Court Opinion

ID: 4473157
Source: CourtListenerOpinion
Date Created: 2020-01-14 19:35:08.879013+00
Date Added: 2024-06-11T14:53:48.327108
License: Public Domain

Ruwe, J., dissenting: I disagree with the standards that the majority opinion uses for determining whether Ms. Read’s transfer of stock to MMP qualifies as a transfer to which section 1041 applies. When considering whether section 1041 can be applied to a transfer to a third party, it is necessary to examine the tax consequences for both spouses. This is because symmetrical treatment of both spouses is necessary to achieve the purposes of section 1041. The transaction in issue in this case is Ms. Read’s transfer of stock to MMP. This transaction was a corporate redemption that left Mr. Read in control of MMP. A substantial body of case law has developed regarding the tax results of such redemptions. Long before the enactment of section 1041, courts were required to deal with the tax ramifications of a corporate redemption of one shareholder’s stock that left a remaining shareholder in control of the redeeming corporation. From one perspective, such a redemption conferred a control benefit on the remaining shareholder. Based on this, the Commissioner argued that the corporation’s redemption payment constituted a constructive dividend to the remaining shareholder. On the other hand, the postredemption value of the corporation was diminished by the distribution of corporate funds used in the redemption, suggesting that the remaining shareholder may have received no real benefit from the redemption. From this latter perspective, the redemption simply reflects a shareholder’s sale of stock to the corporation. Given these considerations, courts have consistently held that a corporate distribution to redeem one shareholder’s stock could be treated as a corporate dividend to the remaining shareholder only if the redemption transaction satisfied the remaining shareholder’s primary and unconditional personal obligation to purchase the stock. See Arnes v. Commissioner, 102 T.C. 522, 527 (1994) (Arnes II); Edler v. Commissioner, T.C. Memo. 1982-67, affd. 727 F.2d 857 (9th Cir. 1984). As we explained in Edler. The issue is whether the stock redemption resulted in a constructive dividend to petitioner. We are faced with the rule that where a corporation redeems stock which its remaining shareholder was obligated to buy, the remaining shareholder receives a constructive dividend. Wall v. United States, 164 F.2d 462 (4th Cir. 1947). However, the rule of Wall has been limited to those circumstances where the obligation of the purchasing shareholder is both primary and unconditional. Enoch v. Commissioner, 57 T.C. 781 (1972); Priester v. Commissioner, 38 T.C. 316 (1962). If, on the other hand, the corporation redeems stock which the remaining shareholder was not obligated to buy, no constructive dividend is received by that shareholder. Edenfield v. Commissioner, 19 T.C. 13 (1952). Applying the above rules, certain disparate tax consequences become apparent. When two shareholders own a corporation, there is no practical economic difference between using a stock redemption and using a dividend distribution to the remaining shareholder to fund the acquisition of the selling shareholder’s stock. Nevertheless, the tax consequences to the remaining shareholder are profoundly different. A knowledgeable shareholder could negotiate a dedemption by the corporation and escape harsh tax consequences to himself; whereas, a less knowledgeable shareholder might unwilling commit himself to effect the purchase and be threatened with an unintended dividend. Except for the tax consequences, the shareholder’s economic positions are identical. Obviously, in this area of the tax law, the form employed is critical and taxpayers are free to choose the form most beneficial to themselves. It is against this background that the rule of Wall has been limited to circumstances where the obligation which has been discharged is both primary and unconditional. [Fn. refs, omitted.] If a redemption satisfied a primary and unconditional obligation of the remaining shareholder, the remaining shareholder was generally treated as having received a constructive dividend. See Hayes v. Commissioner, 101 T.C. 593, 599 (1993). While the primary and unconditional standard is often referred to as determinative of whether a redemption of one shareholder’s stock is a constructive dividend to the remaining shareholder, this is an oversimplification. The standard really determines only whether a redemption of one shareholder’s stock should