Opinion
Dockets Nos. 52128 55505.
1956-01-31
WILLIAM HERBERT BROWN AND MARY F. BROWN (HUSBAND AND WIFE), PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Harry C. Avery, Esq., and Loren E. Massey, Esq., for the petitioners. Urban C. Bergbauer, Jr., Esq., for the respondent.
In 1947, petitioner William H. Brown redeemed notes in the total amount of $32,500, secured by a deed of trust on a parcel of property which he and his wife owned. The notes were not canceled nor was the deed of trust released of record at that time. A trustee held the uncanceled notes as the property of petitioner's two minor children and petitioner filed a gift tax return for 1947 reporting cash gifts of $16,250 to each of of the children. In 1949, petitioner canceled the notes and released the deed of trust of record. He then gave each child his personal note for $16,250. In 1951 and 1952, he made interest payments to the children on such notes and petitioners claimed interest deductions for such payments on their returns for those years. Held, no valid debt was owed by petitioner to his children and the respondent properly disallowed the payments made in 1951 and 1952 as deductible interest under section 23(b) of the 1939 Code. Harry C. Avery, Esq., and Loren E. Massey, Esq., for the petitioners. Urban C. Bergbauer, Jr., Esq., for the respondent.
These consolidated proceedings involve deficiencies in income tax and an addition to the tax determined by the respondent under the provisions of the 1939 Code as follows: Year— Deficiency— Sec. 294(d)(1)(B) addition to tax
+----------------------------------------+ ¦ ¦ ¦Sec. 294 (d)(1)(B) ¦ +------+------------+--------------------¦ ¦Year ¦Deficiency ¦addition to tax ¦ +------+------------+--------------------¦ ¦1951 ¦$2,639.74 ¦$87.50 ¦ +------+------------+--------------------¦ ¦1952 ¦1,673.08 ¦ ¦ +----------------------------------------+
The sole issue is whether the respondent erred in disallowing payments to petitioners' son and daughter as deductible interest expenses under section 23(b)
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein by this reference.
During the years in issue, William H. Brown (hereinafter referred to as the petitioner) and his wife, Mary F. Brown, were residents of St. Louis County, Missouri. They filed their individual income tax returns on the cash receipts and disbursements basis with the collector of internal revenue at St. Louis for the year 1951, and with the director of internal revenue for the year 1952. Petitioners were the parents of two children, William H. Brown, Jr., born November 5, 1929, and Jane F. Brown, born September 24, 1934.
In 1945, petitioner acquired a parcel of real property in the city of St. Louis, which was subject to a deed of trust dated September 8, 1937, in the amount of $32,500. The 74 notes which such deed of trust secured bore interest of 4 percent per annum payable semiannually, and matured on September 8, 1947.
On September 8, 1947, petitioner delivered to William H. Lippelmann of the Hahn-Lippelmann Real Estate Company, by check, his personal funds in the amount of $32,500. By instrument bearing such date, Lippelmann acknowledged receipt of the checks and agreed to pay them over to a trust company which was to redeem all 74 notes secured by the aforementioned deed of trust. Lippelmann was to receive the redeemed notes but was not to cancel them, and was to deliver such uncanceled notes in equal amounts to petitioners' two minor children. The deed of trust securing such notes was extended by petitioner for a 15-year period. During the ensuing 6 to 8 months, Lippelmann redeemed the notes, and retained such notes in his office safe until early in 1949. Petitioner filed a gift tax return for 1947 reporting gifts in the amount of $16,250 cash to each of his children.
In January 1949, petitioners desired to and did borrow $25,000 for use in their business. In order to secure such loan, they released the 1937 deed of trust of record, canceled the 74 notes which such deed of trust had secured, and executed a new deed of trust on the property as security for the $25,000 loan made to them. Upon the cancellation of the 74 notes and the release of record of the deed of trust securing such notes, petitioner, on January 27, 1949, executed unsecured demand notes to each of his children in the amount of $16,250, bearing interest of 4 per cent per annum with no fixed interest dates.
At no time during the years 1947, 1948, 1949, and 1950 did petitioner make interest payments on any notes held by his children. On March 16, 1951, he issued checks, payable to his son and daughter in the amount of $1,552.77 each, as interest on the notes which he gave to them in 1949. On December 29, 1952, petitioner issued checks to his son and daughter in the amount of $1,300 each, as interest payments on the 1949 notes. Such promissory notes in the total amount of $32,500 were paid by petitioner on July 20, 1954.
On their returns for 1951 and 1952, the petitioners deducted the above-described interest payments. In determining the deficiencies herein, respondent disallowed such deduction as not constituting interest payments allowable as deductions under section 23(b) of the 1939 Code.
OPINION.
RICE, Judge:
Petitioners argue that a cash gift of $32,500 was made by William H. Brown to his two children on September 8, 1947; that such cash was used to redeem the 74 notes which the 1937 deed of trust secured; and that the subsequent exchange of such notes for petitioner's personal note in 1949 resulted in a bona fide debt owed by him to his children, on which petitioners are entitled to deduct interest payments made during the years in issue.
In support of his determination disallowing such deductions, the respondent argues that the substance of the transactions created no bona fide debt and that the notes held by petitioners' children were mere promises on petitioner's part to make gifts to them sometimes in the future and that such gifts were, in fact, made in 1954, when the notes were paid, and, hence, that the alleged interest payments deducted by petitioners on their returns in 1951 and 1952 were not interest payments on bona fide debts but were gifts to the children.
The transactions here in question are subject to rigid scrutiny since they were not arm's-length transactions as between strangers but took place between William H. Brown as the donor of alleged gifts to his children on the one hand, and himself as their guardian and custodian on the gifts, on the other. Commissioner v. Culbertson, 337 U.S. 733 (1949); William Francis Mercil, 24 T.C. 1150 (1955). Subjecting the transactions before us to the scrutiny which they merit convinces us that the respondent's determination was correct and that the petitioners' argument to the contrary does not square with the facts of record.
We think it clear that petitioner made no gift of cash to his children on September 8, 1947. His intent to make such a gift to them on that day, as evidenced by Lippelmann's acknowledgement of the receipt of the checks, and petitioners subsequent filing of a gift tax return, does not establish a valid, bona fide gift of cash because petitioner retained complete control over his funds and paid such funds directly to Lippelmann for the purpose of redeeming the 74 notes secured by the 1937 deed of trust. R. C. Coffey, 1 T.C. 579 (1943), affd. 141 F.2d 204 (C.A.5, 1944); Marian Bourne Elbert, 45 B.T.A. 685 (1941); and F. Coit Johnson, 33 B.T.A. 1003 (1936), affd. 86 F.2d 710 (C.A.2, 1936). Those 74 notes were no more than his promise to make a gift to them at some future time. That is equally true of his 2 personal notes which replaced the 74 notes in 1949. No consideration passed from the children to petitioner and hence, no valid debt was owed by petitioner to his children. It therefore follows that petitioners are not entitled to deduct the amounts purportedly paid as interest in 1951 and 1952 under the provisions of section 23(b). Marian Bourne Elbert, supra; Julius G. Day, 42 B.T.A. 109 (1940), affd. 121 F.2d 856 (C.A.2, 1941); Irene W. Johnson, 39 B.T.A. 702 (1939), affd. 108 F.2d 104 (C.A.8, 1939); F. Coit Johnson, supra; Sand Springs Railway Co., 21 B.T.A. 1291 (1931); and Simon Benson, 9 B.T.A. 279 (1927).
Decisions will be entered for the respondent.