Case Name: Lester Crown, Petitioner v. Commissioner of Internal Revenue, Respondent
Court: United States Tax Court
Jurisdiction: United States
Decision Date: 1977-03-31
Citations: 67 T.C. 1060
Docket Number: Docket No. 9192-74
Parties: Lester Crown, Petitioner v. Commissioner of Internal Revenue, Respondent
Judges: Drennen, Quealy, and Hall, JJ., did not participate in the consideration and disposition of this case.
Reporter: Reports of the Tax Court of the United States
Volume: 67
Pages: 1060–1070

Head Matter:
Lester Crown, Petitioner v. Commissioner of Internal Revenue, Respondent
Docket No. 9192-74.
Filed March 31, 1977.
Byron S. Miller, for the petitioner.
Seymour I. Sherman, for the respondent.

Opinion:
OPINION
Dawson, Chief Judge:
Respondent determined a deficiency of $46,084.54 in petitioner's Federal gift tax for the year 1967.
The issue presented for decision is whether interest-free loans to relatives of the lender (or trusts for the benefit of such relatives) give rise to taxable gifts from the lender to the borrowers to the extent of the value of the use of the funds loaned; and, if so, what is the proper measure of the amount of such gifts.
All of the facts were stipulated by the parties. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. The pertinent facts are summarized below.
Petitioner was a legal resident of Wilmette, Ill., when he filed his petition herein. He filed his Federal gift tax return for the calendar year 1967 with the District Director of Internal Revenue at Chicago, Ill. Petitioner and his two brothers, Robert Crown (now deceased) and John J. Crown, were equal partners in Areljay Co., Not Incorporated (Areljay), an Illinois general partnership formed in 1944.
In 1967 the Areljay partners had a total of 15 children, separate trusts for 12 of whom are involved herein. Harry N. Wyatt was the trustee of all the trusts, and he was also the trustee of a trust for a first cousin of the Areljay partners and of separate trusts for 11 children of first cousins of the Areljay partners.
As of January 1, 1967, Areljay had loans receivable outstanding from 13 of the foregoing trusts in the aggregate amount of $2,262,574, most of which were represented by non-interest-bearing demand notes. The other 11 trusts were not indebted to Areljay at that date. On January 3, 1967, Areljay made separate open account loans, aggregating $15,960,000, to all 24 trusts to enable each trust to acquire an interest in a partnership known as Henry Crown & Co. (Not Incorporated). During the balance of 1967 Areljay made other miscellaneous loans to some of these trusts and received some repayments on account, so that as of December 31,1967, loans represented by demand notes totaled $2,073,649 and loans on open account totaled $15,956,375.
All of the aforementioned loans were recorded in the books of Areljay and the respective borrowing trusts, and were evidenced by either demand notes or open accounts. Although none of the demand notes made any provision for interest before demand, all provided for interest at 6 percent per annum after demand. None of the open account loans had a provision with respect to interest. At no time during 1967 did any of the trusts pay, nor were any requested to pay, any amount of interest in respect of any of the loans. During 1967 the market prime rate of interest ranged between 5% percent and 6 percent per annum, averaging 5.63 percent.
At all pertinent times, Areljay, its partners, and all of the trusts have operated on the cash basis method of accounting, and have used the calendar year as their respective taxable year.
In his notice of deficiency pertaining to petitioner's gift tax return for 1967, respondent determined that each interest-free loan made by the Areljay partnership to the various trusts constituted a gift of the value of the use of the money loaned. Respondent determined a reasonable rate of interest to be 6 percent per annum, and computed the amount of interest that parties bargaining at arm's length would have charged by applying that rate on a daily basis with respect to the outstanding balances of the amounts due both on the demand notes and the open-account loans. The total amount of interest computed in this manner was $1,086,407.75. One-third of this total amount, or $362,135.92, was deemed by respondent to have been a gift by petitioner, as a one-third owner of Areljay.
The issue presented here is one of first impression in this Court. Respondent seeks to apply the gift tax to the value of interest-free use of loaned funds. In 1973, the year before the notice of deficiency was sent to petitioner, respondent issued Rev. Rul. 73-61, 1973-1 C.B. 408, setting forth his position that:
The right to use property, in this case money, is itself an interest in property, the transfer of which is a gift within the purview of section 2501 of the Code unless full and adequate consideration in money or money's worth is received. The tax would be imposed on the value of the right to use the money.
The ruling states that in the case of a term loan, the present value of the interest-free use of the money for the entire term of the loan is to be determined actuarially and deemed to be a completed gift as of the date the loan is made; and, in the case of a demand loan, the value of the use of the money must be calculated on a quarterly basis and deemed a gift during each calendar quarter in which such interest-free loan is actually outstanding.
The revenue ruling then makes reference to, and specifically refuses to follow, the decision in Johnson v. United States, 254 F.Supp. 73 (N.D. Tex. 1966), the only case in which this specific issue has previously been litigated. In the Johnson case, the District Court squarely held that interest-free loans to family members, repayable upon demand, did not constitute gifts of the value of the use of the money. For the reasons stated hereinafter, we think the decision reached in Johnson v. United States, supra, was correct, and that respondent's position, as stated in the revenue ruling and at issue in this case, cannot be sustained.