be treated as a corporate distribution to the remaining shareholder.1 While treating a redemption of one shareholder’s stock as a corporate distribution to the remaining shareholder has generally resulted in a finding that the remaining shareholder received a constructive dividend, dividend treatment also depends on the existence of corporate earnings and profits.2  The primary and unconditional standard is applicable to stock redemptions required by divorce judgments. For example in Edler v. Commissioner, supra, a divorce settlement and judgment required a redemption of the wife’s corporate shares, leaving the husband in control of the corporation. This Court and the Court of Appeals for the Ninth Circuit found that the redemption required by the “modified” settlement and judgment did not relieve the husband of a primary and unconditional obligation to purchase his wife’s stock, and as a result, the husband did not receive a constructive dividend. In Edler, the “original” settlement and judgment required the husband to pay his wife for her stock interest. The Court of Appeals for the Ninth Circuit noted that had the “original” divorce settlement and judgment remained in effect, the corporation’s redemption payment to the wife would have satisfied the husband’s obligation and would have been treated as a dividend to the husband. See Edler v. Commissioner, 727 F.2d at 860. Court opinions dealing with taxable years prior to the enactment of section 1041 generally do not discuss the tax treatment of the stockholder whose stock was being redeemed. This was because there was no question that the person whose stock was being redeemed would be taxable on any gain on the sale of his or her stock, regardless of who paid for the stock or whether the remaining shareholder was treated as having received a dividend. The enactment of section 1041 introduced a broad rule of nonrecognition for transfers of property between spouses and former spouses incident to divorce. Section 1041 makes no reference to transfers to third parties. However, temporary regulations issued under section 1041 explain the circumstances in which a spouse’s transfer to a third party qualifies as a transfer to which section 1041 applies. See sec. 1.1041-lT(c), Q&A-9, Temporary Income Tax Regs. (Q&A-9), 49 Fed. Reg. 34453 (Aug. 31, 1984). Q&A-9 does not specifically address a spouse’s transfer of stock to the issuing corporation as part of a corporate redemption that was required by a divorce judgment. However, in this case and prior cases, the Commissioner has consistently treated Q&A-9 as applying to divorce-related corporate redemptions, and this position has been adopted by the Court of Appeals for the Ninth Circuit in Arnes v. United States, 981 F.2d 456 (9th Cir. 1992). See also Hayes v. Commissioner, supra, and Craven v. United States, 83 AFTR 2d 99—1268, 99-1 USTC par. 50,336 (N.D. Ga. 1999), in which Q&A-9 was applied to divorce-related redemptions of stock.3  One of the purposes for enacting section 1041 was to prevent divorcing spouses from whipsawing the Commissioner by taking inconsistent positions on divorce-related transfers. In Blatt v. Commissioner, 102 T.C. 77, 79 (1994), we explained: In part, Congress enacted section 1041 to replace the holding in United States v. Davis, 370 U.S. 65 (1962), that a divorce-related transfer of property in exchange for the release of marital claims resulted in recognition of gain to the transferor. H. Rept. 98-432, at 1491-1492 (1984). Before the enactment of section 1041, as a result of Davis, the transferring former spouse was taxable on a divorce-related transfer of appreciated property to his or her former spouse, and the recipient received a basis in the transferred property equal to its fair market value on the date of transfer. United States v. Davis, supra. Thus, the Government was whipsawed if such a transferor did not report any gain on a transfer of appreciated property. Accordingly, in 1984, Congress enacted section 1041 to remedy this whipsaw. H. Rept. 98-432, at 1491-1492 (1984). [Fn. ref. omitted.] Q&A-9 specifies the way a transaction will be treated for both spouses and requires symmetrical results as to those spouses in order to prevent a whipsaw. Under Q&A-9, if a spouse’s transfer to a third party qualifies for nonrecognition under section 1041, then she is treated as if she transferred the property to the other spouse (nontransferring spouse). Section 1041(b)(2) provides that the nontransferring spouse’s basis in the property is the same as the transferring spouse’s basis. The nontransferring spouse