1998 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

8-10-1998

Geftman v. Comm IRS

Precedential or Non-Precedential:

Docket 97-7313

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Recommended Citation

"Geftman v. Comm IRS" (1998). 1998 Decisions. Paper 190.

http://digitalcommons.law.villanova.edu/thirdcircuit_1998/190
Filed 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 United States District 

Court for the Eastern District of Pennsylvania, sitting 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 March 17, 

1997, holding him liable for an income tax deficiency and 

for additions to tax due to his failure to report as taxable 

income a distribution he received from a trust established 

by his late father Raymond Geftman. The Tax Court entered 

its decision pursuant to its opinion filed September 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 of a 

petition contesting a Notice of Deficiency issued to him on 

July 3, 1991, pursuant to 26 U.S.C. S 6212. Appellate 

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 resided 

within this Circuit when he filed his petition contesting 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 Geftman. 

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 

 2 
provide for the benefit of " his son Jonathan Geftman, the 

taxpayer-appellant in this case, who was 14 years old at 

the time of his father's death. The will further provided that 

"[n]o action should be taken . . . which would unreasonably 

detract from [Geftman's] ability to receive the maximum 

income and principal to which he is entitled." The will 

established three trusts, designated A, B, and C, to be 

funded from the residuary estate with Trust A receiving 40 

percent of the residuary estate and Trusts B and C each 

receiving 30 percent. 

As specified in the will, Geftman was the sole beneficiary 

of Trust C and the decedent's fiancee, Edith Kermer, was 

the sole income beneficiary of Trust B, while the income 

beneficiaries of Trust A included the decedent's accountant 

Steven Love, his real estate agent Warren Welt, his

bookkeeper Paul Creedy, and several of their relatives. The 

will named Love, Welt and Creedy, along with the 

decedent's attorneys, Terrence Russell and Jonathan Beloff, 

as personal representatives of the estate ("representatives"), 

trustees of the trusts, and directors of Berkley Mortgage 

Corporation ("Berkley") and BOP, Inc. ("BOP"), real estate 

development enterprises the estate owned. 

The will authorized the trustees to make distributions 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 education 

and the cost of establishing him in a business or 

profession. Geftman then would receive the remaining 

principal of Trust C in installments beginning at age 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 distributions 

from the principal of Trusts A or B, and provided that 

Trusts A and B were to make the specified distributions to 

their beneficiaries only to the extent that the trusts had 

current net income after expenses.1 The remainders of 

Trusts A and B after these trusts had made all specified 

_________________________________________________________________ 

1. Several beneficiaries of Trust A were to receive distributions for life 

while the others were to receive distributions only until age 25. 

 3 
distributions 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. Because 

the estate had not settled all of its liabilities, the personal 

representatives required all beneficiaries of the trusts to 

execute consents permitting the estate to recall all trust 

assets to the estate as necessary to satisfy the estate's 

obligations, even if the recall completely depleted the trusts.2 

In December 1983 the estate entered into a Settlement 

Agreement resolving lawsuits pending against it. During the 

same month, the trusts began brokerage borrowing on

margin at rates of 11.50% to 13.25% using their municipal 

bond assets as collateral and transferring the funds 

borrowed to the estate. See app. at 178-92; 131. The trusts 

borrowed $74,950.97 in December 1983, see app. at 154, 

$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 memorandum 

of their meeting: 

 The Settlement Agreement . . . was ratified. . . . 

 The actions necessary to pay or transfer estate 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 stockbroker 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 was 

 ratified, however it was acknowledged that Paul Creedy 

 had dissented from the decision to borrow for purposes 

_________________________________________________________________ 

2. Because Geftman was a minor, his mother executed his consent in her 

capacity as his legal guardian. 

 4 
 of carrying out the settlement agreement, however Paul 

 Creedy agreed to the ratification of the action. 

App. at 135a. The estate received additional transfers from 

the trusts during 1984 for a total of $2,850,408 as of 

August 31, 1984, which represented the maximum amount 

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 reflected the 

monthly interest which the broker charged on the margin 

loans. On the statements for the months of April through 

July 1984, handwritten notations indicated that a portion 

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 Edith Kermer. 

See app. at 160-99. The loan to Edith Kermer was secured 

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 interest at 

a rate of 1% above the rate charged to the trusts by E.F. 

Hutton. See app. at 416. 

On four occasions the estate paid the trusts an amount 

equal to the notation on the prior month's statement 

indicating the amount of margin interest attributable to the 

estate. During the period from April through August 1984, 

the handwritten notations and corresponding payments 

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, 818 

(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 

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

condominium development ventures, including ventures 

known as "La Playa" and "Blue Grass." The representatives 

determined that because a financing arrangement for the 

La Playa condominium development had fallen through, it 

was necessary for the trusts to sell their municipal bonds 

and transfer the proceeds to Berkley and BOP. The bonds 

were sold for a capital loss of approximately $100,000 and 

the proceeds were used to satisfy the margin debt owed to 

E.F. Hutton. According to the memorandum of the 

September 5 meeting, the remaining proceeds from the sale 

of the bonds were transferred to La Playa "as a down 

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, although 

Berkley would hold the title to them. The memorandum 

stated that, 

 the prior action[s] taken with regard to Trust A, B and 

 C . . . were confirmed . . . . Approximately $2,000,000 

 in first mortgages at LaPlaya have been bought 

 outright by the Trust . . . . Title to the mortgages[was] 

 taken in the name of Berkley Mortgage Corp. as 

 collection agent for the Trust . . . . The balance 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 purchase 

of the mortgages corresponding to the transaction described 

in the February 4, 1985 memorandum. However, "adjusting 

journal entries" recorded on June 11, 1985, after the trusts' 

tax year ended on February 28, 1985, indicated that the 

trusts had received $2,029,390 in La Playa condominium 

mortgages from the estate as a "partial debt settlement." 

Supp. app. at 40.3 

A document entitled "Berkley Mortgage Corp. Accrued

Interest and Principal Collections" set forth cumulative 

_________________________________________________________________ 

3. The estate's tax year ended March 31 while the trusts' ended February 

28. 

 6 
totals of the principal and interest which Berkley received 

on the La Playa and Blue Grass mortgages for the tax year 

ended February 28, 1985, and for the "Ten Months Ended 

12/31/85." The document indicated that Berkley had 

collected $90,595.81 in payments on mortgages at the La 

Playa and Blue Grass developments, and attributed these 

amounts to the trusts. See supp. app. at 39. One of the 

representatives testified that the document was prepared no 

earlier than December 31, 1985, ten months after the end 

of the tax year. See supp. app. at 33. 

