A CPA traveled to Russia to investigate business opportunities. He deducted expenses of $21,000 on his tax return for the trip. The Tax Court held that he was not “carrying on a trade or business.” The court concluded the CPA was investigating “potential trade” opportunities rather than engaging in trade activities because it found no evidence of completed business transactions. The deduction was disallowed and treated as a start-up expense. ( Massa v . Commissioner, TC Memo, 1999-63).

— Michael Lynch, CPA, Esq., professor of tax accounting at
Bryant College, Smithfield, Rhode Island.

When parents are asked to help their children financially, they frequently respond with gifts and loans. Sometimes, the loans may be to businesses the children own. What is the tax effect if a parent cancels or forgives a loan made to a child’s corporation?

On June 17, 1981, Lavonna Stinson sold property to a corporation owned by her children and grandchildren. In exchange, she received cash and a corporate note. From 1982 through 1985, Stinson forgave $147,000 of the corporate debt. She paid gift tax on that amount as if it were a gift of a present interest. Following her death, the IRS audited the estate and determined the gifts were not of a present interest but, instead, of a future interest, which meant additional gift taxes were due. The estate paid the taxes and sued for a refund.

Result . For the IRS. The district court said neither the code nor the regulations address gifts to corporations. In addition, there was no binding precedent the court could apply. However, other courts have dealt with gifts to corporations, and revenue ruling 71–443 also covers the issue.

The regulations define the gift of a present interest as “an unrestricted right to the immediate use, possession or enjoyment of property or the income from property.” Previously, the Ninth Circuit Court of Appeals ruled that a gift of land to a corporation was not a present interest because the individual donees could not enjoy the land unless the corporation declared a dividend or liquidated itself. The court based its ruling on a U.S. Supreme Court decision that a gift to a trust was a future interest because it took joint action by two trustees for the beneficiary to gain possession of the property; the Tax Court and the Court of Claims reached similar conclusions about gifts to corporations. In revenue ruling 71–443, the IRS adopted this reasoning in holding that gifts to corporations were gifts of future interests.

The Stinson estate argued the debt cancellation was a gift of a present interest because it immediately increased the value of the corporation’s stock. It tried to distinguish the situation from prior cases on the grounds those cases all derived from gifts to trusts, which differ significantly from corporations. But the district court accepted the reasoning of the Ninth Circuit and the revenue ruling in concluding that cancellation of corporate debt was not a gift of a present interest. The only way the shareholders could gain possession of the property was for the corporation to distribute it or to sell their shares. Each required action before the donee could enjoy the property. The court also pointed out that to accept the estate’s argument would effectively convert all gifts to present interests because a beneficiary can always obtain a current benefit by disposing of his or her interest in the gifted property or in the entity receiving the property.

The estate also raised a second argument. Since the gift was made to a corporation, the estate maintained that minority and lack-of-marketability discounts should be taken into consideration in establishing its value. The court rejected this argument since gift taxes are imposed on the property given and not on the property the donee receives.

Based on this case and prior decisions, taxpayers can save on gift taxes if they make gifts only to individual donees, not to corporations. A recipient could then transfer the gift to a corporation.

• Estate of Lavonna Stinson v . United States (DC Ind. 1998) 82 AFTR 2d 98-6714.

Prepared by Edward J. Schnee, CPA, PhD, Joe Lane Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.

According to IRC section 1041, no gain or loss is recognized on a transfer of property between spouses in a divorce. However, there are circumstances in which a transfer of property to a third party on behalf of a spouse (or former spouse) also qualifies for nonrecognition treatment.

A transfer is considered to be “on behalf of” a spouse if it satisfies that spouse’s obligation or liability. In a situation where a property transfer to a third party is required by a divorce or separation agreement, the transfer is treated as if it had been made to the nontransferring spouse and, then, transferred by that spouse to the third party (regulations section 1.104-1T(c), Q & A 9).

In United States v . Craven, DC GA 2-18-99, 83 AFTR 99-526, a wife sued her husband for divorce and equitable distribution of their marital property. The settlement agreement required the couple’s closely held corporation (third party) to redeem the wife’s stock. The agreement also required the husband to guarantee the corporation’s payment to the wife.

