Opinion ID: 409490
Heading Depth: 1
Heading Rank: 3

Heading: other courts, other cases

Text: 20 In Blackburn v. Commissioner, 20 T.C. 204 (1953), the taxpayer transferred property worth $245,000 to her children for a 30-year secured promissory note in the amount of $172,517.65, bearing interest at 2.25%. At that time, the usual rate of interest for a similarly secured note was 4%. The taxpayer conceded that the difference between the value of the property transferred and the face amount of the note was a gift. The issue presented was whether a gift resulted from the transfer of property worth $172,517.65 for a note in that exact amount but bearing a below-market interest rate. The Tax Court held that it was, and that the amount of the gift was the difference between $172,517.65 and the note's fair market value, which reflected a discount because of its low interest rate. 21 The same reasoning was applied in Estate of Berkman v. Commissioner, 387 T.C.M. (CCH) 183 (1979). There the decedent made five loans to his daughter, her husband and their controlled corporation during the years from 1968 to 1972. The loans were each evidenced by a promissory note, with the principal payable in a balloon at the end of 20 years. None of the notes was secured. On Mr. Berkman's death in 1974, none of the loans had been repaid. The Commissioner argued that the difference between the amount lent and the value of the notes, discounted to reflect their below-market interest rate, gave rise to a taxable gift. The Tax Court agreed that the loans were not arms-length transactions, and therefore any difference between the amount of each transfer and the fair market value of each promissory note given in exchange constitutes a taxable gift. Id. at 186. 22 These cases would appear to require gift taxation when a non-interest-bearing term note is used to secure a loan. The taxpayers argue, though, that they lend no guidance here simply because they involved bargain exchanges. We find that the taxpayers' efforts to distinguish the principles underlying these cases are unavailing; the cases suggest that the transfers here resulted in taxable gifts to the extent that the value of property transferred exceeded the value of the notes given in return by Artesian and Lyle.
23 It is here that the taxpayers can point to direct authority for their position. The Commissioner has been totally unsuccessful in persuading courts that a taxable gift occurs when money is loaned for no interest and is subject to repayment on demand. The courts have explicitly or implicitly justified their results on the differences between demand and term loans. 24 The first decision on this issue was Johnson v. United States, 254 F.Supp. 73 (N.D.Tex.1966). There, the taxpayers had made a series of non-interest-bearing loans to their two adult children during each of the years in issue, and the IRS attempted to impose a gift tax on the value of the use of the money on loan during each year. The court held that there were no taxable gifts, finding that the taxpayers had no right to interest, either express or implied, on the loans made to their children. The court stated:The time has not yet come when a parent must suddenly deal at arms-length with his children when they finish their education and start out in life. There is no legal requirement, express or implied, to charge them interest on money advanced to them at that stage, whether it be to open a law office and hang out a shingle, to go into the oil business on a substantial scale, or to begin life on their own in some other way. 25 Id. at 77. 26 We believe that the court's analysis missed the point of the issue before us. There is, of course, no legal requirement that parents charge their children interest on loans; there is likewise no legal requirement that parents charge for any property they might choose to transfer to their children. An owner is free to use or not to use his property, and there are no tax implications from the failure of an owner to make the highest and best use of such property. However, if an owner does transfer property for less than full consideration, that does constitute a taxable gift. 27 The other reason given in Johnson to support its holding was the conclusion that if the loans went untaxed that would not permit the taxpayers to avoid estate tax by reducing their estate. Id. The court reasoned that had the taxpayers not made the loans, they were under no duty to invest the money. Thus, the court apparently believed the loans only reduced the taxpayers' potential estates (i.e., including the interest they might have charged) rather than their actual estates. The loans in Johnson, just as in this case, could in fact reduce the taxpayers' actual estates, since the value of a lender-decedent's right to repayment of a loan, whether on demand or after a definite period, may well be worth less than face. A discount for collectibility, as well as for the delay in repayment, would be entirely possible. If an individual makes a loan for one year and receives a note calling merely for the repayment of the principal, and if such individual then dies, the amount includable in his estate is the discounted value of the note, which is less than the amount transferred by the decedent. Crown v. Commissioner, 67 T.C. at 1069-70 (Simpson, J., dissenting). The imposition of the gift tax here would thus bolster the estate tax. 6 28 We conclude, therefore, that Johnson rests on erroneous premises and reasoning. See generally, e.g., O'Hare, The Taxation of Interest-Free Loans, 27 Vand.L.Rev. 1085 (1974); Westover, Gift Taxation of Interest-Free Loans, 19 Stan.L.Rev. 870 (1967); 65 Mich.L.Rev. 1014, 1018 (1967). 