dissenting: As a long-time continuing proponent of the view that the “on behalf of” standard of Q&A-9 applying section 1041 should be equated with the “primary and unconditional obligation” standard of traditional redemption tax law, see Arnes v. Commissioner, 102 T.C. 522, 531-542 (1994) (Beghe, J., concurring); Blatt v. Commissioner, 102 T.C. 77, 85-86 (1994) (Beghe, J., concurring), I have joined the dissenting opinions of Judges Ruwe and Halpern. However, I write on to express my own views of how the cases of Mr. and Ms. Read should be decided and to try to provide some perspective on the variety of expressed views about the decisions and their governing rationales.
Two preliminary observations are in order.
First, it is not accurate to say, as does the majority opinion: “Respondent’s role here is that of a stakeholder”1 (majority op. p. 25). Mr. Read and mmp have much more at stake than Ms. Read because the combined deficiencies of Mr. Read and MMP substantially exceed Ms. Read’s deficiencies:2 Ms. Read has already reported the interest portion of the deferred payments; Ms. Read’s only adjustments in issue stem from her failure to include the principal payments in taxable gain for 1989 and 1990. Mr. Read’s deficiencies arise from respondent’s inclusion in his ordinary income as dividends of both principal and interest payments on the stock purchase for 1988, 1989, and 1990.3 Mr. Read also suffers the indirect financial burden of the disallowance of the interest deductions claimed by MMP for the same years.4 I note, without further comment, as does the majority opinion (id.), that “respondent has indicated that ‘Ms. Read has the better argument that she should not recognize any gain from the sale of her stock pursuant to I.R.C. § 1041.’”
Second, about the procedural settings on appeal: An appeal in Ms. Read’s case would go to the Court of Appeals for the Ninth Circuit; Mr. Read’s appeal would go to the Court of Appeals for the Eleventh Circuit. Therefore, a whipsaw of respondent is not out of the picture, irrespective of how we decide the cases of Mr. Read and Ms. Read.5
It has been difficult to reach consensus about how to write up this case, much less decide it, because one or another of four different approaches might be used to determine the relationship of the “on behalf of” and “primary and unconditional obligation” standards. A summary and comment follow on each of the possible approaches.
(1) My continuing view is that the “primary and unconditional obligation” standard of traditional redemption tax law and the “on behalf of” standard of Q&A-9 should be construed and applied consistently; redemption tax law should govern the interpretation and application of the “on behalf of” standard. The correct application of this view in the case at hand would result in no taxable income to Mr. Read because he never had the primary and unconditional obligation to purchase the stock; he was entitled under both the settlement agreement and the divorce decree to lay his purchase obligation off on mmp, which he did. See Enoch v. Commissioner, 57 T.C. 781 (1972); Kobacker v. Commissioner, 37 T.C. 882 (1962); Rev. Rul. 69-608, 1969-2 C.B. 43, 44 (Situation 6). Furthermore, MMP became primarily and unconditionally obligated to purchase and pay for the stock, notwithstanding that Ms. Read became entitled to Mr. Read’s guaranty — his secondary obligation — and a pledge of the redeemed shares to secure the satisfaction of MMP’s obligation. See Bennett v. Commissioner, 58 T.C. 381 (1972); Edenfield v. Commissioner, 19 T.C. 13 (1952).
The Reads’ settlement agreement and divorce decree, which tied the amounts of Mr. Read’s obligation to make periodic alimony payments to initial and continued compliance with the provisions for payment for Ms. Read’s stock, did not saddle Mr. Read with the primary and unconditional obligation to purchase and pay for Ms. Read’s stock.6 The obligation to purchase and pay for her stock was assigned to and assumed by MMP as its primary and unconditional obligation. •
(2) Judges Laro and Marvel believe that Q&A-9 just does not apply to redemptions. Adoption of this approach could cause both individual parties to a redemption of the stock of a divorcing spouse to incur tax liability if they are not well advised. In most cases the departing shareholder ex-spouse would recognize capital gain on the transaction that terminates his or her stock interest. Whether the remaining shareholder ex-spouse has a dividend would depend on whether he or she is considered as having the primary and unconditional obligation to purchase the departing shareholder’s stock that was satisfied by the redemption.
