United States District Court, Northern District of Illinois, E. D
October 18, 1973
COYE C. MASON AND LOIS T. MASON, PLAINTIFFS,
UNITED STATES OF AMERICA, DEFENDANT.
The opinion of the court was delivered by: Austin, Judge.
MEMORANDUM OPINION AND JUDGMENT ORDER
This action was brought for the refund of an overpayment of
federal income tax and interest for the year 1966.*fn1 During
the course of preparation of the case for trial, counsel
agreed with this court that there were but three crucial
questions of fact; that they would be immediately tried to a
jury; and that, if the answers to the interrogatories
propounded to the jury were in plaintiffs' favor, any
remaining questions of law would be resolved by the court. It
so happened that the answers were in plaintiffs' favor;*fn2
and the subject of this opinion is resolution of the issues of
law presented by the parties' cross motions for summary
The undisputed facts are as follows. On January 1, 1966, Dr.
Coye C. Mason, a cash method taxpayer, sold all of his shares
in Illinois Transfusion Service, Inc. to Chicago Blood Donor
Service, Inc., a not for profit corporation qualified to
receive charitable contributions. The shares had a fair market
value of $117,000 and an adjusted basis of $29,750. In full
payment for his shares, Dr. Mason received from the Chicago
Blood Donor Service, Inc. $4,507.50 cash plus its $112,689.42
promissory note having a fair market value of $81,000. In
March, 1966, the fair market value of an identical note held
by Dr. Grimm, one of Dr. Mason's associates, had been set at
$80,776.03 for purposes of determining Grimm's gross estate.
On his 1966 federal income tax return, he claimed a
charitable deduction in the amount of the difference between
the fair market value of the shares sold and the fair market
value of the consideration received. Thus, according to the
findings of the jury in this case,*fn3 the amount properly
deducted was $31,492.50 [$117,000 - ($81,000 $4,507.50)].
The claimed deduction was disallowed, and a tax deficiency in
the amount of $18,456.11 plus $3,751.90 interest was assessed.
This was paid in September, 1970. Dr. Mason then filed for a
tax refund of $17,161.90 plus interest, but it was disallowed.
This action was filed to recover that amount.
Because the jury found Dr. Mason intended to make a gift
when he sold his shares to the charitable corporation, the
Government now concedes he is entitled to the charitable
deduction. However, it asserts that as a result of the
deduction, his recognized gain from the sale must be
recomputed so as to report additional ordinary income. In
reporting his gain, Dr. Mason elected the installment method
under section 453 of the Internal Revenue Code, the
computation of which was as follows (numbers are rounded to
the nearest dollar):
(a) Selling price (cash plus note) $117,197.
(b) Basis 29,750.
(c) Total gain (a - b) $87,447.
(d) Gross profit percentage (c ÷ a) 74.6154%
(e) Payments received in 1966 $10,142.
(f) Gain recognized in 1966 (d x e) 7,568.
The recognized gain in 1966 was reported as a capital gain,
rather than as ordinary income, on the ground that the shares
sold were capital assets.
In opposition to this, the Government now argues that that
portion of each payment received by Dr. Mason which represents
the ratable difference between the face amount ($112,689.42)
and the fair market value ($81,000) of the promissory note
must be reported as ordinary income.
Thus, the question for decision is whether the difference
between the face amount and fair market value of a promissory
note is to receive capital gains treatment as it is paid,
where: 1) such difference was deducted as part of a charitable
contribution; 2) the note was received as part of the purchase
price in the sale of a capital asset; and 3) the taxpayer
properly elected to report his recognized gain from the
transaction under the installment method of section 453. For
the following reasons, it is concluded that only part of the
amount in question is entitled to capital gains treatment.
Under section 453(b) of the Internal Revenue Code, income
from a casual sale of personal property for a price exceeding
$1,000 may be reported in the manner prescribed in section
453(a) — provided that payments in the taxable year of the
sale (other than promissory notes) do not exceed 30% of the
selling price. In the present case, Dr. Mason met all these
prerequisites to electing
the installment method. Section 453(a) provides in pertinent
Under regulations prescribed by the Secretary or
his delegate, a person who . . . sells . . .
personal property on the installment plan may
return as income therefrom in any taxable year
that portion of the installment payments actually
received in that year which the gross profit,
realized or to be realized when payment is
completed, bears to the total contract price.
