The Tax Court held that a friend's $24,775,000 in transfers to a taxpayer were not gifts eligible for an exclusion from gross income under Sec. 102(a), as the taxpayer claimed.
Facts: The taxpayer, Burt Kroner, worked in the discounted cash flow industry. Kroner met David Haring in 1992, when Kroner sought capital from a company in which Haring was an investor, to purchase discounted privately held mortgages. Kroner and Haring continued to work together on various business ventures. Robert Bernstein, an attorney who represented Haring, also provided legal advice to Kroner.
In 2000, Kroner started a credit counseling business called First Mutual Financial, which he operated for approximately six to seven years. Haring provided a loan facility through Avenger, an entity under his control. In 2007, Kroner paid off the loan using some of the funds transferred to him, purportedly as gifts, by Haring.
Haring also provided emergency funding and loan guaranties to Settlement Funding LLC, doing business as Peachtree Settlement Funding. When asked at trial whether Kroner had any interest in Peachtree, Bernstein testified only that Kroner's name did not appear as owner on any of the paperwork.
During tax years 2005, 2006, and 2007, Kroner received wire transfers from Haring or related entities in the aggregate amounts of $4,425,000, $15,350,000, and $5 million, respectively. Bernstein advised Kroner that the transfers were gifts on the basis of a conversation with Kroner and a note he drafted for Haring stating they were gifts. On his tax returns for the years at issue, Kroner did not report any of the transfers from Haring as income.
The IRS determined income tax deficiencies for tax years 2005, 2006, and 2007 of $1,635,206, $5,765,384, and $1,821,277 and accuracy-related penalties under Sec. 6662 of $327,041, $1,153,077, and $364,255, respectively. Kroner petitioned the Tax Court for redetermination.
Issues: Sec. 61(a) provides that gross income is from whatever source derived unless otherwise excluded. Sec. 102(a) provides an exclusion of the value of property acquired by gift.
In Duberstein, 363 U.S. 278, 285 (1960), the Supreme Court defined a gift under Sec. 102 as a transfer that proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity, or like impulses. This rules out payments made from a moral duty or other expectation, or for services, even if made under no legal compulsion. The most important consideration in ascertaining whether a gift has been made is the intention of the donor. However, the donor's characterization of intent is not determinative, and courts must objectively inquire into it.
Secs. 6662(a) and (b)(2) impose a 20% penalty on the portion of an underpayment that is attributable to, among other things, a substantial understatement of income tax. Sec. 6751(b)(1) provides that, subject to exceptions, the IRS may not assess a penalty unless the initial determination of the assessment has been personally approved in writing by the immediate supervisor of the individual making the assessment. The Tax Court has held an initial determination to occur no later than when the IRS formally notifies the taxpayer in writing that it has completed its work and made an unequivocal decision to assert a penalty and of the taxpayer's right to appeal.
Kroner argued that the transfers were gifts. The IRS argued that the transfers should be included in gross income. Kroner also contested the accuracy-related penalties under Sec. 6751(b)(1).
Holding: The Tax Court held that the transfers were not gifts eligible for an exclusion under Sec. 102(a) and must be included in gross income.
The court first considered the timing of the transfers to Kroner and the liquidity events Haring experienced as a Peachtree investor. It found that their correlation and certain other aspects of Kroner's story raised a question as to whether Haring acted as a nominee for an investment by Kroner in Peachtree and the transfers were payments to Kroner for that investment.
The Tax Court also noted that Haring did not testify at trial that the transfers to Kroner were intended to be gifts. In two cases cited by Kroner, the court had stated that the donor's testimony had been key to its holding that a transfer was a gift. The court said that it was surprised that Haring did not testify, given his allegedly close relationship with Kroner, and that the record consisted largely of unsubstantiated and self-serving testimony from which the court could not find credible evidence to determine Haring's intentions regarding the payments.
Regarding the penalties, the IRS contended that a Letter 915 it delivered to Kroner on Aug. 6, 2012, was not an initial determination for purposes of Sec. 6751(b)(1) because it was not a "30-day letter" and was meant to invite Kroner to submit additional information at a time when it was understood he would not yet pursue an administrative appeal. However, the court agreed with Kroner that the delivery of the Letter 915 was an initial determination for purposes of Sec. 6751(b)(1) because it proposed accuracy-related penalties and offered him an opportunity to protest the proposed adjustments with the IRS Appeals Office.
Finding that the Letter 915 was issued to him before the supervisory approval form was signed on Oct. 31, 2012, the court held that the IRS could not satisfy its initial burden of production under Sec. 6751(b) and concluded that Kroner was not liable for accuracy-related penalties.
- Kroner, T.C. Memo. 2020-73
— By Maria M. Pirrone, CPA, LL.M., associate professor of taxation, St. John's University, Queens, N.Y.