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. e du/thir dc ir c uit_1998/190Filed August 10, 1998

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 97-7313

JONATHAN B. GEFTMAN,

Appellant

v.

COMMISSIONER OF INTERNAL REVENUE

On Appeal from the United States Tax Court (T.C. No. 91-22392)

Argued: May 18, 1998

BEFORE: SLOVITER and GREENBERG, Circuit Judges , and POLLAK,* Senior District Judge

(Filed: August 10, 1998)

Steven M. Kwartin (argued) Raoul G. Cantero, III Adorno & Zeder, P.A. 2601 South Bayshore Drive, #1600 Miami, FL 33133

Attorneys for Appellant

___________________________________________________ ______________ *Honorable Louis H. Pollak, Senior Judge of the Uni ted States District Court for the Eastern District of Pennsylvania, sit ting by designation.Loretta C. Argrett

Teresa E. McLaughlin (argued) Ellen Page Delsole
Tax Division Department of Justice
Post Office Box 502 Washington, D.C. 20044

Attorneys for Appellee

OPINION OF THE COURT

GREENBERG, Circuit Judge.

I. INTRODUCTION

Appellant Jonathan Geftman ("Geftman") appeals from a decision of the United States Tax Court entered Mar ch 17, 1997, holding him liable for an income tax deficien cy and for additions to tax due to his failure to report a s taxable
income a distribution he received from a trust esta blished by his late father Raymond Geftman. The Tax Court e ntered its decision pursuant to its opinion filed Septembe r 30, 1996, as amended by an order of December 23, 1996. The Tax Court had jurisdiction under 26 U.S.C. #8E8E # 7442, 6213(a) and 6214 based on Geftman's timely filing o f a petition contesting a Notice of Deficiency issued t o him on July 3, 1991, pursuant to 26 U.S.C. S 6212. Appella te jurisdiction rests on 26 U.S.C. S 7482(a)(1). Venue is proper pursuant to 26 U.S.C. S 7482(b)(1)(A), as Geftman r esided within this Circuit when he filed his petition cont esting the notice of deficiency. For the reasons that follow, we will reverse the Tax Court's decision, thus vacating the tax deficiency and the additions to tax imposed on Geft man.

II. FACTUAL AND PROCEDURAL HISTORY

A. The Trusts

Raymond Geftman died on February 28, 1983, leaving a will which provided that its "primary purpose" was "to

2provide for the benefit of " his son Jonathan Geftm an, the

taxpayer-appellant in this case, who was 14 years o ld at the time of his father's death. The will further pr ovided that "[n]o action should be taken . . . which would unre asonably detract from [Geftman's] ability to receive the max imum income and principal to which he is entitled." The will established three trusts, designated A, B, and C, t o be funded from the residuary estate with Trust A recei ving 40 percent of the residuary estate and Trusts B and C each receiving 30 percent.

As specified in the will, Geftman was the sole bene ficiary of Trust C and the decedent's fiancee, Edith Kermer , was the sole income beneficiary of Trust B, while the i ncome beneficiaries of Trust A included the decedent's ac countant Steven Love, his real estate agent Warren Welt, his bookkeeper Paul Creedy, and several of their relati ves. The will named Love, Welt and Creedy, along with the decedent's attorneys, Terrence Russell and Jonathan Beloff, as personal representatives of the estate ("represe ntatives"), trustees of the trusts, and directors of Berkley Mo rtgage Corporation ("Berkley") and BOP, Inc. ("BOP"), real estate development enterprises the estate owned.

The will authorized the trustees to make distributi ons to
Geftman from Trust C's current income or from its principal, to the extent "necessary for his health, support, maintenance and education," including higher educat ion and the cost of establishing him in a business or profession. Geftman then would receive the remainin g principal of Trust C in installments beginning at a ge 30 or upon his admission to the bar, if earlier.

In contrast to these terms governing distributions to Geftman from Trust C, the will prohibited distribut ions from the principal of Trusts A or B, and provided t hat Trusts A and B were to make the specified distribut ions to their beneficiaries only to the extent that the tru sts had current net income after expenses.1 The remainders of Trusts A and B after these trusts had made all spec ified

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1. Several beneficiaries of Trust A were to receive distributions for life while the others were to receive distributions only until age 25.

3distributions were to be added to the principal of Trust C

for Geftman's benefit. See app. at 127-30.

B. The Margin Transactions

In August 1983 the estate funded the trusts by transferring tax-exempt municipal bonds worth approximately $3 million to brokerage accounts held in the name of the trusts through the E.F. Hutton and PaineWebber brokerage firms. See app. at 130-32. Be cause the estate had not settled all of its liabilities, the personal representatives required all beneficiaries of the t rusts to execute consents permitting the estate to recall al l trust assets to the estate as necessary to satisfy the es tate's obligations, even if the recall completely depleted the trusts.2

In December 1983 the estate entered into a Settleme nt Agreement resolving lawsuits pending against it. Du ring the same month, the trusts began brokerage borrowing on margin at rates of 11.50% to 13.25% using their mun icipal bond assets as collateral and transferring the fund s borrowed to the estate. See app. at 178-92; 131. Th e trusts borrowed $74,950.97 in December 1983, see app. at 1 54, $870,000 on January 5, 1984, see app. at 192, and $300,000 on January 9, 1984, see app. at 152, for a total of $1,244,950.97 by January 9. On January 17, 1984, the representatives met and issued the following memora ndum of their meeting:

The Settlement Agreement . . . was ratified.

. . .

The actions necessary to pay or transfer est ate assets needed for the settlement was also ratified, however, there was lengthy discussion on the issue as to the ratification of the borrowing from the stock broker by using trust assets as collateral as opposed to the sale of estate assets to pay the sums due for the settlement.
The action which had been taken to borrow wa s ratified, however it was acknowledged that P aul Creedy
had dissented from the decision to borrow fo r purposes

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2. Because Geftman was a minor, his mother executed his consent in her capacity as his legal guardian.

4of carrying out the settlement agreement, ho wever Paul

Creedy agreed to the ratification of the act ion.

App. at 135a. The estate received additional transf ers from the trusts during 1984 for a total of $2,850,408 as of August 31, 1984, which represented the maximum amou nt that could be borrowed on margin against the trusts ' $3 million municipal bond collateral. See app. at 131.

The trusts' E.F. Hutton account statements reflecte d the monthly interest which the broker charged on the ma rgin loans. On the statements for the months of April th rough July 1984, handwritten notations indicated that a p ortion of the margin interest charges was attributable to the amounts forwarded to the estate while a portion was
attributable to funds which the trusts lent to Edit h Kermer. See app. at 160-99. The loan to Edith Kermer was se cured by a first mortgage in favor of the trusts and was repayable pursuant to the terms of an installment note which provided for monthly payments of principal plus int erest at a rate of 1% above the rate charged to the trusts b y E.F. Hutton. See app. at 416.

On four occasions the estate paid the trusts an amo unt equal to the notation on the prior month's statemen t indicating the amount of margin interest attributab le to the estate. During the period from April through August 1984, the handwritten notations and corresponding payment s were as follows:

Statement Notation of Estate's Deposit Into
Date Share of Interest Account

4/84 $16,086 -- 5/84 $20,538 $16,086 6/84 $21,580 $20,538 7/84 $24,560 $21,580 8/84 -- $24,560

__________________________________________________

total $82,764 $82,764

See Geftman v. Commissioner, 72 T.C.M. (CCH) 816, 8 18 (1996); app. at 179, 181, 183, 185, 187.

C. The Mortgage Transactions

The representatives, including those who served as officers and directors of Berkley and BOP, met on

5September 5, 1984, regarding Berkley's and BOP's

condominium development ventures, including venture s known as "La Playa" and "Blue Grass." The represent atives determined that because a financing arrangement for the La Playa condominium development had fallen through , it was necessary for the trusts to sell their municipa l bonds and transfer the proceeds to Berkley and BOP. The b onds were sold for a capital loss of approximately $100, 000 and the proceeds were used to satisfy the margin debt o wed to E.F. Hutton. According to the memorandum of the September 5 meeting, the remaining proceeds from th e sale of the bonds were transferred to La Playa "as a dow n payment for the purchase of all new first mortgages . . . on the La Playa units." App. at 135a-b.

A memorandum dated February 4, 1985, indicated that the trusts had acquired the La Playa mortgages, alt hough Berkley would hold the title to them. The memorandu m stated that,

the prior action[s] taken with regard to Tru st A, B and C . . . were confirmed . . . . Approximately $2,000,000 in first mortgages at LaPlaya have been boug ht outright by the Trust . . . . Title to the m ortgages[was] taken in the name of Berkley Mortgage Corp. as collection agent for the Trust . . . . The b alance of Trust assets for approximately $1,000,000 has been used to buy mortgages from BOP, Inc. which were also taken in Berkley's name as collection agent.

App. at 135c. The trusts' books did not reflect a p urchase of the mortgages corresponding to the transaction d escribed in the February 4, 1985 memorandum. However, "adjus ting journal entries" recorded on June 11, 1985, after t he trusts' tax year ended on February 28, 1985, indicated that the trusts had received $2,029,390 in La Playa condomin ium mortgages from the estate as a "partial debt settle ment." Supp. app. at 40.3

A document entitled "Berkley Mortgage Corp. Accrued Interest and Principal Collections" set forth cumul ative

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3. The estate's tax year ended March 31 while the t rusts' ended February
28.

