UNITED STATES TAX COURT
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T.C. Memo. 1996-76
UNITED STATES TAX COURT
ALICE BERGER, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 2464-93, 3130-93,
3133-93.
Filed February 22, 1996.
Richard C. Antonelli, for petitioner in docket No. 2464-93.
John M. McNally, for petitioners in docket Nos. 3130-93 and
3133-93.
William F. Halley and Caroline Ades-Pierri, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
BEGHE, Judge:
1
Respondent determined the following
Cases of the following petitioners are consolidated
herewith: Estate of Howard Berger, Deceased, Susan Berger,
Administratrix, docket No. 3130-93; and Estate of Howard Berger,
Deceased, Susan Berger, Administratrix, and Susan Berger, docket
No. 3133-93.
- 2 deficiencies in and additions to petitioners' Federal income tax:
Howard and Alice Berger (Docket Nos. 3130-93 and 2464-93):
Year
1988
Deficiency
$155,646
Addition to tax
Sec. 6653(a)(1)
$7,782
Alice Berger (Docket No. 2464-93):
Year
1989
Deficiency
$307,202
Addition to tax
Sec. 6651(a)(1)
$76,801
Penalty
Sec. 6662
$61,440
Howard and Susan Berger (Docket No. 3133-93):
Year
1989
Deficiency
$68,801
Addition to tax
Sec. 6651(a)(1)
$23,577
The cases in the above-mentioned dockets have been
consolidated for trial, briefing, and opinion.
Following the
trial, we granted respondent's motion for leave to file an
amended answer asserting the following increased deficiency and
addition to tax against Howard and Susan Berger (Docket No. 313393):
Year
1989
Deficiency
$237,936
Addition to tax
Sec. 6651(a)(1)
$57,404
Petitioners Howard and Susan Berger did not file a reply to
respondent's amended answer.
However, their opening brief
contends that their 1989 return overstated taxable income from
mausoleum crypt sales, none of which, they now assert, should
have been reported by Howard Berger, and asserts an overpayment
of $61,106.
- 3 All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
The parties have settled some issues, and respondent has
conceded the section 6653(a)(1) addition against Howard and Alice
Berger for 1988 and the section 6651(a)(1) addition against
Howard and Susan Berger for 1989.
be decided:
(1)
The following issues remain to
Evidentiary objections to certain exhibits and
testimony; (2) whether Alice Berger signed the 1988 Form 1040
under duress so as to invalidate it as a joint return; (3) Howard
Berger's and Alice Berger's respective ownership interests in the
assets and business of Woodbine Cemetery (Woodbine) during 1988
and 1989 for purposes of determining their rights to income
therefrom; (4)(a) whether petitioners' method of accounting for
mausoleum crypt sales and costs should be upheld generally and
(b) whether Howard Berger must accrue income or recognize gain on
the transfer of his interest in Woodbine to Alice Berger pursuant
to their divorce settlement agreement; (5)(a) whether Howard
Berger or Alice Berger or both of them are required to recognize
gain in 1989 from the sale of Woodbine to their daughter and sonin-law, (b) the adjusted basis of Woodbine at the time of sale,
(c) whether a portion of the sale constituted a dealer
disposition under section 453(b), which would prohibit use of the
installment method for dealer assets, and (d) if so, whether and
- 4 how an allocation should be made between dealer and nondealer
assets in order to determine whether and to what extent the gain
on sale is entitled to installment treatment; (6) whether Howard
Berger and Alice Berger are liable for additional self-employment
tax for 1988 and 1989; and (7) whether Alice Berger is liable for
the section 6651(a) addition to tax or section 6662 accuracyrelated penalty for 1989.
After addressing the evidentiary questions, we hold that the
1988 return was a valid joint return and that petitioners used a
proper method of accounting for mausoleum crypt sales.
As a
result, neither Howard Berger nor Alice Berger has taxable income
from Phase II mausoleum crypt sales for 1988.
We allocate
cemetery income, including Phase II mausoleum crypt sales income,
between Howard and Alice Berger for 1989.
We hold that the gain
on the sale of Woodbine is attributable in its entirety to Alice
Berger.
After discussing the rules for determining the bases of
the Woodbine assets in the hands of Alice Berger, we use the rule
of Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930), to
determine the portion of Alice Berger's Woodbine sale gain
entitled to installment treatment as a nondealer disposition,
leaving the details to a Rule 155 computation.
We hold that
Howard and Alice Berger are both subject to self-employment tax
for 1988 and 1989, and that Alice Berger is not liable for the
section 6651(a) addition to tax or the section 6662 accuracy-
- 5 related penalty for 1989.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulations of fact filed by the parties and the
accompanying exhibits are incorporated herein by this reference.
When petitioners filed their respective petitions, Alice Berger
resided in Vermont, and Howard Berger and Susan Berger resided in
Florida.
Howard Berger and Alice Berger were married in 1953.
During
the marriage, Alice Berger was not employed outside the home.
Prior to 1979, Howard Berger was an insurance salesman, and he
continued to receive renewal commissions through 1989.
In 1979, Howard Berger purchased the Woodbine real property
and cemetery business, located in Oceanport, New Jersey, from
John and Lois Flock, for $100,000.
The Flocks had operated
Woodbine as a cemetery for in-ground interments.
Howard Berger continued the business of operating Woodbine
as a cemetery for in-ground interments.
From 1979 through 1989,
the income of Woodbine from the sale of cemetery plots, interment
fees, and headstones was reported on the cash basis method of
accounting, as were most expenses.
However, the cost of grave
plots ($23 per plot) was carried in an inventory account and
expensed for accounting and tax purposes when plots were sold.
By deed dated October 26, 1983, Howard Berger transferred
- 6 legal title in the Woodbine land, buildings, and structures into
the joint names of Howard Berger and Alice Berger.
Howard Berger
put the Woodbine real property in their joint names because he
believed that Alice Berger already had an interest in the
property by reason of their marriage.
By the end of 1983, Alice
Berger knew that she was a joint owner of Woodbine.
After Howard
Berger transferred Woodbine into his and Alice Berger's joint
names, he thought that they were its joint owners.
Subsequent to the 1983 transfer, Alice Berger's signature,
or a copy thereof, appeared on deeds conveying cemetery spaces to
customers of Woodbine.
From 1979 through 1986, Howard Berger managed and operated
Woodbine and regularly went to work there.
During this period,
Alice Berger did not participate in the operation of Woodbine. In
1984, Howard Berger hired his son-in-law, Gregg Kunkowski, the
husband of his and Alice's daughter Julia, as a salesman for
Woodbine.
In 1984 Howard Berger began to construct a mausoleum on the
Woodbine property (Phase I) and to solicit customers and receive
deposits and installment payments for mausoleum crypts.
The
deposits and installment payments received prior to completion of
Phase I were not recorded as income when received but were
recorded as deposits pending completion of the Phase I mausoleum.
The costs of construction of Phase I were not deducted as
- 7 incurred but were instead carried as inventory costs.
In 1986 construction of Phase I was completed.
Certificates
of occupancy were obtained, and certificates of ownership were
issued to all customers who had paid in full.
Howard and Alice
Berger reported as income for 1986 all deposits and installment
payments previously received for this phase.
The cost of
construction of Phase I was allocated to the total number of
crypts, and the allocated cost of unsold crypts was deducted
ratably as "cost of sales" as Woodbine issued certificates of
ownership to subsequent crypt purchasers at or after completion
of construction of the mausoleum.
In June 1986, during a trip to Scotland, Howard Berger
became ill with a heart condition, and he and Alice Berger
separated.
When Howard Berger returned from Scotland, he did not
move back to the family home in West Long Branch, New Jersey, but
moved instead to Waterboro, Maine.
He never resumed day-to-day
management or operation of Woodbine.
During Howard Berger's absence, Gregg Kunkowski acted as
manager of Woodbine.
After it became clear that Howard Berger
was not going to return to work, Gregg Kunkowski proposed a
contract setting forth the terms for his continuing employment in
the Woodbine business.
He presented his proposal to Dr. Florence
F. Forgotson, Alice Berger's attorney, who drafted an agreement.
On December 1, 1986, Howard Berger and Alice Berger (as
- 8 employers) and Gregg Kunkowski (as employee "General Manager")
entered an employment agreement.
The employment agreement
provided for a 5-year term with an option to renew, compensation
equal to 20 percent of "the total gross sales of space in the
mausoleum", and rent-free occupancy by the Kunkowskis of "the
home renovated by them on the premises, indefinitely".
Construction of the second Woodbine mausoleum (Phase II)
began in 1987 and was completed in May 1989.
In 1987, Gregg
Kunkowski, as manager of Woodbine, began to solicit customers for
crypts in the mausoleum to be constructed in Phase II.
In 1987
Woodbine began to receive deposits and installment payments for
crypts in Phase II.
A customer who paid a deposit on a crypt in Phase II would
execute a contract setting forth the location of the crypt, the
price, and the payment terms (the crypt purchase contracts
generally provided that the customer would pay any unpaid portion
of the purchase price in equal monthly installments--without
stated interest--over a period of not more than 24 months).
Prior to completion of construction, the purchaser would receive
a Temporary Certificate of Ownership upon payment of the full
contract price for a crypt in Phase II and then a Certificate of
Ownership when the mausoleum was completed.
After completion of
construction, the purchaser would receive a Certificate of
Ownership upon payment of the full contract price for space in
- 9 Phase II.
The deposits and installment payments received by
Woodbine in 1987 and 1988 for Phase II were not recorded as
income when received; instead they were recorded as deposits
pending completion of Phase II.
From October 1986 until March 14, 1989 (except for a short
period during late 1987), Gregg Kunkowski wrote to each of Alice
Berger and Howard Berger a $500 weekly check from Woodbine's bank
account.
These checks were posted to accounts on Woodbine's
books entitled "AB Draw" or "Alice Berger Draw" and "HB Draw" or
"Howard Berger Draw", respectively.
Gregg Kunkowski also used
the Woodbine business account to pay some of Howard and Alice
Berger's personal expenses (e.g., telephone and utility bills).
During 1988, Howard Berger and Alice Berger received $42,676 and
$45,578, respectively, from the Woodbine business account.
In early 1987, Alice Berger initiated New Jersey divorce
proceedings against Howard Berger.
Alice Berger and Howard
Berger were represented by counsel in these proceedings.
r
about September 22, 1987,2 Dr. Forgotson, as Alice Berger's
attorney, sent Gregg Kunkowski a letter stating:
Alice Berger has instructed me to advise you that as a
joint owner of the Woodbine Cemetery & Mausoleum
business, you are instructed not to make any payments
on behalf of Howard Berger and/or Susan Moorehouse, for
any reason, without the consent of Alice Berger * * *
2
Although the letter is dated Sept. 22, 1988, subsequent
court orders, dated Oct. 21, 1987, and Dec. 18, 1987, which
restrain Alice Berger from interfering with Howard Berger's
receipt of $500 per week from Woodbine, make clear that the
letter should have been dated Sept. 22, 1987, and was sent about
that time.
- 10 Dr. Forgotson sent copies of the letter to Alice Berger and
Howard Berger's attorney.
On October 21, 1987, the Superior
Court of New Jersey, Chancery Division, Family Part, Monmouth
County (the Chancery Court),
ORDERED that plaintiff [Alice Berger] and/or her
attorney [Dr. Forgotson] be and is hereby restrained
from interfering with defendant's [Howard Berger's]
receipt of income as a partner of the Woodbine Cemetery
& Mausoleum in the amount of $500 per week * * * .
On December 18, 1987, the Chancery Court issued an order
confirming that Howard Berger was entitled to draw $500 per week
from the Woodbine business, retroactive to September 24, 1987.
During property settlement negotiations, Howard and Alice
reached an impasse.
Both of them wanted Woodbine, and neither
was willing to let the other have it.
To break the impasse,
Howard and Alice Berger agreed that whoever was awarded Woodbine
would sell it to Gregg and Julia Kunkowski for $680,000.
On May
28, 1988, Howard and Alice Berger and Gregg and Julia Kunkowski
executed an agreement (sale agreement), which stated:
In the event that I, Alice Berger or I, Howard Berger,
am awarded the property and business known as "Woodbine
Cemetery" * * *; I will immediately sell Woodbine
Cemetery to my daughter and son-in-law Julia B. and
Gregg W. Kunkowski, who have been managing the business
for the past two years.
In late 1988, Gregg Kunkowski began to solicit deposits and
installment payments for crypts in a planned Phase IIIA
mausoleum, construction of which did not commence until after
November 17, 1989.
Total deposits received on Phase IIIA crypts
prior to November 17, 1989, totaled $49,616.
- 11 On November 25, 1988, American Cemetery Consultants
submitted an appraisal of Woodbine to Gregg Kunkowski.
According
to this appraisal, which used both income valuation and net asset
valuation methods, Woodbine at that time had a fair market value
of $696,038.
The gross and net assets of Woodbine were valued as
follows:
Cash (as of 10/1/88)
Accounts receivable ($428,601 @ 41.6%)
Office building
Residence
Service building
Storage building
Equipment and furnishings
Uninsured office and grounds equipment
Salable inventory: grave spaces
Salable inventory: mausoleum crypts
Salable inventory: cremation niches
Undeveloped land
Roads, landscaping, etc.
Gross Asset Valuation
Less: Debt to McCleskey Mausoleum Co.
Net Asset Valuation
$20,000
172,298
100,000
75,000
80,000
40,000
17,000
26,000
12,518
42,992
14,205
219,555
43,200
1
878,681
175,000
703,681
The correct sum of these figures is not $878,681 but $862,768, which
brings the net asset valuation figure closer to the price of $680,000
ultimately agreed upon and paid.
1
American Cemetery Consultants viewed this result as supporting
the valuation resulting from the income valuation method.
On or about March 14, 1989, Howard and Alice Berger entered
into a settlement agreement, which resolved the issues of
alimony, equitable distribution, counsel fees, and costs.
Under
the terms of the settlement agreement, the Berger family assets
be divided as follows:
- 12 Alice Berger
Vermont house
New Jersey house1
New Jersey furniture2
Bonds
Note I
Note II
Keogh
Stock
Woodbine
Annuity
1
Howard Berger
$250,000
333,000
27,000
40,000
--------680,000
--1,330,000
--$666,000
27,000
120,000
50,300
292,205
92,000
14,400
--13,000
1,274,905
The house was to be sold and the proceeds divided.
2
Howard Berger was to use his share of the proceeds of sale of the
house to purchase one-half the furniture from Alice Berger.
The Bergers' assets were divided approximately equally according
to gross value.
Although income tax liabilities were inherent in
several of the assets (e.g., Woodbine, Keogh, and Note II (an
installment sale note with a 78-percent gross profit
percentage)), the settlement agreement did not expressly take
account of or otherwise refer to tax liabilities.
The settlement
agreement provided that Howard Berger would indemnify Alice
Berger for income taxes for years prior to 1986, but that they
were equally liable for any income taxes due for 1986.
The
settlement agreement provided that the Bergers would file a joint
income tax return for 1988 and share equally in any savings that
resulted from filing a joint return.
The settlement agreement stated that "The property and
business known as Woodbine Cemetery and Mausoleum including real,
personal and business assets shall be transferred to * * * [Alice
Berger]".
