McCaffrey, Carlyn S.

McCaffrey, John C.

English

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ACTEC Law Journal Volume 42 Number 1 Article 19 3-1-2016 Dickman v. Commissioner: Loans as Property Transfers Carlyn S. McCaffrey John C. McCaffrey Follow this and additional works at: https://scholarlycommons.law.hofstra.edu/acteclj  Part of the Estates and Trusts Commons, Taxation-Federal Estate and Gift Commons, and the Tax Law Commons Recommended Citation McCaffrey, Carlyn S. and McCaffrey, John C. (2016) "Dickman v. Commissioner: Loans as Property Transfers," ACTEC Law Journal: Vol. 42: No. 1, Article 19. Available at: https://scholarlycommons.law.hofstra.edu/acteclj/vol42/iss1/19 This Article is brought to you for free and open access by Scholarship @ Hofstra Law. It has been accepted for inclusion in ACTEC Law Journal by an authorized editor of Scholarship @ Hofstra Law. For more information, please contact lawscholarlycommons@hofstra.edu. Dickman v. Commissioner :Loans as Property TransfersCarlyn S. McCaffrey* and John C. McCaffrey**DESCRIPTION OF THE CASEThe Dickmans were successful farmers and produce packagers inFlorida.  Paul and Esther Dickman, their son Lyle, Lyle’s wife and Lyle’schildren owned Artesian Farm, Inc.  Mr. and Mrs. Dickman made sub-stantial loans to Lyle and Artesian Farm on an interest-free, demandbasis.1Mr. Dickman’s death in 1976 brought the loans to the attention ofthe I.R.S.  The I.R.S. treated the loans as taxable gifts of the value of theuse of the loaned funds.  It established that value by using the interestrates applicable under section 6621 to the underpayment of tax in theyears the loans were outstanding.2  The I.R.S. issued notices of gift taxdeficiency to Mr. Dickman’s estate and to his widow individually.  TheEleventh Circuit agreed with the I.R.S.3The Supreme Court granted certiorari to resolve a conflict betweenthe Eleventh and Seventh Circuits.4  The Seventh Circuit had sided withthe taxpayer on the interest-free loan issue four years earlier in Crownv. Commissioner.5  In Dickman, the Court resolved the circuit split byagreeing with the Eleventh Circuit, concluding that the right to usemoney is a property interest, that the gratuitous transfer of that right is aproperty transfer within the meaning of section 2501(a)(1), and that thegift tax value of that transfer is the reasonable value of the right to usethe loaned funds.6* Carlyn S. McCaffrey is a Partner in the New York office of McDermott Will &Emery and an ACTEC Fellow.** John C. McCaffrey is the manager of Family Asset Transfers Enterprises, LLC.1 Dickman v. Comm’r, 465 U.S. 330, 332 (1984).2 Id.3 Dickman v. Comm’r, 690 F.2d 812, 819-20 (11th Cir. 1982).4 Dickman v. Comm’r, 459 U.S. 1199 (1983).5 585 F.2d 234, 234-35 (7th Cir. 1978).6 Dickman, 465 U.S. at 340-45.101102 ACTEC LAW JOURNAL [Vol. 42:101WHAT HAS CHANGED SINCE DICKMAN?Within a few months after Dickman, Congress enacted section7872.7  This section provided a framework for answering any valuationquestions for most future interest-free and below-market demand loansthat are gift loans.8A demand loan is a below-market loan if interest on the loan iscalculated at a rate lower than the applicable federal rate.9  A loan is agift loan if the lender’s forgoing of interest is in the nature of a gift.10“Forgone interest” is the amount of interest that would have beencharged on a demand loan if the lender had charged the applicable fed-eral rate.11  Section 7872 treats the “forgone” interest on a demand giftloan as a gift to the borrower from the lender of the amount of theforgone interest followed by a deemed payment of the interest amountto the lender as interest on the last day of each calendar year.12  Theapplicable federal rate is the federal short-term rate determined undersection 1274(d).13The Joint Committee on Taxation’s explanation of section 7872states that the section is intended to supersede Dickman’s treatment ofthe amount of the gift attributable to an interest-free loan as the reason-able value of the loan by providing an objective set of rules for deter-mining gift tax value.14  Value is determined without regard to the actualfair market value of the note issued by the lender.  The value of an im-pecunious child’s unsecured demand note is determined in the samemanner as that of a wealthy child’s secured demand note.Section 7872 applies to most, but not all, below-market loans.  Sub-section (f)(7) treats married spouses as one person.  Presumably thismeans that section 7872 does not apply to interspousal loans.  