is then treated as having transferred the property to the third party. Thus if Q&A-9 applies to this case, Ms. Read will be treated as having transferred her stock to Mr. Read, and Mr. Read’s basis in the transferred stock will be the same as Ms. Read’s — zero. Mr. Read will then be treated as having transferred the stock to MMP. It follows that the redemption proceeds should be treated as having been received by Mr. Read who in turn is treated as having paid Ms. Read. Pursuant to Q&A-9, a transfer of property to a third party required by a divorce or separation instrument will be treated as qualified under section 1041 only if it is made “on behalf of” the nontransferring spouse. In order to accomplish this regulatory scheme and the statutory goal of eliminating whipsaws, the phrase “on behalf of” must have the same meaning when applied to each of the divorcing spouses. There is nothing in Q&A-9 to indicate that the Commissioner was attempting to, or could, change the existing standards for determining whether a corporate redemption of one shareholder’s stock could be treated as a distribution to the remaining shareholder. Indeed, Q&A-9 is a temporary regulation intended only to effect the legislative objective of section 1041. Nothing in section 1041, or its legislative history, suggests that it was intended to displace longstanding principles used in determining whether a corporate redemption of one shareholder’s stock could be treated as a distribution to the remaining shareholder. In Arnes II, we specifically held that the enactment of section 1041 did not change the primary and unconditional standard for determining whether a redemption of one spouse’s stock can result in a constructive dividend to the other spouse. In Arnes II, 102 T.C. at 528, we stated: “The rationale of Edler [the primary and unconditional test] was not affected by the enactment of section 1041, and the case is still the law of the Court of Appeals for the Ninth Circuit, to which this case is appeal-able.”4 That is undoubtedly why all the parties in the instant cases presented their arguments as if the primary and unconditional obligation standard applied for purposes of determining the inextricably related questions of whether Q&A-9 applies and whether the redemption of Ms. Read’s stock should be treated as a dividend to Mr. Read.5  Respondent’s position is that Mr. Read had a primary and unconditional obligation to purchase Ms. Read’s stock and that the redemption of Ms. Read’s stock (a necessary and integral part of which was her transfer of stock to MMP) satisfied Mr. Read’s obligation. Mr. Read, MMP, and Ms. Read agree that the primary and unconditional obligation standard should be determinative of whether Ms. Read’s transfer of stock was “on behalf of” Mr. Read within the meaning of Q&A-9. On this point, the parties are all correct.6 The primary and unconditional standard is still controlling law for determining whether a divorce-related redemption distribution to one shareholder spouse can ever be a dividend to the remaining shareholder spouse. See Arnes II, supra. Because symmetrical treatment is required by section 1041, it should be obvious that the same primary and unconditional standard must also be the standard for determining whether Q&A-9 applies to a redemption transaction. Arnes II was decided for a tax year to which Q&A-9 was applicable. Indeed, the Court of Appeals for the Ninth Circuit had applied Q&A-9 to Mrs. Arnes, giving her the nonrecognition benefit of section 1041. See Arnes v. United States, 981 F.2d 456 (9th Cir. 1992).7 Our majority opinion in Arnes II dealt only with whether Mr. Arnes had received a constructive dividend. In Arnes II, we found that the redemption of one spouse’s stock could be a constructive dividend to the other spouse only if the redemption satisfied a primary and unconditional obligation of the nontransferring spouse. In Arnes II, the majority opinion expressed no view on whether the primary and unconditional standard had to be met in order for section 1041 and Q&A-9 to apply to a corporate redemption. That opened the possibility that a different standard would be applicable for purposes of giving section 1041 relief to the transferring spouse. This, in turn, opened the possibility that the Commissioner could be whipsawed. However, a total of 9 of the 18 Judges who participated in the consideration of Arnes II (including the author of the majority opinion in Arnes II) indicated in concurring and dissenting opinions that section 1041 and Q&A-9 required symmetrical results with respect to both spouses. The