Diedrich v. Commissioner
457 U.S. 191, 72 L. Ed. 2d 777, 1982 U.S. LEXIS 123 (1982)
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Rule of Law:
A donor who makes a gift of property on the condition that the donee pay the resulting gift taxes realizes taxable income to the extent that the gift taxes paid by the donee exceed the donor's adjusted basis in the property.
Facts:
- In 1972, Victor and Frances Diedrich made gifts of approximately 85,000 shares of stock to their three children.
- The gifts were subject to the condition that the children pay the resulting federal and state gift taxes.
- The Diedrichs' adjusted basis in the transferred stock was $51,073, while the gift tax paid by the children was $62,992.
- In a separate but similar case, Frances Grant gave 90,000 voting trust certificates to her son in 1970 and 1971.
- This gift was also conditioned on her son paying the resulting gift tax.
- Grant's adjusted basis in the certificates was $8,742.60, while the gift tax paid by her son was $232,620.09.
- In both instances, the donors did not report as income the amount by which the gift tax paid by the donees exceeded their basis in the property.
Procedural Posture:
- The Diedrichs and Frances Grant did not report income on their tax returns from the conditional gift transactions.
- The Commissioner of Internal Revenue determined that they had realized income and assessed tax deficiencies against them.
- The taxpayers petitioned the United States Tax Court for redetermination of the deficiencies.
- The Tax Court, in separate proceedings, held for the taxpayers in both cases, concluding that no income had been realized.
- The Commissioner appealed both decisions to the United States Court of Appeals for the Eighth Circuit.
- The Eighth Circuit consolidated the appeals and reversed the Tax Court's decisions, holding that the donors realized taxable income.
- The taxpayers (the Diedrichs and Grant's estate) petitioned the U.S. Supreme Court for a writ of certiorari, which was granted to resolve a conflict among the circuits.
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Issue:
Does a donor who makes a gift of property on the condition that the donee pays the resulting gift tax realize taxable income to the extent that the gift tax paid by the donee exceeds the donor's adjusted basis in the property?
Opinions:
Majority - Chief Justice Burger
Yes, a donor realizes taxable income in such a transaction. The payment of a donor's gift tax liability by a donee constitutes a discharge of indebtedness, which is a form of gross income under 26 U.S.C. § 61. Citing the principles from Old Colony Trust Co. v. Commissioner and Crane v. Commissioner, the Court reasoned that the substance of the transaction is that the donor receives a tangible economic benefit by being relieved of a legal obligation. This transaction is properly characterized as a part-sale and part-gift; the 'amount realized' from the sale portion is the value of the gift tax liability discharged, and the donor's taxable gain is the amount by which that liability exceeds the donor's adjusted basis in the entire property.
Dissenting - Justice Rehnquist
No, a taxable transaction has not taken place. The majority improperly applies precedents like Old Colony and Crane, which concerned the amount of income in concededly taxable events (employment and sales), not whether a taxable event occurred in the first place. A gift transaction is governed by a separate gift tax system, which makes both the donor and donee potentially liable for the tax. There is no evidence in the tax statutes that Congress intended for a private agreement between a donor and donee on who pays the gift tax to transform a donative transfer into a partial sale for income tax purposes.
Analysis:
This decision resolved a significant circuit split and clarified the income tax consequences of 'net gifts.' The Court solidified the 'economic benefit' theory of income, holding that relief from a tax liability is equivalent to receiving cash income. By characterizing the transaction as a part-sale, part-gift, the ruling has major implications for estate and tax planning, requiring donors of highly appreciated property to account for potential capital gains tax if they structure a gift to have the donee pay the tax. The case serves as a key precedent for looking at the substance, rather than the form, of a transaction to determine tax consequences.