- 13 The settlement agreement also set forth the terms of the
sale agreement requiring whoever was awarded Woodbine (Alice
Berger) to sell it to Gregg and Julia Kunkowski for $680,000.
On March 14, 1989, Howard and Alice Berger and their
counsel appeared in the Chancery Court and entered into the
record the terms and conditions of the settlement agreement.
Alice Berger testified that she understood the terms of the
settlement agreement, that she had participated in its
negotiation, that she agreed the settlement was fair and
equitable, that no one had compelled her to accept its terms, and
that she would abide by them if they were made a part of the
Court's judgment.
Howard Berger's beneficial ownership interest in the
Woodbine assets and business ceased on March 14, 1989.
Thereafter, he no longer received weekly payments of $500 from
the Woodbine business account, although several of his personal
bills that had accrued prior to March 14, 1989, were paid
thereafter.
During 1989, Howard Berger received $10,034 from the
Woodbine business account, $7,795 of which was paid prior to
March 14, 1989.
From March 20 until November 13, 1989, Alice Berger received
weekly payments of $1,000 (twice as much per week as she had been
receiving prior to March 14, 1989) from the Woodbine business
account.
In addition, some of her personal expenses continued to
be paid from the Woodbine business account.
During 1989, Alice
- 14 Berger received, directly or indirectly, $61,404 from the
Woodbine business account, $7,560 of which was paid prior to
March 14, 1989.
On April 24, 1989, the Chancery Court entered a Judgement
For Divorce.
The judgment incorporated the settlement agreement
and was stated to be effective as of March 14, 1989.
The
Chancery Court did not purport to pass on whether the settlement
agreement was fair and reasonable, but stated that, based upon
its observations and the parties' testimony, the settlement
agreement had been voluntarily and knowingly entered into by the
parties with able assistance of counsel.
The Chancery Court
determined that the settlement agreement became binding as a
contract and as a judgment of the Court.
The requirement in the settlement agreement for a subsequent
sale of Woodbine to Gregg and Julia Kunkowski was placed in the
Judgement for Divorce at the insistence of Gregg Kunkowski. On
May 8, 1989, Gregg Kunkowski wrote the following letter, on the
Woodbine letterhead, to Alice Berger and Howard Berger, and to
Julia's sister and brother, Florence and Richard Berger, who play
no roles in this case:
May 8, 1989
Dear Alice, Florence, Howard, & Richard
I am writing this letter to appraise [sic] all of you
of the situation which now exists here at the Cemetery
and is of the utmost importance to all of us.
When building mausoleums in phases, as we are doing at
Woodbine, it is common practice to segregate a certain
- 15 amount of crypts to be used for temporary entombment.
These spaces are intended for those people who have
purchased in future phases but had the misfortune of
dying prior to the building's completion.
We have recently filled our last temporary entombment
space in Phase I and now must seek a Certificate of
Occupancy so that we may legally make entombments in
Phase II. However, in obtaining a Certificate of
Occupancy drastic tax ramifications will result for
Howard and Alice in their 1989 tax situation. All
monies collected for Phase II have been recorded as
deposits so no tax has been paid on these monies. This
is acceptable, legal accounting practice as we had not
yet taken possession of the building. The moment we so
take possession of the building, all the aforementioned
monies become income to Howard and Alice and are then
subject to income tax. Simply stated, Howard and Alice
will have one wopping [sic] tax bill for 1989.
As we have no choice but to immediately obtain a C.O.
and take possession of Phase II, there is but one
alternative to circumvent this problem. Howard and
Alice must immediately deed over the lands to the now
existing Non-Profit Corporation, Woodbine Cemetery
Association of Oceanport. Once it's done, the tax
situation will no longer exist as the Association will
not be subject to income tax.
The next step is to have the new corporation issue the
necessary Certificates of Indebtedness. Howard has
asked that these certificates be issued in both his and
Alice's names. This is impossible as to do so would be
a direct violation of a standing court order signed by
Judge Kennedy on April 24, 1989, which reads as
follows: "The Property and Business known as Woodbine
Cemetery and Mausoleum including real personal and
business assets shall be transferred to the wife, and
the business known as Woodbine Cemetery and Mausoleum
shall be thereafter sold to Julia Berger Kunkowski and
her husband Gregg Kunkowski for the sum of $680,000.
plus interest, all of which shall be paid over a period
of twenty-five years at the rate of $72,717. per year
and payable monthly at $6059.75 per month." The
Certificates must be issued in Alice's name and the
balance of the order executed.
This week I must obtain a Certificate of Occupancy so
that entombment can be continued here at Woodbine. For
- 16 the good of all we have to go forward with the above as
quickly as possible.
A cemetery is a public trust. No one's personal
problems should ever be permitted to supersede the
needs of the members of the community whom we serve.
Very truly yours,
Gregg Kunkowski
Cemetery Manager
On June 10, 1989, Howard Berger and Susan Moorehouse were
married, and she became known as Susan Berger.
By deed dated June 23, 1989, Howard Berger transferred his
remaining legal title to the Woodbine real property to Alice
Berger.
The delay in transfer of full legal title to Woodbine
from Howard Berger to Alice Berger resulted from delay in
securing an attorney to draft the necessary papers.
Howard and Alice Berger filed joint returns for 1979 through
1987, reporting the Woodbine income and expenses on Schedule C.
They reported that Howard Berger was the proprietor of Woodbine
and that all the income from Woodbine was self-employment income
of Howard Berger.
On October 4, 1989, the Chancery Court ordered Alice Berger
to show cause why an order should not be entered "Directing
plaintiff [Alice Berger] to sign the 1988 Federal and state
income tax returns and return them to defendant [Howard Berger]
for filing".
counsel.
The order was served on Alice Berger and her
On October 12, 1989, Alice Berger and her counsel
- 17 appeared before the Chancery Court.
They were not able to
persuade the Chancery Court that Alice Berger should not have to
sign the return as required by the terms of the settlement
agreement.
Although Alice Berger believed that the 1988 return
was erroneous, she also believed that the Chancery Court had
ordered her to sign it, and she signed it at the courthouse.
Howard Berger had previously signed the 1988 return on May 5,
1989.
On October 14, 1989, Alice Berger and Howard Berger timely
filed their 1988 Form 1040.
Attached to the return was the
statement:
I, Alice W. Berger, do CERTIFY that I am signing this
return under duress by court order. It is my
contention that there was a change in the accounting
method of Woodbine Cemetery without approval of the
Internal Revenue Service, and that this change does not
clearly reflect income earned.
I intend to seek relief under Furnish v. Comm., 59-1
USTC, para 9189 and Brown v. Comm., 51TC116.
None of the Federal income tax returns filed by Howard or
Alice Berger for the taxable years 1986 through 1989 reported any
gross income in respect of payments to them or on their behalves
from the Woodbine business account.
By deed dated November 17, 1989, Alice Berger transferred
ownership of the Woodbine real property to Woodbine Cemetery
Association of Oceanport, Inc. (Woodbine Association), in
exchange for Woodbine Association Certificates of Debt having a
- 18 face value of $680,000 and bearing interest at 9-3/4 percent.3
On the same day, Alice Berger transferred her interest in the
Woodbine Association Certificates of Debt to Gregg and Julia
Kunkowski in exchange for a $680,000 note signed by Gregg and
Julia Kunkowski as makers to Alice Berger as payee.
The note
called for monthly payments of principal and interest of
$6,059.75 for a term of 25 years.
During 1989, Alice Berger
received two payments, totaling $12,119.50, on the note.
The parties have stipulated that the 1989 income statement
of Woodbine accurately reflects its income, expenses, and net
income for the period January 1 through November 17, 1989
(including therein $491,432 of deposits with respect to Phases I,
II, and IIIA, and $217,124 allocated as cost of goods sold for
Phases II and IIIA), if all such deposits are found to be
properly includable in income for 1989.
The Woodbine 1989 income
statement shows net income of $383,133, which the parties have
stipulated is the taxable income of Woodbine for the period
January 1-November 17, 1989, if such deposits are found to be
properly includable in income for 1989.
Fully reported on the Howard and Alice Berger 1988 joint
3
Although the Certificates of Debt are not in evidence,
Special Resolution #2 attached to the minutes of the Nov. 17,
1989, meeting of the Board of Trustees of Woodbine Association
recites that the face amount of the Certificates of Debt was
$680,000, plus interest at 9-3/4 percent, "with interest payments
only made on a monthly basis in the amount of $5,525 per month.
The principal shall be due within 180 days of demand made by the
Holder of the Certificates".
- 19 return Schedule C were the following amounts received in 1988:
The total cemetery sales income (plot sales, openings and
markers) received in 1988; the total interest from the
maintenance and preservation account; and the total deposits and
installment payments received on the Phase I mausoleum.
The total deposits and installment payments received on
sales of crypts in the Phase II and Phase IIIA mausoleums in 1987
and 1988 were as follows:
Phase II
Phase IIIA
1987
1988
Total
$131,922
-0131,922
$352,193
7,317
359,510
$484,115
7,317
491,432
These amounts were not reported on the 1987 and 1988 joint
returns of Howard and Alice Berger.
The total deposits and installment payments received on
sales of Phase I, II, and IIIA mausoleum crypts for the periods
January 1 to March 14, 1989, and March 15 to November 17, 1989,
were as follows:
Jan. 1-Mar. 14, 1989
Phase I
Phase II
Phase IIIA
Adjustment
Refunds
$49,733.81
48,074.82
-02,378.35
( 1,107.60)
99,079.38
Mar. 15-Nov. 17, 1989
$106,989.26
149,681.00
42,299.48
-0( 3,158.00)
295,811.74
The total cemetery income (plot sales, openings, and
markers) for the above periods in 1989 was as follows:
Jan. 1-Mar. 14, 1989
Mar. 15-Nov. 17, 1989
- 20 Cemetery Income
$36,030.36
$126,710.40
The total interest income (interest on maintenance and
preservation funds) for the above periods in 1989 was as follows:
Jan. 1-Mar. 14, 1989
Interest Income
$7,262.19
Mar. 15-Nov. 17, 1989
$22,779.55
The total cost of the Phase II mausoleum was $313,869,
which, when divided by the number of crypt spaces--324--yields a
per-unit cost of $968.73.
The allocated cost of goods with regard to 1987 and 1988
sales of crypts in the Phase II mausoleum and Phase IIIA
mausoleum (full payment made) was $217,124.12, computed as
follows:
224 Phase II units at $968.73
4 Phase IIIA units at $32.15
Total
$216,995.52
128.60
217,124.12
The above amounts were based upon total construction costs
incurred as of November 17, 1989.
The remaining cost of the assets shown on the books of
Woodbine--cash, grave and mausoleum inventories, building
improvements and equipment, less depreciation (Howard Berger's
original cost was $100,000)--as of November 17, 1989, was
$75,945.
This included $5,000 of purchased goodwill, which had
not been assigned any value in the American Cemetery Consultants
appraisal.
In addition, the face amount of the receivables of
Woodbine on that date was $429,371.
Alice Berger's accountant signed, and timely filed on behalf
- 21 of Alice Berger, an application for an automatic extension of
time, until August 15, 1990, to file her 1989 income tax return,
and for an additional extension until October 15, 1990.
The
explanation of why the additional extension was needed states:
"1988 return is under audit and changes may affect 1989".
The
District Director approved the application for additional
extension about August 20, 1990.
Alice Berger made no estimated
tax payments with her applications for extensions to file her
1989 return.
Alice Berger mailed her 1989 income tax return
(Form 1040) on October 12, 1990, and it was received by the
Service Center on October 17, 1990.
Schedule C attached to Alice Berger's 1989 income tax return
reported a net loss from Woodbine of $4,101, having included
slightly less than one-half of Woodbine's gross income and almost
all of its expenses for 1989.
Attached to the return was the
following statement:
Schedule C was originally prepared by Daniel Hochberg,
accountant for Woodbine Cemetery. In 1989 the 1988
Federal income tax return of Howard and Alice Berger
was audited and accordingly, an adjustment to income
was made for an additional $229,396. This item
represented deferred income that was being book [sic]
for future years. Therefore upon receipt of the RAR,
this adjustment was made on the 1989 Federal tax
return.
Alice Berger reported the 1989 sale of Woodbine, using Form
6252 for the installment method, on her 1989 income tax return.
She reported the sale price of $680,000 but claimed that the
adjusted basis was $680,000, resulting in no reported gain or
- 22 loss.
On September 13, 1990, approximately 1 month prior to the
filing of Alice Berger's 1989 income tax return, the Internal
Revenue Service had issued a report, Form 4549, in connection
with the examination of the 1988 income tax return of Howard and
Alice Berger.
The report took the position that Phase II
mausoleum crypt sales payments were taxable Schedule C income in
the amount of $229,396 to Howard and Alice Berger.
The statutory
notice issued by respondent to Howard and Alice Berger for 1988
determined that their Schedule C gross income in respect of
Woodbine should be increased by $491,432 in respect of Phases II
and IIIA mausoleum crypt sales payments, without any offset for
the costs allocable thereto.
On March 18, 1991, the Internal Revenue Service issued a
report, Form 4549, in connection with the examination of the 1989
income tax return of Alice Berger.
The report took the position
that Alice Berger's Schedule C taxable income from Woodbine
during the year amounted to $208,889.
The report also took the
position that Alice Berger realized and recognized taxable income
of $604,055 on the sale of Woodbine, allowing a cost basis equal
to $75,945.
The statutory notice issued by respondent to Alice
Berger for 1989 determined that her gross income from Woodbine
should be increased by $475,112 in respect of mausoleum crypt
sales payments, without any offset for the costs allocable
thereto, and also determined that she realized and recognized
- 23 taxable ordinary income of $604,055 on the sale of Woodbine.
Howard and Susan Berger filed a timely application for an
automatic extension of time until August 15, 1990, to file their
1989 Form 1040.
They included a $10,000 estimated tax payment
with the application.
Howard and Susan Berger filed their 1989
Form 1040 on July 26, 1990.
On Schedule C attached to Howard and Susan Berger's 1989
return, they reported $175,142 of taxable income from the
Woodbine business, based upon a computation of one-half of the
income from before March 14, 1989, for Phase II mausoleum crypt
sales and less than 10 percent of the total Woodbine operating
expenses for 1989.
On July 1, 1991, the Internal Revenue Service issued an
amended report, Form 4549, in connection with the examination of
the 1989 income tax return of Howard and Susan Berger.
The
report and respondent's statutory notice took the position that
Howard Berger's Schedule C taxable income from Woodbine during
1989 should be increased by $245,716, without any offset for the
costs allocable thereto.
Respondent's amended answer takes the
position that Howard Berger also realized and recognized taxable
income of $604,055 on the sale of Woodbine to the Kunkowskis.
Howard Berger died on April 20, 1994.
- 24 OPINION
As in many cases in which we sort out the tax consequences
to former spouses of the property settlement attending the
dissolution of their marriage, respondent is largely a
stakeholder.
But although the cases have been consolidated, and
properly so, the benefits of consolidation could prove to be
transitory and ephemeral.
Barring stipulations to the contrary,
the consolidated cases will be appealable in different circuits
because the former spouses had changed residence by the times
they filed their petitions.