majority now holds that the “on behalf of” requirement in Q&A-9 is satisfied by a standard that is substantially lower and less precise than the primary and unconditional obligation test of Edler v. Commissioner, T.C. Memo. 1982-67, and Arnes II. The majority holds that the “on behalf of” test is satisfied if the transfer was “in the interest of” or was made by the transferring spouse acting “as a representative. of” the nontransferring spouse. This standard presumably could be met if the nontransferring spouse received some general benefit or if the obligation of the non-transferring spouse was either secondary, conditional, or both. Based on this lower standard, the majority holds that Ms. Read is entitled to rely on section 1041 and, therefore, need not recognize gain on the transfer of her stock.8 I believe this is an error. One of the problems with simply applying the dictionary meaning of “on behalf of” to a divorce-related corporate redemption is that the redemption will usually, in a general sense, be in the interest of both the spouse whose stock is redeemed- and the spouse who is the remaining shareholder. For example, the transferring spouse receives money from the corporation in return for her stock. This receipt of money (especially if it represents a substantial gain as in this case) benefits the transferring spouse. Oftentimes the transfer will also generally benefit the spouse who is the remaining shareholder. This is the same dilemma that courts confronted in trying to determine whether a redemption of one shareholder’s stock could ever be considered a constructive dividend to the remaining shareholder. As a result, the courts fashioned the primary and unconditional obligation test that we applied in Arnes II. The fact that Ms. Read’s transfer was simply “in the interest of” Mr. Read or. that Mr. Read received “some general benefit” is an insufficient reason for us to conclude that Mr. Read could have a constructive dividend. See Ingham v. United States, 167 F.3d 1240 (9th Cir. 1999), where the court explained that a transfer to a third party would not be considered “on behalf of” the other spouse within the meaning of Q&A-9 unless the transfer relieved the other spouse of a “specific legal obligation or liability.” Id. at 1244. The fact that the other spouse receives “some general benefit” is insufficient. Id. Because Q&A-9 controls the tax treatment of both spouses, a divorce-related corporate redemption transaction should not be considered to be a transfer “on behalf of” the non-transferring spouse within the meaning of Q&A-9 unless the nontransferring spouse had a primary and unconditional obligation to purchase the redeemed stock. The majority’s error is compounded by concluding that Mr. Read must recognize a constructive dividend but failing to give any legal explanation for this result. How could Mr. Read have a constructive dividend in light of our prior Court-reviewed opinion in Arnes II, where we said that section 1041 made no change in prior law and held that a redemption of one spouse’s stock cannot result in a constructive dividend to the other stockholder spouse, unless the redemption satisfied the latter’s primary and unconditional personal obligation to purchase the redeemed shares? This is a problem that the majority refuses to confront. Instead, the majority simply states that Mr. Read and MMP “indicated” that if the Court were to find that section 1041 applies to Ms. Read, then respondent’s determinations regarding Mr. Read and MMP should be sustained. The majority’s attempt to extricate itself from this dilemma by latching onto an isolated statement in the motion filed by Mr. Read and MMP is unjustified by the record and fundamentally unfair. The “indication” by Mr. Read and MMP is taken out of context. The full argument made by Mr. Read and MMP is that Q&A-9 cannot apply to a corporate redemption unless the redemption satisfies a primary and unconditional obligation of the nontransferring spouse. They “indicate” that if this standard is met and Q&A-9 applies, then respondent’s determinations should be sustained. To take the latter statement out of context after having rejected the argument on which it is predicated is totally unwarranted. In any event, we should never rely upon and apply a party’s statement of law that is contrary to a holding contained in a prior Court-reviewed opinion of this Court that is still binding precedent.9 No matter how convenient it may be to avoid unreconcilable differences in our opinions, justice demands that we decide issues of law that control the outcome of cases