Section 2501, I.R.C. 1954, imposes the gift tax upon "the transfer of property by gift." Section 2511(a) sets forth the generally intended scope of the tax as applying:
whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible;
The scope of the tax is amplified in section 25.2511-l(c), Gift Tax Regs., as follows:
Thus, all transactions whereby property or property rights or interests are gratuitously passed or conferred upon another, regardless of the means or device employed, constitute gifts subject to tax.
The crux of the matter before us is that respondent only recently has begun to assert that the making of non-interest-bearing loans is a taxable event, even though the statutory authorities offered in support of that position have been in existence since the creation of our income and gift tax laws. Complicating this problem is the failure of any court considering the question to accept respondent's position with regard to either the income tax or gift tax provisions in the Code.
As previously noted, Johnson v. United States, 254 F.Supp. 73 (N.D. Tex. 1966), is the only case that has considered the issue presented as it pertains to the gift tax laws. The facts in Johnson are very similar to those present in this case. A taxpayer made a series of non-interest-bearing demand loans to each of his two adult children during the years in issue, and the Internal Revenue Service attempted to impose a gift tax on the value of the use of money transferred during each year. After considering the intrafamily relationship between lender and borrowers, the purpose of the gift tax laws expressed in Harris v. Commissioner, 340 U.S. 106 (1950), and the unequivocal intention of the parties that interest not be charged, the District Court upheld the taxpayer's claim for refund on the ground that no gifts had been made within the meaning of section 2501 of the Code.
Essential to the District Court's holding in the Johnson case was its realization that since the principal of these loans would remain in the lender's estate at death, nothing about the transfers permitted the lender to avoid future estate taxes by reducing his current estate by means of inter vivos gifts of principal. The Commissioner was concerned, instead, that the ultimate estate would be reduced by the amounts of money which the lender could have earned with the loaned funds during the period of the loans. However, that approach was properly rejected by the District Court because our income tax system does not recognize unrealized earnings or accumulations of wealth and no taxpayer is under any obligation to continuously invest his money for a profit. The opportunity cost of either letting one's money remain idle or suffering a loss from an unwise investment is not taxable merely because a profit could have been made from a wise investment.
Noting that "The right to interest must arise from an express or implied contractual obligation or from statute," the District Court refused to hold that parents must deal with their children at arm's length and charge interest for a loan. 254 F.Supp. at 77. It concluded that Congress should enact a specific statute covering this area if it desired to tax such alleged transfers. We agree with the opinion.
The courts have uniformly rejected every attempt by the Internal Revenue Service to subject the making of non-interest-bearing loans to income or gift taxes. After the Supreme Court's decision in Commissioner v. Duberstein, 363 U.S. 278 (1960), this Court held in J. Simpson Dean, 35 T.C. 1083 (1961), that shareholders of a corporation who receive interest-free loans from that corporation do not have an increase in taxable income by virtue of having received the loans. The Johnson case discussed above was next decided in 1966 with respect to the gift tax provisions. Two years later it was held in Saunders v. United States, 294 F.Supp. 1276, 1282 (D. Hawaii 1968), revd. on another issue 450 F.2d 1047 (9th Cir. 1971), that a taxpayer did not receive compensation when he was issued non-interest-bearing loans. Finally, in Joseph Lupowitz Sons, Inc. v. Commissioner, 497 F.2d 862 (3d Cir. 1974), affg. in part a Memorandum Opinion of this Court, the Court of Appeals for the Third Circuit relied on our reasoning in J. Simpson Dean, supra, when it held that the interest-free use of funds did not create a taxable constructive dividend for a taxpayer. The unanimity of those authorities is complete.
If the making of non-interest-bearing loans is to become a taxable event, we think Congress, not the judiciary, should clearly say so. Our reluctance to undertake such broad steps is not novel. Prior to the promulgation of section 1.482-2, Income Tax Regs., the courts refused to sanction a creation of income by the Internal Revenue Service which sought to impute interest on interest-free or low-interest loans between related business entities. See Tennessee-Arkansas Gravel Co. v. Commissioner, 112 F.2d 508 (6th Cir. 1940); Smith-Bridgman & Co., 16 T.C. 287 (1951). That refusal was predicated in part upon the absence of any realization of cash income. The courts have receded from their former position since the Commissioner was granted the authority to make appropriate allocations to reflect an arm's-length interest rate. See, e.g., B. Forman Co. v. Commissioner, 453 F.2d 1144 (2d Cir. 1972), cert. denied 407 U.S. 934 (1972); but compare Fitzgerald Motor Co., 60 T.C. 957, 962 (1973), affd. on other grounds 508 F.2d 1096 (5th Cir. 1975).
Moreover, there are policy considerations which militate against viewing the value use of money or property as a taxable event for gift tax purposes. If respondent's position herein were sustained, the principle established could be extended to a multitude of situations involving gratuitous use or sharing of real or personal property among relatives. The application of the gift tax to common intrafamily sharing of use of property seems administratively unmanageable, and such situations point up the difficulty with the concept of gift taxation attaching to mere permissive use. Thus, we are inclined to follow in this area Justice Holmes' admonition that "a page of history is worth a volume of logic." New York Trust Co. v. Eisner, 256 U.S. 345, 349 (1921).
Accordingly, if the scope of the gift tax is to be expanded to encompass such permissive use, we think it should come through congressional action, and not through unnecessarily broad judicial interpretation.
Decision will be entered for the petitioner.
Reviewed by the Court.
Drennen, Quealy, and Hall, JJ., did not participate in the consideration and disposition of this case.
All section references herein are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.