# Opposition Brief — Owen v. Commissioner > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385020_0550%3A2 ## Record - **Collection:** Supreme Court brief - **Document type:** Opposition Brief - **Published:** January 1, 1990 - **Citation:** 493 U.S. 1070 ## Text . at 2 ; : i ~ Supreme Court, U.S. ‘ es > ir RAED x | ay Oy, JAN 24 1550 ay ¥ , : OL, JR. tis CLERK > «—- Suthe Supreme Court of the United States Sen OCTOBER TERM, 1989 . i WILLIAM F. OWEN AND GRETCHEN K. OWEN, PETITIONERS Vv. - | COMMISSIONER OF INTERNAL REVENUE ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT BRIEF FOR THE RESPONDENT IN OPPOSITION KENNETH W. STARR - Solicitor General SHIRLEY D. PETERSON Assistant Attorney General RICHARD FARBER Attorney Department of Justice Washington, D.C. 20530 (202) 633-2217 et oe hag , ve Bs | * if me é% Aa ee J + ‘ hes » - M f 9 JM - & iy tas # d ré od, ye we" QUESTION PRESENTED Whether a taxpayer who transfers property to a controlled corporation realizes taxable gain on the transfer under Section 357(c) of the Internal Reve- nue Code to the extent the transferred property is subject to liabilities that exceed his adjusted basis in the property, even though the taxpayer remains per- sonally liable for those liabilities following the transfer. (1) TABLE OF CONTENTS Page Opinions below ......................-- so 8 EE SEL PORE RO ATO 1 ac ciccnhcebeninbmiateiotininanmenenans 1 Ne ss caainsunbalsubabncebeaniitnmene 2 I chnieenerninassotraninioiantan’ 5 ka a ie Re 10 TABLE OF AUTHORITIES Cases: Commissioner V. Asphalt Products Co., 482 U.S. + eet I ea a 9 Commissioner V. Tufts, 461 U.S. 300 (1983) ........ 7 Griffin v. Oceanic Contractors, Inc., 458 U.S. 564 i cen ananasositiinmnibiabppsicee 6 Lessinger V. Commissioner, 872 F.2d 519 (2d Cir. ORE 2 an 9 McEachron v. Commissioner, 873 F.2d 176 (8th ree Ae SE a 4 Rosen Vv. Commissioner, 62 T.C. 11 (1974), aff’d, Be ee CUE Gs BOUT ercccicccccincecenstceccneccsene 7,8 Smith yv. Commissioner, 84 T.C. 889 (1985), aff’d, 805 F.2d 1073 (D.C. Cir. 1986) ................. 6-7 United States v. Ron Pair Enterprises, Inc., 109 a cnachimienmensiodeses 6 Statutes: Internal Revenue Code of 1954 (26 U.S.C.) : SEED SESS LEN ce 7 Ei Sn SEE eee 6 OL EE ee 6 EES ot RSE Sea eC 5 i oieisieeninelabniiisunelainneh 4 es dic ilidinctelinmindnnaitice 3, 4, 5, 6, 7, 8, 9, 10 TE oh EEE a a 7 Ns coida anieldneiomangcnnn 7 (III) Iu the Supreme Court of the United States OCTOBER TERM, 1989 No. 89-715 WILLIAM F. OWEN AND GRETCHEN K. OWEN, PETITIONERS Vv. COMMISSIONER OF INTERNAL REVENUE ON PETITION FORA WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT BRIEF FOR THE RESPONDENT IN OPPOSITION OPINIONS BELOW The opinion of the court of appeals (Pet. App. Al- A8) is reported at 881 F.2d 832. The memoranduin opinion of the Tax Court (Pet. App. A9-A25) is re- ported at 53 T.C.M. (CCH) 1480. JURISDICTION The judgment of the court of appeals was entered on August 9, 1989. The petition for a writ of cer- tiorari was filed on November 2, 1989. The jurisdic- tion of this Court is invoked under 28 U.S.C. 1254 (1). (1) 2 STATEMENT 1. In 1977, petitioner William F. Owen and Step- hen McEachron formed a general partnership called McO Investment (McO), in which they were equal partners.’ In 1980, petitioner and McEachron en- tered the seismic drilling business. They borrowed money to buy drilling equipment, personally guar- anteeing the loan and giving the lender a security interest in the equipment, and they placed title to the equipment in the partnership. The partners then leased most of the equipment to Western Exploration, Inc., a corporation in which petitioner and McEach- ron each owned 50% of the shares, and Western proceeded to conduct the seismic drilling operations. Pet. App. A2, A10-A12.’? The seismic drilling venture was unsuccessful. Petitioner and McEachron decided in 1981 to aban- don their efforts and to sell the entire venture. They believed that the sale of their business could be more readily accomplished if it were first combined into a single entity. Accordingly, petitioner and McKachron decided to transfer ownership of the drilling equip- 1 Petitioner Gretchen K. Owen is a party to this suit solely by virtue of having filed a joint return with her husband William; accordingly, references to “petitioner” are to Wil- liam F. Owen. 2 Petitioner and McEachron chose to have McO own the equipment and Western conduct the drilling operations be- cause the partnership’s ownership of the equipment would allow them to claim the investment tax credit and deprecia- tion deductions associated with the equipment on their in- dividual tax returns, while the use of a corporation to conduct the drilling operations would provide them with protection against personal liability in case of a catastrophe. Pet. App. All. 3 ment from McO to Western and then sell their stock in Western. The equipment transfer was effected on December 31, 1981. As of that date, the transferred equipment was subject to liabilities of $988,008, which exceeded McO’s adjusted basis in the equip- ment by approximately $200,000. Pet. App. A8, A12- A138. 