6totals of the principal and interest which Berkley received

on the La Playa and Blue Grass mortgages for the ta x year ended February 28, 1985, and for the "Ten Months En ded 12/31/85." The document indicated that Berkley had collected $90,595.81 in payments on mortgages at th e La Playa and Blue Grass developments, and attributed t hese amounts to the trusts. See supp. app. at 39. One of the representatives testified that the document was pre pared no earlier than December 31, 1985, ten months after th e end of the tax year. See supp. app. at 33.

Berkley intermittently transferred funds to the tru sts as
follows:

Oct. 17, 1984 $12,000 Nov. 9, 1984 $ 5,000 Jan. 4, 1985 $25,000 Jan. 29, 1985 $ 1,000 Feb. 5, 1985 $14,000 Feb. 14, 1985 $ 1,000 Feb. 20, 1985 $ 1,000

____________________________________ Total $59,000.4

The trusts recorded their receipt of these transfer s under an account entitled "Berkley Mtg. Co." App. at 384- 85.

On June 16, 1985, Berkley assigned the La Playa and Blue Grass mortgages to Ohio Savings Bank to secure a $1.8 million loan to Berkley and BOP. Berkley repre sented
that it was the "sole and lawful owner" of the mort gages "free and clear of any and all claims and liens," a nd that it possessed "the full right and lawful authority to d eliver, pledge, assign, grant, convey and transfer" the mor tgages as security for the loan. App. at 390.

On July 30, 1986, Ohio Savings Bank reassigned the mortgages to Berkley, and on August 15, 1986, Berkl ey sold the mortgages to Horowitz Finance Corporation and

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4. In the computerized general ledger the first two payments of $12,000 and $5,000, which were recorded separately in the h andwritten journal, were consolidated into one $17,000 payment. An addi tional $10,000 payment was recorded and then reversed, as it occur red after the end of the fiscal year. See app. at 382-88.

7Fleet National Bank. The closing documents identify

Berkley and BOP as the sellers and Horowitz and Fle et as the purchasers. Berkley and BOP used the proceeds o f the sale to satisfy the prior loan from Ohio Savings Ba nk. See app. at 398-407; 73. In December 1987 the estate fo rmally exercised its right to recall the assets it had con veyed to the trusts, and eventually recalled all trust assets du e to the estate's poor cash position. See app. at 135g-i.

D. Distributions and Tax Returns

The estate reported no distributable net income ("D NI") for fiscal years 1984 and 1985.5 For tax year 1984 the estate reported negative taxable income of $860,171 and incurred actual losses of $369,517. For tax year 19 85 the estate reported negative taxable income of $379,955 and incurred actual losses of $327,946.

The trustees, who were also representatives of the estate, did not file any Form 1041 Fiduciary Income Tax Ret urns and did not report any interest income for the tax year ended February 28, 1984. For the tax year ended Feb ruary 28, 1985, the trustees filed a Form 1041 for each o f the trusts, but filed them in February 1986, nine month s after they were due. The Form 1041 for Trust C reported t hat Trust C had received $101,890 in DNI during fiscal year 1985, consisting of Trust C's 30% share of the trus ts' taxexempt municipal bond interest and its 30% share of the
transfers made to the trusts in connection with the E.F. Hutton margin advances and the La Playa and Blue Gr ass mortgage holdings. Although the Form 1041 indicated that the entire $101,890 had been distributed to Geftman , only $46,936 actually was distributed while the rest rem ained in
an E.F. Hutton account to which neither Geftman nor his legal guardian had access. See app. at 135, 216-20. 6

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5. The Distributable Net Income of an estate or a t rust determines the amount that a beneficiary receiving a distribution from the estate or trust must include in the beneficiary's gross incom e. See 26 U.S.C. S 662(a). DNI generally consists of the taxable inc ome of the estate or trust, subject to certain modifications. See 26 U. S.C. S 643(a).

6. The Schedules K-1 attached to the Form 1041 for Trust A indicated that Love, Welt, and Creedy each received trust dis tributions of $13,136. See app. at 206-08.

8Geftman, who received only $2,620 in income apart f rom

the trust distribution, see app. at 126, did not fi le an income tax return for 1985. On July 3, 1991, the Commissioner of Internal Revenue ("Commissioner") i ssued Geftman a Notice of Deficiency finding him liable f or an income tax deficiency of $13,043 on the grounds tha t $48,693 of the $101,890 distribution reported on th e Form 1041 was taxable. The Commissioner also imposed
additions to tax due to Geftman's failure to file a return or pay estimated tax on the distributions. See app. at 137-39.

Geftman filed a timely petition in the United State s Tax Court contesting the asserted deficiency and additi ons to
tax. He contended that his entire distribution from Trust C, which the Commissioner now stipulates totaled $46,9 36 rather than $101,890, was non-taxable pursuant to 2 6 U.S.C. S 662(b) and Treas. Reg. S 1.662(b)-1 becaus e, contrary to the trustees' representations on the Fo rm 1041,
all of the income to Trust C was non-taxable. Accor ding to Geftman, the trustees had mischaracterized the tran sfers from the estate as taxable interest income paid to the trusts in their capacity as creditors in the margin loan transactions and as holders of the La Playa and Blu e Grass mortgages when in reality those transfers constitut ed nontaxable distributions to the trusts as beneficiarie s of an estate which did not have any distributable net inc ome. See 26 U.S.C. S 662(a).

E. The Tax Court Opinion

Following a three-day trial held in December 1995, the Tax Court issued a Memorandum Opinion dated Septemb er 30, 1996, rejecting Geftman's contentions and findi ng that
the transfers from the estate constituted taxable i ncome to the trusts. Geftman v. Commissioner, 72 T.C.M. (CCH ) 816 (1996). The court found that the $82,764 transferre d to the trusts in connection with the E.F. Hutton margin bo rrowing constituted taxable interest income arising from a bona fide debtor-creditor relationship between the estate and the trusts. Id. at 821. The court also found that the $ 90,596 in mortgage payments which Berkley collected on the La Playa and Blue Grass mortgages constituted interest incom e to the trusts because the trusts "clearly owned" the L a Playa

9and Blue Grass mortgages. Id. at 821-22. Thus, the court

concluded, because a portion of the income to the t rusts was taxable, a like proportion of the trusts' distr ibution to Geftman was taxable. See 26 U.S.C. S 662(b); Treas. Reg. S 1.662(b)-1.

Geftman filed a timely motion for reconsideration pursuant to Rule 161 of the Rules of Practice and Procedure of the Tax Court, pointing out that Berkl ey had transferred to the trusts only $59,000 of the $90,5 96 in mortgage income it had attributed to the trusts. In an order dated December 23, 1996, the Tax Court granted the motion, recognizing that the trusts had received on ly $59,000 of the $90,596 which the court had characte rized as mortgage interest income in its September 30, 19 96 opinion.

Based on this corrected amount, the Tax Court found that Trust C had earned $118,251 in distributable n et income and that 36% of this amount, consisting of T rust C's 30% share of the $82,764 margin loan interest a nd of the $59,000 mortgage interest, was taxable while th e remainder was non-taxable interest on the municipal bonds.7 Applying the character rule, which provides that a distribution from a trust is taxable in the same pr oportion that the trust's income is taxable, see 26 U.S.C. S 662(b); Treas. Reg. S 1.662(b)-1, the court found that 36% of Geftman's $46,936 distribution was taxable and issu ed a final order assessing an income tax deficiency of $ 2,638.00 and imposing additions to tax totaling $810.50 for Geftman's failure to file a timely return and pay e stimated

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7. The court computed these amounts as follows, bas ed on Trust C's
30% share of the trusts' net assets:

30% x $82,764 taxable margin transaction in come = $24,829 +30% x $59,000 taxable mortgage transaction income = $17,700

____________________________________________ ______ _______ total taxable income $42,529

total taxable income = $42,529 +30% x $252,406 tax-exempt municipal bond in come = $75,722

____________________________________________ ____ _______ net income to Trust C = $118,251

$42,529 taxable income ö $118,251 net incom e = 36%

See app. at 436-37.

10tax as required under 26 U.S.C. SS 6651 and 6654. S ee

app. at 436-38.8

Geftman timely filed this appeal. We review the Tax Court's factual findings for clear error, but exerc ise plenary
review of its conclusions of law. Fredericks v. Com missioner, 126 F.3d 433, 436 (3d Cir. 1997).9 The taxpayer bea rs the burden of proving the error in the deficiency asses sed against him. See Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 9 (1933); Cebollero v. Commissioner, 967 F .2d 986, 990 (4th Cir. 1992).10

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8. Thirty-six percent of Geftman's $46,936 distribu tion equals $16,897. The Tax Court calculated Geftman's tax liability on $16,428 but did not explain the $469 discrepancy. See app. at 436-37. H owever, the court's calculation of Geftman's ultimate tax liability is not germane to our analysis.