29 In Crown, a majority of the Tax Court, with four judges dissenting, indicated its agreement with Johnson. The taxpayers in Crown, like the taxpayers here, gave close family members the right to use large sums of money indefinitely, until such time as they might demand repayment. The Commissioner asserted that the taxpayers made gifts equal to the fair market value of that property, the value being measured by the interest that would have been charged in arm's length transactions for similar loans. The Tax Court viewed the crux of the matter as being the fact that the Commissioner 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 their creation of our income and gift tax laws. 67 T.C. at 1063. As the dissenting judges noted, however, such considerations do not justify the result reached in Crown: 7 It is well settled that the Commissioner may, even retroactively, change an earlier incorrect interpretation of the law applied by him. Dixon v. United States, 381 U.S. 68(, 85 S.Ct. 1301, 14 L.Ed.2d 223) (1965); Automobile Club of Michigan v. Commissioner, 353 U.S. 180(, 77 S.Ct. 707, 1 L.Ed.2d 746) (1957). It is not altogether certain that the interpretation urged by the Commissioner in this case is entirely new, but even if it is, he is certainly free to correct his prior mistakes and apply the gift tax to those transactions coming within the statutory definition. Though the majority is shocked by the consequences of applying the law to some family transfers, they overlook the fact that this case involves not the usual family transfer, but over $15,000,000. Furthermore, many of the family transfers to which the majority refers would not be subject to tax because of the annual exclusion of § 2503(b). The statute clearly shows that Congress desired a broad application of it, and if an application of the statute as written produces questionable results, those situations should be brought to the attention of Congress. 30 Id. at 1070 (Simpson, J., dissenting). 31 The Seventh Circuit's decision in Crown, 585 F.2d 234, also totally rejected the Commissioner's theories. The court did note that a demand loan could be considered as an outright gift of a 'property right'-namely the right to use the money for an indefinite period, id. at 239, which it analogized to a tenancy at will with respect to real property. However, the court felt that the right to use money embodied in a demand loan did not fit within the language of the Congressional Committee reports quoted supra: 32 (W)e have seen no authority suggesting that the recipient of a loan payable on demand has a legally protectible interest vis-a-vis the lender. Moreover, the Commissioner has produced no evidence showing that the borrower's at will interest has an exchangeable value. Even if the theoretical existence of the possibility of an exchangeable value were conceded, ... the imputation of interest in subsequent time periods is seriously deficient as a measure of that value as of the time of the loan. 33 585 F.2d at 239. 34 We believe that this reasoning is contrary to other tax cases involving the right to use property for an indefinite period. Those cases establish that an at will interest is property, notwithstanding the absence of any rights vis-a-vis the transferor. Additionally, the recipient of a loan payable on demand would have a right with an exchangeable value; the borrower would be free to turn around and transfer that property right to another. For example, Lyle could have lent to a third party, at an arm's length interest rate, the money on loan to him, to be repaid on demand, which would be made when demand was made on Lyle's loan. How much the second borrower might be willing to pay for such a loan would probably be dependent upon how long he was able to retain use of the money lent. The Commissioner proposes to value the no-interest demand loans to Lyle and Artesian in precisely the same manner. 35 The Commissioner argued before the Seventh Circuit that the gift could be viewed as occurring continuously during the period that the loan is outstanding and as being completed only to the extent that the lender continues to refrain from demanding repayment. The court noted that this view of the gift is in harmony with the Commissioner's formula for measuring the amount and timing of the gift. Id. at 240. However, the court apparently believed that this changed the concept of the gift being considered, and that the gift tax statute would not reach such a gift; it stated, To characterize the mere use of property as a transfer of a property right implies a broader concept of what constitutes a property right under the gift tax laws than has heretofore been recognized. Id. (Footnote omitted). 36 We disagree with the Seventh Circuit's reasoning. The gift being considered does not change merely because it is valued upon completion of the gift each quarter. The right to use money is the property right being transferred; the period of use of that property-the length of time the donee is given the property right-is merely the means of valuing the property. See Crown, 67 T.C. at 1069 (Simpson, J., dissenting). 37 In sum, for the reasons set forth, we are unpersuaded by the views of other courts that have faced the issue before us. 8 We believe that the gift tax statute requires a different result. 9