Adaline v. Kincaid v. United States
50 A.F.T.R.2d (RIA) 6175, 682 F.2d 1220, 1982 U.S. App. LEXIS 16441 (1982)
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Rule of Law:
A transfer of property to a closely held corporation for less than adequate and full consideration, especially within a family context and with donative intent, constitutes a taxable gift to the other shareholders, even if characterized as an "ordinary course of business" transaction.
Facts:
- Adaline V. Kincaid, an 80-year-old widow, joined her two sons, Eugene Davis, Jr. (E.D.) and William Alex (Alex), in organizing AVK Ranch Company, Inc. (AVK) to create an entity to own and operate Mrs. Kincaid’s 5700-acre Texas ranch.
- On June 30, 1973, Mrs. Kincaid contributed $340 to AVK, receiving 3.4 shares of Class A $100 par value common voting stock (34% of the voting stock), while E.D. and Alex each contributed $330 for 3.3 shares of Class A voting stock.
- Mrs. Kincaid transferred her 5700-acre ranch, then worth $634,000, to AVK in exchange for 1,000 shares of Class B (nonvoting) common stock and 2,400 shares of preferred stock.
- On July 6, 1973, the day the deed was recorded, Mrs. Kincaid gave her sons 460 shares of her Class B common stock and her sons and grandchildren all 2,400 shares of her preferred stock.
- Restrictions were imposed on the transferability of all AVK stock, including that it could not be sold or encumbered during an owner’s lifetime (though it could be transferred to immediate family), and upon death, the estate had to sell shares to the corporation for par value.
- Mrs. Kincaid was elected president and a director of AVK at a salary of $1,000 per month; her sons were also directors and corporate officers at a salary of $10 per month each, and her grandson was named assistant secretary and assistant treasurer without salary.
Procedural Posture:
- The Internal Revenue Service (IRS) audited Mrs. Kincaid's 1973 gift tax return and determined that the values of the Class B and preferred stock should be increased, assessing a deficiency of $57,777.39.
- Mrs. Kincaid paid the tax deficiency and accumulated interest, totaling $70,374.17.
- Mrs. Kincaid sued the United States in federal district court for a refund.
- The Government filed a motion for summary judgment, arguing Mrs. Kincaid made a gift to the Class A common shareholders (her sons) when she transferred the ranch, but the district court denied this motion.
- At the close of Mrs. Kincaid's case, the Government moved for a directed verdict, which was denied.
- The case was submitted to a jury on two special interrogatories: one asking the value of the Class B and preferred stock, and the second asking whether the transfer of the ranch to AVK was made "in the ordinary course of business."
- The jury found a value of $51.30 for the Class B stock and $50 for the preferred stock, and found that the transfer occurred "in the ordinary course of business."
- The Government moved for judgment notwithstanding the verdict (J.N.O.V.) or, in the alternative, for a new trial, asserting the jury's finding was inconsistent with its valuation and unsupported by evidence, and that a taxable gift was made; the district court denied this motion.
- The Government appealed the district court's judgment to the United States Court of Appeals for the Fifth Circuit.
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Issue:
Does a transfer of property to a closely held family corporation for stock valued significantly less than the transferred property, where the transfer enhances the value of other family members' stock, constitute a taxable gift, notwithstanding a jury finding that the transfer was "in the ordinary course of business"?
Opinions:
Majority - Alvin B. Rubin
Yes, the transfer of property to a closely held family corporation for stock valued significantly less than the transferred property, which enhances the value of other family members' stock, constitutes a taxable gift, irrespective of a jury's finding that the transaction was "in the ordinary course of business." The court determined that Mrs. Kincaid made a gift to her sons, as shareholders of the Class A common stock, because the ranch's value ($634,000) significantly exceeded the value of the stock she received in exchange ($171,300, based on the jury's valuations). The difference, after accounting for Mrs. Kincaid's retained interest, amounted to a taxable gift. Citing Treasury Regulation § 25.2511-1(h)(1), the court stated that a transfer of property to a corporation for less than full consideration generally represents gifts to the other individual shareholders. This transaction was deemed analogous to Heringer v. Commissioner, where a transfer of land to a family corporation for no consideration was held to be a gift to the children whose stock was enhanced in value, further noting that "the family context of the transactions created a presumption of gift." The court found the jury's conclusion that the transfer was "in the ordinary course of business" to be without evidentiary support. It reasoned that no bona fide businesswoman would engage in such a transaction if 66% of the voting stock were owned by strangers, particularly given the restrictive covenants on the stock. Citing Robinette v. Helvering, the court asserted that a transaction primarily motivated by a desire to pass family wealth to others cannot be considered "in the ordinary course of business." The court concluded that Mrs. Kincaid's acceptance of low-value nonvoting stock for her more valuable ranchland was a donative act, specifically designed to transfer wealth to her descendants, thus making it a taxable gift.
Analysis:
This case significantly narrows the application of the "ordinary course of business" exception to gift tax, particularly for intra-family transfers to closely held corporations. It establishes that while there may be legitimate business reasons for incorporating an asset, a transfer for less than adequate consideration within a family context will be scrutinized for donative intent, and the exception will not apply if such intent is present. The decision reinforces the IRS's power to recharacterize transactions based on their economic substance rather than their form, preventing taxpayers from disguising gifts as business dealings. This precedent will likely lead to stricter examination of valuations and underlying motivations in estate planning involving family-controlled entities, making it more challenging to avoid gift tax through disproportionate exchanges of property for stock.