Even though New Jersey equitable
distribution orders can only be modified under exceptional and
compelling circumstances, Torwich v. Torwich, 660 A.2d 1214, 1216
(N.J. Super. Ct. App. Div. 1995), there could be further
litigation to decide how the tax liabilities we determine in
these cases will be finally allocated between Alice Berger and
the Estate of Howard Berger.
Cf. In re Hargrave, 43 Cal. Rptr.
2d 474 (Ct. App. 1995); Hill v. Richards, 667 A.2d 695 (N.J.
1995).
Although "[W]e are not called upon to determine the
ultimate responsibility for such tax" as between Alice Berger and
the Estate of Howard Berger, Yonadi v. Commissioner, T.C. Memo.
1992-602, revd. and remanded on other grounds 21 F.3d 1292 (3d
Cir. 1994), the past, current, and possible future expenditures
of judicial and party resources would have been substantially
reduced if the parties had followed our suggestions that they
- 25 enter a comprehensive settlement of the cases that we are now
required to decide.
By 1988 amendment to the New Jersey equitable distribution
law, the tax consequences to each spouse of a proposed
distribution are included in the factors to be considered by the
New Jersey court.
& Supp. 1995).
N.J. Stat. Ann. sec. 2A:34-23.1(j) (West 1987
New Jersey courts recognized--even before this
amendment--that tax consequences, including Federal tax
consequences, should be taken into account in making an equitable
distribution.
Dugan v. Dugan, 457 A.2d 1, 10 (N.J. 1983); Stern
v. Stern, 331 A.2d 257, 261 (N.J. 1975); Painter v. Painter, 320
A.2d 484, 493 (N.J. 1974).
Compare Goldman v. Goldman, 646 A.2d
504, 508-509 (N.J. Super. Ct. App. Div. 1994) with Orgler v.
Orgler, 568 A.2d 67, 74 (N.J. Super. Ct. App. Div. 1989).
The fact that a New Jersey court ordering an equitable
distribution would have considered Federal tax consequences was
an important factor in the decision of the Court of Appeals for
the Third Circuit in Yonadi v. Commissioner, 21 F.3d at 1296,
that the wife was liable for the capital gains tax attributable
to the sale proceeds from the portion of the appreciated assets
of a business allocated to her under a New Jersey divorce
settlement agreement.4
4
The Court of Appeals held that imposition
Alice Berger asks us to disregard Yonadi v. Commissioner,
21 F.3d 1292 (3d Cir. 1994), revg. and remanding on other grounds
T.C. Memo. 1992-602, because no appeal in the case at hand would
(continued...)
- 26 of the capital gains tax entirely on the husband would materially
distort the one-third/two-thirds distribution that the New Jersey
court intended.
Under New Jersey law, equitable distribution is not to be
skewed along fault lines.
N.J. Stat. Ann. sec. 2A:34-23.1 (West
1987 & Supp. 1995); Chalmers v. Chalmers, 320 A.2d 478, 482 (N.J.
1974); Tweedley v. Tweedley, 649 A.2d 630, 633 (N.J. Super. Ct.
Ch. Div. 1994); Kothari v. Kothari, 605 A.2d 750, 755 (N.J.
Super. Ct. App. Div. 1992).
Assuming as we do that Howard and
Alice Berger originally intended an approximately equal
distribution, we have no reason to believe that they also
intended, as Alice Berger now would have it, that Howard Berger
was to bear the entire burden of the Federal income tax known to
inhere in the deposits and unrealized receivables attributable to
crypt sales of the Phase II mausoleum completed in 1989, as well
as the gain on the sale of Woodbine to the Kunkowskis.
Looking at the asset allocation under the settlement
agreement, see supra p. 12, it's obvious that there would be a
substantial imbalance in favor of Alice--to the detriment of
Howard's estate--if he were subjected to all Federal income tax
4
(...continued)
lie to the Court of Appeals for the Third Circuit. We cite and
apply the approach of the Court of Appeals in Yonadi because that
court has special familiarity with New Jersey law, which governs
the marital property rights of Howard and Alice Berger, and
because we find persuasive its approach to arriving at an
understanding of the interaction of the New Jersey equitable
distribution law and the Federal tax law.
- 27 inherent in the cemetery assets and business transferred to the
Kunkowskis.
Not only was Howard Berger to receive property
having a gross value $55,000 less than what was to be received by
Alice Berger; if he were to be saddled with all the tax
liabilities inherent in Woodbine, while Alice Berger were to
receive Woodbine free and clear of such liabilities, the aftertax advantage to Alice Berger would be even more lopsided.
Cf.
Arnes v. Commissioner, 102 T.C. 522, 540-541 (1994) (Beghe, J.,
concurring).
This is a state of affairs that we believe a New
Jersey court would have wished to avoid, see Goldman v. Goldman,
646 A.2d at 509, and we will try to avoid it in our effort to
reach an appropriate result.
We conclude, for reasons more fully explained infra, that
Howard Berger should not be subjected to any greater income tax
liability for 1989 than he originally reported on his 1989
return.
We are impressed by the likelihood that Howard's 1989
return position reflected a contemporaneous understanding of how
the parties would treat the property settlement transaction for
tax purposes.
In contrast, Alice's 1989 return positions--which
showed a loss on her share of the Woodbine operation for 1989-and her litigating positions in this case strike us as somewhat
aggressive:
Alice argues that the receipts from the Phase II
mausoleum crypt sales are taxable to Howard in their entirety for
1988 or 1989, and that he is also taxable on the entire gain on
the sale of Woodbine to the Kunkowskis.
- 28 Issue 1.
Evidentiary Problems
The Federal Rules of Evidence generally apply to proceedings
before this Court.
Sec. 7453; Estate of Shafer v. Commissioner,
80 T.C. 1145, 1151 (1983), affd. 749 F.2d 1216 (6th Cir. 1984).
Issue 1(a).
Exhibit 36-AJ, Letter From Gregg Kunkowski
Respondent's opening brief "objects to the admission of this
[May 8, 1989] letter to prove the truth of the assertions within
such letter, on hearsay grounds".
Respondent goes on to state
that "The letter is admitted for the limited purpose of showing
what was communicated to Howard and Alice Berger on or about such
date."
Neither Howard Berger nor Alice Berger has asserted that
the letter qualifies for an exception to the hearsay rule, nor
has either proposed facts based on the letter.
The letter is
admitted for the purpose specified by respondent and for whatever
bearing the fact that it was communicated to Howard and Alice
Berger might have on their states of mind in consummating the
1989 transaction in which Woodbine was transferred to the
Kunkowskis.
It also tends to indicate that Gregg Kunkowski
played a dominant role in planning the Woodbine transactions in
1989.
Issue 1(b). Exhibits 46-AT, 57, and 58, Documents Signed by
Alice Berger
Alice Berger asserts that these exhibits are hearsay and
objects to their use to prove that she was an owner of the
Woodbine business.
Respondent asserts that they are party
- 29 admissions.
See Fed. R. Evid. 801(d)(2).
We agree with
respondent.
Rule 801(d) of the Federal Rules of Evidence provides that
"A statement is not hearsay if--* * * (2) Admission by partyopponent.--The statement is offered against a party and is * * *
(B) a statement of which * * * [he] has manifested * * * [his]
adoption or belief in its truth".
Alice Berger signed Exhibit 46-AT, the 1-1/2 page employment
agreement, which was
made this 1st day of December, 1986, between ALICE
BERGER and HOWARD BERGER, husband and wife, and owners
of the Woodbine Cemetery and Mausoleum, * * *
hereinafter referred to as the "employers", and GREGG
KUNKOWSKI, * * * hereinafter referred to as the
"employee".
Alice Berger's attorney, Dr. Forgotson, drafted, and Alice
Berger signed, Exhibit 57, an answer to Howard Berger's motions
for restraint, which was filed with the Superior Court of New
Jersey in the Bergers' divorce action.
In five different places,
the answer describes the Woodbine business as "jointly" owned.
On or about September 22, 1987, Dr. Forgotson drafted and
signed, and Alice Berger signed, Exhibit 58, a letter sent to
Gregg Kunkowski at the Woodbine business office.
The letter is
from Dr. Forgotson and states:
Alice Berger has instructed me to advise you that as a
joint owner of the Woodbine Cemetery & Mausoleum
business, you are instructed not to make any payments
on behalf of Howard Berger and/or Susan Moorehouse, for
any reason, without the consent of Alice Berger. * * *
- 30 We find that Alice Berger read and adopted the statements
contained in Exhibits 46-AT, 57, and 58.
party admissions and not hearsay.
Therefore, they are
Fed. R. Evid. 801(d)(2)(B).
Issue 1(c). Exhibit 59, Letter From Alice Berger's Divorce
Counsel to Judge Fundler
Alice Berger asserts that a letter dated April 13, 1987,
from Dr. Forgotson to Judge Fundler is hearsay and objects to its
use to prove that she was an owner of the Woodbine business.
Respondent asserts that it is a party admission.
Evid. 801(d)(2).
See Fed. R.
We agree with respondent.
Rule 801(d) of the Federal Rules of Evidence provides that
A statement is not hearsay if--* * * (2) Admission by
party-opponent.--The statement is offered against a
party and is * * * (C) a statement by a person
authorized by * * * [him] to make a statement
concerning the subject * * * .
On March 13, 1987, in the case of Berger v. Berger, No. FM09545-87 (N.J. Super.), Judge Fundler ordered Howard Berger to
make certain payments to Alice Berger.
On April 13, 1987, Dr.
Forgotson, acting as Alice Berger's counsel in the divorce
proceeding, sent Judge Fundler the April 13 letter to clarify his
March 13 order.
In the April 13 letter, Dr. Forgotson stated
that "Mrs. Berger owns one half interest in the Woodbine Cemetary
[sic] business.
Any sums payable by the cemetary [sic] are
therefore coming out of her share of the business as well."
We find that Dr. Forgotson's statements in the letter to
Judge Fundler were authorized by Alice Berger; therefore they are
- 31 party admissions, not hearsay.
Issue 1(d).
Fed. R. Evid. 801(d)(2)(C).
Testimony of Gregg Kunkowski
At trial, Gregg Kunkowski's testimony about Alice Berger's
statements of ownership was admitted for the purpose of proving
that Alice Berger held herself out as a joint owner.
Alice
Berger asserts that the testimony is hearsay and objects to its
use to prove that she was an owner of the Woodbine business.
Respondent asserts that it is a party admission.
See Fed. R.
Evid. 801(d)(2).
We find that Alice Berger's statements to Gregg Kunkowski
are party admissions, not hearsay.
Fed. R. Evid. 801(d)(2)(A).
Although Alice Berger's admissions of joint ownership in the
Woodbine business do not conclusively establish her ownership,
they are strong evidence that she held herself out as an owner
and that she accepted the benefits and burdens of ownership.
Issue 2. Duress
The settlement agreement of March 14, 1989, between Howard
and Alice Berger provided that they would file a joint income tax
return for 1988 and share equally in any resulting tax savings.
When Alice Berger appeared in the Chancery Court with
counsel on March 14, 1989, she testified that she understood the
terms of the settlement agreement, that she had participated in
its negotiation, that the settlement agreement was fair and
equitable, that no one had compelled her to accept its terms, and
that she would abide by them if they were made a part of the
- 32 court's judgment.
The Chancery Court's Judgment for Divorce,
entered April 24, 1989, recited that, based upon the court's
observations and the parties' testimony, the settlement agreement
had been voluntarily and knowingly entered into by the parties
with able assistance of counsel.
The judgment also stated that
the settlement agreement had become binding as a contract and as
the court's judgment.
Although Alice Berger received various benefits under the
settlement agreement, she did not sign the joint 1988 Federal
income tax return prepared for Howard Berger until, subsequent to
his application, the Chancery Court ordered her, on October 4,
1989, to show cause why an order should not be entered directing
her to sign it.
On October 12, 1989, she appeared with her
counsel before the Chancery Court and tried but was not able to
persuade the Chancery Court that she should not have to sign the
return.
Then, in the belief that the Chancery Court had ordered
her to sign the return, she signed it at the courthouse.
However, she attached to the return a statement that she was
signing a return that she believed to be incorrect and that she
intended to seek relief under Furnish v. Commissioner, 262 F.2d
727, 733 (9th Cir. 1958), affg. in part and remanding in part on
this issue Funk v. Commissioner, 29 T.C. 279 (1957), and under
Brown v. Commissioner, 51 T.C. 116 (1968).
She now argues that
the return is not a valid joint return because she signed it
under duress.
- 33 When spouses file a joint return, the tax is computed on
their aggregate income, and their liability for the tax is joint
and several.
Sec. 6013(d)(3).
A taxpayer's liability on a joint
return depends on the taxpayer's voluntary execution of the
return.
Stanley v. Commissioner, 45 T.C. 555, 560 (1966).
A
taxpayer who signs a return under duress has not voluntarily
executed the return and will not be held liable for the tax shown
due thereon, or for any tax deficiency for the year in question
that is attributable to the other spouse.
Stanley v.
Commissioner, 81 T.C. 634, 637-638 (1983).
We have stated that duress is determined "under a uniform
standard unaffected by the idiosyncracies of particular State
law" and implied that we would develop an independent Federal
standard.
Brown v. Commissioner, 51 T.C. at 119-120.
However,
the cases that we cited support this conclusion only to a limited
extent,5 and recent
opinions of the Supreme Court seem to indicate that we should
5
We said that the Court of Appeals in Furnish v.
Commissioner, 262 F.2d 727, 733 (9th Cir. 1958), affg. in part
and remanding in part on this issue Funk v. Commissioner, 29 T.C.
279 (1957), "[formulated] a standard of duress applicable in
Federal tax controversies", but it would appear that court was
rather clearly applying the California law of duress. The other
case cited in Brown v. Commissioner, 51 T.C. 116 (1968), in
support of our statement was Stanley v. Commissioner, 45 T.C. 555
(1966); while that case did support a nationwide uniform standard
of duress for the purpose of determining the validity of a
Federal income tax return as a joint return, id. at 561-562, it
expressly denied that it was establishing a Federal common law of
duress, id. at 562 n.12.
- 34 apply State law on this issue.6
One reason to apply State law is that, in the area of
duress, as in other areas, a distinct Federal common law has not
developed.7
However, if we were to develop it, we would
presumably follow the Restatement, Contracts 2d (1981).
Street
v. J.C. Bradford & Co., 886 F.2d 1472, 1481 (6th Cir. 1989)
(using Restatement, Contracts 2d to determine minimum
requirements under Federal common law of contracts with respect
to duress and abuse-of-fiduciary-relationship issues).
Under the
Restatement, an improper threat by a party to a contract makes
that contract voidable by the other party for reasons of duress
when that threat leaves the victim no reasonable alternative to
6
Although Federal contracts are a paradigm area for the
application of Federal common law, Boyle v. United Technologies
Corp., 487 U.S. 500, 504 (1988), the Supreme Court expressly
refused to commit itself on whether State or Federal law governed
on the issue of duress in connection with a Federal military
contract in United States v. Bethlehem Steel Corp., 315 U.S. 289,
299-300 (1942). The Supreme Court's latest extended
pronouncement on the issue of Federal common law, O'Melveny &
Myers v. FDIC, ___ U.S. ___, 114 S. Ct. 2048 (1994), a unanimous
decision, would seem to indicate that State law should be applied
to decide the duress issue before us.