Berkley intermittently transferred funds to the trusts 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 transfers 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 represented 

that it was the "sole and lawful owner" of the mortgages 

"free and clear of any and all claims and liens," and that it 

possessed "the full right and lawful authority to deliver, 

pledge, assign, grant, convey and transfer" the mortgages 

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, Berkley 

sold the mortgages to Horowitz Finance Corporation and 

_________________________________________________________________ 

4. In the computerized general ledger the first two payments of $12,000 

and $5,000, which were recorded separately in the handwritten journal, 

were consolidated into one $17,000 payment. An additional $10,000 

payment was recorded and then reversed, as it occurred after the end of 

the fiscal year. See app. at 382-88. 

 7 
Fleet National Bank. The closing documents identify

Berkley and BOP as the sellers and Horowitz and Fleet as 

the purchasers. Berkley and BOP used the proceeds of the 

sale to satisfy the prior loan from Ohio Savings Bank. See 

app. at 398-407; 73. In December 1987 the estate formally 

exercised its right to recall the assets it had conveyed to the 

trusts, and eventually recalled all trust assets due to the 

estate's poor cash position. See app. at 135g-i. 

D. Distributions and Tax Returns 

The estate reported no distributable net income ("DNI") 

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 1985 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 Returns 

and did not report any interest income for the tax year 

ended February 28, 1984. For the tax year ended February 

28, 1985, the trustees filed a Form 1041 for each of the 

trusts, but filed them in February 1986, nine months after 

they were due. The Form 1041 for Trust C reported that 

Trust C had received $101,890 in DNI during fiscal year 

1985, consisting of Trust C's 30% share of the trusts' 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 Grass 

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 remained in 

an E.F. Hutton account to which neither Geftman nor his 

legal guardian had access. See app. at 135, 216-20.6 

_________________________________________________________________ 

5. The Distributable Net Income of an estate or a trust determines the 

amount that a beneficiary receiving a distribution from the estate or 

trust must include in the beneficiary's gross income. See 26 U.S.C. 

S 662(a). DNI generally consists of the taxable income 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 distributions of $13,136. 

See app. at 206-08. 

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

the trust distribution, see app. at 126, did not file an 

income tax return for 1985. On July 3, 1991, the 

Commissioner of Internal Revenue ("Commissioner") issued 

Geftman a Notice of Deficiency finding him liable for an 

income tax deficiency of $13,043 on the grounds that 

$48,693 of the $101,890 distribution reported on the 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 States Tax 

Court contesting the asserted deficiency and additions to 

tax. He contended that his entire distribution from Trust C, 

which the Commissioner now stipulates totaled $46,936 

rather than $101,890, was non-taxable pursuant to 26 

U.S.C. S 662(b) and Treas. Reg. S 1.662(b)-1 because, 

contrary to the trustees' representations on the Form 1041, 

all of the income to Trust C was non-taxable. According to 

Geftman, the trustees had mischaracterized the transfers 

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 Blue Grass 

mortgages when in reality those transfers constituted nontaxable distributions to the trusts as beneficiaries of an 

estate which did not have any distributable net income. 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 September 

30, 1996, rejecting Geftman's contentions and finding that 

the transfers from the estate constituted taxable income to 

the trusts. Geftman v. Commissioner, 72 T.C.M. (CCH) 816 

(1996). The court found that the $82,764 transferred to the 

trusts in connection with the E.F. Hutton margin borrowing 

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 income to 

the trusts because the trusts "clearly owned" the La Playa 

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

concluded, because a portion of the income to the trusts 

was taxable, a like proportion of the trusts' distribution 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 Berkley had 

transferred to the trusts only $59,000 of the $90,596 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 only 

$59,000 of the $90,596 which the court had characterized 

as mortgage interest income in its September 30, 1996 

opinion. 

Based on this corrected amount, the Tax Court found

that Trust C had earned $118,251 in distributable net 

income and that 36% of this amount, consisting of Trust 

C's 30% share of the $82,764 margin loan interest and of 

the $59,000 mortgage interest, was taxable while the 

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 proportion 

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 issued 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 estimated 

_________________________________________________________________ 

7. The court computed these amounts as follows, based on Trust C's 

30% share of the trusts' net assets: 

 30% x $82,764 taxable margin transaction income = $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 income = $75,722 

 ________________________________________________ _______ 

 net income to Trust C = $118,251 

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

See app. at 436-37. 

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

app. at 436-38.8 

Geftman timely filed this appeal. We review the Tax

Court's factual findings for clear error, but exercise plenary 

review of its conclusions of law. Fredericks v. Commissioner, 

126 F.3d 433, 436 (3d Cir. 1997).9 The taxpayer bears the 

burden of proving the error in the deficiency assessed 

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 

_________________________________________________________________ 

8. Thirty-six percent of Geftman's $46,936 distribution 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. However, the court's 

calculation of Geftman's ultimate tax liability is not germane to our 

analysis. 

9. While the determinations as to whether the transaction gave rise to a 

bona fide debt and whether the trusts owned the mortgages could be 

considered to be findings of "ultimate fact," we have held that "we no 

longer recognize the ultimate fact exception to the standard that factual 

findings are reviewed only for clear error." Pleasant 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 demonstrated that 

the Commissioner's determination of a deficiency arbitrarily and 

erroneously rested on a Form 1041 which inaccurately reported that 

Trust C had distributed $101,890 instead of $46,936 to him. See 

Cebollero v. Commissioner, 967 F.2d at 990; Portillo v. Commissioner, 932 

F.2d 1128, 1133 (5th Cir. 1991); Anastasato v. Commissioner, 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 with the Taxpayer." 

Anastasato, 794 F.2d at 887. Because the record contains sufficient 

evidence to satisfy the Commissioner's burden of going forward, but 

more importantly clearly satisfies Geftman's ultimate burden of proving 

that the deficiency was assessed in error, we need not address Geftman's 

argument that the Tax Court improperly allocated him the burden of 

proof. 

 11 
III. DISCUSSION 

A. Margin Interest Transactions 

The Tax Court's conclusion that a portion of Geftman's 

distribution from Trust C was taxable rested in significant 

part on its finding that the $82,764 which the estate paid 

to the trusts in connection with the margin advances 

constituted taxable interest income which the trusts 

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 determination 

that the $2.85 million which the trusts transferred to the 

estate gave rise to a bona fide debt owed by the estate to 

the trusts. See id. 