The related Treasury Regulations define "gross profit" as "the
selling price less the adjusted basis." Treas. Reg. §
1.453-1(b)(1). (emphasis added).
From the words of the Statute and the Regulations
thereunder, it is clear that the "selling price" and "contract
price" are one and the same figure. See Gralapp v. United
States, 319 F. Supp. 265, 268 (D.Kan. 1970); 2 Mertens, Law of
Federal Income Taxation § 15.16 at 46. It is also clear from
the words used that that figure is the face amount of the
consideration received, rather than its fair market value.
Otherwise, the arithmetic of the statute simply would not work
properly.*fn4 Furthermore, where gain from the sale of a
capital asset is properly reported under the installment
method, such gain is entitled to capital gains treatment. See
Carl G. Dreymann, 11 TC 153 (1948); 2 Mertens, Law of Federal
Income Taxation § 15.11 at 36.
Because section 453 requires the use of the face amount of
the note to compute Dr. Mason's recognized gain, and because
capital gains treatment is available to the entire recognized
gain in the installment sale of a capital asset, it follows
that the amount represented by the difference between the face
amount and fair market value of the note in this case is
entitled to capital gains treatment.
In arguing that the fair market value of the note should be
used to compute the extent of the capital gain recognized by
the taxpayer in this case, the Government apparently seeks to
interject the rules of section 1001 into section 453. Section
1001(b) provides, in pertinent part:
The amount realized from the sale or other
disposition of property shall be the sum of any
money received plus the fair market value of the
property (other than money) received. (emphasis
Thus, it would appear that, if section 1001 applied to
installment sales of capital assets, the fair market value of
the consideration received in return (other than money) would
be used to measure the extent of capital gains treatment of
the recognized gain. Furthermore, if that were so, the
Government would be correct in its contention that Dr. Mason
is not entitled to capital gains treatment of that portion of
each installment payment which represents the difference
between the fair market value and face amount of the
However, the clear meaning and intent of section 453 does
not permit such an interpretation. Section 453 has its own set
of rules as is noted in section
1001 and the Regulations thereunder. Section 1001(d) provides:
"(d) Installment sales. — Nothing in this
section shall be construed to prevent (in the case of
property sold under contract providing for payment in
installments) the taxation of that portion of any
installment payment representing gain or profit in the
year in which such payment is received."
And Treasury Regulation § 1.1001-1(d) states:
"(d) Installment sales. In the case of property sold
on the installment plan, special rules for the taxation of
the gain are proscribed in section 453."
It is crystal clear that Congress intended only the provisions
of section 453 to govern the installment method of reporting
gain on the sale of a capital asset. Because section 453 so
provides, the face amount of the consideration received must be
used to compute the extent of the capital gain. Accordingly,
the argument of the Government must be rejected as to section
Under section 1232(a)(1) of the Internal Revenue Code, the
holder of a corporate promissory note which is a capital asset
in his hands may report amounts received on retirement of such
note as amounts received in exchange therefor. In other words,
capital gains treatment is available in such a case. This
provision is modified, however, by section 1232(a)(2) which,
at the time of the transaction in this case, provided:
"[U]pon sale or exchange of bonds or other
evidences of indebtedness issued after December
31, 1954, held by the taxpayer more than 6
months, any gain realized which does not exceed
(i) an amount equal to the original issue
discount [as defined in subsection (b)],
shall be considered as gain from the sale or
exchange of property which is not a capital
The taxpayer relies solely on section 1232(a)(1) in arguing
that he is entitled to capital gains treatment of that portion
of the payments representing the difference between the face
amount and the fair market value of the note in question. On
the other hand, the Government relies solely on section
1232(a)(2), contending that the entire amount in question is
an "original issue discount" and is therefore not entitled to
capital gains treatment. In my opinion, both parties err in
taking such narrow and exclusive views of the statute. As a
result, they are only partially correct in their conclusions.
On the one hand, it is true that the taxpayer in this case
meets the prerequisites for capital gains treatment under
section 1232(a)(1). Dr. Mason is the holder of a corporate
promissory note which is a capital asset, since capital assets
are all property held by a taxpayer with certain exceptions
which are not applicable here. 26 U.S.C.A. § 1221. Furthermore,
the installment payments constitute amounts received for
"retirement" of the note.
