dissenting: The doctrine of stare decisis assures stability and equality of treatment — laudable objectives in our legal system. However, when a ruling of the Court is unsound, there is no merit in assuring taxpayers that such ruling will continue to be applied or that it will be applied to all taxpayers equally. This Court has recognized that when it becomes convinced that one of its decisions is unsound, it has the capacity to correct its mistakes. Focht v. Commissioner, 68 T.C. 223 (1977); Sylvan v. Commissioner, 65 T.C. 548 (1975). When I weigh the advantages of applying stare decisis and continuing to follow our decision in Estate of Bell v. Commissioner, 60 T.C. 469 (1973), against the consequences of holding that the entire gain is recognized in the year in which property is exchanged for a private annuity, I am of the view that we should reconsider and reverse our holding in Bell. For that reason, I must dissent.
Section 1001(a) provides that “The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis * * * for determining gain,” and section 1001(b) provides “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.” Whether the receipt of a promise to make future payments of money has a fair market value for such purposes has been a troublesome question. Over the years, it has been the position of this Court that the fair market value of an obligation is realized by a taxpayer using the cash method of accounting only if such obligation is the equivalent of cash, and that “In determining what obligations are the ‘equivalent of cash’ the requirement has always been that the obligation, like money, be freely and easily negotiable so that it readily passes from hand to hand in commerce.” Ennis v. Commissioner, 17 T.C. 465, 470 (1951). See Western Oaks Building Corp. v. Commissioner, 49 T.C. 365 (1968); Estate of Ennis v. Commissioner, 23 T.C. 799 (1955); Johnston v. Commissioner, 14 T.C. 560 (1950). In Warren Jones Co. v. Commissioner, 60 T.C. 663 (1973), the seller of property received a contract calling for future payments of money in satisfaction thereof. The Court found that such contract was transferable and had an ascertainable fair market value. However, to have made such a transfer, the seller would have been required to accept a discount of almost 50 percent. This Court concluded that when a discount of such magnitude is required, the obligation is not the equivalent of cash. On the other hand, when the Warren Jones Co. case was appealed to the Ninth Circuit (524 F.2d 788 (1975)), that court concluded that since the contract was transferable and since its fair market value was ascertainable, such value constituted an amount realized within the meaning of section 1001(b).
Before our decision in Estate of Bell v. Commissioner, supra, it was the position of this Court that when property was exchanged for an unsecured private annuity, the amount to be received by the annuitant could not be ascertained, and therefore, the actuarial value of the annuity was not required to be treated as an amount realized at the time of the exchange. Deering v. Commissioner, 40 B.T.A. 984 (1939); Lloyd v. Commissioner, 33 B.T.A. 903 (1936). Bell reversed that position; the Court said:
It would be manifestly inconsistent to find that the annuity contract had a fair market value for purposes of determining a taxpayer’s cost or investment in the contract under section 72(c), and yet to hold it had no determinable value for purposes of section 1001. [60 T.C. at 476.]
The Court also pointed out that the annuity promise was secured in that case.
In deciding how to treat private annuities under section 1001, we should, in my opinion, recognize that the annuity constitutes a peculiar type of obligation. Both in Bell and in the case before us, the promise to pay the annuity was secured, and for that reason, it is appropriate to deny the annuitant the privilege of recovering his basis before reporting any gain; it is appropriate to require him to begin to report some part of the gain as he receives the annuity payments. On the other hand, there is no certainty as to how much he will receive under the annuity arrangement or how much of the gian he will ultimately realize. In this case, the expected return on the annuity contract was actuarially computed to be $295,548.26; yet, 212 Corp. had no obligation to pay such amount. In fact, it was almost certain that the annuitants would receive more or less than that amount. At the time the Schultzes commenced to receive the annuity payments, there was no certainty that they would even receive payments in excess of their basis in the property.
Prior to 1954, Congress adopted a 8-percent formula in taxing annuities; annuity payments were included in gross income to the extent of 3 percent of the amount paid for the annuity. Any amounts received by the annuitant in excess of the 3 percent were considered to be the return of the annuitant’s capital and were excluded from gross income until the total amount excluded equaled the amount paid for the annuity.1 After the annuitant had recovered the amount paid for the annuity, the entire annuity payments were includable in gross income.