7
"A federal common law of landlord and tenant does not
exist." Powers v. U.S. Postal Service, 671 F.2d 1041, 1045 (7th
Cir. 1982) (Posner, J., deciding to use State law to decide
landlord-tenant dispute to which Postal Service was a party).
"For a variety of reasons having mainly to do with the paucity of
federal common law rules and the desirability of keeping the law
as simple as possible, federal courts asked to make federal
common law do so usually by adopting state law." Harrell v.
United States, 13 F.3d 232, 235 (7th Cir. 1993) (Posner, J.,
using State law to decide quiet title actions against Internal
Revenue Service); see also Street v. J.C. Bradford & Co., 886
F.2d 1472, 1481 (6th Cir. 1989) (Federal common law of release
"largely undeveloped" in cases).
- 35 manifesting assent to the contract.
sec. 175(1) (1981).
1 Restatement, Contracts 2d,
However, an improper threat by a third party
not a party to the transaction will render the contract voidable
only if the uninvolved party to the contract has not in good
faith and without reason to know of the duress either given value
or relied materially on the transaction.
Id. sec. 175(2).
For
our purposes, a threat inducing assent to a contract is improper
either (1) if what is threatened is the use of civil process and
the threat is made in bad faith or (2) if the resulting exchange
is not on fair terms and what is threatened is otherwise a use of
power for illegitimate ends.
Id. sec. 176.
If State law governs, either independently or because
Federal common law so dictates,8 we must decide which State law,
and that is a choice-of-law question.
In this case, we have
jurisdiction under the Internal Revenue Code.
Therefore Federal
common law applies to the choice-of-law rule determination, and
this means applying the approach of the Restatement, Conflict of
Laws 2d (1971).
Morewitz v. West of England Ship Owners Mut.
Protection & Indem. Association (Luxembourg), 62 F.3d 1356, 1362
n.13 (11th Cir. 1995); Congress Talcott Corp. v. Gruber, 993 F.2d
8
Even if Federal common law does govern our issue, it would
appear that the Federal common law would merely apply the
relevant State law. O'Melveny & Myers v. FDIC, ___ U.S. at ___,
114 S. Ct. at 2053; cf. United States v. Kimbell Foods, 440 U.S.
715, 727-729 (1979); United States v. Brosnan, 363 U.S. 237, 241242 (1960) (adopting State law as rule of decision in Federal tax
case despite desirability of uniformity); North Am. Rayon Corp.
v. Commissioner, 12 F.3d 583, 589-590 (6th Cir. 1993), affg. T.C.
Memo. 1992-610 (applying New York law of undue influence).
- 36 315, 319 (3d Cir. 1993) (Federal tax issue); Schoenberg v.
Exportadora de Sal, 930 F.2d 777, 782 (9th Cir. 1991); Albany
Ins. Co. v. Kieu, 927 F.2d 882, 891 (5th Cir. 1991); Edelmann v.
Chase Manhattan Bank, 861 F.2d 1291, 1294 (1st Cir. 1988); Harris
v. Polskie Linie Lotnicze, 820 F.2d 1000, 1003 (9th Cir. 1987);
Pittston Co. v. Allianz Ins. Co., 795 F. Supp. 689-690 (D.N.J.
1992).9
Whatever choice of law rule we were to use, however,
whether it be the most-significant-relationship test of 1
Restatement, Conflict of Laws 2d, section 6 (1971) or some other
test, New Jersey law would apply.10
9
Restatements are used as sources for determining Federal
common law rules in other areas besides conflict of laws. Town
of Newton v. Rumery, 480 U.S. 386, 391-392 (1987) (contracts,
enforceability of release); Central States, Southeast & Southwest
Areas Health & Welfare Fund v. Pathology Labs., P.A., 71 F.3d
1251, 1254 (7th Cir. 1995) (restitution, trusts in ERISA case);
Burlington Northern R. Co. v. Hyundai Merchant Marine Co., 63
F.3d 1227, 1231 (3d Cir. 1995) (judgments, issue preclusion);
Moench v. Robertson, 62 F.3d 553, 566 (3d Cir. 1995) (trusts,
ERISA); United States v. Northrop Corp., 59 F.3d 953, 958-963
(9th Cir. 1995) (contracts, enforceability of release); Luden's
Inc. v. Local 6 Bakery, Confectionery & Tobacco Workers' Intl.
Union of Am., 28 F.3d 347, 354-355 (3d Cir. 1994) (contracts,
collective bargaining agreement in labor law); Livingstone v.
North Belle Vernon Borough, 12 F.3d 1205, 1210 n.6 (3d. Cir.
1993) (contracts, enforceability of release).
10
The result would be the same--and New Jersey law would
apply--under New Jersey's choice-of-law principles. On
contractual issues, New Jersey uses the law of the place where
the contract was concluded, lex loci contractus, unless the
most-significant-relationship test of 1 Restatement, Conflict of
Laws 2d, sec. 6 (1971) compels a different result. NL Indus.,
Inc. v. Commercial Union Ins. Co., 65 F.3d 314, 319 (3d Cir.
1995); Gilbert Spruance Co. v. Pennsylvania Manufacturers'
Association Ins. Co., 629 A.2d 885, 888 (N.J. 1993); Harleysville
Ins. Co. v. Crum & Forster Personal Ins., 588 A.2d 385, 387-388
(N.J. Super. Ct. App. Div. 1990); cf. D'Agostino v. Johnson &
Johnson, Inc., 628 A.2d 305, 320-321 (N.J. 1993).
- 37 In recent years, New Jersey has noticeably liberalized its
law of psychological or moral duress.
Warner-Lambert
Pharmaceutical Co. v. Sylk, 471 F.2d 1137, 1143-1144 (3d Cir.
1972) (citing Rubenstein v. Rubenstein, 120 A.2d 11, 14 (N.J.
1956)).
However, even though New Jersey no longer requires that
duress produce fear sufficient to overcome the will of a person
of ordinary firmness, but only that the fear overcome the will of
the person threatened, it still requires that the threat be
wrongful.
Warner-Lambert Pharmaceutical Co. v. Sylk, 471 F.2d at
1144 (citing Rubenstein v. Rubenstein, 120 A.2d at 14);
Continental Bank v. Barclay Riding Academy, Inc., 459 A.2d 1163,
1175 (N.J. 1983); New Jersey Hosp. Association v. Fishman, 661
A.2d 842, 848 (N.J. Super. Ct. App. Div. 1995).
Alice Berger asserts that the Chancery Court ordered her to
sign the 1988 return and that she signed it because she believed
she had no choice and was afraid of the "consequences" of defying
a court order.
Although she signed the return at the courthouse,
she does not appear to have been signed it before a judge who was
threatening improper or oppressive "consequences".
See In re
N.D.N.Y. Grand Jury Subpoena No. 86-0351-S, 811 F.2d 114 (2d Cir.
1987; In re Marriage of Betts, 558 N.E. 2d 404, 427, 430 (Ill.
App. Ct. 1990).
Alice Berger did not testify that the Chancery
Court had threatened "consequences" directly to her.
Nor did she
testify to the consequences she believed she had been threatened
with.
- 38 Alice Berger and her attorney had an opportunity to show the
Chancery Court why Alice should not be ordered to sign the joint
return; she was ordered to show cause.
Although Alice Berger
testified that her attorney told her--and that she believed--the
Chancery Court had ordered her to sign the return, the Chancery
Court's order was not entered into evidence, and no one else who
testified had personal knowledge of whether she was ordered to
sign the return.
As a result, we're not sure whether Alice Berger signed the
return under a court order or on her attorney's advice.
If she
signed the return on her attorney's advice, we would be reluctant
to intrude into the attorney-client relationship.
If the
Chancery Court ordered her to sign the return, that would appear
to have happened because she failed to show cause why she should
not be ordered to sign it.
Without a showing of abuse of
discretion or threat of improper sanction, we would be reluctant
to impugn the Chancery Court's authority by construing its
exercise to have been improper or wrongful.
See Groom v.
Mortimer Land Co., 192 F. 849, 852-853 (5th Cir. 1912) (execution
of deed under "coercion of the court's decree" is voluntary).
Even if such an order by the Chancery Court might have been
erroneous, Peskin v. Peskin, 638 A.2d 849 (N.J. Super. Ct. App.
Div. 1994) (error for Chancery Court to coerce settlement
agreement in divorce case), we cannot say that it rose to the
level of being improper or wrongful, especially since Alice had
- 39 already freely agreed to the settlement agreement and derived
benefits from it.
See Smith v. Commissioner, 65 F.3d 37, 40-41
(5th Cir. 1995), affg. T.C. Memo. 1994-149; Joyce v. Year Invs.,
Inc., 196 N.E.2d 24, 26 (Ill. App. Ct. 1964).
We therefore
conclude that such an order would not have been improper in the
terms of 1 Restatement, Contracts 2d, sec. 176 (1981).
Thus,
neither under New Jersey law nor under some putative distinct
Federal common law was there duress.
Inasmuch as the result is
the same whether we apply New Jersey law or some distinct Federal
rule, we need not decide which law governs the question of duress
for the purpose of determining the validity of a joint return.
Although Alice Berger attached a disclaimer to the 1988 Form
1040 return that she signed, she did not alter the preprinted
jurat in such a way as to invalidate the return as a joint
return.
Cf. Sloan v. Commissioner, 102 T.C. 137 (1994), affd. 53
F.3d 799 (7th Cir. 1995).
Thus, we hold that the 1988 return was
a valid joint return.11
11
Because no party made the argument, we do not consider at
length whether the open-endedness of the joint and several
liability under a joint return rendered unenforceable Alice
Berger's agreement to sign a joint return. Suffice it to say
that, under the test of Town of Newton v. Rumery, 480 U.S. 386,
391-392 (1987), the relevant consideration would appear to be
whether any public harm resulting from forcing her to honor her
agreement would outweigh the benefits of doing so. Cf. United
States v. Northrop Corp., 59 F.3d 953, 958-963 (9th Cir. 1995).
Under that test, her agreement was clearly enforceable.
- 40 Issue 3.
Ownership of Woodbine
The questions for decision on this issue are who owned the
Woodbine assets and business from the beginning of 1988 through
March 14, 1989, and thereafter, until November 17, 1989.
The
answers to these questions should enable us to allocate the tax
liabilities on the Woodbine income for those periods and on the
gain from the sale of Woodbine to the Kunkowskis.
Income is taxable to the taxpayer who earns and controls it.
Lucas v. Earl, 281 U.S. 111 (1930).
"The choice of the proper
taxpayer revolves around the question of which person or entity
in fact controls the earning of income rather than who ultimately
receives the income."
Vercio v. Commissioner, 73 T.C. 1246, 1253
(1980) (service income assigned to trust).
The owners of land
may be different from the owners of a business located on the
land.
See Crawford v. Commissioner, T.C. Memo. 1984-433 (land
and farm separate); Blunt v. Commissioner, T.C. Memo. 1966-280
(separating mortuary business from land).
To decide when a transfer is complete for tax purposes, we
examine all the surrounding facts and circumstances, no single
one of which is controlling.
124 (1977).
Baird v. Commissioner, 68 T.C. 115,
The focus of our inquiry, however, is on when the
benefits and burdens of ownership have shifted.
Id.
Generally,
a transfer is complete upon the earlier of the transfer of title
or the shift of the benefits and burdens of ownership.
Deyoe v.
Commissioner, 66 T.C. 904, 910 (1976) (citing Dettmers v.
- 41 Commissioner, 430 F.2d 1019, 1023 (6th Cir. 1970), affg. Estate
of Johnston v. Commissioner, 51 T.C. 290 (1968)).
In a Federal tax controversy, State law controls the
determination of the taxpayer's interest in the property, and the
tax consequences are then determined under Federal law.
United
States v. National Bank of Commerce, 472 U.S. 713, 722 (1985)
(and cases cited and quoted therein).
To decide when equitable
title (i.e., the benefits and burdens of ownership) passes, we
consider the following factors under State law:
(1) Legal title;
(2) intent of parties; (3) equity in property; (4) existence of
present obligation to complete transfer; (5) right of possession;
(6) party paying property taxes; (7) party bearing risk of loss;
and (8) party receiving profits from operation and sale of
property.
Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C.
1221, 1237-1238 (1981); Spyglass Partners v. Commissioner, T.C.
Memo. 1995-452.
Although Howard Berger and Alice Berger had held joint legal
title to the Woodbine property since October 26, 1983, Alice
Berger did not participate in the operation of the Woodbine
business prior to Howard Berger's illness in June 1986.
Neither
had she received any benefits from her ownership interest in the
Woodbine property during the years of the marriage prior to June
1986, other than indirectly through the support and maintenance
she received from Howard Berger.
After Howard Berger's illness,
and the breakup of the marriage, however, her involvement in the
- 42 business increased, and she began to receive payments directly
from the Woodbine business account.
Although Alice Berger never participated in the day-to-day
operations of the Woodbine business after June 1986, neither did
Howard Berger.
Cf. Blunt v. Commissioner, supra (joint owner of
real estate was sole and active operator and owner of the
business).
Gregg Kunkowski managed the operations, soliciting
customers, negotiating contracts with customers and contractors,
paying the bills, and keeping the books and records.
He
approached the Bergers only for major decisions.
In 1986, Gregg Kunkowski presented an employment proposal to
Dr. Forgotson, Alice Berger's attorney, who drafted an employment
agreement.
On December 1, 1986, Alice Berger signed the
agreement (as did Howard Berger)
between ALICE BERGER and HOWARD BERGER, husband and
wife, and owners of the Woodbine Cemetery and
Mausoleum, * * * hereinafter referred to as the
"employers", and GREGG KUNKOWSKI, * * * hereinafter
referred to as the "employee".
By presenting the employment agreement to Alice Berger's
representative, Gregg Kunkowski treated Alice Berger as an owner
of the business.
By signing the employment agreement, Alice
Berger bound herself to the terms of the agreement and evidenced
her acceptance of the benefits and burdens of her joint ownership
of the Woodbine business.
By September 22, 1987, Alice Berger exercised enough control
over the Woodbine business to order Gregg Kunkowski to stop
- 43 making payments to Howard Berger.
Gregg Kunkowski appeared to
believe that Alice Berger had the authority to do so because he
stopped making the payments, see Tucker v. Commissioner, T.C.
Memo. 1983-456 (comparing owners' participation in, and control
of, the business), until the Chancery Court ordered him to resume
them.
Throughout the divorce proceedings, Alice Berger represented
to the Chancery Court that she and Howard Berger jointly owned
Woodbine, and that the weekly payments from the Woodbine business
account were in addition to alimony pendente lite.
During 1988, Alice Berger withdrew $45,578 from the Woodbine
business account, and from January 1 until March 14, 1989, she
withdrew $7,560.
During 1988, Howard Berger withdrew $42,676
from the Woodbine business account, and from January 1 until
March 14, 1989, he withdrew $7,795.
During 1988 and until March 14, 1989, Howard and Alice
Berger shared the benefits of the Woodbine business, and
Alice owned the Woodbine business jointly with Howard.
Although full legal title to the Woodbine real property was
not transferred to Alice Berger until June 23, 1989, the
settlement agreement of March 14, 1989, transferred all the
benefits and burdens of the Woodbine property and business to
Alice Berger.
See Deyoe v. Commissioner, supra.
