to why the... why the Tax Court has gone astray here.
If you examine the Turner case, I think one of the things that plagued the decision in that case was the Commissioner's quite unwise conception that the transfers to the trust in those cases didn't produce gain, but that the transfers to the individual donees did, and that involved quite a wrong theory that somehow the trustees didn't have personal liability.
So, the Tax Court could naturally say at that juncture, well, these transactions seem the same to us, and if the trust... if the transfers to the trust aren't taxable, why should the transfers to the individuals be taxable?
Not an unsound reaction, quite frankly.
So the Commissioner lost these cases, and then they were appealed, and I think the court of appeals really didn't consider the cases in any detail, so now you have Turner as a precedent.
Unidentified Justice: Mr. Smith, has the Commissioner's view been... just been a case by case situation, or is it... is it reflected in any regulation or revenue ruling?
Mr. Smith: It has been reflected in a long string of rulings which we cite, since 1957, in our brief, and it is also reflected in Section 1001-1(e) of the regulations which we cite, which talk about transfers of property and part sale and part gift.
The transferor has a gain to the extent that the amount realized by him exceeds his adjusted basis in the property, and that's exactly... I mean, there are a lot of slogans that come--
Unidentified Justice: Of course, that regulation really begs the question.
The question is whether it is part sale and part gift.
Mr. Smith: --Well, that... but I would submit to you that it really is here, because--
Unidentified Justice: Well, I understand.
Your... but that is what the case is all about.
Mr. Smith: --I would almost... and the taxpayer almost concedes that by saying, well, we only wanted to give this certain amount.
I mean, they have this very convoluted retained interest theory, which really... I mean, Mr. Beal in his brief at one point says, well, you know, the donor really held back some of the property, that is what it is tantamount to, to pay the gift tax, or the donee was paying it on behalf of the donor, but--
Unidentified Justice: Actually, the... and the... I guess you both agree, don't you, that in computing the tax you measure the difference between the amount of the tax and the value of the gift?
Mr. Smith: --Right.
Unidentified Justice: That is just--
Mr. Smith: In computing the gift tax.
Unidentified Justice: --In computing the gift tax.
Mr. Smith: Right.
Yes, there is a... there is a ruling which we agree is sound that has an algebraic formula for the computation.
Unidentified Justice: That raised this question with me.
You alluded to the possibility that the donor might give the property to a member of the family, and they just not think about the problem of paying the gift tax.
Mr. Smith: Um-hm.
Unidentified Justice: In that situation, the gift tax would have been larger, wouldn't it, if they just--
Mr. Smith: That's right.
Unidentified Justice: --And then supposing later on they say, oh, my gosh, we didn't think about this, we don't want Mother to pay the tax, and then the donee paid the tax.
What would happen in your view?
Mr. Smith: Well, I suppose on those kinds of facts one could possibly raise an inference that there was a gift back, but that is not this case, and it is not the... it is not the normal--
Unidentified Justice: Then the payment of the tax might be--
Mr. Smith: --I mean, I think... I think--
Unidentified Justice: --subject to gift tax rather than income tax.
Mr. Smith: --Right.
I think careful counsel would want to ensure that a donee, you know, if a donor wanted to shed his liability to pay the gift tax and to have it... to have it assured that it would be paid, I think careful counsel would make that a condition of the sale... I mean, of the transfer.
And once that is made a condition of the transfer, it seems to us that it really is amount realized for the transfer, just as--
Unidentified Justice: I understand.
But your view would be, if it is was not a condition of the sale, or the transfer--
Mr. Smith: --If it were not a condition of the sale, it would be... it might be--
Unidentified Justice: --then, if anything, the payment of the tax by the donee would be subject to gift tax.
Mr. Smith: --It might be a different case.
In fact, that was one... that was really one of the strands in the Hirst opinion in the Fourth Circuit.
It was one of the things that Judge Hainesworth said, that he thought it was a gift back, but it really isn't.
Unidentified Justice: So your... your--
Mr. Smith: --whatever... whatever that might have been, and I take issue, because the record there doesn't reflect any such, you know, any foundation for such a speculation, here, with the conditions really embedded in the agreement of the transfer, there really is no basis for making... for making such a--
Unidentified Justice: --So you are saying that the Commissioner has put a reasonable construction on the sale and exchange provision of the Code.
Mr. Smith: --Yes.
Unidentified Justice: And of his own regulations issued under it.
Mr. Smith: Yes.
I think that is perfectly appropriate.
This is a 25-year-old position.
It is not... it hasn't been dreamed up yesterday, and it seems to me absolutely sound, and I think the Commissioner's persistence in this area is due to the fact that the Tax Court has misconstrued this, and indeed, if... if... if courts could step away and have the luxury of writing on a clean slate, lower courts, I suspect the Tax Court might have already changed its mind, and really, it is that clean slate that this Court has an opportunity--
Unidentified Justice: How do you respond to your opposing counsel, Mr. Beal's explanation as to how the Commissioner has not taken a consistent position for 25 years?
Mr. Smith: --Well, Mr. Beal has... Mr. Beal has referred to another line of cases that we don't think are... is germane.
He has referred to a line of cases in which you have transfers to trust in which the donor has the income of the trust, you know, paid to him to pay the gift taxes.
We have won some of those cases and lost some of those cases on the basis of whether the trust... you know, the details of that kind of trust obligation.
But those cases, really, were decided under the so-called grantor trust provisions of the Internal Revenue Code, Sections 671 through 677, which deal with situations under what conditions a grantor of a trust can be charged with income taxes on the income of the trust, and of course in those instances where we have won those cases, the grantor has... or the donor has been charged with ordinary income, because in effect it is... he is deemed to be the owner of the trust's income.
