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Ballard v. Commissioner of Internal Revenue

decided: July 28, 1988.

ELEANOR M. BALLARD, PLAINTIFF-APPELLANT,
v.
COMMISSIONER OF INTERNAL REVENUE, DEFENDANT-APPELLEE



On Appeal from the United States Tax Court No. 37108-85--Edna G. Parker, Judge.

Wood, Jr., and Kanne, Circuit Judges and Reynolds, Senior Circuit Judge.*fn*

Author: Kanne

KANNE, Circuit Judge

The Commissioner of the Internal Revenue Service assessed gift taxes against Eleanor M. Ballard and imposed a penalty for the late filing of her gift tax return. The taxpayer appealed to the tax court which upheld the imposition of the tax as well as the penalty. We reverse.

Mrs. Ballard entered into a Contract for Conditional Sale of Real Estate with her three children on June 23, 1981. Under the terms of the contract, the children each received a 33 1/3% interest in her 286-acre farm, which had a fair market value of $582,000.00. In return, the children agreed to pay Mrs. Ballard $1,000.00 upon execution of the contract. Additionally, during the first five years of the contract, the children agreed to pay 6% interest on the $386,000.00 sale price. Beginning in the sixth year, the children were obligated to pay $25,590.95 annually, covering both principal and the remaining interest payments. Put another way, Mrs. Ballard sold her property to her children for $386,000.00 at an interest rate of 6% per annum.

On October 26, 1981, Mrs. Ballard filed a gift tax return for the calendar quarter ending June 30, 1981.*fn1 She reported a gift of $184,000.00 equalling the difference between the fair market value of the real estate ($572,000.00) and the face value of the consideration she was to receive from her children under the land sales contract ($386,000.00). Because the taxes owed on the $184,000.00 gift did not exceed a tax credit to which Mrs. Ballard was entitled under the Code, she reported zero taxes due.

The Commissioner issued a notice of a deficiency of gift tax in the amount of $78,340.77 and assessed an $11,751.12 penalty for Mrs. Ballard's failure to timely file her gift tax return. The Commissioner determined that the discounted value of the consideration Mrs. Ballard was to receive under the contract, was only $134,298.20 because the market rate of interest was 18% and not 6% as Mrs. Ballard had provided in the land sales contract.*fn2 Thus, the difference between the market value of the property ($572,000.00) and the now-discounted value of the consideration ($134,298.26) was $437,701.80, representing the actual gift to Mrs. Ballard's children. Based on the revised value of the gift, Mrs. Ballard was assessed higher taxes which no longer were exceeded by the unified tax credit. Consequently, Mrs. Ballard owed gift taxes.

Mrs. Ballard appealed the notice of deficiency to the United States Tax Court arguing that § 483 of the Internal Revenue Code provided a "safe harbor" and permitted her to charge a 6% rate of interest on an installment land sale contract without either income or gift tax consequences.

The Commissioner responded that the 6% "safe harbor" interest rate contained in § 483, applied only to income taxes and did not have anything to do with the valuation of the gift made by Mrs. Ballard to her children.

The U.S. Tax Court agreed:

The issue in this case is valuation, namely, the value for gift tax purposes of the consideration received by petitioner in transferring the real estate described in the contract for sale . . . Section 483 has nothing to do with valuation . . . .

The court then determined that the consideration to be paid by Mrs. Ballard's children was worth substantially less than $386,000.00 and hence, the gift to the children was substantially larger than the one reported by her. The tax court affirmed the Commissioner's imposition of gift taxes. The court also ruled that Mrs. Ballard's failure to file a timely gift tax return was not due to reasonable cause, despite the fact that she had been advised by her attorney that no penalty would result from a late filing where no taxes were due. Consequently, the tax court also affirmed the imposition of a penalty against Mrs. Ballard.

On appeal, Mrs. Ballard makes a very simple, but compelling argument. The prefatory language of § 483 specifically states that § 483 applies to all provisions of the Internal Revenue Code, including the gift tax provisions. Thus, although valuation of property, for purposes of gift taxes, is not directly related to the imputation of taxes on installment contracts for purposes of income taxation; a taxpayer who complies with § 483 and charges a "safe harbor" rate of interest on an installment sales contract, ...


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