Thereafter,
Howard Berger no longer received weekly payments or had his
expenses paid by Woodbine, except those expenses that had already
- 44 accrued, whereas Alice Berger continued to have her expenses paid
through the Woodbine business account and increased her weekly
draw payments to $1,000, receiving more than $50,000 after March
14, 1989.
Alice Berger also received the entire proceeds of sale
of Woodbine in the form of the Kunkowskis' installment note, and
she has been receiving payments of interest and principal on the
note in their entirety ever since.
Alice Berger's assertion that she was merely an
accommodation party is belied by the fact that, without
consulting Howard Berger, who she asserts was the actual owner of
Woodbine, she doubled her draw.
She also did not transfer
Woodbine directly to the Kunkowskis, as was required by the sale
agreement and the settlement agreement.
Instead, she entered
into a relatively complicated transaction, transferring the
business and property to the Woodbine Association in exchange for
Certificates of Debt in the Woodbine Association, and then
transferring the Certificates of Debt to Gregg and Julia
Kunkowski in exchange for their promissory note.
We don't
believe that Alice Berger would have entered into such a
complicated transaction if she were merely an accommodation
party.
Alice Berger was contractually bound to sell Woodbine to
Gregg and Julia Kunkowski, but she had bound herself to sell it
only if and to the extent it was awarded to her.
Howard Berger
would have been similarly bound if Woodbine had been awarded to
- 45 him.
Alice Berger was awarded Woodbine; she alone reaped the
benefits of ownership from March 14 until November 17, 1989.
Among the eight factors under State law recited by Grodt &
McKay Realty, Inc. v. Commissioner, supra, only factor (1), legal
title (and that only to the extent of one-half ownership of the
real property), clearly remained with Howard Berger in the period
between March 1 and June 23, 1989.
We have just seen that for
purposes of factor (8), Alice Berger was the party receiving
profits from the operation and sale of the property during that
period.
In addition, the terms of the settlement agreement
rendered the transfer of full ownership to Alice Berger legally
enforceable, for purposes of factor (4); gave her the right of
possession, for purposes of factor (5); probably transferred to
her the risk of loss, for purposes of factor (7); and left her
with the obligation to pay property taxes, for purposes of factor
(6).
The terms of the settlement agreement also manifested the
intent of the parties to complete the transfer, for purposes of
factor (2), which was done in due course.12
This leaves only the
acquisition of an equity in the property, factor (3),
12
Alice Berger tries to make something of the fact that the
transfer documents of June 23 and Nov. 17, 1989, were nothing
more than conveyances of real property. She argues that she
never received and never transferred the Woodbine business,
including the bank accounts and receivables, and so she should
not be taxed on the income of the business, nor treated as having
sold these assets. We are satisfied, however, on the basis of
the entire record, that she had the benefits and burdens of
ownership of the business during the period Mar. 14-Nov. 17,
1989, as evidenced by the substantial draw payments she received
during this period, and that the $680,000 price she received was
based on the Woodbine assets and business in their entirety.
- 46 indeterminate, but it would appear to us to follow the other
factors that would attribute the full ownership of Woodbine to
Alice Berger after March 14, 1989.
Howard and Alice Berger owned the Woodbine property and
business jointly during 1988 and until March 14, 1989.
Thereafter Alice Berger was the sole owner of the Woodbine
property and business until the sale of November 17, 1989.
Issue 4(a).
Method of Accounting for Mausoleum Sales and Costs
Generally, a taxpayer computes taxable income using the same
method of accounting that he or she regularly uses to compute
income in keeping the books.
Sec. 446(a).
A taxpayer may use
"(1) the cash receipts and disbursements method; (2) an accrual
method; (3) any other method permitted by this chapter; or any
combination of the foregoing methods permitted under regulations
prescribed by the Secretary."
Sec. 446(c).
The regulations
permit "any combination of * * * [the cash, accrual, or other
permissible] methods of accounting * * * if such combination
clearly reflects income and is consistently used."
1(c)(1)(iv), Income Tax Regs.
Sec. 1.446-
A method of accounting includes
both the taxpayer's overall method of accounting and the method
of accounting for any item.
Burck v. Commissioner, 63 T.C. 556,
561 (1975), affd. 533 F.2d 768 (2d Cir. 1976); sec. 1.446-1(a),
Income Tax Regs.
If a taxpayer changes the method of accounting regularly
used to compute income in keeping the books, the taxpayer must
- 47 secure the consent of the Secretary before computing taxable
income under the new method.
Sec. 446(e).
Adoption of a method
of accounting for a new trade or business is not a change in the
method of accounting.
Sec. 1.446-1(e)(1), Income Tax Regs.
Use
of a method of accounting different from a taxpayer's overall
method of accounting is also not a change in the method of
accounting if it results from a change in underlying facts.
1.446-1(e)(2)(ii)(b), Income Tax Regs.
Sec.
For a different method of
accounting to be a change, "the item itself must be basically the
same as an item previously accounted for with the present method
of accounting differing from the prior treatment.
Unless the
transactions are basically the same, the accounting treatment
would not be [a] 'change' of accounting but only a 'new'
accounting method for a different transaction."
Federated Dept.
Stores, Inc. v. Commissioner, 51 T.C. 500, 513-514 (1968), affd.
426 F.2d 417 (6th Cir. 1970).
From 1979 through the years in issue, Woodbine's sales of
grave plots were recognized when cash was received, and most
expenses were recorded when paid.
However, the costs of grave
plots were inventoried and expensed only as plots were sold.
When construction of the first mausoleum began in 1984,
mausoleum crypt sales were accounted for differently.
Until
construction of the mausoleum was complete, customer payments to
purchase crypts were treated as deposits.
When the mausoleum was
completed, prior payments were recognized as income, and the pro
- 48 rata share of construction costs was expensed.
Subsequent sales
of crypts were then treated similarly to grave plot sales; sales
were recorded when cash was received, and the remaining cost of
crypts was inventoried and then expensed as the remaining crypts
were sold.
Alice Berger asserts that Howard Berger, by using a method
of accounting for mausoleum crypt sales different from the method
he used for cemetery plot sales, changed Woodbine's accounting
method to a method that does not clearly reflect income and that
he did so without the Secretary's consent.
She therefore
concludes that receipts from the sale of crypts were income when
received.
Howard Berger asserts that the method of accounting
adopted for mausoleum crypt sales was not a change in accounting
method and that the cash method for grave plot sales and the
accrual method for mausoleum crypt sales is a permissible
combination of methods that clearly reflects income.
Respondent
agrees with Howard Berger that there was no change in accounting
method, and that, until March 14, 1989, Woodbine used a
permissible combination of the cash and accrual methods that
clearly reflected income.
However, respondent asserts that
Howard Berger's 1989 transfer of his interest in the Woodbine
business to Alice Berger caused "a triggering of tax to Howard
and that a pro-rata portion of the profit attributable to * * *
'deposits' [received prior to the transfer] should be taxed to
Howard in 1989."
- 49 We find that there was no change in accounting method, that
Woodbine's combination of methods clearly reflected income during
1988 and 1989, and that, although section 1041 prevents Howard's
March 1989 transfer of his interest in Woodbine to Alice from
being treated as a gain recognition event to him, the transfer
triggered the accrual of Howard's share of the income from crypt
sales that had been previously deferred and that would not have
been otherwise includable in income until the completion of the
Phase II mausoleum in May 1989.
Sales of crypts during construction significantly differed
from sales of cemetery plots.
When a cemetery plot was sold,
ownership of the plot was transferred to the purchaser at
approximately the same time as Woodbine received cash.
The plot
was ready for excavation and use, and Woodbine's cost of the sale
was known.
On the other hand, when a mausoleum crypt was sold
during construction, ownership of the crypt was not transferred
and the crypt was not ready for occupancy until the mausoleum
building was completed.
Prior to completion of the mausoleum,
Woodbine's cost of sale of crypts could only be estimated.
Because sales of crypts significantly differed from sales of
plots, the method of accounting adopted for crypt sales was
neither a change in the overall method of accounting nor a change
in the treatment of a material item.
The method of accounting
for crypt sales was a new method of accounting for a different
item.
Because the new accounting method was not a change in
- 50 method, the Secretary's consent was not required.
Sec. 1.446-
1(e)(2)(ii)(b), Income Tax Regs.
We now discuss why the different method of accounting for
mausoleum crypt sales clearly reflected income.
1(a)(2), Income Tax Regs.
Sec. 1.446-
Alice Berger cites Evergreen Cemetery
Association v. Burnet, 45 F.2d 667 (D.C. Cir. 1930), affg. 13
B.T.A. 638 (1928), for the proposition that "Where forfeiture of
the deposit will result from a breach of the contract by the
customer, the deposit is taxed in the year of receipt."
Alice
Berger asserts that "In Evergreen, the court held that periodic
payments received pursuant to contracts for the sale of mausoleum
crypts during the construction phase were taxable when received
regardless of when construction was completed".
We disagree.
The taxpayer in Evergreen Cemetery Association v. Burnet,
supra, kept its books on an accrual basis.
The taxpayer had sold
crypts in 1920 before its mausoleum was completed, and in 1921,
the year the mausoleum was completed.
Purchasers were allowed to
pay for crypts over time, and at the end of 1921, not all of the
crypts had been paid for in full.
For 1921, the taxpayer
included in income the cash collected during 1920 and 1921 but
did not include the unpaid amounts.
This accounting method was
improper because "the entire sales price of all crypts sold by it
had accrued in the year 1921".
Id. at 669.
Although the court
in Evergreen Cemetery Association did not directly address the
propriety of including 1920 sales in 1921 gross receipts, it
- 51 implicitly agreed that the income from crypt sales was taxable in
the year the mausoleum was completed, regardless of when the cash
had been collected.
Generally, when property is exchanged for cash, the receipt
of cash clearly reflects the receipt of income from the sale of
the property.
However, when cash is received in exchange for a
promise to transfer property that is not yet constructed, the
amount or existence of income is less clear.
As to the crypt
sales in issue, a pure cash receipts and disbursements method of
accounting would recognize income from the sale of a crypt when
cash is received but would delay deduction of the cost of
construction until the cash is spent, certainly not a clear
reflection of income.
See Rotolo v. Commissioner, 88 T.C. 1500,
1514 (1987) ("'the cost of goods sold must be deducted from gross
receipts in order to arrive at gross income'" (quoting Sullenger
v. Commissioner, 11 T.C. 1076, 1077 (1948))); see also Veenstra &
DeHaan Coal Co. v. Commissioner, 11 T.C. 964 (1948).
Until a
mausoleum was completed, Woodbine's overall method of accounting
would not clearly reflect income from crypt sales.
Either the
costs of construction would have to be estimated and accrued, and
a portion expensed, or the recognition of gross receipts delayed
until receipts could be matched with the costs of construction.
Neither method would appear to reflect income more clearly than
the other.
Without a showing either that Woodbine's overall
method of accounting would clearly reflect income from mausoleum
- 52 crypt sales or that the method of accounting adopted for such
sales does not clearly reflect income, we will not change the
accounting method that was consistently used for crypt sales
during the previous 4 years and that had been implicitly
authorized by respondent.
Sec. 1.446-1(c)(2)(ii), Income Tax
Regs.
As a result, we reject Alice Berger's efforts to accelerate
part of Phase II mausoleum crypt sale income into 1988 and to
make it solely taxable to Howard Berger on the ground that she
was not a party to the 1988 joint return.
Issue 4(b).
Recognition of Income Upon Transfer of Woodbine
Respondent argues that Howard Berger's transfer to Alice
pursuant to their settlement agreement is similar to the
transfers of partially completed construction contracts by the
corporations in Jud Plumbing & Heating, Inc. v. Commissioner, 153
F.2d 681 (5th Cir. 1946) (liquidating corporation), affg. 5 T.C.
127 (1945), and Standard Paving Co. v. Commissioner, 190 F.2d 330
(10th Cir. 1951) (nontaxable reorganization), affg. 13 T.C. 425
(1949).
Respondent argues that, as a result of Howard's
transfer, the method of accounting for mausoleum crypt sales that
we have accepted no longer clearly reflected income, at least as
to him.
Respondent relies on section 1.451-5(f), Income Tax
Regs., to justify substituting a percentage of completion method
to account for Howard's share of the income from Phase II
mausoleum crypt sales for 1989.
Although Alice Berger disagrees
- 53 with the assertions of Howard and respondent that she had or
acquired any ownership interest in the Woodbine property and
business, she concurs with respondent's general position on the
application of Jud Plumbing and Standard Paving, and argues,
under the assignment of income principle, that the deposits would
be income to Howard Berger as of the date of transfer.
Howard
Berger now repudiates his 1989 return position and asserts that
the transfer of his remaining one-half interest in the Woodbine
property and business was a nontaxable transfer of property under
section 1041, not an assignment of income, and that Jud Plumbing
does not apply.
We hold that section 1041 does not trump clear reflection of
income in the peculiar factual circumstances of this case.
As a
result, Howard Berger will be required to accrue a share of
income from Phase II mausoleum crypt sales for 1989, even though
he transferred his one-half interest in Woodbine in March 1989, 2
months prior to the completion of the Phase II mausoleum.
However, by reason of section 1041, he recognized no gain on that
transfer or on Alice Berger's subsequent sale of Woodbine to the
Kunkowskis.
Section 1041 was enacted by section 421 of the Deficit
Reduction Act of 1984 (DEFRA), Pub. L. 98-369, 98 Stat. 793-795.
It provides as a general rule that
No gain or loss shall be recognized on a transfer of
property from an individual to * * *
(1) a spouse, or
- 54 (2) a former spouse, but only if the transfer is
incident to the divorce.
Section 1041 is effective generally for transfers after July 18,
1984, in taxable years ending after such date; see DEFRA sec.
421(d), 98 Stat. 795.
Prior to the enactment of section 1041, the resolution of
property rights incident to a divorce gave rise to differing tax
results, depending on how each spouse's rights and obligations
were viewed for State law purposes.
The Supreme Court had ruled
that a transfer of separately owned appreciated property to a
spouse (or former spouse) in exchange for the release of marital
claims resulted in the recognition of gain to the transferor.
United States v. Davis, 370 U.S. 65 (1962).
However, upon an
approximately equal division of community property on divorce, no
gain was recognized on the theory that there was only a
nontaxable partition, not a sale or exchange.
Carrieres v.
Commissioner, 64 T.C. 959, 964 (1975), affd. per curiam 552 F.2d
1350 (9th Cir. 1977); see also Siewert v. Commissioner, 72 T.C.
326, 332-333 (1979).
The Commissioner applied a like result to
the partition of jointly held property.
1974-2 C.B. 26.
See Rev. Rul. 74-347,
The tax treatment of divisions of property
between spouses involving other various types of ownership under
the different State laws was often unclear and resulted in much
litigation.
See H. Rept. 98-432 (Part 2), at 1491 (1984).
Several common law States had tried to avoid the result in the
Davis case by amending and bending their property and equitable
- 55 distribution laws.
Id.
Congress was dissatisfied with the resulting patchwork and
desired to make the Federal tax law less intrusive into marital
property relationships.
result.
Id. at 1492.