If the remaining shareholder is considered to have had his primary and unconditional obligation to purchase the stock satisfied by the redemption, then under general principles of tax law the redemption should be recast as a purchase of the stock by the remaining shareholder, followed by his contribution of the stock to the corporation in exchange for the cash that he constructively received and used to purchase the stock. This recast transaction results in a distribution of cash essentially equivalent to a dividend to him under sections 301 and 302(b)(1), and the departing shareholder ex-spouse should be entitled to nonrecognition of gain under section 1041.
(3) In Judge Colvin’s view, the “on behalf of” standard of Q&A-9 trumps traditional redemption tax law. I don’t favor this view because it results in almost all cases under current law in a greater total tax liability to the private parties. Its adoption would mean that less will be available to pay off the departing shareholder ex-spouse.7 However, Judge Colvin’s view provides clear and consistent treatment of the ex-spouses and is preferable to the majority opinion. Adoption of Judge Colvin’s view by a majority of the Court would provide clear guidance as to how we would resolve the treatment of both private parties in this type of consolidated case.
(4) Maybe the “on behalf of” and “primary and unconditional obligation” standards, in a hard-fought consolidated case with no improvident concession by either private party, can be so applied that both ex-spouses escape tax.8 Both traditional redemption tax law and section 1041 reflect the same policy of facilitating transactions by removing tax impediments. Maybe respondent, instead of being a putative stakeholder, is left holding an empty bag! I don’t think so.
Some concluding thoughts: the parties’ motions and memos in the case at hand leave the impression that Mr. Read’s indication — he loses if Ms. Read wins — was based on what the majority opinion now tells the parties was their mistaken belief about the applicable legal standard. If we are not going to adopt the view that the “on behalf of” and “primary and unconditional obligation” standards are to be applied consistently, so that there need not be a winner and a loser as between the ex-spouses, then Mr. Read should not be bound by his “indication”. My objective in making this suggestion, against the background of what we said and did in Blatt v. Commissioner, 102 T.C. 77 (1994), Hayes v. Commissioner, 101 T.C. 593 (1993), and Arnes and our unsuccessful efforts to reach agreement in this case, is to resolve it in a way that will result in a holding on the merits of the cases of both ex-spouses that will provide comprehensive guidance for future cases. The parties and their counsel and the public and the tax bar, who are looking to us for guidance in this recurring situation, deserve no less.
Unfortunately, the majority opinion’s rejection of a rule of equivalence perpetuates the uncertainty. What “every schoolboy knows,” cf. State Pipe & Nipple Corp. v. Commissioner, T.C. Memo. 1983-339, about how to avoid constructive dividend treatment to the remaining shareholder under traditional redemption tax law will continue, as a result of the variety of views expressed, to fail to provide the guidance that the divorcing spouses and their advisers deserve and need.
I renew my pleas for guidance in the form of an interpretative regulation or a congressional fix. See Arnes v. Commissioner, 102 T.C. at 542 n.10.
Defined by Black’s Law Dictionary 1412 (7th ed. 1999) as: “A disinterested third party who holds money or property, the right to which is disputed between two or more parties.” (Emphasis supplied.)
The writer observed in Arnes v. Commissioner, 102 T.C. 522, 541 (1994) (Beghe, J., concurring):
Hewing to the bright line rules of Rev. Rui. 69-608, supra, ill the marital dissolution context will reduce the tax costs of divorce for the owners of small businesses held and operated in corporate form. If the shareholder spouses can negotiate their separation agreement with the assurance that the redemption will be tax free to the remaining shareholder and a capital gain transaction to the terminating shareholder, the overall tax costs will ordinarily be less than if the terminating spouse qualifies for nonrecognition under section 1041, but the remaining spouse suffers a dividend tax. This will leave a bigger pie to be divided in setting the consideration for the shares to be redeemed. [Pn. ref. omitted.]
