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Commissioner of Internal Revenue v. Kann's Estate

decided: April 19, 1949.


Author: Biggs

Before BIGGS, Chief Judge, and MCLAUGHLIN and O'CONNELL, Circuit Judges.

BIGGS, Chief Judge.

Mrs. Bertha F. Kann, the decedent, sold certain securities to her children in return for their unsecured promises to pay her life annuities. The question presented for our determination is: Did the Tax Court err in holding*fn1 that the decedent realized no taxable gain under Section 111(a) of the Internal Revenue Code, 26 U.S.C.A. § 111(a), and the applicable regulation on the ground that annuity contracts undertaken by individual obligors do not have an ascertainable fair market value as a matter of law? The pertinent statute and regulation are in the margin.*fn2 See also Section 22 of the Internal Revenue Code, 26 U.S.C.A. § 22, set out in note 3.*fn3

As the Tax Court pointed out it is not necessary to decide whether the entire capital is to be recouped before any amount becomes taxable, J. Darsie Lloyd v. Commissioner, 33 B.T.A. 903; Frank C. Deering v. Commissioner, 40 B.T.A. 984, or whether a 3%*fn4 annual return on an investment computed at insurance company rates, Anna L. Raymond v. Commissioner 40 B.T.A. 244, affirmed 7 Cir., 114 F.2d 140, certiorari denied 311 U.S. 710, 61 S. Ct. 319, 85 L. Ed. 462, is to be charged as ordinary income under Section 22(b) (2) until the capital expended has been recovered. See Maude Gillespie v. Commissioner, 43 B.T.A. 399, reversed on other grounds, 9 Cir., 128 F.2d 140. The question at bar turns on the meaning to be ascribed to the phrase "fair market value" in Section 111(b) and the regulation.

The petitioner would have us change what we believe to be a salutary rule of law established by the Board of Tax Appeals in the Lloyd case, supra, that where both the annuitant's life span and the obligor's ability to pay are uncertain no fair market value should be ascribed to the contract or obligation. That rule was again enunciated in the Deering case, supra, and was viewed with approval in Bella Hommel v. Commissioner, 7 T.C. 992. To elaborate a little, the Tax Court has held in the instant case, as in the past, that where obligors are individuals, whether rich or poor, their obligations to pay in the future do not possess such standing as to come within the purview of the statute, that such obligations possess no value by way of ordinary business. It should be noted that this court took a similar view in Evans v. Rothensies, 3 Cir., 114 F.2d 958, and in Cassatt v. Commissioner, 3 Cir., 137 F.2d 745, wherein, it will be observed, the Commissioner took a position diametrically opposed to that which he seeks to maintain in the case at bar. See also Burnet v. Logan, 283 U.S. 404, 51 S. Ct. 550, 75 L. Ed. 1143. Like the Tax Court we think that there is little to be gained by giving up the principle, now well established, that an agreement by an individual to pay a life annuity to another has no "fair market value" for purpose of computing capital gain. In conclusion we state parenthetically that there is little in the record which can support the Commissioner's view that the transactions between Mrs. Kann and her children were ordinary arm's length business transactions. See the Raymond case, supra.

The decision of the Tax Court will be affirmed.

O'CONNELL, Circuit Judge (dissenting).

I agree with my brethren that the record before us offers little to support the assertion that decedent engaged in "ordinary arm's length business transactions" when she transferred to her children and their respective spouses the 1,120 shares of stock in return for their unsecured promises to pay her $24,672 per annum. The considerable doubt I have concerning the purported nature of the transactions dictates to me the appropriate action to be taken by this court on the tax liability of decedent on those shares of stock.

Decedent was 77 1/2 years of age at the time. Each of her eight children received an identical number of shares of the stock, and each made an unsecured promise to pay her $3,084 per annum. The stock was in a company over which her family had the controlling interest. The executed instruments themselves disclose that retention of family control over the company was an integral element in the transactions. That the value of the shares which she transferred was greater than that necessary to purchase the so-called annuity of $24,672 per annum is demonstrated by the fact that, the same year, she paid a gift tax on what was computed to be the $22,733.89 difference in value between the 1,120 shares of stock and what (according to the American Annuitance Mortality Table) was the total consideration necessary to derive annual installments of $24,672. There is still another indication of how decedent viewed the transactions: despite the provisions of Section 22(b) (2) of the Internal Revenue Code, calling for inclusion each year of 3% of the aggregate premiums paid for an annuity, decedent made no such inclusions in her tax returns after these transactions were consummated.

Perhaps an explanation, credible and consistent with an annuity motive, could be offered to show why the same arrangement was made with all eight children, and why no security was required of them; but the combination of all the circumstances outlined above, particularly the payment of a gift tax on what was reputed to be a "sale", seems to me to lead to no conclusion other than that an aged woman made what she believed to be an inter vivos disposition, substitutional of a testamentary one, of that part of her estate represented by the shares of stock.The facts are to me consonant only with the inference that, for federal tax purposes, what decedent really did was to create eight trusts, in each of which she made herself life beneficiary to the extent of $3,084 per annum.

That decedent and her children chose to designate the agreements as private annuity contracts can and should be no obstacle to an inquiry into the real nature of the transactions here involved. Indeed, decedent herself recognized the apparent absence of a bona fide sale when she accepted the Commissioner's valuation and paid the gift tax.

Consequently, as I analyze this case, neither Section 22(b) (2) nor Section 111 of the Internal Revenue Code is properly applicable, there being no sale or capital gain involved. In practical effect, decedent seems to me to have done no more than pass legal title to 1,120 shares, in return for a reserved life estate as to $24,672 per annum of the income therefrom, and a power to invade the corpus, if necessary, to supplement the income if less than $24,672 per annum. On principles not unlike those enunciated in Commissioner of Internal Revenue v. Tower, 1946, 327 U.S. 280, 66 S. Ct. 532, 90 L. Ed. 670, 164 A.L.R. 1135, and Lusthaus v. Commissioner, 1946, 327 U.S. 293, 66 S. Ct. 539, 90 L. Ed. 679, the Commissioner and the Tax Court should have pierced the window-dressing and determined whether the income from the 1120 shares was taxable to decedent under the provisions of Section 22(a) of the Internal Revenue Code, as long as she remained alive, the shares being part of her estate at her death. Cf. Commissioner of Internal Revenue v. Church's Estate, 335 U.S. 632, 69 S. Ct. 322, 337.

Under the view I take, questions of "fair market value" are immaterial at this stage of the proceedings. I would vacate the decision of the Tax Court and remand the cause for a determination of tax ...

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