9. While the determinations as to whether the trans action gave rise to a
bona fide debt and whether the trusts owned the mor tgages could be considered to be findings of "ultimate fact," we ha ve held that "we no longer recognize the ultimate fact exception to the standard that factual findings are reviewed only for clear error." Pleasa nt Summit Land Corp. v. Commissioner, 863 F.2d 263, 268 (3d Cir. 1988) ( citing American Home Prods. Corp. v. Barr Labs., Inc., 834 F.2d 368, 370 n.2 (3d Cir. 1987)).

10. Geftman contends, br. at 17, that the burden of proof should have
been shifted to the Commissioner because Geftman de monstrated that the Commissioner's determination of a deficiency ar bitrarily and erroneously rested on a Form 1041 which inaccuratel y reported that Trust C had distributed $101,890 instead of $46,936 to him. See Cebollero v. Commissioner, 967 F.2d at 990; Portill o v. Commissioner, 932 F.2d 1128, 1133 (5th Cir. 1991); Anastasato v. Comm issioner, 794 F.2d 884, 887 (3d Cir. 1986). However, where the burden is shifted to the Commissioner, the Commissioner only need satisfy a burden of going forward by presenting some evidence of the taxpayer 's liability; the "ultimate burden of proof or persuasion remains wit h the Taxpayer." Anastasato, 794 F.2d at 887. Because the record con tains sufficient evidence to satisfy the Commissioner's burden of go ing forward, but more importantly clearly satisfies Geftman's ultima te burden of proving that the deficiency was assessed in error, we need not address Geftman's argument that the Tax Court improperly allocated hi m the burden of proof.

11III. DISCUSSION

A. Margin Interest Transactions

The Tax Court's conclusion that a portion of Geftma n's distribution from Trust C was taxable rested in sig nificant part on its finding that the $82,764 which the esta te paid to the trusts in connection with the margin advance s constituted taxable interest income which the trust s received in their "capacity as creditor rather than beneficiary of the estate." Geftman, 72 T.C.M. (CCH ) at 821. This finding, in turn, rested on the court's determ ination that the $2.85 million which the trusts transferred to the estate gave rise to a bona fide debt owed by the es tate to
the trusts. See id.

For "disbursements to constitute true loans there m ust have been, at the time the funds were transferred, an unconditional obligation on the part of the transfe ree to repay the money, and an unconditional intention on the part of the transferor to secure repayment." Haag v

. Commissioner, 88 T.C. 604, 615-16 (1987), aff 'd, 8 55 F.2d 855 (8th Cir. 1988) (table); accord Saigh v. Commis sioner, 36 T.C. 395, 419 (1961). In the absence of direct e vidence of intent, the nature of the transaction may be inf erred from its objective characteristics, see Haag, 88 T. C. at 616, including the presence or absence of debt instrumen ts, collateral, interest provisions, repayment schedule s or deadlines, book entries recording loan balances or interest payments, actual repayments, and any other attribut es indicative of an enforceable obligation to repay th e sums advanced. See Fin Hay Realty Co. v. United States, 398 F.2d 694, 696 (3d Cir. 1968).

Where, as here, the transactions occur between rela ted entities rather than at arms' length, they are "sub ject to particular scrutiny because the control element sug gests the opportunity to contrive a fictional debt." In r e Uneco, Inc., 532 F.2d 1204, 1207 (8th Cir. 1976) (citation s and internal quotations omitted). Thus, a transaction m ust be measured against "an objective test of economic rea lity" and characterized as a bona fide loan only if its"intri nsic economic nature" is that of a genuine indebtedness. Fin

12Hay, 398 F.2d at 697. In light of these principles, we must

consider whether the evidence as to the contemporan eous intent at the time of the transfers and the objecti ve attributes and economic realities of the transactio n between the trusts and the estate support the Tax Court's conclusion that the transactions gave rise to a bon afide

debt.

1. Contemporaneous Intent

The Tax Court acknowledged that a transfer will be
characterized as a bona fide loan if " `at the time the funds were transferred, [there was] an unconditional inte ntion on the part of the transferee to repay the money, and an unconditional intention on the part of the transfer or to secure repayment.' " Geftman, 72 T.C.M. (CCH) at 82 0 (quoting Haag, 88 T.C. at 616). The court found tha t the January 17, 1984 memorandum memorializing the lawsu it Settlement Agreement which referred to "borrowing f rom the stockbroker" by "using the trusts assets as col lateral" constituted evidence of the requisite intent. Id . at 821. We disagree.11

The "determinative fact is the intention as it exis ted at the time of the transaction." Saigh, 36 T.C. at 420 . While the Tax Court stated that the January 17 memorandum was "followed by" a transfer of funds from the trus ts to the estate, Geftman, 72 T.C.M. (CCH) at 821, it did not acknowledge that by the time of the January 17 meet ing, the trusts already had borrowed almost $1.25 millio n in brokerage loans and had transferred funds to the es tate with no statements from either entity as to the int ended
nature of those transfers. The Commissioner asserts , br. at 25, that the January 17 meeting merely "ratified" a n intention existing at the time of the initial trans fers. However, the memorandum of that meeting indicates t hat the issue of whether to borrow was the subject of"l engthy discussion" and "dissent" among the estate's representatives. Although the memorandum states tha t the

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11. The parties stipulated that this memorandum con stitutes the "only written evidence of indebtedness reflecting any deb t due from the Estate to the Trusts." App. at 134.

13representatives were able to agree by the end of th at

meeting, the ongoing dissent as of January 17 revea ls that the representatives had not formed the requisite
unconditional intention to enter into a debt transa ction as of December 1983 when the transfers began.

Courts have refused to credit statements of intent made
after the time of the transfer even where the state ments consist of formal resolutions establishing the prec ise terms of a debt. See Georgiou v. Commissioner, 70 T.C.M. (CCH) 1341, 1350-51 (1995). In Saigh, 36 T.C. 395, the co urt rejected the assertion that there was a debt becaus e funds had been transferred between a subsidiary and a par ent corporation and, as in this case, "at that time not hing was said concerning the nature of the transfer." Id. at 419. Although the transferor's directors then authorized a loan consisting in part of the sums already transferred and the transferee then executed a secured note payable to the transferor on demand at a specified interest rate, the court
found this evidence of intent insufficient as it wa s not contemporaneous with the initial transfer. As the c ourt explained, the parties had been undecided as to the nature of the transaction at its inception, and this indec ision "affirmatively dismisses the possibility that on th e date of
transfer there was an unconditional intention on th e part of

the transferee . . . and . . . the transferor to se cure repayment." Id. Similarly, in this case neither the trusts nor the estate expressed the requisite intent to enter into a loan transaction at the time of the initial transfer, an d the evidence that the estate's representatives remained undecided during the following month precludes us f rom finding that they had formed an unconditional inten tion as
the transfers commenced in December 1983.12

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12. The Commissioner asserts that one of the repres entatives testified
that "a loan . . . was intended from the outset." B r. at 29 (citing app.

at 15, supp. app. at 3-5, 10). The record does not sup port this assertion. The cited testimony simply describes the transactio ns in retrospect as "loans" and "borrowing" without clarifying whether the intent to borrow
existed at the time the transfers were made. Wefind nothing in the record suggesting that the intent to create an enfo rceable debt existed as

of December 1983.

14The Commissioner contends, br. at 28-29, that this case

is distinguishable from Saigh because any indecisio n at the January 17 meeting arose from uncertainty over whet her to proceed with a loan "as opposed to the sale of esta te assets," and therefore involved a debate between tw o distinct transactions, whereas in Saigh the parties were considering two different characterizations of the same transaction. Thus, the Commissioner argues, in cont rast to Saigh where the parties could have remained undecid ed while making the transfer, in this case the very fa ct of the transfer reveals that the estate had opted to borro w instead of selling estate assets. We find this distinction unpersuasive.

The mere fact that a transfer occurred does not est ablish
whether that transfer was intended as a bona fide l oan with the requisite unconditional intention to repay. See Haag, 84 T.C. at 616. While the transaction clearly did not entail a sale of estate assets, the fact that it involved a transfer is not sufficient to establish that the transfer may b e characterized as a bona fide loan for tax purposes. In the absence of any evidence that the transfer was inten ded at its inception to create an unconditional obligation to repay the sums transferred, we cannot infer that, simply because there was a transfer, a bona fide indebtedness was created.

Even if the intentions expressed in the January 17 memorandum could be viewed as reasonably contemporaneous with the initial transfer, those in tentions are not sufficient to support a finding of an inten t to create a bona fide debtor-creditor relationship between th e estate and the trusts. The memorandum's only allusion to borrowing refers to "borrowing from the stockbroker by using trust assets as collateral." App. at 135a. Th is statement reflects only the undisputed fact that si gnificant sums were borrowed from the stockbroker, E.F. Hutto n, and then advanced from the trusts to the estate. It does not illuminate whether the trusts, in transferring the borrowed sums to the estate, intended those transfers to be bona fide loans subject to an unconditional obligation to rep ay or whether the estate intended to be bound by an unconditional obligation to repay the advances. The January 17 memorandum, therefore, cannot be constru ed

15as evidence of a contemporaneous, unconditional int ent to

create a bona fide debt owed by the estate to the t rusts. Because this document constitutes the only evidence in the record purporting to express the intent behind the transactions, and because this document indicates t hat the requisite intent had not been formed at the relevan t time, the record cannot support the Tax Court's finding t hat the
estate and the trusts intended at the time of the i nitial
transfer to create an unconditional debt.