2. On audit, the Commissioner determined that, pursuant to Section 357(c) of the Internal Revenue Code,* McO realized taxable gain on the transfer of its drilling equipment to Western to the extent the liabilities to which the equipment was subject ex- ceeded McO’s adjusted basis in the equipment.* The Commissicner’s resulting adjustments to McO’s in- come produced corresponding deficiencies in the in- come tax of its two partners, petitioner and McEach- ron. Each partner petitioned the Tax Court for re- determination of the asserted deficiencies, and their cases were consolidated for trial and opinion. Pet. App. A10. The Tax Court ruled in favor of the Commissioner (Pet. App. A9-A24). Petitioners’ principal conten- tion in the Tax Court with respect to the Section 357(c) issue was that, pursuant to an oral agree- 3 Unless otherwise noted, all statutory references are to the Internal Revenue Code of 1954 (26 U.S.C.), as amended (the Code or I.R.C.). * Section 357(c) (1) of the Code provides that, in the case of a transfer of property by a taxpayer to a controlled cor- poration, “if the sum of the amount of the liabilities assumed, plus the amount of the liabilities to which the property is subject, exceeds the total of the adjusted basis of the property transferred * * *, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of prop- erty which is not a capital asset, as the case may be.” 4 ment with the Wayzata Bank that was in effect by December 31, 1981, the bank had released its security interest in the transferred equipment to the extent that interest exceeded McO’s adjusted basis in the equipment. Therefore, petitioners argued, the liabil- ities to which the transferred property was subject did not exceed the adjusted basis of the property, and Section 357(c) did not require the recognition of any gain on the transfer. See Pet. App. Al9. The Tax Court found as a factual matter, however, that the bank did not agree to the reduction of its security interest until September 1982. It also concluded that this agreement should not be treated as retroactive to December 1981. The court thus concluded that at the time of the equipment transfer the liabilities to which the property was subject did exceed McO’s adjusted basis, resulting in taxable gain under Section 357(c). Pet. App. A21-A23.° 3. On petitioners’ appeal, the Ninth Circuit af- firmed (Pet. App. Al-A8).° The court declined to 5 The Tax Court did agree with petitioners’ contention that a $100,000 certificate of deposit pledged by the partners as additional security for the debt owed to the Wayzata Bank should be treated as a reduction in the amount of indebted- ness to which the equipment was subject on the date it was transferred to Western. Pet. App. A23-A24. This treatment produced a corresponding $100,000 reduction in the amount of gain that McO was deemed to have realized on the transfer under Section 357(c) (1). The Commissioner did not appeal the Tax Court’s ruling on this issue. ® McEachron, a resident of Minnesota at the time he filed his Tax Court petition, appealed to the Eighth Circuit advanc- ing the same arguments as petitioners. The Eighth Circuit also affirmed the decision of the Tax Court, McEachron Vv. Commissioner, 873 F.2d 176 (1988), and McEachron did not seek certiorari. 5 disturb the Tax Court’s conclusion that, despite the 1982 agreement of the bank to reduce the liabilities encumbering the property, the liabilities did exceed the partnership’s adjusted basis in the property at the time of the transfer (id. at A8).’ The court also re- jected petitioners’ alternative argument that, even if the liabilities did exceed the adjusted basis in the equipment at the time of the transfer, Section 357 should not require the recognition of taxable gain be- cause petitioner remained personally liable for the indebtedness to which the property was subject and therefore he received no economic benefit as a result of the transfer. The court held that, under the statu- tory scheme enacted by Congress, petitioner’s contin- uing personal liability for the loans secured by the transferred equipment is irrelevant. Pet. App. A5- A8. ARGUMENT The court of appeals correctly rejected petitioners’ contention that the plain terms of Section 357 (c) (1) should be disregarded and instead a limitation read into the statute to the effect that liabilities to which transferred property is subject may be ignored in computing the transferor’s gain under Section 357, to the extent the transferor remains personally liable for the indebtedness secured by the transferred prop- erty. The court of appeals’ decision accords with the decisions of the other courts of appeals that have con- sidered this issue, and it does not confiict with any decision of this Court. Accordingly, there is no rea- son for review by this Court. 