"A corporate note no longer needs to have
interest coupons attached or be in registered
form, and consequently all payments in
satisfaction of such note appear to be eligible
for capital gain treatment."
3B Mertens, Law of Federal Income Taxation § 22.94 at 568. Thus
the payments in satisfaction of the note must be considered as
amounts received in exchange of a capital asset; and, as a
result, it would appear that the entire amount in question in
this case is entitled to capital gains treatment under section
On the other hand, the taxpayer fails to take into account
section 1232(a)(2) as it existed when he sold his stock. That
section denied capital gains treatment to that amount received
upon the sale or exchange of a note held
over 6 months, which does not exceed the "original issue
discount" on the note. Original issue discount is defined as
"the difference between the issue price and the stated
redemption price at maturity." 26 U.S.C.A. § 1232(b)(1). The
"issue price", for purposes of this case, is the price paid for
the note. 26 U.S.C.A. § 1232(b)(1). "Stated redemption price at
maturity" means the total amount to be paid in satisfaction of
the note. 26 U.S.C.A. § 1232(b)(1).
Applying these principles to the facts of the instant case,
the following figures emerge. The "issue price" of the note
was that portion of the value of the stock given in exchange
for the note, the computation of which would be as follows:
(a) Consideration for stock (cash plus
(b) Face amount of note 112,689.42
(c) Percentage of consideration represented
by note (b ÷ a) 96.15%
(d) Value of stock $117,000.00
(e) "Issue price" (c x d) 112,495.50
The "stated redemption price at maturity" of the note would
be its face amount — $112,689.42. Thus, the "original issue
discount" would be $193.92 ($112,689.42 -$112,495.50), and not
$31,689.42 (the difference between the face amount and fair
market value of the note) as contended by the Government.
Viewing section 1232 as a whole, then, $31,495.50
($31,689.42-$193.92) is eligible for capital gains treatment.
Only that portion of each installment payment on the note
which represents the original issue discount ($193.92) must be
reported as ordinary income.
The essence of the objections of the Government lies in its
observation of the apparently inconsistent positions taken by
the taxpayer. On the one hand, Dr. Mason obtained a charitable
contribution deduction by taking the position that he gave
Chicago Blood Donor Service, Inc. the difference between the
face amount and fair market value of the note. On the other
hand, in his quest for capital gains treatment of his entire
recognized gain from the sale, he asserts that only the face
amount of the note should be used in computing the gain. In
sum, Dr. Mason not only wants to deduct as a charitable
deduction that amount represented by the differnce between the
face amount and fair market value of the note, he also wants
capital gains treatment of that amount as it is received by
him. Although he would be getting his cake and eating it too,
there is no rule of law prohibiting that which he seeks. The
Government admits he was entitled to the charitable deduction.
Furthermore, sections 453 and 1232 govern the transaction in
this case. Section 453 requires that the face amount of the
note be used to compute the gain recognized in the sale of the
stock. Since the stock is a capital asset, the entire gain
would be entitled to capital gains treatment. Section 1232
limits this benefit somewhat by requiring that the original
issue discount of the note ($193.92) be reported as ordinary
Although it is true that the installment sale provisions
were intended to relieve taxpayers of the burden of appraising
the value of promissory notes, the fact that the fair market
value of the note was available to the taxpayer in the present
case when he elected the installment method should not make
those provisions unavailable. There is no mention in section
453 that installment sale treatment is unavailable if the fair
market value of a promissory note is known; and I will not
amend a statute which Congress in its wisdom has fashioned and
enacted. For this reason, the objections of the Government
must be rejected.
It being determined that there is no genuine issue of
material fact, the parties' motions for summary judgment are
granted in part and denied in part in accordance with this
opinion. The plaintiff is hereby adjudged to be entitled to a
charitable contribution deduction for the year 1966 in the
amount of $31,492.50;
and he is entitled to recover, as an overpayment of income
tax, $17,161.90 plus the legal rate of interest on that amount
from September, 1970. Lastly, he is adjudged to be entitled to
capital gains treatment of that portion of each installment
payment on the note which represents $31,495.50 of the amount
represented by the difference between the face amount and fair
market value of the promissory note in question.