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MASON v. UNITED STATES

October 18, 1973

COYE C. MASON AND LOIS T. MASON, PLAINTIFFS,
v.
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 judgment.

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.

I.

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 part:

  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.
  (emphasis added)

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, ...


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