2. Objective Indicia of Indebtedness

The necessary intent to create a bona fide indebted ness can be inferred not only from expressions of the pa rties' intentions, but also from objective aspects of the transaction such as the presence vel non of notes o r other debt instruments, security or collateral, interest charges, repayment schedules or deadlines, book entries reco rding loan balances or payments, actual repayments, or an y other factors indicative of an unconditional obliga tion to repay. See Fin Hay, 398 F.2d at 696; Haag, 88 T.C. at 616. The Tax Court acknowledged that in transferring $2. 85 million to the estate, the trusts did not obtain a debt instrument or other written promise to repay, did n ot require any collateral or security, did not impose any interest charges, did not establish a repayment sch edule or maturity date, and did not make any entries on thei r books treating the transfers as loans. See Geftman, 72 T. C.M. (CCH) at 820-21. In concluding that the transfers nonetheless constituted bona fide loans, the court relied primarily on the fact that the estate had made $82, 764 in repayments to the trusts. See id. at 821. 13 Howeve r, upon analyzing the significance of these repayments and of the

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13. The court also characterized as "objective evid ence of indebtedness" the January 17, 1984 memorandum and a June 11, 1985 "adjusting journal entry" referring to a "partial debt settlem ent" with the trusts. Geftman, 72 T.C.M. (CCH) at 821. However, such"alle gedly objective . . . indicia" which merely represent a party's character ization of the transaction are unpersuasive "unless supported by o bjective factors demonstrating economic reality." Gilbert v. Commiss ioner, 74 T.C. 60, 65 (1980). Accordingly, we confine our analysis to the objective
characteristics of the transfer which bear on its a ctual terms.

16other objective attributes of the transaction, wefi nd that its

objective characteristics preclude us from upholdin g the Tax Court's conclusion that it gave rise to a bonaf ide debt.

a. Repayments

The Tax Court found that the estate's repayments to the trusts of $82,764 were indicative of a bona fide de bt. While the court described the repayments as interest "pai d to the

trusts . . . on loans from the trusts to the estate ," it recognized that the payments constituted "a portion of the margin interest charged on the trusts' loan from E. F. Hutton," as each of the four repayments corresponde d to handwritten notations on the prior month's E.F. Hut ton statement calculating the portion of the E.F. Hutto n interest charges attributable to the sums advanced to the estate. Geftman, 72 T.C.M. (CCH) at 821. The fact t hat the estate merely reimbursed the trusts for a portion o f interest charges that the trusts incurred from a third party belies
the court's conclusion that the trusts received the se payments in the capacity of a bona fide creditor. S ee id.14

Even if the trusts had not owed the $82,764 to the thirdparty lender that provided the capital in this tran saction,
but rather had received that sum from the estate an d retained it as repayment of principal or as payment of interest charged by the trusts themselves, repaymen t in

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14. The Commissioner asserts, br. at 34, that the e state was to pay the trusts enough to allow the trusts to make a profit after paying the interest charged by E.F. Hutton. The Commissioner c oncedes that no documents reflect such an arrangement, and relies s olely on testimony in which one of the representatives initially made the same assertion, but then, when questioned about the lack of records to that effect, acknowledged, "I have to be honest with you. . . . My recollection is it was done at a profit [for the trusts]," but if the records do not so reflect,
then the trusts were to receive "no less than dolla r for dollar" on the amounts they were charged by E.F. Hutton. App. at 1 9. This testimony does not support a finding that the trusts were to earn a profit on the
transactions. While the Tax Court found that the tr usts could not have made their monthly payments to E.F. Hutton unless t hey had received the payments from the estate, see Geftman, 72 T.C.M . (CCH) at 821, this fact does not elucidate whether the payments proper ly may be characterized as interest paid on a bona fide debt.

17that amount would be insufficient to support afindi ng of a

bona fide obligation to repay the $2.85 million tra nsferred to the estate, since repayments which are insubstan tial in
relation to the amount transferred are not indicati ve of a bona fide debt. In In re Uneco, 532 F.2d 1204, the transferee repaid $40,000 on a transfer of $193,090 ; $26,869 on a transfer of $227,571; and $120,728 on a transfer of $207,667, representing repayments of approximately 21%, 12%, and 58%, respectively, for an aggregate repayment of approximately 30% of the tot al amount advanced. The court found these payments
insufficient to establish that the transferee had a n unconditional obligation to repay the principal amo unt transferred. See id. at 1204. Thus, a fortiori, the repayments in this case of $82,764 on a transfer of $2.85 million, representing a repayment of only 3% of the total amount transferred, cannot be regarded as evidence of a bona fide obligation to repay the principal amount

transferred.

In Gilbert v. Commissioner, 74 T.C. 60, 65-66 (1980 ), the court held that even complete repayment of the amou nt
transferred was not indicative of a bona fide debt since the repayment occurred after a long period without repayments, and thus did not correspond to repaymen t
terms or schedules established at the outset of the transaction. The pattern of repayments in this case similarly does not reveal any established repayment terms or schedules, as the estate made the repayments onl y on four occasions from May through August 1984, making no other repayments during the period in which it rece ived

transfers from the trusts.

In Georgiou, 70 T.C.M. (CCH) at 1351, the court fou nd that repayments were not probative of a bona fide d ebt as they not only were "insubstantial in relation to th e advances" but also resulted in "[f]ailure to repay an ever mounting loan balance." In this case the insubstant ial repayments representing only 3% of the amount trans ferred similarly failed to reduce an ever-mounting loan ba lance resulting from the fact that the estate received ad ditional transfers of $746,902 during the months in which it made the repayments of $82,764. See app. at 184, 178.15 For

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15. The parties stipulated that "[t]he total borrow ing on margin as of August 31, 1984 was $2,850,408.34" and that "[a]ll funds that were

18these reasons, the repayments of $82,764 cannot be

regarded as evidence of a bona fide debt, in contra st to repayments that are "regularly made" and result in "an annual net reduction in the balance" by discharging "all stated interest charges" and a portion of the princ ipal. See, e.g., Litton Bus. Sys., Inc. v. Commissioner , 61 T .C. 367, 380 (1973).16 Thus, we find that the Tax Court erre d in characterizing the $82,764 repayments as evidence o f a
bona fide debt.

b. Other Objective Factors

The other objective characteristics of the transact ion are equally inconsistent with the existence of a bonafi de debt.
While the Tax Court noted that the transfers were n ot accompanied by any notes, interest charges, collate ral, repayment schedules, or book entries recording a lo an balance, the court found the absence of these facto rs

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borrowed on margin from E.F. Hutton . . . were tran sferred to the Estate from the Trusts." App. at 131. The E.F. Hutton Stat ements reflect a margin loan balance that increased from $2,103,506 as of May 1984 to $2,850,408 as of August 1984, see app. at 184, 178, for a total increase of $746,902 during that period. Several courts have refused to characterize a transfer as a bona fide loan where, as here, the transferor
did not establish a maximum loan amount but continu ed transferring funds at the transferee's request. See Haag, 88 T.C . 617; Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324, 1328-29 (1971), aff 'd, 496 F.2d 876 (5th Cir. 1974) (table); Roschuni v. Commissioner, 29 T.C. 1193, 1202-04 (1958), aff 'd, 271 F.2d 267 (5th Cir. 1959).

16. The Tax Court found that the trusts received ad ditional repayments when the estate transferred mortgages to the trusts as a "partial debt settlement." See Geftman, 72 T.C.M. (CCH) at 821. H owever, as discussed more fully below, the trusts never receiv ed any beneficial interest in the mortgages. Even assuming that the t rusts had acquired some interest in the mortgages, the June 11, 1985 d ocument making adjusting journal entries and characterizing the pu rported mortgage transfer as a partial debt settlement was contradic ted by contemporaneous documents describing that purported transfer as a purchase. See app. at 135c. Thus we find no evidenc e to support the assertion that the trusts received additional repay ments in the form of a mortgage transfer, and accordingly confine our anal ysis of the repayments to the $82,764 which the trusts actually received.

19insignificant on the grounds that such features wer e not

necessary in transactions between related parties. See Geftman, 72 T.C.M. (CCH) at 820-21. To the contrary
, however, cases examining transactions between relat ed parties have found the absence of such factors high ly significant and have characterized transfers as bon a fide loans only where the record contains sufficient obj ective evidence of an enforceable obligation to repay and a reasonable expectation of repayment.

In Baird v. Commissioner, 43 T.C.M. (CCH) 1173, 118 0- 81 (1982), the court recognized a bona fide debt be tween related parties because the transferee had executed promissory notes establishing a payment schedule an d charging interest at a rate of ten percent, and had delivered the notes to the transferor "prior to . . . receivi ng the checks," while the transferor had recorded the "disbursements on its books as loans." Similarly, i n American Processing & Sales Co. v. United States, 3 71 F.2d 842 (Ct. Cl. 1967), the court found sufficient evid ence of an "enforceable obligation to repay" and a "reasonable expectation of repayment" in a transaction between related corporations, inasmuch as the transferor held a lie n on the transferee's buildings and fixtures and both corpor ations recorded consistent, definite amounts due on the de bt. See id. at 845-46, 856-57.