7 Petitioners do not seek review of this aspect of the Ninth Circuit’s decision. 6 1. The general rule of Section 351(a) of the Code is that no gain or loss is recognized by a taxpayer on the transfer of property to a corporation controlled by him. Section 857(c)(1) expressly establishes an exception to that rule. If, in the case of a Section 351 transfer, the sum of the liabilities assumed by the transferee plus the amount of the liabilities to which the property is subiect exceeds the adjusted basis of the transferred property, then that excess “shall” be considered as taxable gain to the transferor. Peti- tioners do not challenge in this Court the factual de- terminations that the partnership transferred prop- erty to acontrolled corporation and that the liabilities to which the property was subject exceeded the part- nership’s adjusted basis in that preperty. Thus, the plain terms of Section 357(c) (1) dictate the result reached by the courts below. Petitioners contend, however, that the partnership should not be treated as having realized any taxable gain on the transfer because the partners remained personally liable for the loans secured by the trans- ferred property. But petitioners do not suggest how the text of Section 357(c) (1) can be read to support this rule. Nor do they provide any arguable basis for disregarding the apparent meaning of the statutory language since they suggest no reason for believing that the result, reached below is at odds with the in- tent of Congress. See, e.g., United States v. Ron Pair Enterprises, inc., 109 S. Ct. 1026, 1031 (1989) ; Griffin v. Oceanic Contractors, Inc., 458 U.S. 564, 571 (1982). Thus, the partners’ personal liability for the indebtedness provides no basis for departing from the taxable gain consequences required by the plain statutory text, and the courts consistently have so held. See Smith v. Commissioner, 84 T.C. 889, 909 7 (1985), aff'd, 805 F.2d 1078 (D.C. Cir. 1986) (Table); Rosen v. Commissioner, 62 T.C. 11, 19 (1974), aff’d, 515 F.2d 507 (8d Cir. 1975) (Table) ; McEachron v. Commissioner, 873 F.2d 176 (8th Cir. 1988). Moreover, contrary to the main thrust of the peti- tion, there is nothing unreasonable or unfair about the application of Section 357(c) (1) in the circum- stances of this case. Petitioners’ assertion (Pet. 19- 24) that the partners realized no economic benefit as a result of the transfer of the equipment from McO to Western ignores the fact that they obtained sub- stantial tax benefits through the accelerated deprecia- tion deductions claimed by McO with respect to that equipment. As the Tax Court has explained, Section 357(c)(1) “is analogous to other recapture provi- sions in the Code”; its purpose is to recapture tax deductions attributable to property acquired with bor- rowed funds, where the property is transferred to a controlled corporation and the liabilities to which the property is subject (or that are assumed by the transferee) exceed the transferor’s adjusted basis in the property. See Rosen v. Commissioner, 62 T.C. at 19 n.3. Upon its purchase of the drilling equipment in question, McO acquired a depreciable basis in the equipment equal to its cost. I.R.C. § 1012. This cost basis included the amount of the liabilities to which the equipment was subject by virtue of the financing arrangement between McO and the Wayzata Bank. See Commissioner v. Tufts, 461 U.S. 300 (1983). McO’s basis in the equipment was adjusted down- ward.as it claimed depreciation deductions with re- spect to the equipment. I.R.C. §§ 167, 1016. It is because of this downward adjustment ir McO’s basis in the equipment (reflecting its recovery of its in- iii 8 vestment through depreciation), without a corre- sponding reduction in the indebtedness encumbering the property, that the liabilities to which the equip- ment was subject exceeded McO’s adjusted basis on ——the date of the equipment transfer. In enacting Sec- tion 357(c)(1), Congress considered it likely that, in order to avoid foreclosure, the new owner of trans- ferred property that is subject to Habilities will sat- isfy