Arnes v' United States Arnes v' Commissioner Judges: Hug, Fay

1
Arnes v. United StatesArnes v.
CommissionerJudges Hug, Fay

• 981 F.2nd 456
• 102 T.C. 522
• Petra Durova

2

• Facts
• John and Joann Arnes formed Moriah Corporation to
  operate McDonalds franchise. They were the sole
  shareholders.
• 1987 couple agreed to divorce McDonalds
  Corporation required no joint ownership after
  divorce.
• Agreement to have Moriah redeem Joanns 50
  interest in the outstanding stock for 450,000.
  Moriah paid 178,042 in 1988 and reminder in
  monthly installments over 10 years.
• Agreement incorporated into decree of dissolution
  of the marriage in January 1988. Joann
  surrendered her 2,500 shares and Moriah cancelled
  her stock certificate and issued another 2,500
  shares to John.

3

• On her Federal Income Tax return Joann reported
  receiving 178,042 in 1988. She treated 177,045
  as a long-term capital gain and the reminder as
  recovery of portion of her basis.
• On December 1989, she filed a claim for refund of
  53,053 for 1988 claiming she was not required to
  recognize any gain as the transfer was made
  pursuant to divorce instrument (1041).
• IRS didnt allow the claim for refund.
• Joann initiated suit.

4

• The district court found that
• Redemption of stock required by divorce
  instrument, John Arnes benefited.
• Although stock transferred directly to Moriah, it
  was made on behalf of John.
• Following Section 1041, transfer qualified for
  nonrecognition of gain pursuant to exemption for
  transfers made to spouses due to divorce
  settlement.
• Joann won.

5

• Government appeals
• Joann does not qualify for 1041 as shares
  transferred to Moriah, not to John.
• Although Joann should be taxed, if district
  courts ruling upheld, John should be taxed on a
  dividend (or 450,000 would be taken out
  tax-free).
• Court held
• Moriah relieved John of obligation, constructive
  transfer to John.
• District courts ruling affirmed.

6

• John has tax liability, sues in Tax Court
• Issue
• Was Moriahs redemption of Joanns stock a
  constructive dividend to John?
• According to Rev. Rul. 69-608, tax liability if
  obligation of remaining shareholder is both
  primary and unconditional.
• Situation 5 in Rev. Rul. 69-608 supports Johns
  case.
• Court concluded Johns obligation was not primary
  and unconditional.
• Joanns stock not a constructive distribution /
  dividend to John.

7
Conclusion

• The courts ruled in favor of both Joann
• and John and 450,000 were taken out of
• Moriah Corporation tax-free.