Section 1041 was the
The Ways and Means Committee explained
that the transfer of property to a spouse incident to a
divorce will be treated, for income tax purposes, in
the same manner as a gift. Gain (including recapture
income) or loss will not be recognized to the
transferor, and the transferee will receive the
property at the transferor's basis (whether the
property has appreciated or depreciated in value).
* * * This nonrecognition rule applies whether the
transfer is for the relinquishment of marital rights,
for cash or other property, for the assumption of
liabilities in excess of basis, or for other
consideration and is intended to apply to any
indebtedness which is discharged. Thus, uniform
Federal income tax consequences will apply to these
transfers notwithstanding that the property may be
subject to differing state property laws. [Id.; fn.
ref. omitted.]
An assignment of income is generally disregarded unless the
underlying income-producing property is also transferred.
See
generally, 3 Bittker & Lokken, Federal Taxation of Income,
Estates and Gifts, ch. 75 (2d ed. 1991 & Supp. 1995).
Usually
there is no property underlying personal service income so that
assignment of personal service income is disregarded, and the
taxpayer who earned the income is taxed on it under Lucas v.
Earl, 281 U.S. 111 (1930).
In this case, property (a one-half
interest in Woodbine) was transferred, subject to contracts for
sale of mausoleum crypts and related receivables and deposit
liabilities.
Cf. Kochansky v. Commissioner, T.C. Memo. 1994-160
- 56 (contingent legal fee taxable to lawyer who earned it, not spouse
who was awarded it).
But see Siegel v. United States, 464 F.2d
891, 894 (9th Cir. 1972) ("the line between earned income and
income from property is not always marked with dazzling
clarity").
Even though there may be a personal service element in the
income from the operation of a cemetery, this record provides no
factual basis for separating that element from the income from
mausoleum crypt sales, nor do we see any proper theoretical
ground for doing so.
Moreover, Howard and Alice had both
delegated the management and operation of Woodbine to Gregg
Kunkowski.
Respondent's position that the assignment of income
principle can apply to transfers of property with economically
accrued income elements, see Rev. Rul. 87-112, 1987-2 C.B. 207,
so as to trump section 1041, has been criticized as "an
unfortunate step backward into the judicial confusion created by
the Davis rule".
McCaffery & Salten, Structuring the Tax
Consequences of Marriage and Divorce, sec. 604, at 144 (1995)
(citing Asimow, "The Assault on Tax-Free Divorce: Carryover Basis
and Assignment of Income", 44 Tax. L. Rev. 65, 91-112 (1988)).
But see Gabinet, "Section 1041: The High Price of Quick Fix
Reform in Taxation of Interspousal Transfers", 5 Am. J. Tax Pol.
13 (1986).
The concerns expressed by McCaffery & Salten, supra
at 145, extend beyond the resulting uncertainty for parties
- 57 negotiating marital settlements to include the unfairness of
immediately triggering income before cash is in hand and even
causing income actually paid to one spouse to be attributed to
the other.
In Balding v. Commissioner, 98 T.C. 368 (1992), we rejected
the Commissioner's reliance on the assignment of income doctrine
to conclude that the payments a former wife received in
settlement of her claim to a community property interest in her
husband's military pension were nontaxable gifts under sections
1041 and 102.
In the absence of section 1041, we would not hesitate to
uphold respondent's reliance on Jud Plumbing & Heating v.
Commissioner, 153 F.2d 681 (5th Cir. 1946), to apply the clear
reflection of income rule to require Howard Berger to use the
percentage of completion method to determine his share of the
Woodbine income as of the time of the transfer.
Jud Plumbing and
Standard Paving Co. v. Commissioner, 190 F.2d 330 (10th Cir.
1951), are only a couple of examples of the numerous occasions on
which a taxpayer winding up its existence as a tax-paying entity
was required to include income in its final taxable year under
the clear reflection of income rule, even though its otherwise
proper method of accounting would not have otherwise required
inclusion in that year.
See Stephens Marine, Inc. v.
Commissioner, 430 F.2d 679, 687 (9th Cir. 1970), affg. T.C. Memo.
1969-39; Idaho First Natl. Bank v. United States, 265 F.2d 6 (9th
- 58 Cir. 1959); J.M. Turner & Co. v. Commissioner, 247 F.2d 370, 373
(4th Cir. 1957), revg. and remanding on other grounds 26 T.C. 795
(1956); Floyd v. Scofield, 193 F.2d 594 (5th Cir. 1952); United
States v. Lynch, 192 F.2d 718 (9th Cir. 1951); Commissioner v.
Carter, 170 F.2d 911 (2d Cir. 1948), affg. 9 T.C. 364 (1947); see
also Palmer v. Commissioner, 29 T.C. 154 (1957) (clear reflection
of income trumps nonrecognition under section 351, whereas
section 351 generally trumps assignment of income, Rev. Rul. 80198, 1980-2 C.B. 113, 114-115 (citing Hempt Bros. v. United
States, 490 F.2d 1172 (3d Cir. 1974))), affd. 267 F.2d 434, 438439 (9th Cir. 1959).
See generally Bittker & Eustice, Federal
Income Taxation of Corporations and Shareholders, par. 3.17, at
3-82 to 3-86 (6th ed. 1994).
The termination of Howard Berger's performance obligation to
purchasers of Phase II mausoleum crypts, see sec. 1.451-5(f),
Income Tax Regs., makes it appropriate to apply Jud Plumbing and
section 446(b) to his March 14, 1989 transfer.
This is a
situation contemplated by section 1.451-5(f), Income Tax Regs.,
in which "in a taxable year [1989]" Howard's "liability under the
agreement [the Phase II mausoleum crypt sales contracts]
otherwise ends", so as to make it appropriate that "so much of
the advance [payments] as was not includable in his gross income
in preceding taxable years shall be included in his gross income
for such taxable year [1989]".
Any concerns about unfair income triggering and
- 59 misattribution of deferred income need not detain us.
At the
time of the transfer from Howard to Alice on March 14, 1989, less
than 2 months remained before the Phase II mausoleum would be
completed, and the bulk of the pre-completion deposits was
already in hand.
During all of 1987 and 1988 and for the first
10 weeks of 1989, Howard Berger had received draw payments of
$500 per week, plus payments of personal expenses, that were
primarily financed by those deposits.
No misattribution results
from taxing Howard on one-half the income attributable to Phase
II mausoleum crypt sales prior to his March 1989 transfer.
It follows that Howard Berger's taxable income from the
operations of Woodbine includes not only his one-half share of
the operating profits of Woodbine for the period from January 1
through March 14, 1989, computed under Woodbine's method of
accounting, but also a portion of the income from the Phase II
mausoleum crypt sales.
Howard Berger has not furnished "the
cogent proof" that would require us to reduce the $175,142 of net
income that he reported from the Woodbine business for this
period in 1989.
See Estate of Hall v. Commissioner, 92 T.C. 312,
337-338 (1989); Nestle Holdings, Inc. v. Commissioner, T.C. Memo.
1995-441, 70 T.C.M. 683, 707, 1995 RIA TC Memo par. 95,441 at
95-2730.
Consequently, we hold him to the initial admission in
his 1989 return as to the measure of his Woodbine income,
including his share of the Phase II crypt sale income.13
13
The Estate of Howard Berger now takes the position that in
(continued...)
- 60 Respondent would tax Howard under our 50-percent allocation
to him on $145,204 of profit on mausoleum deposits, plus $21,646,
his 50-percent share of other cemetery income and interest
income, for a total of $166,850.
This is not much less than the
amount reported by Howard on his 1989 joint return.
We believe
that respondent's approach to taxing Howard Berger is supported
by the parties' stipulations as to the amounts of Phase II
mausoleum crypt sales deposits and costs that would be taxed on a
percentage of completion basis, as of March 14, 1989, to a 50percent owner.
We treat respondent's argument as a concession,
and reduce Howard Berger's 1989 Schedule C Woodbine income from
$175,142 to $166,850.
We therefore treat Alice Berger as having received the
remainder of Woodbine's taxable income for 1989.
Inasmuch as the
parties have agreed that the total taxable income of Woodbine for
the period in 1989 through November 17, 1989, amounted to
$383,133, Alice Berger is taxable on the remainder of $216,283.
It's not unfair to tax Alice Berger on that amount of Woodbine
operating income for 1989.
Until March 14, 1989, she received
the same monthly draw payments as Howard Berger.
Thereafter,
13
(...continued)
1989 he should be taxed only on $22,853 of Woodbine income, which
approximates the following amounts of pre-March 14, 1989 income:
Cemetery income
$36,030.36
Interest income
7,262.19
2)43,292.55
21,646.28
This is the basis for Howard Berger's argument that he and
Susan Berger have a substantial overpayment for 1989.
- 61 until November 17, 1989, she received draw payments from Woodbine
at $1,000 per week and total payments of $53,844, and Howard
Berger received only $2,239 on account of personal expenses that
had previously accrued.
Under our approach, Alice Berger's 1989
Woodbine taxable income exceeds Howard Berger's 1989 taxable
income by approximately $50,000, the amount by which Alice
Berger's draw payments and withdrawals made after March 14, 1989,
exceeded the payments to Howard Berger during the same period:
1.
2.
3.
4.
Total taxable income
Alice Berger
Howard Berger
2 minus 3
Woodbine 1989
Taxable Income
$383,133
-216,283
166,895
49,431
Issue 5(a). Whether Alice Berger or Howard Berger Is Required to
Recognize Gain From the Sale of Woodbine in 1989
It appears to be undisputed by the parties that the sale
transactions of November 17, 1989, should be treated as a direct
sale of Woodbine to the Kunkowskis in exchange for their
installment note to Alice Berger.
Alice Berger argues that section 1041 does not apply because
the sale to the Kunkowskis was a transfer to third parties on
behalf of a spouse and thus falls under section 1.1041-1T, Q&A-9,
Temporary Income Tax Regs., 49 Fed. Reg. 34453 (Aug. 31, 1984).
For this conclusion, she largely relies on Arnes v. United
States, 981 F.2d 456 (9th Cir. 1992).
However, this Court
concluded in Blatt v. Commissioner, 102 T.C. 77, 82 (1994), that
- 62 Arnes v. United States, supra, had been wrongly decided.14
Under
the test that we expressed in Blatt v. Commissioner, supra at 81,
"A transfer that satisfies an obligation or a liability of
someone is a transfer on behalf of that person".
Alice Berger's
sale of Woodbine to the Kunkowskis does not represent a sale on
behalf of Howard Berger, and thus section 1041 does not attribute
to Howard any gain realized by Alice on her sale of Woodbine to
the Kunkowskis.
Alice Berger asserts that "both parties, Alice and Howard,
were obligated to transfer Woodbine to the Kunkowskis".
However,
neither Howard nor Alice was obligated to sell Woodbine until an
award was entered by the Chancery Court.
The settlement
agreement stated that whoever was awarded Woodbine would
immediately sell it to the Kunkowskis.
Howard Berger was not
awarded Woodbine and so was never obligated to sell it to the
Kunkowskis.
We disagree with Alice's argument that her sale to
the Kunkowskis was made on behalf of Howard.
Alice Berger also argues that section 1041 does not apply
because the sale to the Kunkowskis was part of a step transaction
on behalf of Howard, and that, therefore, he must recognize gain
on the transfer of Woodbine to Alice.
14
Alice also asserts that
See also Arnes v. Commissioner, 102 T.C. 522 (1994). It
is unclear to what Court of Appeals appeal in this case would
lie, but it would almost certainly not be to the Court of Appeals
for the Ninth Circuit. Therefore Golsen v. Commissioner, 54 T.C.
742 (1970), affd. 445 F.2d 985 (10th Cir. 1971), does not
constrain us to follow Arnes v. United States, 981 F.2d 456 (9th
Cir. 1992).
- 63 the step-transaction doctrine applies to collapse the transfer of
the Woodbine assets and business from Howard to Alice to Woodbine
Association to Gregg and Julia Kunkowski into a direct transfer
from Howard to the Kunkowskis.
As for the step-transaction doctrine, section 1.1041-1T(a),
A-2, Example (3), Temporary Income Tax Regs., 49 Fed. Reg. 34452
(Aug. 31, 1984), does say that the step-transaction doctrine may
apply to section 1041 in appropriate circumstances.
However, the
regulation addresses the use of the step-transaction doctrine to
extend, rather than limit, the sweep of section 1041.
A-2 as a
whole says that section 1041 applies to all transfers of property
between spouses, not just those incident to divorce.
Example (2)
says that this includes transfers between one spouse and a sole
proprietorship owned by the other spouse.
Example (3) says that
section 1041 does not apply to transfers between one spouse and a
corporation wholly owned by the other.
Example (3) then goes on
to say that in appropriate circumstances general tax principles,
including the step-transaction doctrine, may apply to
recharacterize the transaction.
The regulation appears to
contemplate that such general principles could be used in
appropriate circumstances as a basis for applying section 1041.
To use the step transaction doctrine to limit the scope of
section 1041 in the circumstances of this case would be
unwarranted.
Indeed, we have already found that Alice Berger
alone reaped the benefits of the ownership of Woodbine from March
- 64 14, 1989, when Howard's beneficial ownership ceased, until
November 19, 1989, when she sold Woodbine to the Kunkowskis.
Neither of Alice Berger's arguments carries the day.
Section 1041 operates to make her liable for tax on the entire
gain realized on the sale of Woodbine to the Kunkowskis.
Issue 5(b). Adjusted Basis of the Woodbine Property and Business
To calculate Alice Berger's gain, we must ascertain her
basis.
Respondent determined that the adjusted basis of the
Woodbine property and business was no greater than $75,945, as
reflected by the total assets shown on the books and records of
Woodbine as of November 17, 1989.
Alice Berger argues that her adjusted basis should be
increased by $100,000, the amount paid for Woodbine by Howard
Berger in 1979, and by the amount of the unrealized receivables
on the books of Woodbine on the date of the March 14, 1989,
transfer.
We consider these arguments, and also whether her
adjusted basis should be increased by any income accrued to
Howard Berger upon his transfer of March 14, 1989, to her and by
her as a result of her income accrued on the completion of the
Phase II mausoleum in May 1989.
The original $100,000 purchase price of the Woodbine assets
and business was already included in Woodbine's books and
records.
The original purchase price was allocated among grave
plots, buildings, equipment, and goodwill.
The goodwill was not
amortized and remained on Woodbine's books.
Buildings and
- 65 equipment had been subject to depreciation from 1979 until
November 17, 1989, and their bases had been appropriately reduced
on Woodbine's books.
Grave plots were held as inventory on
Woodbine's books and were expensed as they were sold.
We
conclude that Howard Berger's original $100,000 cost had been
reduced, as a result of depreciation, and increased--to reflect
the unrecovered costs of unsold mausoleum crypts and cremation
niches--to $75,945, the amount on Woodbine's books on November
17, 1989, the date of Alice Berger's sale to the Kunkowskis.
We next consider whether Howard Berger's accrual of deposit
income on his transfer of March 14, 1989, to Alice changes the
basis of the Woodbine property and business in her hands.
Section 1041(b) provides that after a transfer incident to
divorce the basis of the transferee in the property shall be the
adjusted basis of the transferor.