Likewise, in Litton Bus. Sys., 61 T.C. 367, the tra nsferee corporation adopted a resolution prior to the trans fer authorizing the corporation "to borrow" from its pa rent corporation, and at the time of the transfer both t he transferor and transferee recorded the same "openin g balance" of the amount owed by the subsidiary. More over, the "indebtedness and its essential terms" were rec orded on the books of both companies and in "a substantial a mount of correspondence" which set forth "the existence o f a debt obligation, the amount thereof and payments thereon ,[and] the provision for interest." Furthermore, the inter est rate was "reasonable[ ] in light of the prevailing inter est rates in the financial community at that time," the"due date [was] within the control of the creditors," and there was a "reasonable expectation, at the inception of the [transaction], of repayment . . . based on the[tran sferee's] established financial history." See id. at 376-80.

20The Tax Court cited cases such as Baird, American

Processing, and Litton for the proposition that the absence of certain formalities may be excused when the tran sferor and transferee are related entities. See Geftman , 72 T.C.M. (CCH) at 820-21. The court failed to acknowledge, h owever, that although the courts in those cases did not req uire the presence of every possible indicium of indebtedness , they did not recognize a debt in the absence of all obje ctive indicia, but rather based their recognition of a de bt on numerous objective factors not present in this case . 17

While the foregoing cases demonstrate that the cour ts have required objective indicia of an obligation to support assertions of indebtedness between related parties, perhaps more significantly, numerous cases, including those relied upon by the Tax Court, have rejected assertions of indebtedness between related parties despite the pr esence of significant objective evidence that the transfer was intended as a loan. For instance, in Donisi v. Comm issioner, 26 T.C.M. (CCH) 327 (1967), aff 'd, 405 F.2d 481 (6 th Cir. 1968), the court rejected the assertion that a shar eholder's transfers to his closely held corporation were bona fide loans, although the transferee, prior to the transf ers, had adopted a formal resolution authorizing it to borro w from the transferor at specified interest rates, had com puted and recorded the interest owed on its books, and had ma de several payments designated explicitly as interest owed on
the loans. The court found these factors insufficie nt, inasmuch as the transferor did not require any "not es or other written evidence of indebtedness," and did no t establish a repayment schedule or obtain any collat eral although the transferee had assets "of a kind which

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17. Apart from Baird, American Processing, and Litt on, the Tax Court cited only one case that characterized a transfer b etween related parties as a bona fide debt. That case also relied on objec tive factors not
present in this case, such as a duly executed promissory no te and consistent treatment of the transfer on the parties' books and financial statements as "loan receivables." See Shaken v. Commissioner, 21 T.C. 785, 793 (1954). However, the Shaken court's conclusion that the transfers were loan repayments also rested in large part on an ana lysis of factors which
undermined the Commissioner's assertion in that cas e that the transfers constituted dividends, an analysis that is inapposi te in this case.

21normally are considered excellent security." Id. at 330.

Thus, in Donisi, although the parties had manifeste d an intent to create a loan through objective factors s uch as contemporaneously stated interest rates and book en tries consistent therewith, the court found it significan t that the transferor, like the trusts in this case, did not t ake readily available measures, such as obtaining notes or coll ateral, to ensure repayment.

In Georgiou, 70 T.C.M. (CCH) 1341, the court found that transfers from a corporation to its shareholder wer e not bona fide loans, although the corporation had obtai ned a security interest in the shareholder's assets, esta blished a fixed maturity date, charged the shareholder intere st, treated the transfers as loans on its books, and re ceived funds back from the shareholder which the corporati on explicitly designated as loan repayments. Despite t hese objective indicia of indebtedness, the court found that the transfers did not give rise to a bona fide debt, si nce there
was no indication that the shareholder intended to" enforce the debt against himself." Id. at 1351. Thus, contr ary to the Tax Court's finding that the relatedness of the par ties obviated the need for objective evidence of indebte dness, Georgiou demonstrates that even extensive objective evidence may be insufficient to establish the exist ence of a debt where the close relationship between the trans feror
and the transferee leaves the transferor discretion as to whether to enforce the debt, rendering any obligati on to repay conditional rather than unconditional.

Likewise, in Gilbert, 74 T.C. 60, the court rejecte d the
assertion that a transfer constituted a bona fide l oan although "the transfer was consistently treated as a loan on the books . . . and balance sheets of both corporat ions,"
"the check . . . included a notation that it was a loan," and the transfer subsequently was repaid in full. Id. a t 65. The
court found that the characterization of the transf er as a loan on these documents was unpersuasive, since the transferor did not charge interest, obtain a note, require collateral, impose a repayment schedule, or take ot her measures to ensure repayment. Moreover, the transfe ror had "borrowed the same money at interest" and had " no business purpose . . . to have subsidized" the tran sferee by

22" `loaning' the same funds without requiring the pa yment of

at least an equivalent rate of interest." Id. at 6 6. Finally, the transferee's financial difficulties, which raised d oubts as to
whether the transferee "would have funds available to repay," demonstrated that the transfer was economic ally unreasonable as a loan transaction and precluded th e court from recognizing a bona fide indebtedness. Id. Vir tually all of the factors that weighed against recognition of a debt in Gilbert are present in this case where the trusts b orrowed funds at interest, transferred them to the estate w ithout charging an equal rate of interest and obtaining no tes, collateral, or repayment schedules, and without any basis for believing that the estate would be in a positio n to repay
the funds transferred.18

The foregoing cases demonstrate that, contrary to t he view adopted by the Tax Court, the mere relatedness of the parties is not a sufficient basis to support charac terization of a transaction as a debt in the absence of object ive evidence of indebtedness such as notes, collateral, repayment schedules, interest charges, or other mea sures demonstrating an intent to secure repayment. Rather , these cases demonstrate that transfers between related pa rties
cannot be characterized as bona fide loans unless t he totality of the objective evidence reveals that the transferee had an enforceable obligation to repay the sums transferred. The transactions in this case, which d id not involve any notes, collateral, repayment schedule, interest charges, or book entries reflecting a loan, bear vi rtually none of the objective attributes which denote a bon afide

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18. The Commissioner argues, br. at 26-27, that Gil bert is distinguishable because in this case the trusts ear ned $82,764 in

interest whereas in Gilbert the transferor received no interest payments. This argument is circular, as the $82,764 cannot be characterized as interest earned by the trusts unless the trusts' $2 .85 million transfer to
the estate can be characterized as a bona fide loan based on sufficient objective indicia of an intent to secure repayment. The argument also is unsupported by the record, as the trusts did not ch arge any interest but merely recovered a portion of the E.F. Hutton inter est charges which they incurred in obtaining funds for the estate. Be cause the trusts recovered only a portion of the $133,627 in interes t they paid to E.F. Hutton, see app. at 328, they subsidized the transa ction, just as the transferor did in Gilbert, with no economic advanta ge to themselves.

23loan, and closely resemble transfers which the cour ts have

refused to characterize as a genuine loan because t he
transferor failed to take available measures to sec ure repayment.19 Accordingly, wefind that the objective
attributes of the transactions between the trusts a nd the estate cannot support the Tax Court's conclusion th at they gave rise to a bona fide indebtedness.

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19. The Tax Court cited several other cases which, like those discussed above, refused to characterize transfers between re lated parties as bona fide loans although they bore more objective attrib utes of a loan than did
the transfers in this case. See In re Indian Lakes Estates, Inc., 448 F.2d 574, 578-79 (5th Cir. 1971) (finding that transfer was not a loan in economic substance despite issuance of bonds withfi xed maturity dates and interest rates); Wood Preserving Corp. of Balti more v. United States, 233 F. Supp. 600, 605-07 (D. Md. 1964) (finding tha t advances were not bona fide loans, despite notation of debt in ledger , as transferee made no enforceable promise to repay and could not have obt ained such funds "from any reasonable banker on its own credit"), af f 'd, 347 F.2d 117 (4th Cir. 1965); Electric & Neon, Inc. v. Commissio ner, 56 T.C. 1324, 1328-29 (1971) (holding that disbursements, althoug h recorded on books as balance due and although partially repaid, were not bona fide loans absent notes, maturity dates or repayment sch edules), aff 'd, 496 F.2d 876 (5th Cir. 1974) (table); Astleford v. Comm issioner, 33 T.C.M. (CCH) 793 (1974) (finding that transfers were not b ona fide loans despite interest-bearing promissory notes, notes receivable account entered on books, and significant repayments), aff 'd , 516 F. 2d 1394 (8th Cir. 1975); Chism Ice Cream Co. v. Commissioner, 21 T.C.M. (CCH ) 25 (1962) (finding that transfer was not bona fide loan despi te ledger account entitled "note receivable" and eventual repayment o f entire balance, where no promissory notes were executed or delivere d, no interest was charged or paid, and no collateral was given), aff 'd, 322 F.2d 956 (9th Cir. 1963).

Notably, in each case cited by the Tax Court as wel l as in virtually every other case of which we are aware, it was the taxpayer who sought
to establish the existence of a bona fide debt whil e the Commissioner contested its existence. In this case, by contrast, the typical positions

are reversed and it is the Commissioner who seeks to pr ove the existence of a genuine indebtedness. The transfer, however, fall s far short of the
standards which the Commissioner has advocated and which the courts have adopted in the cases analyzing whether a trans fer constitutes a

debt.