When filing her tax return, the wife argued that because the stock redemption was pursuant to her divorce agreement it qualified for nonrecognition treatment. The IRS disagreed. It claimed that the wife was liable for the capital gains tax related to the redemption of her stock.

The court found that state law required the husband to equitably divide the marital property. It then concluded that the stock redemption satisfied the husband’s marital obligations under the settlement agreement. In finding for the wife, the court relied on United States v . Arnes, 981 F.2d 456 (1992), where the Ninth Circuit Court of Appeals had held that a stock redemption required by a divorce agreement warranted nonrecognition treatment because the stock transfer had relieved her former husband of a debt that he owed directly to her.

In another recent case, United States v . Ingham, CA-9 (2-11-99), a wife sold some real estate to a third party and, as required by her divorce decree, gave the proceeds to her husband. In this situation, according to the court, the sale was not a transfer “on behalf of” her former spouse, because the sale did not relieve him of any obligation or liability that he owed to her or to a third party. The sale merely allowed her to pay off a debt that she already owed her former husband under their property settlement.

Observation . There is no provision in the tax code similar to section 1041 for transfers of property between unmarried individuals who live together and later separate. But, in Commissioner v . Reynolds, TC Memo 1999-62, a court ruling in a situation in which a couple lived together and then separated provides some guidance. Violet and Gregg lived together for 24 years. Gregg told Violet that he would provide for her financially. She took care of the couple’s house and boat. She also acted as hostess for their parties and as Gregg’s nurse when he was ill.

Gregg moved out and broke off the relationship. He sued Violet and asked for a judgment that she had no interest in the property purchased during their relationship. Violet asserted that she had an equitable interest in the property. She settled her claim for $153,500, but did not report this as income on her tax return. She argued it was a gift. The IRS claimed that it was taxable as compensation for past services.

The Tax Court sided with Violet and found that Gregg had paid the disputed amount to Violet in surrender of her rights in the property that he had given to her as a gift during their relationship.

— Michael Lynch, CPA, Esq., professor of tax accounting at Bryant College, Springfield, Rhode Island.

Taxpayers Give Preparers the Thumbs Up

A recent Harris poll revealed that 59% of individual taxpayers paid someone to prepare their taxes. Ninety-six percent of the taxpayers who used a tax preparer were either very satisfied (76%) or somewhat satisfied (20%) with the service they received. Fewer than four percent of those polled were dissatisfied with the service rendered by their tax preparer.

The poll also showed there was a positive correlation between satisfaction with a preparer and the level of a taxpayer’s income. Fifty-seven percent of taxpayers with incomes below $15,000 were “very satisfied” with their tax pro whereas 84% of taxpayers with incomes over $75,000 said they were.

Other findings:

• Forty-four percent of those polled wanted a “completely different” tax system than the current one.
• Sixty percent favored a flat tax over the current system.
• Fifty-seven percent opposed replacing the current system with a national sales tax.

The poll was conducted during this year’s tax season and included responses from over 1,000 adults nationwide.

IRS Sets Record for Web Visits

It didn’t take long for the IRS to set a new record for visits to its Web site. This spring the service recorded 531.3 million online visits from January 1 to March 21. The number represented a 155% increase over the same period last year.

The IRS also reported that the number of individuals who filed their tax returns electronically this tax season increased 19% over last year. The service received 5,647,000 returns by Telefile (e-filed by phone) and 23,346,000 returns e-filed by computer.

Overall computer e-filed returns increased 26.9%. Tax professionals prepared 20.9 million (up 19.8%) and individual taxpayers filed 2.4 million (up 161%) of the e-filed returns.

“We’re pleased with this response to our invitations to go electronic,” said IRS Commissioner Charles O. Rossotti in a statement released recently by the service.

The IRS shouldn’t break out the champagne just yet, however. Despite impressive increases in Web-site and e-file activity, the small number of home computer e-filers—accounting for only 2% of the total 111,507,000 returns received this year—indicates that the majority of taxpayers are reluctant to make the leap into cyberspace when it comes to filing their taxes.

An online survey, performed during the 1999 tax season, revealed only 1.4% of all individual taxpayers had planned to file their tax returns this season electronically through their home computers.

The survey, conducted by Jupiter Communications in New York City, did offer some good news for CPA tax practitioners. One-third of the taxpayers who said they would e-file for the 1999 tax season also said they planned to hire an accountant to prepare the return.