For "disbursements to constitute true loans there must 

have been, at the time the funds were transferred, an 

unconditional obligation on the part of the transferee 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, 855 F.2d 

855 (8th Cir. 1988) (table); accord Saigh v. Commissioner, 

36 T.C. 395, 419 (1961). In the absence of direct evidence 

of intent, the nature of the transaction may be inferred 

from its objective characteristics, see Haag, 88 T.C. at 616, 

including the presence or absence of debt instruments, 

collateral, interest provisions, repayment schedules or 

deadlines, book entries recording loan balances or interest 

payments, actual repayments, and any other attributes 

indicative of an enforceable obligation to repay the 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 related 

entities rather than at arms' length, they are "subject to 

particular scrutiny because the control element suggests 

the opportunity to contrive a fictional debt." In re Uneco, 

Inc., 532 F.2d 1204, 1207 (8th Cir. 1976) (citations and 

internal quotations omitted). Thus, a transaction must be 

measured against "an objective test of economic reality" and 

characterized as a bona fide loan only if its"intrinsic 

economic nature" is that of a genuine indebtedness. Fin 

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

consider whether the evidence as to the contemporaneous 

intent at the time of the transfers and the objective 

attributes and economic realities of the transaction between 

the trusts and the estate support the Tax Court's 

conclusion that the transactions gave rise to a bonafide 

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 intention on 

the part of the transferee to repay the money, and an 

unconditional intention on the part of the transferor to 

secure repayment.' " Geftman, 72 T.C.M. (CCH) at 820 

(quoting Haag, 88 T.C. at 616). The court found that the 

January 17, 1984 memorandum memorializing the lawsuit 

Settlement Agreement which referred to "borrowing from 

the stockbroker" by "using the trusts assets as collateral" 

constituted evidence of the requisite intent. Id . at 821. We 

disagree.11 

The "determinative fact is the intention as it existed 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 trusts to the 

estate, Geftman, 72 T.C.M. (CCH) at 821, it did not

acknowledge that by the time of the January 17 meeting, 

the trusts already had borrowed almost $1.25 million in 

brokerage loans and had transferred funds to the estate 

with no statements from either entity as to the intended 

nature of those transfers. The Commissioner asserts, br. at 

25, that the January 17 meeting merely "ratified" an 

intention existing at the time of the initial transfers. 

However, the memorandum of that meeting indicates that 

the issue of whether to borrow was the subject of"lengthy 

discussion" and "dissent" among the estate's 

representatives. Although the memorandum states that the 

_________________________________________________________________ 

11. The parties stipulated that this memorandum constitutes the "only 

written evidence of indebtedness reflecting any debt due from the Estate 

to the Trusts." App. at 134. 

 13 
representatives were able to agree by the end of that 

meeting, the ongoing dissent as of January 17 reveals that 

the representatives had not formed the requisite 

unconditional intention to enter into a debt transaction 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 statements 

consist of formal resolutions establishing the precise terms 

of a debt. See Georgiou v. Commissioner, 70 T.C.M. (CCH) 

1341, 1350-51 (1995). In Saigh, 36 T.C. 395, the court 

rejected the assertion that there was a debt because funds 

had been transferred between a subsidiary and a parent 

corporation and, as in this case, "at that time nothing 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 was not 

contemporaneous with the initial transfer. As the court 

explained, the parties had been undecided as to the nature 

of the transaction at its inception, and this indecision 

"affirmatively dismisses the possibility that on the date of 

transfer there was an unconditional intention on the part of 

the transferee . . . and . . . the transferor to secure 

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, and the 

evidence that the estate's representatives remained

undecided during the following month precludes us from 

finding that they had formed an unconditional intention as 

the transfers commenced in December 1983.12 

_________________________________________________________________ 

12. The Commissioner asserts that one of the representatives testified 

that "a loan . . . was intended from the outset." Br. at 29 (citing app. 

at 

15, supp. app. at 3-5, 10). The record does not support this assertion. 

The cited testimony simply describes the transactions 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 enforceable debt existed as 

of December 1983. 

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

is distinguishable from Saigh because any indecision at the 

January 17 meeting arose from uncertainty over whether to 

proceed with a loan "as opposed to the sale of estate 

assets," and therefore involved a debate between two 

distinct transactions, whereas in Saigh the parties were 

considering two different characterizations of the same 

transaction. Thus, the Commissioner argues, in contrast to 

Saigh where the parties could have remained undecided 

while making the transfer, in this case the very fact of the 

transfer reveals that the estate had opted to borrow instead 

of selling estate assets. We find this distinction 

unpersuasive. 

The mere fact that a transfer occurred does not establish 

whether that transfer was intended as a bona fide loan 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 be 

characterized as a bona fide loan for tax purposes. In the 

absence of any evidence that the transfer was intended 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 intentions 

are not sufficient to support a finding of an intent to create 

a bona fide debtor-creditor relationship between the 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. This 

statement reflects only the undisputed fact that significant 

sums were borrowed from the stockbroker, E.F. Hutton, 

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 repay or 

whether the estate intended to be bound by an 

unconditional obligation to repay the advances. The

January 17 memorandum, therefore, cannot be construed 

 15 
as evidence of a contemporaneous, unconditional intent to 

create a bona fide debt owed by the estate to the trusts. 

Because this document constitutes the only evidence in the 

record purporting to express the intent behind the 

transactions, and because this document indicates that the 

requisite intent had not been formed at the relevant time, 

the record cannot support the Tax Court's finding that the 

estate and the trusts intended at the time of the initial 

transfer to create an unconditional debt. 

2. Objective Indicia of Indebtedness 

The necessary intent to create a bona fide indebtedness 

can be inferred not only from expressions of the parties' 

intentions, but also from objective aspects of the 

transaction such as the presence vel non of notes or other 

debt instruments, security or collateral, interest charges, 

repayment schedules or deadlines, book entries recording 

loan balances or payments, actual repayments, or any 

other factors indicative of an unconditional obligation 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 not 

require any collateral or security, did not impose any 

interest charges, did not establish a repayment schedule or 

maturity date, and did not make any entries on their 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 However, upon 

analyzing the significance of these repayments and of the 

_________________________________________________________________ 

13. The court also characterized as "objective evidence of indebtedness" 

the January 17, 1984 memorandum and a June 11, 1985"adjusting 

journal entry" referring to a "partial debt settlement" with the trusts. 