24c. Economic Reality

Our conclusion that the contemporaneous intent behi nd and the objective attributes of the transaction dem onstrate
that the transaction cannot be characterized as a b ona fide
loan is consistent with the economic realities surr ounding the relationship between the trusts and the estate, as these
realities further demonstrate that the transfers di d not give rise to a reasonable expectation or enforceable obl igation of repayment. As we explained in Fin Hay Realty Co. v. United States, where "the same persons occupy both sides o f the bargaining table," the form of a transaction"does n ot necessarily correspond to the intrinsic economic na ture of the transaction, for the parties may mold it at the ir will" in order "to create whatever appearance would be of .

. . benefit to them despite the economic reality of the transaction." Fin Hay, 398 F.2d at 697. Accordingly , where
the same individuals control both the transferor an d the transferee, the transaction must be scrutinized acc ording to "an objective test of economic reality" to determin e its true
economic nature. Id.20

The Tax Court acknowledged that the " `same persons occup[ied] both sides of the bargaining table' " in this case
since the same individuals served as both trustees of the trusts and representatives of the estate. Geftman, 72 T.C.M. (CCH) at 821 (quoting Fin Hay, 398 F.2d at 697). As one trustee-representative explained, "[t]rustees, pers onal representatives, we did everything as one. I never separated it." When questioned as to whether the assets held by the trust belonged to the trusts or the estate, this tr usteerepresentative testified that he had "no idea." App . at 60- 61. However, having erroneously cited this common c ontrol as a basis for disregarding the absence of objectiv e indicia of indebtedness, the court did not undertake an ana lysis of

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20. The rule in Fin Hay accords with the general pr inciple that tax consequences must be determined not from "the form of the transaction," but rather from its "true substance." See Diedrich v. Commissioner, 457 U.S. 191, 195-96, 102 S.Ct. 2414, 2417-18 (1982); Commissioner v. Hansen, 360 U.S. 446, 461, 79 S.Ct. 1270, 1279 (1959); Trans-Atlantic Co. v. Commissioner, 469 F.2d 1189, 1193 (1972) (requiring that transaction amount to "debt in subs tance as well as in
form").

25the economic realities surrounding the transaction. See

Geftman, 72 T.C.M. (CCH) at 821.

In analyzing the nature of the advances from the tr usts to the estate, we cannot ignore the fact that the f unds which the estate purportedly "borrowed" from the tr usts were available only because the estate had funded t he trusts by making the municipal bond transfers just four months before the transfers back to the estate bega n. The
courts have refused to characterize transfers as de bts where the purported debtor conveyed its funds to an other entity over which it retained a degree of control o nly to
"borrow" the same funds back a short time later. Se e, e.g., Wilken v. Commissioner, 53 T.C.M. (CCH) 965 (1987) (transfers from trusts to taxpayers who had funded the trust were not bona fide loans, despite promissory notes bearing interest and mortgage securing repayment, s ince taxpayers had retained control over trust assets an d thus were `borrowing' their own assets in order to gener ate deductible interest payments); Ribisi v. United Sta tes, 51 A.F.T.R.2d (RIA) 83-961 (N.D. Cal. 1983) (transfers from trust to taxpayer were not a valid loan, despite pr omissory note, because taxpayer had used trust as "conduit" through which it cycled the funds purportedly borrowed), af f 'd, 746 F.2d 1487 (9th Cir. 1984) (table).

Nor can we disregard the degree of control which th e estate exercised over the trusts' assets by virtue of the fact that the estate retained the right to reclaim any a nd all trust assets for its own purposes at any time. Alth ough the estate did not directly and formally recall the $3 million municipal bond portfolio to the estate until 1987, it did so in economic substance during 1983 and 1984 by havin g the trusts borrow over $2.85 million against these assets worth $3 million and transferring the proceeds to t he estate with no promise to repay or collateral securing rep ayment. The Commissioner contends, br. at 32, that the tran sfers
should not be viewed as a de facto recall of trust assets
because the estate did not issue a formal recall un til well after the transfers were complete. This argument, h owever, focuses on the form which the representatives gave to the transactions rather than their economic reality. Be cause the transfers effectively conveyed back to the esta te

26virtually all of the equity in the trusts' assets, so that the

proceeds from the eventual sale of the bonds had to be used primarily to satisfy the margin debt incurred on behalf of the estate, the transfers in essence depleted th e equity in the trusts' portfolio and thus amounted to a de fac to recall.

While the estate's representatives did not characte rize the transactions as an asset recall, these individuals, who also
controlled the trusts and were beneficiaries of Tru st A, had every incentive to obscure the economic reality tha t the net
economic effect of the transaction was to return al l value of the trusts' assets to the estate, inasmuch as these
individuals were to receive distributions from Trus t A only to the extent that the trusts generated current net income. Although these individuals attempted to characteriz e the transaction as a profitable endeavor for the trusts in their capacity as creditors lending funds to the estate, because these individuals wielded the "power to create what ever appearance would be of . . . benefit to them despit e the economic reality of the transaction," Fin Hay , 398 F.2d at 697, we cannot accept this characterization which d oes not accord with the economic reality that the actual ef fect of the transaction was to transfer $2.85 million of th e equity held by the trusts back to the estate with no assur ance that the estate intended to repay these sums to the trusts.

A court may ascertain the true nature of an asserte d loan transaction by measuring the transaction against th e "economic reality of the marketplace" to determine whether a third-party lender would extend credit under simi lar circumstances. Scriptomatic, Inc. v. United States, 555 F.2d 364, 367-68 (3d Cir. 1977); see also Fin Hay, 398 F .2d at 697. It is clear that no reasonable third-party len der would have extended $2.85 million of credit with no promi se of repayment, no interest charges, no security, no rep ayment schedule, and no book entries recording a balance d ue, particularly if that entity did not have capital to lend but rather had to place its assets at risk to borrow th e funds at rates of up to 13.25% in order to transfer them to an entity
that offered no assurance that it would be in afina ncial position to repay the funds. See app. at 178-98. Be cause this was not a transaction that "the market would a ccept as debt," Scriptomatic, 555 F.2d at 368, wefind that i ts terms

27were defined by the relationship between the estate and the

trusts as donor and beneficiary and not as debtor a nd
creditor.21

The Commissioner argues that E.F. Hutton's willingn ess to lend the trusts funds which the trusts then tran sferred
to the estate demonstrates that the transaction bet ween the trusts and the estate was economically reasonable a s a debt transaction on the open market. See br. at 33. We disagree. E.F. Hutton lent funds to the trusts on t erms radically different from the terms on which the tru sts
advanced the same funds to the estate. E.F. Hutton secured its loans to the trusts with $3 million in municipal bonds as collateral, charged the trusts substantial amounts of interest, and collected payments monthly. The tr usts, by contrast, made no attempt to obtain a security inte rest in any of the estate's assets, although the estate had real estate holdings that might have served as collatera l. Moreover, the trusts did not charge the estate inte rest or require regular payments, but rather received only four payments in amounts that only partially reimbursed the trusts for the costs they incurred in borrowing fro m E.F. Hutton. Thus, the contrasts between E.F. Hutton's l oans to the trusts, and the trusts' transfers to the estate in fact
demonstrate that the latter transaction did not cre ate a debtor-creditor relationship.

Moreover, the terms on which the trusts transferred the funds to the estate differed not only from the term s on which third parties would lend those funds, but als o from
the terms on which the trusts lent funds to other r elated parties. Edith Kermer, a trustee and beneficiary of Trust B,

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21. We recognize that credit may be extended betwee n related parties on
terms that differ from those that would exist on th e open market. Thus, while the Commissioner is correct, br. at 33, that a transfer need not be profitable for the transferor in order to constitut e a bona fide loan, in this case the transfer was not merely unprofitable in the sense that it
did not generate any interest income for the trusts. Ra ther, it required the
trusts to incur substantial costs and risks to thei r assets with no reasonable expectation that even the principal amou nt would be repaid. Under the circumstances, which reveal no obligation to repay and no expectation of repayment, we cannot characterize th e transaction as a
bona fide extension of credit.

28obtained a loan from the trusts by executing a mort gage on

her home in favor of the trusts and a written agree ment to repay the trusts by certain dates at an interest ra te of one percent above the rate charged to the trusts by E.F

. Hutton. See app. at 416-19. The absence of comparab le terms surrounding the transfers made to the estate further
demonstrates that in economic substance these trans fers were not loans made with a reasonable expectation o f repayment, but rather were a conveyance of trust as sets back to an estate which effectively had exercised i ts right to reclaim such assets for its own purposes.

The economic realities surrounding the transaction, the objective features of the transfer, and the lack of contemporaneous unconditional intent to create an enforceable debt all support Geftman's assertion th at the
transactions between the trusts and the estate did not give rise to a genuine indebtedness. In the absence of a ny evidence establishing a bona fide debtor-creditor relationship between the estate and the trusts, we must reject as clearly erroneous the Tax Court's conclus ion that the $82,764 which the estate paid to the trusts con stituted taxable interest income earned by the trusts in the ir capacity as creditors rather than non-taxable distr ibutions received by the trusts in their capacity as benefic iaries of
an estate that had no distributable net income.