those liabilities regardless of whether it has any personal obligation to do so. Absent the recapture nrovisions of Section 357(c) (1), the satisfaction of those liabilities by the transferee would result in un- warranted tax benefits for the transferor because the transferor has already received the benefit of depre- ciation deductions-computed on the assumption that he would satisfy the liabilities to which the property is subject. See Rosen v. Commissioner, 62 T.C. at 19 n.3. Thus, petitioner’s continuing liability for the in- debtedness secured by the equipment transferred to Western is irrelevant; the statutory scheme is based on the expectation that the new owner of the property (i.e., Western) will satisfy that indebtedness. If this assumption proves unfounded, it will result in no un- fairness to the partners, as petitioners candidly rec- ognize (see Pet. 16). In that event, the partners’ basis in their Western stock would be increased to reflect the reduction of indebtedness, which would serve to increase their loss or reduce their gain on their disposition of that stock. In essere, petitioners’ complaint is that the statu- tory scheme is founded on-the wrong assumption, which, they assert, can affect the “timing and char- acter” of the tax (Pet. 16). In petitioners’ view, where the transferor of property remains personally 9 liable for indebtedness to which the transferred prop- erty is subject, it should be presumed that the trans- feror, not the transferee, will satisfy those liabilities. If so, the transferor should not be treated as realiz- ing gain at the time of the transfer, but rather should realize gain only in the event that it is the transferee who satisfies the indebtedness. The sim- ple answer to petitioners’ argument is that, while Congress could have chosen to adopt such a statutory scheme based on the assumption that the transferor will satisfy the liability, it clearly did not do so. The courts below correctly applied the statute that Con- gress cnose to enact. See Commissioner v. Asphait Products Co., 482 U.S. 117, 121 (1987). 2. Contrary to petitioners’ contention (Pet. 12-14, 17-19), the decision below does not conflict witn that of the Second Circuit in Lessinger v. Commissioner, 872 F.2d 519 (1989). In that case, the transferor, at the time of a transfer that on its face appeared to come within Section 357(c) (1), obiigated himself to pay the transferee an amount equal to the excess of the liabilities assumed by the transferee over the ad- justed basis of the property subject to those liabili- ties. This obligation was entered on the transferee’s books as a receivable due from the transferor, and the transferor subsequently gave the transferee a note evidencing his obligation to pay the amount of the receivable. Although the Tax Court was of the view that the receivable had no effect on the ap- plicability of Section 357(c)(1), the Second Circuit reversed. It held that the receivable constituted addi- tional property transferred to the transferee and that the property had a basis in the transferee’s hands equal to the face value of the transferor’s obligation. 872 F.2d at 525-526. Under this analysis, the liabil- ities to which the transferred property was subject 10 did not exceed the adjusted basis of the transferred property, and, consequently, the court of appeals held that the transferor recognized no gain on the trans- fer under Section 357(c) (1). While the correctness of the Second Circuit’s deci- sion is, in our view, open to question, its holding does not conflict with the decision below. The court in Lessinger held that no gain was realized on the trans- fer because, after taking into account the receivable due from the transferor, the liabilities to which the transferred property was subject did not exceed the adjusted basis of that property. In other words, the Second Circuit held that no gain was realized be- cause, in its view, there had not been a transfer that came within the terms of Section 357(c)(1). That holding is fully consistent with the decision below that when a transfer does come within the statute, gain must be recognized in accordance with its terms, notwithstanding the fact that the transferor remains personally liable to a bank for the indebtedness to which the transferred property is subject. CONCLUSION The petition for a writ of certiorari should be denied. Respectfully submitted. KENNETH W. STARR Solicitor General SHIRLEY D. PETERSON Assistant Attorney General RICHARD FARBER Attorney JANUARY 1990 WY U. S. GOVERNMENT PRINTING OFFICE; 1990 262203 726 --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385020_0550%3A2. Public record. Not legal advice.