Although for the years in issue in the cases at hand, long-term capital gain and ordinary income were subject to tax at the same rates, the writer’s observation in Arnes applies to more recent and current taxable years, in which long-term capital gains are subject to tax at lower rates than ordinary income.
Even in cases in which there are other remaining shareholders of the distributing corporation, treating the corporation’s payment to the departing shareholder ex-spouse as a distribution in redemption of the purchased stock to the remaining shareholder ex-spouse will cause the constructive distribution to be treated as a dividend to the remaining shareholder ex-spouse under sec. 301 rather than as a substantially disproportionate redemption under sec. 302(b)(2) qualifying as a distribution in payment in exchange for the stock under sec. 302(a), with resulting capital gain treatment. This is because the proportionate interest in the corporation of the remaining shareholder ex-spouse will always be increased as a result of the reduction in the number of outstanding shares that occurs by reason of the redemption.
Mr. Read has not put in issue respondent’s determination that he is liable to dividend treatment on the subsequent years’ payments of interest and principal on the note for years following the year the note was issued. Conceivably, the correct approach would have been for respondent to treat the fair market value of the note as a dividend distribution to him in the year of issuance, see Maher v. Commissioner, 55 T.C. 441 (1970), supplemented 56 T.C. 763 (1971), revd. and remanded 469 F.2d 225 (8th Cir. 1972); see also Bittker & Eustice, Fedei'al Income Taxation of Corporations and Shareholders, par. 8.23 (1999 Cum. Supp. 1), a year for which the period of limitation on assessment of a deficiency has expired. See also note 2 and accompanying text of the joint dissenting opinion of Judges Laro and Marvel. There is no occasion to comment on how that issue should be decided if Mr. Read had raised it in a timely fashion.
It is understood that Mr. Read has not raised the point — and it is not in issue in the cross-motions for partial summary judgment before the Court — that if the corporate payments are to be included in his gross income as constructive dividends, then he is entitled to deduct the interest portion of the payments as business interest. There is no occasion here to comment on this point, other than to observe that, under the analysis of the concurring opinion, the obligation to pay interest to Ms. Read would be the deemed obligation of Mr. Read, rather than that of the corporation. Cf. Seymour v. Commissioner, 109 T.C. 279 (1997).
Cf., e.g., Baptiste v. Commissioner, 100 T.C. 252 (1993), revd. 29 F.3d 433 (8th Cir. 1994), affd. 29 F.3d 1533 (11th Cir. 1994).
Even if the standard espoused by Judges Ruwe and Halpern and the writer should be adopted, a Judge adopting that standard might conclude that Mr. Read did not divest himself of the primary and unconditional obligation to purchase Ms. Read’s stock. The ground of that conclusion, with which the writer would disagree, is that the integration of and reciprocal relationship between Mr. Read’s alimony obligations and MMP’s continuing obligation to complete the scheduled payments in satisfaction of the obligation to purchase Ms. Read’s stock left Mr. Read with the primary and unconditional continuing obligation to purchase her stock.
See supra note 2.
There’s another way (a far-out fifth possibility): the Court could hold that both parties escape tax, which the Court has properly rejected. There is a view (disagreed with in the writer’s Arnes v. Commissioner, 102 T.C. 522 (1994) (Arnes II) concurrence) that the Court of Appeals for the Ninth Circuit, with whose views the Court expressed disagreement in Blatt and Arnes II, has indicated in Arnes v. United States, 981 F.2d 456 (9th Cir. 1992) (Arnes I), and Ingham v. United States, 167 F.3d 1240 (9th Cir. 1999), that it reads the “on behalf of” standard more expansively than the Court has been willing to do. The Court could have decided in favor of Ms. Read under Golsen v. Commissioner, 54 T.C. 742, 757 (1970), affd. 445 F.2d 985 (10th Cir. 1971), and decided in favor of Mr. Read by applying the “primary and unconditional obligation standard”, as Judge Halpem and the writer would do, or the view of Judges Laro and Marvel that the “on behalf of” standard of Q&A-9 does not apply to redemptions.