B. Mortgage Transactions

The Tax Court found that the trusts earned addition al taxable income in the form of interest paid on the La Playa and Blue Grass condominium mortgages. Although Berk ley, one of the estate's wholly owned corporations, held title to these mortgages and collected all mortgage payments , the court found that Berkley held the mortgages and pro cessed these payments merely as an agent or nominee for th e trusts who were the beneficial owners of the mortga ges. The
court based its conclusion that the trusts were the beneficial owners of the mortgages on an "adjusting journal entry" indicating that Berkley had transferred the mortgages to the trusts as a "partial debt settleme nt," and on a "work paper" attributing to the trusts the $90 ,596 in mortgage payments which Berkley collected. See Geft man,

2972 T.C.M. (CCH) at 821-22. Based on these documents , the

court found that the "trusts clearly owned the . .

. mortgages," so that the $59,000 which Berkley trans ferred to them constituted taxable interest income generat ed by those mortgages rather than nontaxable transfers fr om an estate with no distributable net income. See id. 22

While it is undisputed that Berkley held title to t he mortgages at all relevant times and did not formall y assign them to the trusts, the true ownership of the mortg ages and the proper attribution of the income derived th erefrom does not depend on legal title, but rather turns on "actual command over the property" and the right to receive the "actual benefit" that accrues from ownership. Frank Lyon Co. v. United States, 435 U.S. 561, 572-73, 98 S.Ct . 1291, 1298 (1978); accord Cepeda v. Commissioner, 67 T.C. M. (CCH) 2181, 2183-84 (1994), aff 'd, 56 F.3d 1384 (5 th Cir. 1995) (table). Accordingly, we must determine wheth er the trusts acquired "the benefits and burdens of the in cidents of ownership" of the mortgages based upon "the obje ctive evidence provided by the . . . overt actions" with respect to the mortgages. Cordes v. Commissioner, 68 T.C.M. (C CH) 356, 358 (1994) (citations omitted); accord Frank L yon Co., 435 U.S. at 572-73, 98 S.Ct. at 1298.

Upon analyzing these factors, we conclude that, con trary to the representations in the adjusting journal ent ry and the work paper, the objective evidence as to contro l over the mortgages and the income derived therefrom clearly demonstrates that Berkley and BOP retained all inci dents of beneficial ownership of the mortgages, precludin g reliance on the documents cited by the Tax Court.

1. Documentary Evidence

The Tax Court's conclusion that the trusts had acqu ired a beneficial interest in the mortgages rested in si gnificant

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22. The court initially found that the trusts recei ved $90,596 in mortgage interest income, consisting of the entire amount at tributed to the trusts on the work paper, but corrected its finding on rec onsideration in light of the stipulation that only $59,000 had been trans ferred to the trusts. See app. at 436-37.

30part on the June 11, 1985 "adjusting journal entry, " which

was prepared over three months after the trusts' ta x year ended on February 28, 1985. The adjusting journal e ntry refers only to the La Playa mortgages with no refer ence to the Blue Grass mortgages, contrary to the court'sfi nding that this document revealed the trusts' ownership o f both sets of mortgages. See supp. app. at 40. 23

Most significantly, however, records of Berkley and BOP prepared during the relevant tax year controvert th e adjusting journal entry's representation that owner ship of the mortgages had been transferred to the trusts. A document entitled "BOP, Inc. et al Schedule of Real Estate Holdings As of January 31, 1985" identifies BOP as the owner of the La Playa and Blue Grass mortgages whic h were titled to Berkley. See app. at 408-15. The sch edule, which contained numerous footnotes explaining the s tatus of various properties, contained no notation indica ting that the trusts held an interest in the La Playa or Blue Grass mortgages. While the Commissioner contends that the "et
al" after BOP's name could be construed to include the trusts, the Commissioner relies on the testimony of a representative who conceded that he had no knowledg e of what the "et al" meant. App. at 76-77. We reject th e Commissioner's suggestion that the schedule of BOP holdings can be construed as comprising assets owne d by the trusts, since the trusts undisputedly held a mo rtgage on the home of Edith Kermer, yet the Kermer mortgag e was not identified on the list of BOP's holdings. 24 Ac cordingly, we find that this document identifying BOP as the o wner of the mortgages one month before the end of the tax y ear precludes reliance on the "adjusting journal entry" which,

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23. The Commissioner contends that the adjusting jo urnal entry is supported by the minutes of a representatives' meet ing held September 5, 1984, stating that the mortgages had been "bough t outright" by the trusts. See app. at 135. While the September 1984 d ocument alludes to a mortgage transfer, the inconsistency as to whethe r the mortgages were purchased or were transferred to settle a debt unde rmines the
Commissioner's assertion that these documents accur ately describe a transaction that actually occurred.

24. The "et al" apparently refers to BOP's sister c orporation Berkley which held title to some of the properties identifi ed in the document.

31six months later, asserted that the mortgages had b een

transferred to the trusts during that tax year.

2. Objective Incidents of Beneficial Ownership

a. Transactions Involving the Mortgages

Even if Berkley and BOP had recorded consistent, contemporaneous documents stating that the mortgage s had been transferred to the trusts, such documents would be insufficient to establish the trusts' ownership of the mortgages for tax purposes unless the "objective ev idence" as to the "overt actions" with respect to the mortg ages, Cordes, 68 T.C.M. (CCH) at 358, demonstrated that t he trusts enjoyed "actual command" over the mortgages and the right to receive the "actual benefit" of owning them. Frank Lyon Co., 435 U.S. at 572-73, 98 S.Ct. at 129 8. The Tax Court, in relying on documents reflecting the p urported mortgage transfer, did not analyze the significance of the numerous overt acts in which the mortgages were ass igned, pledged and sold to third parties. The court thus f ailed to make the essential determination as to which party retained actual command over the mortgages and the right to receive the benefits of owning them. Upon examin ation of the overt acts involving the mortgages, it becomes apparent that, consistent with the schedule reflecting BOP's ownership of the mortgages, Berkley and BOP retaine d actual command over the mortgages and the benefits flowing therefrom.

Within five days of the June 11, 1985 journal entry reflecting the purported mortgage transfer, BOP and Berkley, acting jointly, pledged the mortgages to O hio Savings Bank to secure a loan and executed a "Colla teral Assignment" of the mortgages dated June 16, 1985, w hich they recorded in public records. In the course of t his transaction, Berkley and BOP held themselves out as the "sole and lawful owners" of the mortgages"free and clear of any and all claims" and possessing the "full right and lawful authority to deliver, pledge, assign, grant, convey and transfer" the mortgages. Berkley and BOP used t he proceeds of the sums borrowed against the mortgages for

32their own business activities, completing the proce ss of

hypothecating the mortgages with no participation o r authorization from the trusts. See app. at 389-97, 133, 29- 36, 43, 63-68.

One year later, Ohio Savings Bank reassigned the mortgages to BOP and Berkley in a written reassignm ent to them in their names, which they recorded in the pub lic records with no mention of the trusts. Shortly ther eafter, Berkley and BOP sold the mortgages to Horowitz Fina nce Corporation and Fleet National Bank, again represen ting themselves as the sole lawful owners, seeking no participation from the trusts, and using the procee ds for their own purposes. See app. at 29-38, 63-68, 41, 9 0, 398-
407.25

These transactions clearly demonstrate that, despit e the "adjusting journal entry" stating that the trusts o wned the mortgages, Berkley and BOP had full command over th ose assets and over the beneficial incidents of owning them, freely pledging them to obtain credit and selling t hem to raise cash for their own undertakings. Courts have refused to recognize purported asset transfers where the as sets remain within the control of the purported transfer or and remain subject to claims of the purported transfero r's creditors, as was the case here where Berkley and B OP continued to enter into transactions with respect t o the mortgages and pledged the mortgages to their credit ors. See In re Johnson, 88 T.C. 225, 236-37 (rejecting asser tion that
estate had transferred assets where assets remained sufficiently within control of estate that they"wou ld not be insulated from the claims of [its] creditors"), aff 'd, 838 F.2d 1201 (2d Cir. 1987); Donisi v. Commissioner, 26 T.C .M. (CCH) 327, 331 (1967) (disregarding asset transfer recorded

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25. Berkley and BOP used a large portion of the pro ceeds to satisfy their debt to Ohio Savings Bank and used the remainder to pursue their real estate endeavors. While one of the estate's represe ntatives asserted that the trusts had authorized the various dispositions of the mortgages, he conceded that all relevant documents referred only to the estate, Berkley and BOP. See supp. app. at 12-16. In light of the s ubstantial evidence of transactions carried out exclusively by Berkley and BOP, the record cannot support a finding that the trusts exercised any control over the decisions with respect to the mortgages.