Subsec-tion (c)(3) specifically excepts gift loans between individuals if theamount outstanding between the individuals is not more than $10,000.If a below-market loan is not covered by section 7872, it is unclear how7 Section 7872 is effective for term loans made after June 6, 1984 and for demandloans outstanding after that date.  Deficit Reduction Act of 1984, Pub. L. No. 98-369,§ 172(a), 98 Stat. 494.8 Section 7872 also provides a set of rules for the gift tax treatment of below-mar-ket term loans and the income tax treatment of all below-market loans, subjects beyondthe scope of this short commentary.9 I.R.C. § 7872(e)(1).10 § 7872(f)(3).11 § 7872(e)(2).12 § 7872(a).13 § 7872(f)(2).14 STAFF OF THE JOINT COMM. ON TAX’N, 98TH CONG., GENERAL EXPLANATION OFTHE REVENUE PROVISIONS OF THE DEFICIT REDUCTION ACT OF 1984, 529 (Comm. Print1984).Spring 2016] DICKMAN v. COMMISSIONER 103it should be treated for gift tax purposes.  So long as the lender is aUnited States citizen, the marital deduction should protect demandloans to the lender’s spouse from the gift tax.15  In theory, the I.R.S.could attempt to impose the Dickman rationale on loans of less than$10,000.  Such an approach would be inconsistent with the policy, if notthe letter, of section 7872, and there is no indication that the I.R.S. in-tends to take this position.STRENGTH OF THE COURT’S ANALYSISThe technical basis for the Supreme Court’s Dickman decisionseems sound.  The imposition of a gift tax requires only that a transfer ofproperty16 be made for less than an adequate consideration in money ormoney’s worth.17  In order for the Supreme Court to conclude that theDickmans’ demand loans were subject to gift tax, it had to determinethat the making of a demand loan is a transfer of property and that,when made on an interest free basis, is made for inadequate considera-tion in money or money’s worth.The Court considered the first requirement satisfied because, in itsview, the revocable right to use valuable property, such as money, is aproperty interest, analogous to the use of real property under a tenancyat will.18The second requirement was more difficult.  Arguably, the value ofthe note issued by the borrower is equal to the amount of the loan be-cause the lender can take back the funds at any time by demanding re-payment.  The Court treated this requirement as satisfied bycharacterizing a demand loan as an incomplete transfer, one over whichthe transferor had not yet relinquished dominion and control.19  As theloan remains outstanding, the borrower “enjoys” the property withinthe meaning of Treasury Regulation section 25.2511-2(f), under whichthe enjoyment “operates to free . . . the . . . enjoyment from the [do-nor’s] power and constitutes a gift of . . . [the] enjoyment.”20IMPORTANCE OF THE DECISIONLoans as an Estate Planning Technique.  Intra-family loans are animportant planning technique.  To the extent the borrower is able to15 I.R.C. § 2523(a).  Section 2523(i) disallows the marital deduction for transfers tospouses who are not U.S. citizens.  Query whether the non-deductible terminable interestrule of section 2523(b) exposes an interest free interspousal term loan to gift tax?16 § 2501(a)(1).17 § 2512(b).18 Dickman v. Comm’r, 465 U.S. 330, 337-38 (1984).19 Id. at 338 n.7; see Treas. Reg. § 25-2511-2(b).20 Treas. Reg. § 25-2511-2(f).104 ACTEC LAW JOURNAL [Vol. 42:101invest funds to achieve an investment return higher than the interestrate charged on the loan, assets are shifted on a gift-tax-free basis fromthe lender to the borrower.  The chances of the strategy succeeding areenhanced if the loan is interest-free.Although Dickman took away some of the advantage of intra-fam-ily loans, the prompt enactment of section 7872 gave clear guidance asto how the technique could be used without gift tax risk.  Section 7872eliminated the uncertainty as to how the borrower’s note would be val-ued.  If the interest rate is the federal short-term interest rate, the note’svalue is face value.  If there is no interest, the amount of the gift is lim-ited to the forgone interest.When section 7872 was enacted, the applicable federal rate forshort term loans was 10.78%.21  Average prime rates were about 13%.22If a borrower could achieve a return equal to or better than prime, theloan would make good estate planning sense.  Of course, if the lenderknew that the loan would enable the borrower to make an investment,say in a family business with better than average expected growth poten-tial, the loan would be even more attractive.In August, 2016, the applicable federal rate for short term loans wasonly .56%.23  In this environment, interest-free loans are a powerful es-tate planning tool.24Application to Non-Cash Loans.  