Geftman, 72 T.C.M. (CCH) at 821. However, such"allegedly objective . . . 

indicia" which merely represent a party's characterization of the 

transaction are unpersuasive "unless supported by objective factors 

demonstrating economic reality." Gilbert v. Commissioner, 74 T.C. 60, 65 

(1980). Accordingly, we confine our analysis to the objective 

characteristics of the transfer which bear on its actual terms. 

 16 
other objective attributes of the transaction, wefind that its 

objective characteristics preclude us from upholding the 

Tax Court's conclusion that it gave rise to a bonafide debt. 

a. Repayments 

The Tax Court found that the estate's repayments to the 

trusts of $82,764 were indicative of a bona fide debt. While 

the court described the repayments as interest "paid 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 corresponded to 

handwritten notations on the prior month's E.F. Hutton 

statement calculating the portion of the E.F. Hutton 

interest charges attributable to the sums advanced to the 

estate. Geftman, 72 T.C.M. (CCH) at 821. The fact that the 

estate merely reimbursed the trusts for a portion of interest 

charges that the trusts incurred from a third party belies 

the court's conclusion that the trusts received these 

payments in the capacity of a bona fide creditor. See id.14 

Even if the trusts had not owed the $82,764 to the thirdparty lender that provided the capital in this transaction, 

but rather had received that sum from the estate and 

retained it as repayment of principal or as payment of 

interest charged by the trusts themselves, repayment in 

_________________________________________________________________ 

14. The Commissioner asserts, br. at 34, that the estate 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 concedes that no 

documents reflect such an arrangement, and relies solely 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 dollar for dollar" on the 

amounts they were charged by E.F. Hutton. App. at 19. 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 trusts could not have 

made their monthly payments to E.F. Hutton unless they had received 

the payments from the estate, see Geftman, 72 T.C.M. (CCH) at 821, this 

fact does not elucidate whether the payments properly may be 

characterized as interest paid on a bona fide debt.

 17 
that amount would be insufficient to support afinding of a 

bona fide obligation to repay the $2.85 million transferred 

to the estate, since repayments which are insubstantial in 

relation to the amount transferred are not indicative 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 total 

amount advanced. The court found these payments 

insufficient to establish that the transferee had an 

unconditional obligation to repay the principal amount 

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 amount 

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 repayment 

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 only on 

four occasions from May through August 1984, making no 

other repayments during the period in which it received 

transfers from the trusts. 

In Georgiou, 70 T.C.M. (CCH) at 1351, the court found 

that repayments were not probative of a bona fide debt as 

they not only were "insubstantial in relation to the 

advances" but also resulted in "[f]ailure to repay an ever 

mounting loan balance." In this case the insubstantial 

repayments representing only 3% of the amount transferred 

similarly failed to reduce an ever-mounting loan balance 

resulting from the fact that the estate received additional 

transfers of $746,902 during the months in which it made 

the repayments of $82,764. See app. at 184, 178.15 For 

_________________________________________________________________ 

15. The parties stipulated that "[t]he total borrowing on margin as of 

August 31, 1984 was $2,850,408.34" and that "[a]ll funds that were 

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

regarded as evidence of a bona fide debt, in contrast 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 principal. See, 

e.g., Litton Bus. Sys., Inc. v. Commissioner , 61 T.C. 367, 

380 (1973).16 Thus, we find that the Tax Court erred in 

characterizing the $82,764 repayments as evidence of a 

bona fide debt. 

b. Other Objective Factors 

The other objective characteristics of the transaction are 

equally inconsistent with the existence of a bonafide debt. 

While the Tax Court noted that the transfers were not 

accompanied by any notes, interest charges, collateral, 

repayment schedules, or book entries recording a loan 

balance, the court found the absence of these factors 

_________________________________________________________________ 

borrowed on margin from E.F. Hutton . . . were transferred to the Estate 

from the Trusts." App. at 131. The E.F. Hutton Statements 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 continued 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 additional repayments 

when the estate transferred mortgages to the trusts as a "partial debt 

settlement." See Geftman, 72 T.C.M. (CCH) at 821. However, as 

discussed more fully below, the trusts never received any beneficial 

interest in the mortgages. Even assuming that the trusts had acquired 

some interest in the mortgages, the June 11, 1985 document making 

adjusting journal entries and characterizing the purported mortgage 

transfer as a partial debt settlement was contradicted by 

contemporaneous documents describing that purported transfer as a 

purchase. See app. at 135c. Thus we find no evidence to support the 

assertion that the trusts received additional repayments in the form of a 

mortgage transfer, and accordingly confine our analysis of the 

repayments to the $82,764 which the trusts actually received. 

 19 
insignificant on the grounds that such features were 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 related 

parties have found the absence of such factors highly 

significant and have characterized transfers as bona fide 

loans only where the record contains sufficient objective 

evidence of an enforceable obligation to repay and a 

reasonable expectation of repayment. 

In Baird v. Commissioner, 43 T.C.M. (CCH) 1173, 1180- 

81 (1982), the court recognized a bona fide debt between 

related parties because the transferee had executed

promissory notes establishing a payment schedule and 

charging interest at a rate of ten percent, and had delivered 

the notes to the transferor "prior to . . . receiving the 

checks," while the transferor had recorded the 

"disbursements on its books as loans." Similarly, in 

American Processing & Sales Co. v. United States, 371 F.2d 

842 (Ct. Cl. 1967), the court found sufficient evidence of an 

"enforceable obligation to repay" and a "reasonable

expectation of repayment" in a transaction between related 

corporations, inasmuch as the transferor held a lien on the 

transferee's buildings and fixtures and both corporations 

recorded consistent, definite amounts due on the debt. See 

id. at 845-46, 856-57. 

Likewise, in Litton Bus. Sys., 61 T.C. 367, the transferee 

corporation adopted a resolution prior to the transfer 

authorizing the corporation "to borrow" from its parent 

corporation, and at the time of the transfer both the 

transferor and transferee recorded the same "opening 

balance" of the amount owed by the subsidiary. Moreover, 

the "indebtedness and its essential terms" were recorded on 

the books of both companies and in "a substantial amount 

of correspondence" which set forth "the existence of a debt 

obligation, the amount thereof and payments thereon,[and] 

the provision for interest." Furthermore, the interest rate 

was "reasonable[ ] in light of the prevailing interest 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[transferee's] 

established financial history." See id. at 376-80. 

 20 
The 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 transferor 

and transferee are related entities. See Geftman , 72 T.C.M. 

