F I L E D
United States Court of Appeals
Tenth Circuit
PUBLISH
MAR 3 1998
UNITED STATES COURT OF APPEALS
PATRICK FISHER
Clerk
TENTH CIRCUIT
JULIAN P. KORNFELD,
Petitioner-Appellant,
v. No. 96-9016
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellee.
APPEAL FROM THE UNITED STATES TAX COURT
(T.C. No. 13169-95)
Submitted on the briefs:
Tom M. Moore and Clarke L. Randall of Kornfeld Franklin Renegar & Randall,
Oklahoma City, Oklahoma, for Petitioner-Appellant.
Richard Farber and Thomas J. Sawyer, Attorneys, Tax Division, Department of Justice,
Washington, D.C., for Respondent-Appellee.
Before SEYMOUR, Chief Judge, LOGAN and MURPHY, Circuit Judges.
LOGAN, Circuit Judge.
This appeal presents the question whether the Tax Court correctly relied on the
substance over form doctrine in determining that Julian P. Kornfeld (taxpayer) was not
entitled to a federal income tax deduction for amortization of a life interest in bonds that
he purportedly jointly purchased with his daughters and secretary, who took remainder
interests.
The legal right of a taxpayer to decrease the amount of what otherwise
would be his taxes, or altogether avoid them, by means which the law
permits, cannot be doubted. . . . But the question for determination is
whether what was done, apart from the tax motive, was the thing which the
statute intended.
Gregory v. Helvering, 293 U.S. 465, 469 (1935).1
I
When a taxpayer purchases a bond the normal rule is that the security is not
depreciable or amortizable for federal income tax purposes.2 5 J. Mertens, Law of
Federal Income Taxation § 23A.93 (1990). Instead the taxpayer has a cost basis in the
bond and when the bond matures or is called or sold the money received is treated as a
nontaxable return of capital to the extent of that basis. The interest paid while the
taxpayer holds the bond is taxable income unless, as here, it is tax exempt. See Internal
1
After examining the briefs and appellate record, this panel has determined
unanimously to grant the parties’ request for a decision on the briefs without oral
argument. See Fed. R. App. P. 34(f); 10th Cir. R. 34.1.9. The case is therefore ordered
submitted without oral argument.
2
In the case of a taxable--not a tax-exempt--bond, the amount of the amortizable
bond premium for the tax year may be allowed as a deduction. IRC § 171.
2
Revenue Code (IRC) § 1001. If the taxpayer owns the bond at his death its value is
included in his estate for federal estate tax purposes. Id. § 2033. If during his lifetime he
should transfer ownership of the bond by gift reserving income for his life the entire value
of the bond would still be included in his estate for federal estate tax purposes. Id.
§ 2036. Additionally, because the gift would be of a future interest the $10,000 per donee
annual gift tax exclusion of IRC § 2503(b) would not apply.
Taxpayer, an experienced tax attorney, apparently believed he found a way to
structure purchases of tax-exempt bonds to give him other income and estate and gift tax
benefits. His method was to enter into agreements (through a revocable trust he created)
with his daughters, Nancy and Meredith, to jointly purchase the bonds with taxpayer
buying a life estate and his daughters buying the remainder interests in the following
manner: Taxpayer ordered bonds from Prudential-Bache Securities Inc. which billed his
trust. Under the agreements with the remaindermen taxpayer determined the value of his
life estate based on Internal Revenue Service (IRS) estate and gift tax actuarial tables.
Taxpayer’s trust paid Prudential-Bache the value of his life estate interests. Taxpayer
contemporaneously sent checks to his daughters in the amount of the purchase price of
their shares. The daughters would then pay Prudential-Bache for the sum representing
their remainder interests.3
3
After the first transaction taxpayer became concerned about his daughter
Meredith’s precarious financial situation and he did not want her interests to be attached
(continued...)
3
After taxpayer executed two agreements, Congress amended the Code to provide
that “[n]o depreciation deduction shall be allowed . . . to the taxpayer for any term interest
in property for any period during which the remainder interest in such property is held
(directly or indirectly) by a related person.” IRC § 167(e). A “term interest in property”
is defined to include a life estate, and “related persons” includes taxpayers’ children. Id.
§§ 167(e), 267, 1001(e)(2). Taxpayer modified the later agreements so that rather than
purchase the entire remainder interest Nancy would purchase a second life estate to take
effect after taxpayer’s death; taxpayer’s secretary, Patsy Permenter, purchased the final
remainder interest with funds given her by taxpayer. Taxpayer reported the gifts to
Nancy, Meredith and Permenter on belatedly filed gift tax returns, claiming the $10,000
annual exclusion for each donee and using his lifetime exemption (unified credit) to avoid
paying any tax. See IRC §§ 2010 and 2505. The tax-exempt bonds at issue here had a
combined face value of $1,510,000. The actuarial value of taxpayer’s life estate based on
IRS tables was about $1,262,000.
3
(...continued)
by her creditors. Thus the second, third, and fourth agreements included Nancy but not
Meredith.