But those cases don't have... those cases don't signal any inconsistency.
In fact, they simply reflect the Commissioner's responding to the particular kind of transaction.
Let me, if I may, you know, refer... we quote it in our brief in a footnote, but it is almost... it is almost worth setting it forth in just a few brief sentences.
In the Hirst case, which was the last major pronouncement of the Tax Court in this matter, Judge Raum wrote the opinion for the Tax Court, in which he felt bound... of course, the Tax Court, unless they are going to overrule one of their old decisions, is bound by them, and he felt bound by Turner and that progeny, but he said at the end that if he were going to write on a clean slate, they might really come out the other way because of the torturous, myriad details of the decisions in this area.
And he said, and I think with a good deal of candor and sound analysis,
"We recognize that there is much force to the government's position."
"The gift tax itself is imposed only upon the net gift, that is, upon the gross amount of the property transferred minus the gift tax paid by the donee."
"In substance, a portion of the transferred property equal in value to the amount of the gift tax is not treated as having been part of the gift, but surely that portion did not vanish into thin air, and a strong argument can be advanced for the conclusion that it was exchanged for the donee's payment of the gift tax on the net gift, a transaction that may result in the realization of gain or loss depending upon the donor's basis in the property."
We are making that strong argument here, and this Court has the unique and weighty responsibility to write on the clean slate that Judge Raum wishfully opined that he had.
And we urge that the court of appeals in these cases reached the sound result and should be affirmed.
Unidentified Justice: If the property had depreciated in value, and the donee agreed to pay some minor benefit to the donor at the time of the transfer, would you let the donor take a loss?
Mr. Smith: Whether the donor could take a loss or not really depends upon other Code provisions.
While a loss might be realized in such a situation, not every loss is deductible for income tax purposes.
If I may refer the Court to Section 165(c)(1) of the Code, (c)1, 2, 3, which lists a number of losses, kinds of losses that are not deductible.
For example, if you were to sell your personal residence at a loss, it would not be a deductible loss.
Unidentified Justice: But, Mr. Smith, under your regulation there is no loss, is there?
Don't you expressly--
Mr. Smith: --Under the regulation, there is... the regulation flatly says that there is no loss, but without going into that, I can simply say that in this particular case there would be no loss, in these particular cases, and in the typical net gift transaction there would be no loss, because Section 267 of the Code provides for a number of situations of intra-family transfers in which there is no loss.
If you sell... if a father sells property to a son, or any collateral relative like that, listed in that Code section, those losses are disallowed by statute.
So, there may be a loss for computational purposes, but there may not be a loss which is permitted to be recognized for income tax purposes.
Chief Justice Burger: Do you have anything further, Mr. Beal?
You have about four minutes.
You may complete before we rise.
ORAL ARGUMENT OF NORMAN E. BEAL, ESQ. ON BEHALF OF THE PETITIONERS -- REBUTTAL
Mr. Beal: Thank you very much.
Mr. Chief Justice, and may it please the Court, I would like to hit a couple of things real fast.
The government is asking for a per se rule that any time consideration is paid by a donee in connection with a gift, the donor recognizes taxable gain to the extent that consideration exceeds his adjusted basis in the property.
Section 2512(d) of the gift tax code provides that whenever property is transferred for less than an adequate and full consideration in money or money's worth, then the amount by which the value of the property exceeded the value of the consideration shall be deemed a gift.
The Commissioner is asking in this case that the corollary to 2512(d) be judicially adopted.
Congress saw fit and saw a necessity to adopt a specific provision making a part... making a sale in part a gift in an instance where there was less than full consideration.
Congress did not see any necessity to impose a similar income tax requirement in the situation where a gift does involve some payment of consideration by the donee.
If the... if there was a necessity to adopt 2512(d) in the first instance, then there has to have been a necessity, or it seems to us there is a necessity for there to be a corollary code, corollary provision in the Income Tax Code, and there is none.
Point Number Two.
There is no tax abuse involved in these transactions.
The only thing that is involved is a carryover basis which is a necessary part of any gift transactions, and the... and a potential for deferral of capital gains or deferral of gain in the hands of the donee, which is another integral part of a gift transactions.
Those aspects of an ordinary gift are the only instances in which there is "any tax gain" off of these transactions.
The third thing I want to hit is the nature of the gift tax itself.
The government, relying upon a provision of the gift tax code, states that it is a personal obligation of the donee.
The estate tax code and the gift tax codes are in pari materia.
The provisions... the interpretations of one apply to the other.
The gift tax... the estate tax code imposes the estate tax on the executor in language that is substantially identical to the language in the gift tax code, yet I don't think even the government would contend that in an instance where most of the property transfers through joint tenancies or through trust estates outside the probate estate, that we would impose an income tax consequence on the executor because the recipient of the property in the joint tenancy situation or as a recipient from a trust made payment of that federal estate tax.
That is exactly... that is the corollary, though, to the argument that the gift tax is the obligation of the donor.
The gift tax is a tax on the transfer.
It is an opportunity for the government to take a portion of wealth that is moving from one generation to another, and the importance of one party paying it as opposed to another party doesn't have any... doesn't have anything to do with the underlying policies for the gift tax and estate tax laws.
Unidentified Justice: That might be a very good argument to address to the Congress, the theory that you have just advanced.
Mr. Beal: Well, it seems to me that that theory is exemplified by the Congressional enactment of two provisions imposing a tax on a particular person for payment purposes, and yet in the one instance, when it is really the corresponding tax, it is not in any economic sense a tax of the executor.
It's a tax on that property that's going down by... by a death transfer, the movement of property from one generation to another.
Thank you very much.
Chief Justice Burger: Thank you, gentlemen.
The case is submitted.