(CCH) at 820-21. The court failed to acknowledge, however, 

that although the courts in those cases did not require the 

presence of every possible indicium of indebtedness, they 

did not recognize a debt in the absence of all objective 

indicia, but rather based their recognition of a debt on 

numerous objective factors not present in this case. 17 

While the foregoing cases demonstrate that the courts 

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 presence 

of significant objective evidence that the transfer was 

intended as a loan. For instance, in Donisi v. Commissioner, 

26 T.C.M. (CCH) 327 (1967), aff 'd, 405 F.2d 481 (6th Cir. 

1968), the court rejected the assertion that a shareholder's 

transfers to his closely held corporation were bonafide 

loans, although the transferee, prior to the transfers, had 

adopted a formal resolution authorizing it to borrow from 

the transferor at specified interest rates, had computed and 

recorded the interest owed on its books, and had made 

several payments designated explicitly as interest owed on 

the loans. The court found these factors insufficient, 

inasmuch as the transferor did not require any "notes or 

other written evidence of indebtedness," and did not 

establish a repayment schedule or obtain any collateral 

although the transferee had assets "of a kind which

_________________________________________________________________ 

17. Apart from Baird, American Processing, and Litton, the Tax Court 

cited only one case that characterized a transfer between related parties 

as a bona fide debt. That case also relied on objective factors not 

present 

in this case, such as a duly executed promissory note and consistent 

treatment of the transfer on the parties' books andfinancial 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 analysis of factors which 

undermined the Commissioner's assertion in that case that the transfers 

constituted dividends, an analysis that is inapposite in this case. 

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

Thus, in Donisi, although the parties had manifested an 

intent to create a loan through objective factors such as 

contemporaneously stated interest rates and book entries 

consistent therewith, the court found it significant that the 

transferor, like the trusts in this case, did not take readily 

available measures, such as obtaining notes or collateral, to 

ensure repayment. 

In Georgiou, 70 T.C.M. (CCH) 1341, the court found that 

transfers from a corporation to its shareholder were not 

bona fide loans, although the corporation had obtained a 

security interest in the shareholder's assets, established a 

fixed maturity date, charged the shareholder interest, 

treated the transfers as loans on its books, and received 

funds back from the shareholder which the corporation 

explicitly designated as loan repayments. Despite these 

objective indicia of indebtedness, the court found that the 

transfers did not give rise to a bona fide debt, since there 

was no indication that the shareholder intended to"enforce 

the debt against himself." Id. at 1351. Thus, contrary to the 

Tax Court's finding that the relatedness of the parties 

obviated the need for objective evidence of indebtedness, 

Georgiou demonstrates that even extensive objective

evidence may be insufficient to establish the existence of a 

debt where the close relationship between the transferor 

and the transferee leaves the transferor discretion as to 

whether to enforce the debt, rendering any obligation to 

repay conditional rather than unconditional. 

Likewise, in Gilbert, 74 T.C. 60, the court rejected the 

assertion that a transfer constituted a bona fide loan 

although "the transfer was consistently treated as a loan on 

the books . . . and balance sheets of both corporations," 

"the check . . . included a notation that it was a loan," and 

the transfer subsequently was repaid in full. Id. at 65. The 

court found that the characterization of the transfer 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 other 

measures to ensure repayment. Moreover, the transferor 

had "borrowed the same money at interest" and had "no 

business purpose . . . to have subsidized" the transferee by 

 22 
" `loaning' the same funds without requiring the payment of 

at least an equivalent rate of interest." Id. at 66. Finally, the 

transferee's financial difficulties, which raised doubts as to 

whether the transferee "would have funds available to 

repay," demonstrated that the transfer was economically 

unreasonable as a loan transaction and precluded the court 

from recognizing a bona fide indebtedness. Id. Virtually all 

of the factors that weighed against recognition of a debt in 

Gilbert are present in this case where the trusts borrowed 

funds at interest, transferred them to the estate without 

charging an equal rate of interest and obtaining notes, 

collateral, or repayment schedules, and without any basis 

for believing that the estate would be in a position to repay 

the funds transferred.18 

The foregoing cases demonstrate that, contrary to the 

view adopted by the Tax Court, the mere relatedness of the 

parties is not a sufficient basis to support characterization 

of a transaction as a debt in the absence of objective 

evidence of indebtedness such as notes, collateral,

repayment schedules, interest charges, or other measures 

demonstrating an intent to secure repayment. Rather, these 

cases demonstrate that transfers between related parties 

cannot be characterized as bona fide loans unless the 

totality of the objective evidence reveals that the transferee 

had an enforceable obligation to repay the sums 

transferred. The transactions in this case, which did not 

involve any notes, collateral, repayment schedule, interest 

charges, or book entries reflecting a loan, bear virtually 

none of the objective attributes which denote a bonafide 

_________________________________________________________________ 

18. The Commissioner argues, br. at 26-27, that Gilbert is 

distinguishable because in this case the trusts earned $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 charge any interest but 

merely recovered a portion of the E.F. Hutton interest charges which 

they incurred in obtaining funds for the estate. Because the trusts 

recovered only a portion of the $133,627 in interest they paid to E.F. 

Hutton, see app. at 328, they subsidized the transaction, just as the 

transferor did in Gilbert, with no economic advantage to themselves. 

 23 
loan, and closely resemble transfers which the courts have 

refused to characterize as a genuine loan because the 

transferor failed to take available measures to secure 

repayment.19 Accordingly, wefind that the objective

attributes of the transactions between the trusts and the 

estate cannot support the Tax Court's conclusion that they 

gave rise to a bona fide indebtedness. 

_________________________________________________________________ 

19. The Tax Court cited several other cases which, like those discussed 

above, refused to characterize transfers between related parties as bona 

fide loans although they bore more objective attributes 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 withfixed maturity dates 

and interest rates); Wood Preserving Corp. of Baltimore v. United States, 

233 F. Supp. 600, 605-07 (D. Md. 1964) (finding that advances were not 

bona fide loans, despite notation of debt in ledger, as transferee made no 

enforceable promise to repay and could not have obtained such funds 

"from any reasonable banker on its own credit"), aff 'd, 347 F.2d 117 

(4th Cir. 1965); Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324, 

1328-29 (1971) (holding that disbursements, although recorded on 

books as balance due and although partially repaid, were not bona fide 

loans absent notes, maturity dates or repayment schedules), aff 'd, 496 

F.2d 876 (5th Cir. 1974) (table); Astleford v. Commissioner, 33 T.C.M. 