Under pre-1954 law, an annuitant who transferred appreciated property for an annuity recovered his basis in the property in the same manner as an annuitant who transferred cash in exchange for an annuity recovered his capital investment. Thus, annuity payments were included in gross income to the extent of 3 percent of the consideration paid for the annuity (the fair market value of the property transferred). The remainder was excluded from gross income until the total amount excluded equaled the annuitant’s adjusted basis in the property transferred. Subsequent payments, to the extent they exceeded 3 percent of the fair market value of the property transferred, were taxable as gain from the sale of such property, until the total of the payments so taxed equaled the gain. Thereafter, the payments were includable in full in gross income. Hill’s Estate v. Maloney, 58 F. Supp. 164, 174-175 (D. N.J. 1944); Rev. Rul. 239, 1953-2 C.B. 53.
In 1954, Congress eliminated the 3-percent rule, which had been criticized as erratic:
the annuitant finds that after being retired for a few years and becoming accustomed to living on a certain amount of income after tax, he suddenly has to make a sizeable downward adjustment in his living standard because, when his exclusion is used up, the annuity income becomes fully taxable. [S. Rept. 1622,83d Cong., 2d Sess. 11 (1954).]
Congress sought to eliminate this problem by enacting section 72, under which there is a proration of the cost of the annuity. A portion of each annuity payment is treated as a return of the annuitant’s cost (his “investment in the contract”) and is excluded from gross income; the remainder is treated as interest on the taxpayer’s investment.
When property is exchanged for a secured private annuity, it seems that under section 72, the gain should be prorated in a similar manner. Just as Congress decided that the recovery of the investment in the contract should be prorated in order to even out the tax consequences of receiving an annuity, it seems that the taxation of the gain should also be prorated for the same reason. By prorating the gain, the taxpayer is not required to report the entire gain in a single year; nor is he permitted to exclude the portions of the annuity payments attributable to the investment in the contract for some years and then become taxable wholly on such portions of the payments.
The suggested proration of the gain has been adopted by the Treasury regulations as the treatment for nonassignable2 annuities issued by charitable organizations. Section 1.1011-2(c), Income Tax Regs., in example (8)(c), provides that in the case of a bargain sale of appreciated property to a charitable organization in exchange for an annuity, the capital gain is to be reported ratably over the life expectancy of the annuitant. The capital gain is reportable out of that portion of the annual payments which constitutes a return of the annuitant’s investment in the contract under section 72. Annuities issued by charitable organizations generally are considered sufficiently comparable to annuity contracts issued by commercial insurance companies so as to justify the application of the same standard of valuation to both. Rev. Rui. 62-137,1962-2 C.B. 28; Raymond v. Commissioner, 40 B.T.A. 244 (1939), affd. 114 F.2d 140 (7th Cir. 1940), cert. denied 311 U.S. 710 (1940). It is difficult to justify a finding that a taxpayer who exchanges property for a private annuity (albeit a secured one) must report his entire capital gain in the year of the exchange, even though under the regulations, a taxpayer who exchanges property for a semicom-mercial annuity is entitled to report the gain ratably over his life expectancy.
In conclusion, this case presents an unusual situation: In Bell and in this case, the Court embraces a rule not sought by either party. In this case, the Commissioner did ultimately support the position of Bell, but he expressly stated that he was doing so to protect the revenue; it is clear that as a matter of principle, even he recognizes that such a rule is not advisable. Under these circumstances, it is clear to me that we should reconsider our position in Bell and adopt a different position.
Dawson, Tannenwald, Wiles, and Wilbur, JJ., agree with this dissenting opinion.Sec. 22(b)(2), I.R.C. 1939, provided in relevant part as follows:
Amounts received as an annuity under an annuity or endowment contract shall be included in gross income; except that there shall be excluded from gross income the excess of the amount received in the taxable year over an amount equal to 3 per centum of the aggregate premiums or consideration paid for such annuity (whether or not paid during such year), until the aggregate amount excluded from gross income under this chapter or prior income tax laws in respect of such annuity equals the aggregate premiums or consideration paid for such annuity. * * *
The annuity in the case before us was not assignable.