that come before us. Today’s majority opinion puts in place one legal standard for determining whether a transferring spouse receives the benefits of section 1041 while leaving in place the different and more stringent standard of Arnes II for purposes of determining whether the corresponding tax burdens can be placed on the nontransferring spouse. This opens the door in future cases for both spouses to escape the tax impact of a divorce-related transfer of appreciated property and therefore contravenes one of the purposes of section 1041. The question we should ask and answer is whether mmp’s redemption of Ms. Read’s stock satisfied a primary and unconditional obligation of Mr. Read. If the answer is yes, we should hold that Q&A-9 applies, Mr. Read had a constructive dividend, and Ms. Read gets the benefit of section 1041. If Mr. Read did not have a primary and unconditional obligation to purchase Ms. Read’s stock, then we should hold that Q&A-9 does not apply, the redemption of Ms. Read’s stock did not result in a constructive dividend to Mr. Read, and Ms. Read’s transfer of stock to MMP should be treated as a simple redemption resulting in a taxable capital gain to Ms. Read. Beghe, J., agrees with this dissent.   The constructive “treatment” of the participants in a redemption that satisfied the primary and unconditional obligation of the remaining shareholder under pre-sec.-1041 case law would be the same as that prescribed in sec. 1.1041-1T(c), Q&A-9, Temporary Income Tax Regs., 49 Fed. Reg. 34453 (Aug. 31, 1984); i.e., the transferring shareholder would be treated as transferring stock to the remaining shareholder who would be treated as transferring the stock to the redeeming corporation in return for the corporate distribution.    No one questions that MMP had earnings and profits in excess of the redemption payments. MMP’s income tax returns for the relevant years show unappropriated retained earnings in excess of $1 million.    It has been suggested that Q&A-9 can never apply to a corporate redemption. If this were true, a corporate redemption of one spouse’s stock that satisfied the other spouse’s primary and unconditional obligation to purchase that stock could result in both spouse’s being taxed on the redemption. Such a result is contrary to the objective of sec. 1041, the Commissioner’s position, and existing case law.    It has been suggested that Arnes II did not discuss the impact that sec. 1041 and Q&A-9 would have on the spouse who was the remaining shareholder. However, as indicated above, in Arnes II we held that enactment of sec. 1041 had no impact on the tax treatment of the spouse who was the remaining shareholder after a divorce-related redemption of the other spouse’s stock. This issue was clearly before the Court as shown by the various concurring and dissenting opinions in Arnes II.    It has also been suggested that the primary and unconditional standard has no applicability to sec. 1041 and Q&A-9 because the primary and unconditional standard focuses on the purpose served by the corporate distribution to redeem stock rather than the spouse’s transfer of stock to the corporation. However, a redemption distribution to a spouse that satisfies a primary and unconditional obligation of the other spouse is completely dependent on the transfer of stock to the redeeming corporation. If a redemption distribution that satisfies a primary and unconditional obligation of the nontransferring spouse is totally dependent on the transfer of stock being redeemed, then the transfer of stock to the redeeming corporation is an integral part of satisfying the primary and unconditional obligation of the nontransferring spouse.    Ms. Read and respondent argue that the redemption satisfied Mr. Read's primary and unconditional obligation, while Mr. Read and MMP argue that Mr. Read was never primarily and unconditionally obligated to purchase Ms. Read’s stock.    The Court of Appeals for the Ninth Circuit concluded that the obligation to purchase Mrs. Arnes’ stock was Mr. Arnes’ obligation, not the corporation’s. Thus, the Court of Appeals’ opinion is consistent with the primary and unconditional obligation standard.    It has also been suggested that sec. 1041 and Q&A — 9 apply to all divorce-related transactions that are made to divide a marital estate. This approach is more encompassing than the majority’s approach and is contrary to established precedent. See Ingham v. United States, 167 F.3d 1240 (9th Cir. 1999); Blatt v. Commissioner, 102 T.C. 77 (1994).    The majority does not purport to overrule or modify Arnes II.