(CCH) 793 (1974) (finding that transfers were not bona 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 despite ledger account 

entitled "note receivable" and eventual repayment of entire balance, 

where no promissory notes were executed or delivered, 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 well 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 while the Commissioner 

contested its existence. In this case, by contrast, the typical positions 

are 

reversed and it is the Commissioner who seeks to prove the existence of 

a genuine indebtedness. The transfer, however, falls far short of the 

standards which the Commissioner has advocated and which the courts 

have adopted in the cases analyzing whether a transfer constitutes a 

debt. 

 24 
c. Economic Reality 

Our conclusion that the contemporaneous intent behind 

and the objective attributes of the transaction demonstrate 

that the transaction cannot be characterized as a bona fide 

loan is consistent with the economic realities surrounding 

the relationship between the trusts and the estate, as these 

realities further demonstrate that the transfers did not give 

rise to a reasonable expectation or enforceable obligation of 

repayment. As we explained in Fin Hay Realty Co. v. United 

States, where "the same persons occupy both sides of the 

bargaining table," the form of a transaction"does not 

necessarily correspond to the intrinsic economic nature of 

the transaction, for the parties may mold it at their 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 and the 

transferee, the transaction must be scrutinized according to 

"an objective test of economic reality" to determine 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, personal 

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 trusteerepresentative testified that he had "no idea." App. at 60- 

61. However, having erroneously cited this common control 

as a basis for disregarding the absence of objective indicia 

of indebtedness, the court did not undertake an analysis of 

_________________________________________________________________ 

20. The rule in Fin Hay accords with the general principle 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 substance as well as in 

form"). 

 25 
the economic realities surrounding the transaction. See 

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

In analyzing the nature of the advances from the trusts 

to the estate, we cannot ignore the fact that the funds 

which the estate purportedly "borrowed" from the trusts 

were available only because the estate had funded the 

trusts by making the municipal bond transfers just four 

months before the transfers back to the estate began. The 

courts have refused to characterize transfers as debts 

where the purported debtor conveyed its funds to another 

entity over which it retained a degree of control only to 

"borrow" the same funds back a short time later. See, 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, since 

taxpayers had retained control over trust assets and thus 

were `borrowing' their own assets in order to generate 

deductible interest payments); Ribisi v. United States, 51 

A.F.T.R.2d (RIA) 83-961 (N.D. Cal. 1983) (transfers from 

trust to taxpayer were not a valid loan, despite promissory 

note, because taxpayer had used trust as "conduit" through 

which it cycled the funds purportedly borrowed), aff 'd, 746 

F.2d 1487 (9th Cir. 1984) (table). 

Nor can we disregard the degree of control which the 

estate exercised over the trusts' assets by virtue of the fact 

that the estate retained the right to reclaim any and all 

trust assets for its own purposes at any time. Although 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 having 

the trusts borrow over $2.85 million against these assets 

worth $3 million and transferring the proceeds to the estate 

with no promise to repay or collateral securing repayment. 

The Commissioner contends, br. at 32, that the transfers 

should not be viewed as a de facto recall of trust assets 

because the estate did not issue a formal recall until well 

after the transfers were complete. This argument, however, 

focuses on the form which the representatives gave to the 

transactions rather than their economic reality. Because 

the transfers effectively conveyed back to the estate 

 26 
virtually 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 the equity in 

the trusts' portfolio and thus amounted to a de facto recall. 

While the estate's representatives did not characterize the 

transactions as an asset recall, these individuals, who also 

controlled the trusts and were beneficiaries of Trust A, had 

every incentive to obscure the economic reality that the net 

economic effect of the transaction was to return all value of 

the trusts' assets to the estate, inasmuch as these

individuals were to receive distributions from Trust A only 

to the extent that the trusts generated current net income. 

Although these individuals attempted to characterize 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 whatever 

appearance would be of . . . benefit to them despite the 

economic reality of the transaction," Fin Hay , 398 F.2d at 

697, we cannot accept this characterization which does not 

accord with the economic reality that the actual effect of 

the transaction was to transfer $2.85 million of the equity 

held by the trusts back to the estate with no assurance 

that the estate intended to repay these sums to the trusts. 

A court may ascertain the true nature of an asserted loan 

transaction by measuring the transaction against the 

"economic reality of the marketplace" to determine whether 

a third-party lender would extend credit under similar 

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 lender would 

have extended $2.85 million of credit with no promise of 

repayment, no interest charges, no security, no repayment 

schedule, and no book entries recording a balance due, 

particularly if that entity did not have capital to lend but 

rather had to place its assets at risk to borrow the 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 afinancial 

position to repay the funds. See app. at 178-98. Because 

this was not a transaction that "the market would accept as 

debt," Scriptomatic, 555 F.2d at 368, wefind that its terms 

 27 
were defined by the relationship between the estate and the 

trusts as donor and beneficiary and not as debtor and 

creditor.21 

The Commissioner argues that E.F. Hutton's willingness 

to lend the trusts funds which the trusts then transferred 

to the estate demonstrates that the transaction between the 

trusts and the estate was economically reasonable as a 

debt transaction on the open market. See br. at 33. We 

disagree. E.F. Hutton lent funds to the trusts on terms 

radically different from the terms on which the trusts 

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 trusts, by 

contrast, made no attempt to obtain a security interest in 

any of the estate's assets, although the estate had real 

estate holdings that might have served as collateral. 

Moreover, the trusts did not charge the estate interest 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 from E.F. 

Hutton. Thus, the contrasts between E.F. Hutton's loans to 

the trusts, and the trusts' transfers to the estate in fact 

demonstrate that the latter transaction did not create a 

debtor-creditor relationship. 

Moreover, the terms on which the trusts transferred the 

funds to the estate differed not only from the terms on 

which third parties would lend those funds, but also from 

the terms on which the trusts lent funds to other related 

parties. Edith Kermer, a trustee and beneficiary of Trust B, 

_________________________________________________________________ 

21. We recognize that credit may be extended between related parties on 

terms that differ from those that would exist on the open market. Thus, 

while the Commissioner is correct, br. at 33, that a transfer need not be 

profitable for the transferor in order to constitute 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. Rather, it required the 

trusts to incur substantial costs and risks to their assets with no 

reasonable expectation that even the principal amount would be repaid. 

Under the circumstances, which reveal no obligation to repay and no 

expectation of repayment, we cannot characterize the transaction as a 

bona fide extension of credit. 

 28 
obtained a loan from the trusts by executing a mortgage on 

her home in favor of the trusts and a written agreement to 

repay the trusts by certain dates at an interest rate of one 

percent above the rate charged to the trusts by E.F. 