The bonds apparently were held in street name with no indication of the division of
ownership between the life tenant and the remaindermen. The agreements also provided
that evidence of ownership “may also be held by the First Interstate Bank of Oklahoma, as
custodian” in such names or forms “as the custodian shall deem appropriate and
convenient.” Ex. 4-D. The parties agreed to sell, assign, or pledge only on joint direction
of all parties, and to give to each other a right of first refusal at the valuations established
by the IRS regulations in the event any one sought to dispose of his or her interest.
4
We have only an income tax question before us. Taxpayer’s federal income tax
returns for the years 1990 and 1991 reflected tax-exempt interest income on the bonds of
$118,972 and $122,974, respectively. Taxpayer also claimed an amortization deduction
on his life estate in the bonds of $56,203.94 for each year. After an audit the
Commissioner disallowed the amortization deductions. Taxpayer petitioned the Tax
Court for a redetermination of the deficiency and before trial the parties stipulated to the
facts and presented the case on that fully stipulated record.
Relying on the substance over form doctrine, the Tax Court found that the taxpayer
had acquired the entire ownership interest in the bonds and then made a gift of the
remainder interests to his daughters and Permenter. Thus, the Tax Court upheld the
Commissioner’s determination that taxpayer was liable for income tax deficiencies of
$11,803 for 1990 and $13,122 for 1991.
II
Taxpayer first asserts we must review the Tax Court’s decision de novo because
the parties submitted the case to the Tax Court on a fully stipulated record, citing ABC
Rentals of San Antonio, Inc. v. Commissioner of Internal Revenue, 97 F.3d 392 (10th Cir.
1996). In ABC Rentals, we stated that “given the stipulated facts, the question of whether
the [rental] inventory fits into the exception [] presents a legal issue regarding application
and interpretation of [the applicable statute],” 97 F.3d at 395. We went on to note,
however, that even if the facts had not been stipulated, that case presented “a mixed
5
question of law and fact in which the legal issues predominate.” Id. at 395-96. In
contrast, in a case involving whether a transfer of contract rights was genuine, we said
that findings “as to what is substance in a transaction are to be treated as questions of
fact,” Wisebart v. Commissioner, 564 F.2d 34, 37 (10th Cir. 1977), and thus reviewed
under the clearly erroneous standard. See Anderson v. City of Bessemer, 470 U.S. 564,
574 (1985) (“Where there are two permissible views of the evidence the factfinder’s
choice between them cannot be clearly erroneous. . . . This is so even when the district
court’s findings do not rest on credibility determinations, but are based instead on
physical or documentary evidence or inferences from other facts.”). In the instant case,
although the facts were stipulated, the Tax Court was still charged with making ultimate
findings of fact as to the substance of the transaction. We do not need to determine which
standard of review is applicable here, however, because under either standard we hold the
Tax Court correctly disallowed the amortization deduction.
III
The taxation scheme set out in the Internal Revenue Code is complicated and the
tax consequences of many transactions depend on form, how the transaction is structured.
At the same time it has long been held that “[t]he incidence of taxation depends upon the
substance of a transaction. . . . To permit the true nature of a transaction to be disguised
by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the
effective administration of the tax policies of Congress.” Commissioner v. Court Holding
6
Co., 324 U.S. 331, 334 (1945). Ascertaining the “true nature” of the transaction while
adhering to neutral principles of statutory construction is often difficult. That is
exemplified by the instant case, in which the Tax Court opinion and the two others closest
factually--one relied on by taxpayer and the other by the Commissioner--were authored by
the same judge. Compare Gordon v. Commissioner, 85 T.C. 309 (1985) (where taxpayer
gave family trust funds to purchase remainder interests in bonds for which he purchased a
life estate, and claimed amortization deduction, Tax Court determined that in substance
taxpayer purchased the bonds and gave remainder to trust) with Richard Hansen Land,
Inc., 65 T.C.M. (CCH) 2869 (1993) (distinguishing Gordon because although corporation
was source of funds for shareholders’ purchase of remainder interests, the corporation
that purchased a term interest did not use shareholders’ bank accounts as “mere stopping
place” for funds).
There would be no doubt of taxpayer’s right to annual amortization deductions had
he acquired only a limited interest in the bonds in arm’s length commercial transactions in
which the remainder interests had been retained, or independently acquired, by persons
having no connection to taxpayer. A taxpayer may amortize a limited interest in property
if the “intangible asset is known from experience or other factors to be of use in the . . .
production of income for only a limited period, the length of which can be estimated with
reasonable accuracy.” Treas. Reg. § 1.167(a)-3. Here, however, one hundred percent
ownership of the bonds was acquired from or through Prudential-Bache in a market
7
transaction; but taxpayer presented no evidence that any brokerage firm would sell only a
life estate in the bonds. The division of the interests between taxpayer’s life estate and
the remainders was made by the separate agreements between taxpayer and his daughters
and secretary; the valuations were not determined by market forces but in accordance
with IRS valuation tables formulated for estate and gift tax purposes. The broker sent one
bill to taxpayer’s trust, and taxpayer calculated the respective shares based on the IRS
tables, and then immediately gave the remaindermen gifts of nearly the exact amounts
they needed to pay their shares. The parties stipulated that “[t]he purpose of these [gift]
checks was to provide Meredith and Nancy with sufficient monies to pay their respective
proportionate shares of the purchase price.” Doc. 14 at 7.
