Allen M. Early and Jeannette B. Early v. Commissioner of Internal Revenue
445 F.2d 166 (1971)
Rule of Law:
For federal income tax purposes, property received in settlement of a disputed claim, where the underlying nature of the claim is a purported gift, bequest, or inheritance, is deemed to have been acquired by gift, bequest, or inheritance, thereby triggering I.R.C. § 273's prohibition on deductions for amortization of a life or terminable interest.
Facts:
- Allen and Jeannette Early were friends with Sam and Rose Van Wert, and Allen Early served as Mrs. Van Wert’s accountant for several years.
- In November 1957, Mrs. Van Wert executed stock powers in favor of Allen Early (50,000 shares) and Jeannette Early (20,000 shares) for 70,000 shares of El Paso Natural Gas Company stock that were in Allen Early’s possession.
- Mrs. Van Wert died on August 12, 1958, leaving a will and codicil that appointed Allen Early as co-executor, made various bequests, and directed the residue of her estate into a trust with income for other beneficiaries, but did not specifically mention the 70,000 shares of El Paso stock.
- The Earlys claimed ownership of the 70,000 shares of El Paso stock, asserting Mrs. Van Wert had intended to make them a gift by executing the stock powers.
- Mrs. Van Wert’s will and codicil were contested by 44 intestate heirs on grounds of undue influence and lack of testamentary capacity, and several parties objected to the Earlys' retention of the El Paso stock.
- In November 1959, a settlement was reached where the Earlys surrendered the 70,000 shares of El Paso stock to the estate and destroyed the stock powers.
- In return for surrendering the stock, the Earlys were granted a joint life interest in 32% of the income from the testamentary trust, reduced by $4,000 during each of the first four years.
- The El Paso stock transferred to the estate had a fair market value of $2,288,125 and constituted approximately 53% of the corpus delivered to the testamentary trust.
Procedural Posture:
- The Commissioner of Internal Revenue determined deficiencies in Allen and Jeannette Early's federal income tax for the years 1964-1965, disallowing periodic deductions for amortization of the value of their joint life estate.
- Allen and Jeannette Early filed a petition for redetermination in the Tax Court.
- The Tax Court, with six members dissenting, overruled the Commissioner's determination and sustained the Earlys' claims for refunds.
- The Commissioner appealed the Tax Court's decision to the United States Court of Appeals for the Fifth Circuit.
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Issue:
Does Internal Revenue Code § 273 prohibit taxpayers from taking periodic deductions for amortization of a life interest acquired through a settlement agreement, when their claim to the underlying property that formed the basis of the settlement was a substantially disputed purported gift?
Opinions:
Majority - Godbold, Circuit Judge
Yes, Internal Revenue Code § 273 prohibits taxpayers from amortizing the cost basis of a life estate received in a settlement agreement when their claim to the underlying property was based on a disputed prior purported gift, because such an interest is treated as acquired by gift for income tax purposes. The court reversed the Tax Court's decision, concluding that the rationale of Lyeth v. Hoey, 305 U.S. 188 (1938), dictates this outcome. Lyeth held that property received by an heir in compromise of a will contest is acquired "by bequest, devise, or inheritance" for income tax purposes. The court extended this principle, stating that when a settlement is in substantial measure to resolve an underlying and disputed claim based upon a purported gift, bequest, or inheritance, what is received in settlement must be characterized for tax purposes by the nature of that underlying claim. The Earlys' claim to the El Paso stock originated from an alleged gift, and its validity was vigorously disputed. Although the settlement involved an exchange resembling a sale of the stock for the life interest, the court distinguished cases like Gist v. United States, 296 F.Supp. 526 (S.D. Cal.1968), and Bell v. Harrison, 212 F.2d 253 (7th Cir. 1954), where the taxpayer's right to the property exchanged was undisputed. Here, the Earlys' claim of ownership was "very much in dispute." The court held that where a "substantial controversy" exists in which a taxpayer claims as a donee, what is received in settlement is received for tax purposes as a donee. Consequently, under I.R.C. § 273, no amortization deductions are allowed for a life interest acquired by gift. The court also addressed the argument regarding a gift tax paid in 1957, clarifying that gift tax and income tax provisions are not in pari materia, meaning they operate under different principles, and therefore the prior gift tax payment does not affect the income tax treatment or create estoppel.
Analysis:
This case expands the reach of Lyeth v. Hoey beyond traditional will contests, establishing that its principles apply to settlements of contested inter vivos gift claims. It clarifies that the characterization of property received in a settlement for tax purposes hinges on the nature of the underlying disputed claim, even if the transaction superficially resembles a sale or exchange. This ruling restricts the ability of taxpayers to amortize life interests acquired through such compromises, reinforcing the principle that a disputed donative transfer, when settled, retains its donative character for income tax purposes, thereby limiting potential tax benefits.