Hutton. See app. at 416-19. The absence of comparable 

terms surrounding the transfers made to the estate further 

demonstrates that in economic substance these transfers 

were not loans made with a reasonable expectation of 

repayment, but rather were a conveyance of trust assets 

back to an estate which effectively had exercised its 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 that the 

transactions between the trusts and the estate did not give 

rise to a genuine indebtedness. In the absence of any 

evidence establishing a bona fide debtor-creditor 

relationship between the estate and the trusts, we must 

reject as clearly erroneous the Tax Court's conclusion that 

the $82,764 which the estate paid to the trusts constituted 

taxable interest income earned by the trusts in their 

capacity as creditors rather than non-taxable distributions 

received by the trusts in their capacity as beneficiaries of 

an estate that had no distributable net income. 

B. Mortgage Transactions 

The Tax Court found that the trusts earned additional 

taxable income in the form of interest paid on the La Playa 

and Blue Grass condominium mortgages. Although Berkley, 

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 processed 

these payments merely as an agent or nominee for the 

trusts who were the beneficial owners of the mortgages. 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 settlement," and 

on a "work paper" attributing to the trusts the $90,596 in 

mortgage payments which Berkley collected. See Geftman, 

 29 
72 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 transferred 

to them constituted taxable interest income generated by 

those mortgages rather than nontaxable transfers from an 

estate with no distributable net income. See id. 22

While it is undisputed that Berkley held title to the 

mortgages at all relevant times and did not formally assign 

them to the trusts, the true ownership of the mortgages 

and the proper attribution of the income derived therefrom 

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 (5th Cir. 

1995) (table). Accordingly, we must determine whether the 

trusts acquired "the benefits and burdens of the incidents 

of ownership" of the mortgages based upon "the objective 

evidence provided by the . . . overt actions" with respect to 

the mortgages. Cordes v. Commissioner, 68 T.C.M. (CCH) 

356, 358 (1994) (citations omitted); accord Frank Lyon Co., 

435 U.S. at 572-73, 98 S.Ct. at 1298. 

Upon analyzing these factors, we conclude that, contrary 

to the representations in the adjusting journal entry and 

the work paper, the objective evidence as to control over the 

mortgages and the income derived therefrom clearly 

demonstrates that Berkley and BOP retained all incidents 

of beneficial ownership of the mortgages, precluding 

reliance on the documents cited by the Tax Court. 

1. Documentary Evidence 

The Tax Court's conclusion that the trusts had acquired 

a beneficial interest in the mortgages rested in significant 

_________________________________________________________________ 

22. The court initially found that the trusts received $90,596 in mortgage 

interest income, consisting of the entire amount attributed to the trusts 

on the work paper, but corrected its finding on reconsideration in light 

of the stipulation that only $59,000 had been transferred to the trusts. 

See app. at 436-37. 

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

was prepared over three months after the trusts' tax year 

ended on February 28, 1985. The adjusting journal entry 

refers only to the La Playa mortgages with no reference to 

the Blue Grass mortgages, contrary to the court'sfinding 

that this document revealed the trusts' ownership of 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 the 

adjusting journal entry's representation that ownership 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 which 

were titled to Berkley. See app. at 408-15. The schedule, 

which contained numerous footnotes explaining the status 

of various properties, contained no notation indicating 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 knowledge of 

what the "et al" meant. App. at 76-77. We reject the 

Commissioner's suggestion that the schedule of BOP 

holdings can be construed as comprising assets owned by 

the trusts, since the trusts undisputedly held a mortgage 

on the home of Edith Kermer, yet the Kermer mortgage was 

not identified on the list of BOP's holdings. 24 Accordingly, 

we find that this document identifying BOP as the owner of 

the mortgages one month before the end of the tax year 

precludes reliance on the "adjusting journal entry" which, 

_________________________________________________________________ 

23. The Commissioner contends that the adjusting journal entry is 

supported by the minutes of a representatives' meeting held September 

5, 1984, stating that the mortgages had been "bought outright" by the 

trusts. See app. at 135. While the September 1984 document alludes to 

a mortgage transfer, the inconsistency as to whether the mortgages were 

purchased or were transferred to settle a debt undermines the 

Commissioner's assertion that these documents accurately describe a 

transaction that actually occurred. 

24. The "et al" apparently refers to BOP's sister corporation Berkley 

which held title to some of the properties identified in the document. 

 31 
six months later, asserted that the mortgages had been 

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 mortgages 

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 evidence" 

as to the "overt actions" with respect to the mortgages, 

Cordes, 68 T.C.M. (CCH) at 358, demonstrated that the 

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 1298. The 

Tax Court, in relying on documents reflecting the purported 

mortgage transfer, did not analyze the significance of the 

numerous overt acts in which the mortgages were assigned, 

pledged and sold to third parties. The court thus failed 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 examination 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 retained 

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 Ohio 

Savings Bank to secure a loan and executed a "Collateral 

Assignment" of the mortgages dated June 16, 1985, which 

they recorded in public records. In the course of this 

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 the 

proceeds of the sums borrowed against the mortgages for 

 32 
their own business activities, completing the process of 

hypothecating the mortgages with no participation or 

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 reassignment to 

them in their names, which they recorded in the public 

records with no mention of the trusts. Shortly thereafter, 

Berkley and BOP sold the mortgages to Horowitz Finance 

Corporation and Fleet National Bank, again representing 

themselves as the sole lawful owners, seeking no 

participation from the trusts, and using the proceeds for 

their own purposes. See app. at 29-38, 63-68, 41, 90, 398- 

407.25 

These transactions clearly demonstrate that, despite the 

"adjusting journal entry" stating that the trusts owned the 

mortgages, Berkley and BOP had full command over those 

assets and over the beneficial incidents of owning them, 

freely pledging them to obtain credit and selling them to 

raise cash for their own undertakings. Courts have refused 

to recognize purported asset transfers where the assets 

remain within the control of the purported transferor and 

remain subject to claims of the purported transferor's 

creditors, as was the case here where Berkley and BOP 

continued to enter into transactions with respect to the 

mortgages and pledged the mortgages to their creditors. See 

In re Johnson, 88 T.C. 225, 236-37 (rejecting assertion that 

estate had transferred assets where assets remained

sufficiently within control of estate that they"would 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 

_________________________________________________________________ 

25. Berkley and BOP used a large portion of the proceeds to satisfy their 

debt to Ohio Savings Bank and used the remainder to pursue their real 

estate endeavors. While one of the estate's representatives 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 substantial 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. 