Taxpayer tries to focus the question before us on the cash nature of the gifts to the
daughters and secretary. He argues that they had sufficient independent assets to make
their proportionate payments, and that they were not legally obligated to use the money
gifted to them to make the payments for which they were obligated under their
agreements. Thus he would have the court treat the gifts as separate from the purchases
of the bonds, and he would have the court regard the remainder purchases in the bonds as
independent investor decisions.
The government has applied, and the Supreme Court expressly sanctioned, a step-
transaction doctrine to deal with purportedly separate transactions that the government
believes should be treated as integrated. See Commissioner v. Clark, 489 U.S. 726, 738
8
(1989). “Under this doctrine, interrelated yet formally distinct steps in an integrated
transaction may not be considered independently of the overall transaction. By thus
linking together all interdependent steps with legal or business significance, rather than
taking them in isolation, federal tax liability may be based on a realistic view of the entire
transaction.” Id. (quotation and citation omitted). In Associated Wholesale Grocers, Inc.
v. United States, 927 F.2d 1517 (10th Cir. 1991), we identified three step transaction
tests: “end result,” “interdependence,” and “binding commitment.”
Taxpayer essentially argues that the facts here meet the “binding commitment” test
because his daughters and secretary were not legally obligated to use his gifts to purchase
the bonds. But in Associated Wholesale Grocers we stated that this test is seldom
applied. See id. at 1522 n.6. We thus examine the facts under the other step transaction
tests. The “end result” test amalgamates into a single transaction separate events which
appear to be component parts of something undertaken to reach a particular result. Id. at
1523. The instant case would appear clearly to satisfy the “end result” test. The
“interdependence test” focuses on the relationship between the steps, whether under a
reasonably objective view the steps were so interdependent that the legal relations created
by one of the transactions seem fruitless without completion of the series. Id. Although
the gifts here could stand on their own without relation to the investments, it is difficult to
conceive that the parties would have made the investments as they did, or that they would
9
have agreed to the valuations between life estates and remainders, in the absence of the
gifts taxpayer made. Thus this case would seem to satisfy the “interdependence” test.
We conclude that the Tax Court properly characterized the transactions in the
instant case as impermissible attempts to create amortizable term interests out of
nondepreciable property. We agree with the Gordon opinion that “it is important to note
that what is involved in this case is a simultaneous joint acquisition of income interests
and remainder interests where the consideration moved to a third party who was not in
any way concerned with the arrangements between the joint acquirers. . . . [and that] it is
appropriate to take into account the fact that the participation of the acquirer of the
remainder interest is an essential element in affording the acquirer of the income interest
the opportunity to obtain the tax benefit of an amortization deduction.” 85 T.C. at 325.
We also agree with the Gordon opinion that where, as here, the “parties to the
transactions in question are related, the level of skepticism as to the form of the
transaction is heightened, because of the greater potential for complicity between related
parties in arranging their affairs in a manner devoid of legitimate motivations.” Id.
(quotation and citation omitted).4 Complicity among the parties is further supported by
the following: the parties established their respective purchase obligations by IRS tables
4
Although Permenter is not a natural object of taxpayer’s bounty in the same sense
as his daughters, she is his long time secretary, cotrustee of his revocable trust, and
taxpayer made contemporaneous gifts to her to enable the purchases of her remainder
interests. In such circumstances it is not inappropriate to treat her in the same category as
a related party.
10
that are only periodically adjusted and which reflect market values only in a general way;
the parties committed to acting jointly in disposing of their interests, agreeing that if one
wanted to sell he or she must offer to the others at the IRS table valuations; and that there
is no external manifestation of their separate ownerships (as would be the case of
recorded real estate deeds specifying term interests) to permit marketing of a limited
interest to outside parties. Cf. Schultz v. United States, 493 F.2d 1225 (4th Cir. 1974)
(brothers’ gifts of shares in closely held corporation to each other’s children were
reciprocal transactions made to enlarge gifts to own children and thus gift tax exclusion
was properly disallowed).
Finally, although there was no legal requirement that remaindermen would use the
gifts of money to purchase the bonds, taxpayer stipulated that his intention in making the
gifts was to enable the donees to make the purchases. We question the financial capacity
of at least some donees, noting taxpayer ceased making daughter Meredith a party for fear
her creditors might attach her interests. And there is no reason these remaindermen
would question making the investments when taxpayer was giving them the funds to
make their purchases. Expressed colloquially, one does not look a gift horse in the
mouth.
AFFIRMED.
11