Sec. 1.1041-1T(d), A-11,
Temporary Income Tax Regs., 49 Fed. Reg. 34453 (Aug. 31, 1984),
describes the treatment of the transferee of property under
section 1041 as follows:
The transferee of property under section 1041
recognizes no gain or loss upon receipt of the
transferred property. In all cases, the basis of the
transferred property in the hands of the transferee is
the adjusted basis of such property in the hands of the
transferor immediately before the transfer. Even if
the transfer is a bona fide sale, the transferee does
not acquire a basis in the transferred property equal
to the transferee's cost (the fair market value). This
carryover basis rule applies whether the adjusted basis
of the transferred property is less than, equal to, or
greater than its fair market value at the time of
transfer (or the value of any consideration provided by
- 66 the transferee) and applies for purposes of determining
loss as well as gain upon the subsequent disposition of
the property by the transferee. Thus, this rule is
different from the rule applied in section 1015(a) for
determining the basis of property acquired by gift.
[Emphasis added.]
On the basis of this regulation (and of the words of section
1041(b)), we decided in Godlewski v. Commissioner, 90 T.C. 200,
206 (1988), that a husband who bought title to their house from
his former wife for $18,000 under the terms of a divorce
agreement could not increase his basis in the house under section
1041 by the $18,000 that he paid her.
Our conclusion was based
on the assumption, properly adopted in that case, that a transfer
subject to section 1041 is a nonrecognition event to both
transferor and transferee.
However, section 1041(e), enacted in
1986, after section 1041 had been enacted in 1984, provides for
recognition of gain on transfers that would otherwise be
nonrecognized under section 1041(a), if (1) the transfer is in
trust and (2) liabilities assumed or encumbering the property
exceed the adjusted basis.
It further provides that "Proper
adjustment shall be made under subsection (b) in the basis of the
transferee in such property to take into account gain recognized
by reason of the preceding sentence"; i.e., that the transferee's
basis is adjusted to reflect any gain recognized upon the
transfer by the transferor.
The structure of section 1041, as amended, would therefore
appear to support by analogy adjusting Alice Berger's carryover
- 67 basis in Woodbine to reflect the taxable income accrued to Howard
Berger under section 446(b) and Jud Plumbing & Heating v.
Commissioner, 153 F.2d 681 (5th Cir. 1946), by reason of his
transfer of March 14, 1989, to her.
We believe that her basis
should be so adjusted.
We therefore distinguish Godlewski v. Commissioner, supra,
which involved a transfer on which no gain or other income was
recognized by either spouse.
What Godlewski really rejects is
treating the transfer of the interest in the house in question as
a sale when section 1041(b) dictated that it should be treated as
a gift.
Making adjustments to the basis in Woodbine in our case
to reflect Howard's income accrual on his transfer to Alice does
not present the same difficulty.
In order to determine Alice Berger's gain upon the transfer
of Woodbine to the Kunkowskis, we should make all adjustments to
the basis of Woodbine that are properly attributable to capital
account up to the time of that transfer.
Secs. 1016(a),
7701(a)(42)-(44); United States v. Hill, 506 U.S. 546, 555
(1993); Ayer v. Commissioner, 37 B.T.A. 767, 778 (1938), vacated
on other grounds 100 F.2d 850 (1st Cir. 1939); sec. 1.1016-2(a),
Income Tax Regs.
Proper adjustments are to be made for the
period of joint ownership by both Howard and Alice Berger, for
the income accrued when Howard Berger's interest was transferred
to Alice Berger, and for the subsequent period of sole ownership
by Alice Berger.
Some of these adjustments, as we have seen,
- 68 have already been accounted for in respondent's figure of
$75,945.
However, those not so accounted for include:
(1) The
income, from whatever Woodbine-associated source, that Howard
Berger must accrue or had otherwise included no later than the
time of the transfer of his interest to Alice Berger (to be added
to basis); (2) the deposit income that Alice must accrue upon the
completion of the Phase II mausoleum and her other income from
the operation of Woodbine (also to be added to basis); (3)(a) the
draw payments and payments of Howard's expenses by Woodbine (to
be subtracted from basis) and (b) the similar payments by
Woodbine to or on behalf of Alice (also to be subtracted from
basis).15
All these adjustments must be made to the Woodbine
basis of $75,945 before we can determine Alice Berger's adjusted
15
That the adjustments upward for (1) and (2) are
appropriate should be clear from the above discussion. The same
is true for the adjustments downward for (3) and (4). Neither
Howard nor Alice Berger reported any of the draw payments as
taxable income, and they were right not to do so. However, now
that we must determine Alice Berger's gain on the sale to the
Kunkowskis, the draw payments can no longer be ignored for tax
purposes. We must make the same changes to the basis of Woodbine
that we would make to the basis of partnership interests in the
hands of the partners. With respect to (3) and (4), we will have
potential windfalls if we don't make the adjustments predicated
upon Howard's and Alice's having received distributions from the
Woodbine business that were never taxed to them. Generally,
partners don't recognize gain or loss on receipt of cash
distributions from a partnership, sec. 731(a), but a partner's
basis in his partnership interest (outside basis) is reduced by
the amount of any money distributed by the partnership, secs.
705(a)(2), 733, provided the amounts he receives from the
partnership do not exceed his outside basis, sec. 731(a)(1).
The same is true here of Howard's and Alice's interests in
Woodbine.
- 69 basis in Woodbine and her taxable gain on the sale to the
Kunkowskis.
Because the record does not enable us to ascertain
all the figures, we leave the details to the Rule 155
computation.
Before leaving the subject of basis, we address the Woodbine
receivables, which were omitted from the Woodbine 1989 balance
sheet that showed the unrecovered cost of the Woodbine assets to
be $75,945.
The accounts receivable generated by the sale of
mausoleum crypts were ordinary income assets16 in the hands of
Howard and Alice Berger.
Sec. 1221(1); Philhall Corp. v. United
States, 546 F.2d 210, 215 (6th Cir. 1976) (land option, ordinary
income); McHugh v. Commissioner, T.C. Memo. 1957-4 (land
contracts, ordinary income).
They had a zero basis in the hands
of Alice Berger to the extent they had not been properly taken
into Woodbine income by Howard at the time of his transfer of
March 14, 1989, to Alice, and by Alice, at the time of the
completion of the Phase II mausoleum.
Bongiovanni v.
Commissioner, 470 F.2d 921, 923 (2d Cir. 1972) (zero basis),
revg. on other grounds T.C. Memo. 1971-262; Hempt Bros., Inc. v.
United States, 354 F. Supp. 1172, 1177 (M.D. Pa. 1973) (zero
16
The test for whether income from sales of land is ordinary
income or capital gain is whether (1) the taxpayer was engaged in
the trade or business, (2) whether the taxpayer held the property
primarily for sale in the business, and (3) whether the sales
contemplated by the taxpayer were "ordinary" in the course of
that business. Bramblett v. Commissioner, 960 F.2d 526, 530 (5th
Cir. 1992), revg. T.C. Memo. 1990-296. Under this test, Woodbine
receivables from crypt sales were ordinary income assets.
- 70 basis), affd. on other grounds 490 F.2d 1172 (3d Cir. 1974); cf.
sec. 1.1221-2(c)(5)(i), Income Tax Regs.; sec. 1.1221-2T(b)(2),
Temporary Income Tax Regs., 58 Fed. Reg. 54075 (Oct. 20, 1993).
Respondent did not determine and has not asserted--although
there might have been valid grounds for doing so--that unrealized
receivables with respect to Phase II mausoleum crypt sales should
have been accrued prior to or upon completion of the Phase II
mausoleum in May 1989.17
It therefore appears that the Woodbine
receivables were not taken into income, under Woodbine's method
of accounting, which respondent has not disturbed, until they
were collected.
As a result, the receivables on hand at the time
of Alice Berger's sale to the Kunkowskis, on November 17, 1989,
had a zero basis in her hands.18
It appears that the proceeds of
17
Cf. Evergreen Cemetery Association v. Burnet, 45 F.2d 667
(D.C. Cir. 1930), affg. 13 B.T.A. 638 (1928), discussed supra pp.
48-49.
18
It does not escape our notice that there were elements of
financial and tax planning in the structuring of the sale
transaction that do not appear to have been brought to the
attention of Howard or Alice Berger, to the financial and tax
detriment of Alice Berger.
The American Cemetery Consultants appraisal valued the
Woodbine receivables, as of Oct. 1, 1988, which then had a face
amount of $428,600, by deeply discounting them to a fair market
value of $172,298. The latter figure is the value we have
attributed to the receivables for purpose of allocating the sale
price among the various assets; after all, the $172,298 valuation
of the receivables was used in computing the $680,000 sale price
of Woodbine to be received by Alice Berger. By causing the
receivables to be transferred to the Cemetery Association, the
Kunkowskis in effect caused the difference between the deeply
discounted value of the receivables, which has been included as
(continued...)
- 71 subsequent collection of those receivables by Woodbine has, to a
substantial extent, provided the wherewithal for the payments on
the Woodbine Association Certificates of Indebtedness held by the
Kunkowskis and on the Kunkowskis' note to Alice Berger.
Issue 5(c).
Installment Method
The gain or loss realized by the seller of property usually
must be recognized at the time of sale.
However, the seller who
is eligible to use the installment method may defer recognition
of gain, and the liability to pay tax thereon, over the period of
and in proportion to the payments as they are made.
Sec. 453(c).
Under the installment method, the seller is able to recognize
gain over the period during which the installment payments are
18
(...continued)
part of Alice's gain, and their substantially higher face amount,
assuming that they were collected by the Cemetery Association in
due course over the following 2-year period, with few if any bad
debts, to escape tax entirely. Perhaps that difference, if the
receivables should be considered, along with the other Woodbine
assets, to have been transferred to the Kunkowskis, and retransferred by them to the Cemetery Association for its
Certificates of Indebtedness, should have been taxed to the
Kunkowskis if the receivables in fact had a value greater than
$172,298 on Nov. 17, 1989. If that difference should be so large
as to extend the period of limitations under sec. 6501(e) on the
Kunkowskis' 1989 return, respondent may still have time to
consider that possibility and determine whether the Kunkowskis
realized and recognized a substantial ordinary gain on their
constructive transfer to the Cemetery Association of the
previously undervalued Woodbine receivables from purchasers of
Phase II mausoleum crypts.
The transactions of Nov. 17, 1989, were structured for tax
purposes in such fashion that, as we shall see in the discussion
of issue 5(c), Alice Berger will be required to pay a substantial
current tax liability, even though she is receiving the $680,000
sale price in the form of monthly payments, with interest, over
25 years.
- 72 received, rather than be taxed on the entire gain in the year of
sale.
See Leon H. Perlin Co. v. Commissioner, T.C. Memo.
1993-79.
Alice Berger claims installment treatment of her entire
gain from the sale of Woodbine.
Respondent asserts that the sale on November 17, 1989, of
Woodbine was a dealer disposition and therefore does not qualify
as an installment sale under section 453.19
The installment
method is not available for dispositions of personal property of
a kind required to be included in the inventory of the taxpayer
on hand at the close of the taxable year.
Sec. 453(b)(2)(B);
sec. 15A.453-1(b)(4), Temporary Income Tax Regs., 46 Fed. Reg.
10710 (Feb. 4, 1981).
The installment method is also not
available for a dealer disposition, sec. 453(b)(2)(A), which
includes any disposition of real property held by the taxpayer
for sale to customers in the ordinary course of trade or
business.
Sec. 453(b)(2)(A), (l).
It would therefore appear to
be immaterial for our purposes whether the Woodbine burial rights
are classified as personal property or real property.20
19
Respondent has not determined or argued for the
application of sec. 453(g) or (e), concerning the sale of
depreciable property between related persons, and second
disposition by related persons, respectively. See generally
Shelton v. Commissioner, 105 T.C. 10 (1995).
20
Whether the sale of burial rights constitutes personalty
or realty is generally determined under State law. National
Memorial Park, Inc. v. Commissioner, 145 F.2d 1008 (4th Cir.
1944). The Woodbine property and business is located in New
Jersey. Under New Jersey case law and statutory law, title to a
cemetery plot is a legal estate in real property. N.J. Stat.
Ann. sec. 8A:7-2 (West 1987 & Supp. 1995) (burial space passes to
(continued...)
- 73 The evidence in the record with respect to the Woodbine
burial rights, developed or undeveloped, does not indicate any
use of them by Woodbine other than for sale to customers in the
ordinary course.
See Major Realty Corp. v. Commissioner, 749
F.2d 1483, 1488 (11th Cir. 1985) (assets sold in the ordinary
course of business), affg. in part and revg. and remanding on
other issues T.C. Memo. 1981-361.
The Woodbine books and
records reflect these assets under an "inventory" classification.
So does the appraisal prepared by American Cemetery Consultants.
Therefore, the burial rights that had not yet been sold to
customers were inventory or property held for sale to customers
in the ordinary course of trade or business and not eligible for
the installment method.
In identifying dealer dispositions of both personalty and
realty, the Code refers to "any disposition".
and (B).
Sec. 453(l)(1)(A)
Therefore the sale, whether in bulk or individually, of
the burial rights that are normally sold to the public would be
a dealer disposition of property.
As a dealer disposition, the
sale of those component assets of Woodbine is not eligible for
the installment method.
The component assets clearly not
entitled to installment treatment are those classified in the
American Cemetery Consultants' appraisal as grave spaces,
20
(...continued)
heirs-at-law or devisees of the deceased owner); Weiss v. Cedar
Park Cemetery, 572 A.2d 662, 666-667 (N.J. Super. Ct. App. Div.
1990). Therefore, the Woodbine burial rights appear to be more
in the nature of real property than personalty.
- 74 mausoleum crypts, and cremation niches.
Respondent concedes that the Woodbine assets used in the
trade or business not held for sale to customers in the ordinary
course, such as the office building, the residence, the two
service buildings, and the equipment, would qualify for
installment treatment.
We also include in the category of assets
qualifying for installment treatment the roads, landscaping, lot
markers, drainage, and fencing.
This leaves to be resolved the characterization of the
Woodbine accounts receivable and undeveloped land.
The unrealized receivables of Woodbine arose from sales of
inventory or property held primarily for sale to customers,
consisting of mausoleum crypts.
As such, they were ordinary
income assets, deriving their character from the property that
generated them, property that was held for sale to customers in
the ordinary course of trade or business.
See Coast Coil Co. v.
Commissioner, 50 T.C. 528, 532-535 (1968), affd. per curiam 422
F.2d 402 (9th Cir. 1970); Family Record Plan, Inc. v.
Commissioner, 36 T.C. 305, 308-313 (1961), affd. on other grounds
309 F.2d 208 (9th Cir. 1962); Liberty Natl. Bank & Trust v.
Commissioner, T.C. Memo. 1979-74; cf. Fourth Natl. Bank v. United
States, 36 AFTR 2d 75-5226, 75-2 USTC par. 9594 (N.D. Okla.
1975).
It would be anomalous to allow the sale of the
receivables to be entitled to installment treatment when the
sales of the mausoleum crypts that generated them were not and
would not have been entitled to installment treatment.
Cf.
- 75 Liberty Natl. Bank & Trust Co. v. Commissioner, supra; Fourth
Natl. Bank v. United States, supra.
We now turn to whether the Woodbine undeveloped land was
entitled to installment treatment.
The record contains no
evidence whether the entire Woodbine tract was zoned exclusively
for cemetery purposes, or whether the undeveloped land was
already exclusively dedicated for cemetery development and sale
to customers in the form of grave plots, mausoleum crypts, or
cremation niches.