 33 
on books where purported transferor subsequently"took 

out two loans using the [assets] as collateral"), aff 'd, 405 

F.2d 481 (6th Cir. 1968).26 Because Berkley and BOP

retained all incidents of beneficial ownership including the 

power to pledge the mortgages as collateral, sell them to 

third parties and retain the proceeds of these transactions 

while the trusts did not enjoy any of these incidents of 

ownership, we find that the objective evidence of actual 

control over the mortgages precludes a finding that the 

trusts were the true owners of the mortgages. See Frank 

Lyon Co., 435 U.S. at 572-73, 98 S.Ct. at 1298. 27 

_________________________________________________________________ 

26. The Commissioner contends, br. at 38, that this case is 

distinguishable from Johnson because Berkley paid the trusts $59,000 of 

the income generated by the mortgages, thus providing 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 the trusts owned and 

controlled the mortgages, the transfers from the estate cannot be 

characterized as mortgage interest income. In this case, as in Johnson, 

there is no evidence that the trusts assumed the right to control the 

mortgages as suggested in book entries. Thus the transfer 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 accorded "minimal 

weight" because they occurred after the end of the relevant tax year. We 

disagree, and find Berkley's and BOP's complete control 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 status of the mortgages. 

The Commissioner's argument is particularly unpersuasive in light of the 

Commissioner's extensive reliance on the journal entry dated June 11, 

1985, as evidence bearing on ownership during the tax year ended 

February 28, 1985. The Commissioner also asserts that Berkley's and 

BOP's dispositions of the mortgages are irrelevant because they involved 

"nothing more than transfer of bare legal title." Br. at 38. However, as 

the estate's representatives conceded, in pledging the mortgages as 

collateral to Ohio Savings Bank, Berkley and BOP placed the value of the 

mortgages directly at risk in the event of a default, see app. at 47, 69-

70, 

123, 170-71, and in selling the mortgages Berkley and BOP relinquished 

all control over them. There is nothing in the record to support the 

assertion that these transfers involved only the bare legal title of the 

mortgages. 

 34 
b. Control Over Mortgage Income 

Berkley's control over the revenues generated by the 

mortgages further demonstrates that the trusts did not 

hold the incidents of beneficial ownership of the mortgages. 

Contrary to the Tax Court's finding that Berkley merely 

"serviced" the mortgages by collecting mortgage payments 

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 payments 

which it collected without accountability to the trusts. 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 paper," 

id. at 822, listing cumulative totals of the payments made 

on the La Playa and Blue Grass mortgages through 

December 31, 1985, and through the end of fiscal year 

1985, and attributing these cumulative amounts to the 

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 prepared 

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 attributing a 

cumulative amount to the trusts, the documents prepared 

during the tax year in the ordinary course of Berkley's 

business did not attribute to the trusts any of the mortgage 

payments which Berkley collected. See app. at 329-34. 

These documents accounting for each mortgage payment 

received, with no reference to the trusts' purported interest 

therein, undermine the Commissioner's assertion that 

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 absence of any 

_________________________________________________________________ 

28. In support of this assertion, the Commissioner cites only the "work 

paper" prepared after the end of the tax year and the 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 having been received 

on behalf of the trusts, particularly since the documents recorded during 

the tax year do not reflect such a practice. 

 35 
contemporaneous documents attempting to account for the 

trusts' purported mortgage income separately from 

Berkley's other income, the single document retrospectively 

characterizing a cumulative amount as income to the trusts 

fails to establish that the trusts enjoyed a beneficial interest 

in that income. 

Berkley's handling of the actual funds received further 

undermines the Commissioner's assertion that Berkley 

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 Blue 

Grass developments, see app. at 99, Berkley's transfers to 

the trusts did not correspond to the amounts purportedly 

received on their behalf, but rather occurred at irregular 

intervals and in haphazard, fluctuating, and sometimes 

nominal amounts, which, as Geftman accurately notes, 

"bore no reasonable relationship to the regular remittance 

of monthly principal and interest payments which would 

have been received by a legitimate mortgage servicing 

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 obligation to 

forward the mortgage payments to the trusts each month, 

but rather remitted the money "as we saw fit, as we needed 

_________________________________________________________________ 

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 such, but rather 

recorded this sum in an account simply entitled"Berkley Mtg. Corp." See 

app. at 384-85. 

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

reveals that Berkley did not function merely as a nominee 

or agent processing payments on behalf of its principal, but 

rather was free to use the money it collected as it saw fit to 

further its own business purposes. Berkley's full control 

over the income from the mortgages demonstrates that 

Berkley, rather than the trusts, enjoyed this incident of 

beneficial ownership. 

As the Tax Court acknowledged, "[t]he owner of property 

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 participate in 

transactions pledging them as collateral and selling them, 

did not receive any of the proceeds from those transactions, 

and did not have control over the monthly mortgage 

payments which Berkley collected and retained for its own 

business purposes, forwarding funds to the trusts only 

when it chose to do so. In light of this evidence that the 

trusts did not enjoy any of the incidents of beneficial 

ownership of the mortgages and that the mortgages 

remained within the exclusive control of Berkley and BOP, 

we find that the Tax Court clearly erred in concluding, 

based on an adjusting journal entry and a work paper 

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 mortgages, we 

must reject the Tax Court's conclusion that the $59,000 

transferred to the trusts constituted taxable mortgage 

interest income earned by the trusts as owners of the 

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 provides 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 trust's 

distributions to its beneficiaries are treated as consisting 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. 

 37 
S 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 consisted of 

taxable interest income generated by the margin 

transactions and the La Playa and Blue Grass mortgages, 

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 that 

the Tax Court erred in characterizing the transfers to the 

trusts of $82,764 in connection with the E.F. Hutton 

margin transaction and $59,000 in connection with the 

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 characterized 

only as non-taxable distributions from an estate which had 

no distributable net income, rendering all of the trusts' 

income, and thus all of the distribution to Geftman, nontaxable. See 26 U.S.C. S 652(a); Treas. Reg. S 1.652(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 of nontaxable income. Consequently, we will vacate the Tax 

Court's imposition of additions to tax pursuant to 26 U.S.C. 

SS 6651 and 6654, as the court's application of these 

provisions rested on its finding of an underlying income tax 

liability. We will remand the matter to the Tax Court 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 

_________________________________________________________________ 

30. For an explanation of the calculations underlying this 36% figure, see 

note 7, supra. 

 38