33on books where purported transferor subsequently"to ok

out two loans using the [assets] as collateral"), a ff 'd, 405 F.2d 481 (6th Cir. 1968).26 Because Berkley and BOP retained all incidents of beneficial ownership incl uding the power to pledge the mortgages as collateral, sell t hem to third parties and retain the proceeds of these tran sactions while the trusts did not enjoy any of these inciden ts of ownership, we find that the objective evidence of a ctual control over the mortgages precludes a finding that the trusts were the true owners of the mortgages. See F rank Lyon Co., 435 U.S. at 572-73, 98 S.Ct. at 1298. 27

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26. The Commissioner contends, br. at 38, that this case is distinguishable from Johnson because Berkley paid t he trusts $59,000 of the income generated by the mortgages, thus providi ng an objective act to corroborate the purported transfer of beneficial ownership. We disagree. The very issue in dispute is whether the $59,000 transferred to

the trusts can be characterized as interest income generated by the mortgages, since in the absence of evidence that th e trusts owned and controlled the mortgages, the transfers from the es tate cannot be characterized as mortgage interest income. In this case, as in Johnson,
there is no evidence that the trusts assumed the ri ght to control the mortgages as suggested in book entries. Thus the tr ansfer of $59,000 is

immaterial.

27. The Commissioner argues, br. at 37-38, that the hypothecation and sale of the mortgages to third parties should be ac corded "minimal weight" because they occurred after the end of the relevant tax year. We disagree, and find Berkley's and BOP's complete con trol of the mortgages as of June 16, 1985, highly probative of the locus of control during the tax year ended February 28, 1985, especially since the record contains no indication of any intervening change in the stat us of the mortgages. The Commissioner's argument is particularly unpersu asive in light of the Commissioner's extensive reliance on the journal en try dated June 11, 1985, as evidence bearing on ownership during the t ax year ended February 28, 1985. The Commissioner also asserts th at Berkley's and BOP's dispositions of the mortgages are irrelevant because they involved "nothing more than transfer of bare legal title." B r. at 38. However, as the estate's representatives conceded, in pledging the mortgages as collateral to Ohio Savings Bank, Berkley and BOP pl aced the value of the mortgages directly at risk in the event of a defaul t, see app. at 47, 69- 70, 123, 170-71, and in selling the mortgages Berkley a nd BOP relinquished all control over them. There is nothing in the reco rd to support the assertion that these transfers involved only the ba re legal title of the
mortgages.

34b. Control Over Mortgage Income

Berkley's control over the revenues generated by th e mortgages further demonstrates that the trusts did not hold the incidents of beneficial ownership of the m ortgages. Contrary to the Tax Court's finding that Berkley me rely "serviced" the mortgages by collecting mortgage pay ments and forwarding them to the trusts, see Geftman , 72 T.C.M. (CCH) at 821, the record clearly demonstrates that Berkley retained exclusive control over the mortgage paymen ts which it collected without accountability to the tr usts. The only document indicating that Berkley collected the mortgage payments on behalf of the trusts consists of a single page, which the court described as a "work p aper," id. at 822, listing cumulative totals of the paymen ts made on the La Playa and Blue Grass mortgages through December 31, 1985, and through the end of fiscal ye ar 1985, and attributing these cumulative amounts to t he trusts. See supp. app. at 39. As one of the estate' s representatives conceded, the cumulative nature of this document reveals that it could not have been prepar ed before December 31, 1985, see supp. app. at 33, ten months after the close of the trusts' fiscal year.

In contrast to this document retrospectively attrib uting a cumulative amount to the trusts, the documents prep ared during the tax year in the ordinary course of Berkl ey's business did not attribute to the trusts any of the mortgage payments which Berkley collected. See app. at 329-3 4. These documents accounting for each mortgage paymen t received, with no reference to the trusts' purporte d interest therein, undermine the Commissioner's assertion tha t Berkley "accounted for the interest received on the La Playa and Blue Grass condominiums as having been received on account of the trusts." Br. at 37.28 In the absenc e of any

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28. In support of this assertion, the Commissioner cites only the "work paper" prepared after the end of the tax year and t he testimony of one of the representatives who conceded that he was"not familiar with the books" in which Berkley accounted for the mortgage payments it collected. App. at 78. This evidence cannot support a finding that Berkley accounted for the mortgage payments as havi ng been received on behalf of the trusts, particularly since the doc uments recorded during the tax year do not reflect such a practice.

35contemporaneous documents attempting to account for the

trusts' purported mortgage income separately from Berkley's other income, the single document retrosp ectively characterizing a cumulative amount as income to the trusts fails to establish that the trusts enjoyed a benefi cial interest
in that income.

Berkley's handling of the actual funds received fur ther
undermines the Commissioner's assertion that Berkle y merely processed payments belonging to the trusts. While Berkley collected regular monthly mortgage payments whose total amount increased steadily as additional condominium units were sold at the La Playa and Blu e Grass developments, see app. at 99, Berkley's trans fers to the trusts did not correspond to the amounts purpor tedly received on their behalf, but rather occurred at ir regular intervals and in haphazard, fluctuating, and someti mes nominal amounts, which, as Geftman accurately notes
, "bore no reasonable relationship to the regular rem ittance of monthly principal and interest payments which wo uld have been received by a legitimate mortgage servici ng company." Br. at 41.29

Significantly, Berkley forwarded to the trusts only $59,000 of the $90,596 which it later characterized as payments collected on behalf of the trusts. As representative Love explained, Berkley had no oblig ation to forward the mortgage payments to the trusts each mo nth, but rather remitted the money "as we saw fit, as we needed

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29. The transfers occurred as follows:

Oct. 17, 1984 $12,000 Nov. 9, 1984 $ 5,000 Jan. 4, 1985 $25,000 Jan. 29, 1985 $ 1,000 Feb. 5, 1985 $14,000 Feb. 14, 1985 $ 1,000 Feb. 20, 1985 $ 1,000

_______ Total $59,000.

Although the trusts' ledger contained accounts for recording interest income, the trusts did not record the $59,000 as su ch, but rather recorded this sum in an account simply entitled"Ber kley Mtg. Corp." See app. at 384-85.

36the cash to run the business." App. at 102. This te stimony

reveals that Berkley did not function merely as a n ominee or agent processing payments on behalf of its princ ipal, but rather was free to use the money it collected as it saw fit to further its own business purposes. Berkley's full c ontrol over the income from the mortgages demonstrates tha t Berkley, rather than the trusts, enjoyed this incid ent of beneficial ownership.

As the Tax Court acknowledged, "[t]he owner of prop erty is the one who will reap the benefits of ownership. " Geftman, 72 T.C.M. (CCH) at 822. In this case, the trusts did not hold title to the mortgages, did not partic ipate in transactions pledging them as collateral and sellin g them, did not receive any of the proceeds from those tran sactions, and did not have control over the monthly mortgage payments which Berkley collected and retained for i ts own business purposes, forwarding funds to the trusts o nly when it chose to do so. In light of this evidence t hat the trusts did not enjoy any of the incidents of benefi cial ownership of the mortgages and that the mortgages remained within the exclusive control of Berkley an d BOP, we find that the Tax Court clearly erred in conclud ing, based on an adjusting journal entry and a work pape r prepared well after the close of the tax year, that the trusts were the true owners of the mortgages. Because the trusts did not hold any beneficial interest in the mortgag es, we must reject the Tax Court's conclusion that the $59 ,000 transferred to the trusts constituted taxable mortg age interest income earned by the trusts as owners of t he mortgages rather than non-taxable transfers from an estate
that had no distributable net income.

C. Effect on Appellant's Tax Liability

Section 662(b) of the Internal Revenue Code provide s that
income which is taxable in the hands of a trust is taxable in the hands of the trust's beneficiary. Thus, when a trust receives both taxable and non-taxable income, the t rust's
distributions to its beneficiaries are treated as c onsisting of both taxable and non-taxable elements, in the same proportion as the taxable and non-taxable elements of the trust's net income. See 26 U.S.C. S 662(b); Treas. Reg.

37S 1.662(b)-1. The Tax Court found that 36% of the

distribution to Geftman was taxable, based on its
conclusion that 36% of Trust C's net income consist ed of taxable interest income generated by the margin transactions and the La Playa and Blue Grass mortga ges, while the remainder consisted of tax-exempt income earned on the trusts' municipal bonds. See app. at 436-38. 30

However, for the reasons discussed above, we find t hat the Tax Court erred in characterizing the transfers to the trusts of $82,764 in connection with the E.F. Hutto n margin transaction and $59,000 in connection with t he mortgages as taxable income. Because these amounts were not paid to the trusts as a bona fide creditor or a bona fide holder of the mortgages, the transfers can be chara cterized only as non-taxable distributions from an estate wh ich had no distributable net income, rendering all of the t rusts' income, and thus all of the distribution to Geftman , nontaxable. See 26 U.S.C. S 652(a); Treas. Reg. S 1.65 2(a)-2(b).

IV. CONCLUSION

For the foregoing reasons, we will reverse the Tax Court's decision holding Geftman liable for an income tax deficiency, as the distribution from Trust C which gave rise to the finding of a deficiency consisted entirely o f nontaxable income. Consequently, we will vacate the Ta x Court's imposition of additions to tax pursuant to 26 U.S.C. SS 6651 and 6654, as the court's application of the se provisions rested on its finding of an underlying i ncome tax liability. We will remand the matter to the Tax Cou rt for entry of a decision in accordance with this opinion and for such other proceedings as may be appropriate.

A True Copy:

Teste:

Clerk of the United States Court of Appeals
for the Third Circuit

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30. For an explanation of the calculations underlyi ng this 36% figure, see note 7, supra.

38