However, the American Cemetery Consultants
appraisal report reflects the assumption that the undeveloped
acreage would be so used, and the appraised value of the
undeveloped land was based on that assumption.
In the absence of any proof to the contrary by Alice Berger,
we conclude that the undeveloped land of Woodbine was most likely
held for later development into grave sites and similar property
and was therefore held for sale to customers, thereby requiring
it to be treated as dealer property.
T.C. Memo. 1993-63.
Cf. Tollis v. Commissioner,
In so doing, we reject Alice Berger's
argument that she was never in the cemetery business; we have
already held that she was.
We also reject any argument by her
that the events of 1989 were occasioned by her decision to retire
from the cemetery business, so as to change the character of the
Woodbine dealer assets to capital assets in her hands.
We
rejected a similar argument in Tollis v. Commissioner, supra, and
we do so here.
See Lawrie v. Commissioner, 36 T.C. 1117 (1961);
Estate of Ferber v. Commissioner, 22 T.C. 261 (1954); Grace
- 76 Bros., Inc. v. Commissioner, 10 T.C. 158 (1948), affd. 173 F.2d
170 (9th Cir. 1949); Martin v. United States, 330 F. Supp. 681
(M.D. Ga. 1971).
Respondent argues that the evidence in the record does not
permit us to allocate the total Woodbine sale price of $680,000
among component assets qualifying and not qualifying for
installment treatment.
(1963).
Cf. Monaghan v. Commissioner, 40 T.C. 680
Respondent therefore insists that Alice Berger has
failed to carry her burden of showing that any of her gain
qualifies for installment treatment and that therefore her entire
gain on the sale to the Kunkowskis is taxable as ordinary income.
We disagree.
The rule of Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir.
1930), permits us to approximate the amounts of gain allocable to
assets that qualify for the installment method.
Cohan treatment
has been given to allocations of accounting expenses between the
capitalizable cost of selling a capital asset and the deductible
expense of general auditing duties, Ellis Banking Corp. v.
Commissioner, 688 F.2d 1376, 1383 (11th Cir. 1982), affg. in part
and remanding in part on this issue T.C. Memo. 1981-123, of an
estate's partnership assets to land, a building, and personal
property, McKelvey v. Commissioner, 246 F.2d 609, 613 (3d Cir.
1957), affg. T.C. Memo. 1956-70, and of the purchase price of a
business among physical assets of the business, good will, and a
covenant not to compete, Kreider v. Commissioner, 762 F.2d 580,
589 (7th Cir. 1985), affg. T.C. Memo. 1984-68; Levine v.
- 77 Commissioner, 324 F.2d 298, 302 (3d Cir. 1963), affg. T.C. Memo.
1962-68.
The American Cemetery Consultants appraisal identified the
gross value of the assets that we find to be qualified for
installment treatment as $381,200, out of a total gross asset
valuation of $842,768.21
We therefore find, using the Cohan
rule, that 45 percent of Alice Berger's gain from the sale
qualifies for installment treatment.22
We leave for the Rule 155
computation the determination of the ordinary gain currently
taxable to Alice Berger on the sale and the amounts and character
(as long-term or short-term) of the items of gain entitled to
installment treatment in her hands.
21
Removing the $20,000 of cash from the equation leaves the
following allocation of capital gain (installment treatment) and
ordinary gain (dealer disposition) items:
Assets qualifying for
installment treatment
Office building
$100,000
Residence
75,000
Service building
80,000
Storage building
40,000
Equipment
17,000
Other equipment
26,000
Roads & landscaping 43,200
Total
381,200
22
Assets not qualifying
for installment treatment
Accounts receivable
Grave spaces
Mausoleum crypts
Creamation niches
Undeveloped land
$172,298
12,518
42,992
14,205
219,555
_______
461,568
In so doing, we take account of the fact that the
appraisal company substantially discounted the value of the
Oct.1, 1988, receivables, amounting to $428,601--approximately
the same amount as the stipulated Nov. 17, 1989, face amount of
the receivables ($429,371)--to 41.6 percent of their face amount:
$172,298.
- 78 Issue 6.
Self-Employment Tax
Alice Berger asserts that she is not liable for any selfemployment tax because she never owned or had a share in the
ownership of the Woodbine business, as opposed to the land, and
did not participate in the day-to-day operations or management of
the business.
Howard Berger similarly argues that during 1988
and 1989 neither he nor Alice Berger participated in the
operation of the cemetery business, so that no self-employment
tax should be imposed on the Woodbine income of either of them.
Section 1401 imposes a tax on the "self-employment income"
of every individual.
"Self-employment income" is defined
generally in section 1402(b) as "the net earnings from
self-employment derived by an individual * * * during any taxable
year".
Section 1402(a) defines the term "net earnings from self-
employment" as the "gross income derived by an individual from
any trade or business carried on by such individual, less the
deductions allowed by this subtitle which are attributable to
such trade or business".
Section 1.1402(a)-2(b), Income Tax
Regs., provides that "The trade or business must be carried on by
the individual, either personally or through agents or
employees."
These provisions are to be broadly construed to
favor treatment of income as earnings from self-employment.
Hornaday v. Commissioner, 81 T.C. 830, 834 (1983).
Petitioners do not deny that Woodbine was a trade or
business under the principles laid down by Commissioner v.
Groetzinger, 480 U.S. 23 (1987).
It doesn't matter whether Alice
- 79 and Howard Berger did or did not personally conduct the trade or
business of Woodbine during the years in question.
They carried
on the business through Gregg Kunkowski, their agent or employee.
Moorhead v. Commissioner, T.C. Memo. 1993-314; Price v.
Commissioner, T.C. Memo. 1993-265.
During 1988 and until March 14, 1989, Howard and Alice
Berger are each subject to self-employment tax on their
respective shares of Woodbine's net earnings.
During the period
thereafter that Alice Berger alone owned the Woodbine business,
she is subject to self-employment tax on her net earnings from
the business, excluding any capital gain from her sale of the
business.
Issue 7(a):
Sec. 1402(a)(3)(A).
Late Filing Addition Under Section 6651(a)
If a taxpayer fails to file a return by the due date,
including extensions of time for filing, and cannot show that the
failure is due to reasonable cause and not willful neglect,
section 6651(a)(1) imposes an addition to tax equal to 5 percent
of the underpayment of tax for each month, or fraction of a
month, that the return is late, not to exceed 25 percent.
Although Alice Berger filed her 1989 income tax return before the
due date as extended, respondent determined that Alice Berger's
requests for extensions of time to file were invalid and that she
is therefore liable for an addition to tax under section
6651(a).23
23
Respondent has conceded that Howard and Susan Berger are
(continued...)
- 80 If an extension of time to file is deemed invalid, it will
not extend the due date of the return, and the taxpayer must show
that the failure to file a return by the original due date was
due to reasonable cause and not due to willful neglect.
v. Commissioner, 92 T.C. 899, 912 (1989).
Crocker
An extension of time
to file may be deemed invalid if the taxpayer did not make a bona
fide and reasonable estimate of his tax liability using the
information available at the time of the extension request.
at 908.
Id.
Good faith reliance on the advice of a tax return
preparer, who has been fully apprised of all relevant facts, may
show that the taxpayer made a bona fide and reasonable estimate
of tax liability.
1994-395.
See O'Sullivan v. Commissioner, T.C. Memo.
In addition, "The fact that we have come to a
substantive conclusion about the * * * issue different from that
of petitioners does not of itself indicate that petitioners filed
their extension request with a lack of due care or reasonable
cause".
Id.
Alice Berger testified, and we believe, that she relied on
her accountant to prepare her extensions and returns for 1989.
She was receiving fairly sophisticated tax advice, even if
it turned out, as we have seen, that the advice was wrong in
various important respects.
We would not expect a former
housewife, inexperienced in business, financial, or tax matters,
to prepare a rider to the 1988 joint return, citing legal
23
(...continued)
not liable for this addition to tax.
- 81 authorities, as was done, to support her position that the return
was invalid because she was signing under duress.
At the times
her accountant signed the requests to extend the times for filing
her 1989 return, the 1988 return was under audit by the Internal
Revenue Service.
On September 13, 1990, the revenue agent issued
a report taking the position that a substantial part of the Phase
II deposits was taxable on the 1988 return.
Her 1989 return, as
filed on October 12, 1990, pursuant to the extensions, took the
position, obviously with the return preparer's advice, that there
was no tax due.
This appears to have been due to the combination
of three mistaken positions:
First, that she had a net loss of
$4,101 from Woodbine operations because the bulk of the gross
income had been taxable in the prior year, in accordance with the
revenue agent's recently issued report; second, the even more
aggressive position she has been taking in this proceeding, that
she was not taxable on any part of the 1989 Woodbine operating
income because Howard Berger owned the Woodbine business in its
entirety; and third, that she had no gain on the sale to the
Kunkowskis because the attribution of the sale to Howard Berger
under either or both of the "on behalf of" and step-transaction
approaches under section 1041 gave her a basis in Woodbine equal
to the amount realized of $680,000.
Although we have concluded
otherwise on the merits, we believe that there was a reasonable
basis for Alice Berger's 1989 return positions, and for her
failures to pay tax with her extension applications.
We reject
respondent's imposition of the section 6651(a) addition to tax.
- 82 Issue 7(b).
Accuracy-Related Penalty Under Section 6662
Respondent also determined that Alice Berger was liable for
the accuracy-related penalty under section 6662 for 1989.
If any
portion of an underpayment is attributable to negligence,
disregard of rules or regulations, or substantial understatement
of income tax, an amount equal to 20 percent of the portion of
the underpayment attributable to such negligence, disregard, or
understatement, is added to the tax.
Sec. 6662(a).
Petitioner
Alice Berger bears the burden of proving that she is not liable
for this penalty.
Rule 142(a).
Negligence is the failure to exercise due care or the
failure to act as a reasonable and prudent person.
Commissioner, 85 T.C. 934, 947 (1985).
Neely v.
The term "disregard"
includes any careless, reckless, or intentional disregard.
6662(c).
Sec.
We have found that Alice Berger acted as a reasonable
and prudent person when reporting her 1989 income because she had
a reasonable basis for estimating her 1989 tax liability as zero.
By a parity of reasoning, we find that she did not carelessly,
recklessly, or intentionally disregard rules and regulations in
connection with the preparation and filing of her 1989 return.
See Weis v. Commissioner, 94 T.C. 473, 487 (1990).
An understatement is substantial if it exceeds the greater
of 10 percent of the tax required to be shown or $5,000.
6662(d)(1)(A).
Sec.
An "understatement" is defined as the excess of
the tax required to be shown on the return over the tax actually
shown on the return, but the understatement will be reduced if
- 83 the taxpayer either had "substantial authority" for, or
adequately disclosed, the tax treatment shown on the return.
Sec. 6662(d)(2)(B).
Alice Berger provided enough information on her return for
respondent to identify the potential controversy arising from the
omission of $229,396--the amount the revenue agent's report had
included on the 1988 joint return for the prior year--from her
share of Woodbine's ordinary income for 1989.
See Schirmer v.
Commissioner, 89 T.C. 277, 285-286 (1987).
This leaves the question whether Alice Berger's 1989 return
provided enough information for respondent to identify the
potential controversy concerning her disposal of Woodbine.
On
that score, her 1989 return reported the sale proceeds of
$680,000 and claimed a basis of $680,000, resulting in no
reported gain.
This disclosure was not sufficient to apprise
respondent of the potential controversy.
We therefore address whether Alice Berger had substantial
authority for her 1989 return positions.
We decide whether a
taxpayer had substantial authority by using the same analysis and
the same precedents that we would use in deciding whether the
taxpayer's treatment of the item was proper.
Antonides v.
Commissioner, 91 T.C. 686, 702 (1988), affd. 893 F.2d 656 (4th
Cir. 1990).
We consider the authorities at the time the return
was filed, or at the end of the taxable year in question, even if
those authorities are ultimately held inapplicable.
Collins v.
Commissioner, T.C. Memo. 1992-478, affd. 3 F.3d 625 (2d Cir.
- 84 1993); Harston v. Commissioner, T.C. Memo. 1990-538, affd.
without published opinion 936 F.2d 570 (5th Cir. 1991).
Substantial authority is an objective standard, less difficult to
satisfy than "more likely than not", but more difficult to
satisfy than "reasonable basis".
Antonides v. Commissioner,
supra at 702; secs. 1.6661-3(a)(2) and (b)(1), 1.6662-4(d)(2),
Income Tax Regs.
The weight of authorities supporting a
taxpayer's treatment of an item must be substantial in relation
to the weight of the authorities supporting contrary positions,
and an authority is given little weight if it is materially
distinguishable on its facts.
Secs. 1.6661-3(b)(1), (3), 1.6662-
4(d)(3)(ii), Income Tax Regs.
A taxpayer's position may be supported by authority even
though there is no decided case or ruling supporting the
position.
"Thus, a taxpayer may have substantial authority for a
position that is supported only by a well-reasoned construction
of the applicable statutory provision."
Secs. 1.6661-3(b)(3),
1.6662-4(d)(3)(ii), Income Tax Regs.
We believe that Alice Berger had well-reasoned positions
that what we have held to be her share of the Woodbine income was
not taxable to her under the assignment of income doctrine,24 and
24
When Alice Berger filed her 1989 return, in October 1990,
the question whether the assignment of income doctrine or sec.
1041 would control the allocation of the income attributable to
Howard Berger's interest in Woodbine had not been addressed in a
published decision. However, the Internal Revenue Service had
taken the position that the assignment of income doctrine could
trump sec. 1041, and indeed apply to transfers of property with
(continued...)
- 85 because Howard Berger was the controlling owner of the Woodbine
business so that he earned its entire income, which was paid to
her as a property settlement.
We hold that Alice Berger had
substantial authority for not reporting the ordinary income of
Woodbine that she was led to believe by her advisers was properly
taxable to Howard Berger.
We further believe that Alice Berger had substantial
authority, also in the form of a well-reasoned position, that she
had no taxable gain on the sale of Woodbine to the Kunkowskis.
Her position was that section 1041 and the temporary regulations
thereunder are susceptible to the interpretation and application
that the transfer of the full interest in Woodbine to Alice
Berger, followed by her previously agreed-upon court-ordered sale
to the Kunkowskis, was "on behalf of" Howard Berger, or should be
so regarded under step-transaction principles.
Cf. Arnes v.
United States, 981 F.2d 456 (9th Cir. 1992).
Having concluded that Alice Berger had substantial authority
for her 1989 return position that there was no tax due on her
Woodbine transactions, we reject respondent's imposition of the
section 6662 accuracy-related penalty.
To reflect the foregoing,
24
(...continued)
inhering accrued income elements. Compare Rev. Rul. 87-112,
1987-2 C.B. 207 with Asimow, "The Assault on Tax-Free Divorce:
Carryover Basis and Assignment of Income", 44 Tax L. Rev. 65
(1988). Our opinion in Balding v. Commissioner, 98 T.C. 368
(1992), a case of first impression holding that sec. 1041 trumps
the assignment of income doctrine (see discussion supra pp. 5455), was not published until March 1992.
- 86 Decisions will be entered
under Rule 155.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.