The Dickman decision, section7872 and the legislative history left open the question of how to treatloans of tangible property.  Thirty-two years later, there has been noguidance on this point.  The Court did characterize the grant by a parentto a child of the rent-free, indefinite use of commercial property as atransfer of a valuable property right.25  But it also said that it assumedthat the I.R.S. would not tax traditional familial transactions such as giv-ing adult children the use of cars and vacation cottages.  Additionally,the authority it cited in support of its conclusion that the right to useproperty was an interest in property dealt with the right to use property“to the exclusion of others.”26  Perhaps so long as the use right grantedto a child is simply the right to share property with his or her parent andnot the exclusive right to use it, the right does not rise to the dignity of a21 Applicable Federal Rates for 1984, EVANS-LEGAL.COM, http://evans-legal.com/dan/afr84.html (last visited Nov. 30, 2016).22 Prime Rate History, FEDPRIMERATE.COM, http://www.fedprimerate.com/wall_street_journal_prime_rate_history.htm (last visited Nov. 30, 2016).23 Rev. Rul. 2016-11, 2016-19 I.R.B. 717.24 See Steven R. Akers & Philip J. Hayes, Estate Planning Issues With Intra-FamilyLoans and Notes, 38 ACTEC L.J. 51, 56 (2012) for an excellent discussion of the issuesinvolved in intra-family loans.25 Dickman v. Comm’r, 465 U.S. 330, 336-37 (1984).26 Id. at 336; Passailaigue v. United States, 224 F.Supp. 682, 686 (M.D. Ga. 1963).Spring 2016] DICKMAN v. COMMISSIONER 105property right or is of such negligible value that its taxation isimpractical.The gift tax system relies on self-assessment for its operation, par-ticularly in the case of undocumented transactions such as loans of tan-gible personal property.  Until the I.R.S. addresses these matters, mosttaxpayers are likely to assume that they have no responsibility to reportthe value of loans of tangible property on their gift tax returns.Risks of Reliance on Decisions When the I.R.S. Disagrees.  The Su-preme Court’s decision in Dickman applied to the Dickmans and to allother taxpayers who had relied on the failure of the I.R.S. to challengeinterest-free demand loans as well as the I.R.S.’s initial losses when itfinally decided to challenge them.During the first forty years of the gift tax,27 the I.R.S. did not takethe position that interest-free demand loans were taxable gifts.  When itfinally took this position in Johnson v. United States, in 1966,28 it lostand waited six years before announcing its disagreement.29  In 1977 andin 1978 it lost the issue in the Tax Court30 and in the Seventh Circuit inCrown v. Commissioner.31The Supreme Court in Dickman showed no sympathy for taxpayerswho relied on the earlier administrative practice of the I.R.S.  It reaf-firmed statements made in prior decisions that “the Commissioner maychange an earlier interpretation of the law, even if such a change ismade retroactive. . . .”32The retroactivity of the Dickman decision had draconian conse-quences for those taxpayers who had not reported their interest-free de-mand loans.33  The I.R.S. took the position that these taxpayers wereobligated to report their interest-free demand loans as gifts no matterhow long ago they were made.34  Not only did it publish a chart listingthe interest rates taxpayers were required to use for the years starting asfar back as 1939, it advised taxpayers with unreported interest-free de-27 Revenue Act of 1924, Pub. L. No. 68-176, ch. 234, § 300, 43 Stat. 253, 303-04, 313(1925).28 254 F. Supp. 73, 77 (N.D. Tex. 1966).29 The I.R.S. announced disagreement with Johnson in Rev. Rul. 73-61, 1973-1 C.B.73.30 Crown v. Comm’r, 67 T.C. 1060, 1064 (1977).31 Crown v. Comm’r, 585 F. 2d 234, 241 (7th Cir. 1978).32 Dickman v. Comm’r, 465 U.S. 330, 343 (1984).33 See Cohen v. Comm’r, 910 F. 2d 422, 423-28 (7th Cir. 1990) (requiring taxpayersto calculate gift tax on more than $69 million dollars’ worth of gifts based on interestrates prescribed by Rev. Proc. 85-46 between 6% and 12%).34 Rev. Proc. 85-46, 1985-2 CB 507, 508.106 ACTEC LAW JOURNAL [Vol. 42:101mand loans from earlier periods to obtain the appropriate interest ratesby writing to the Associate Chief Counsel.35The consequences of the retroactive application of Dickman are areminder of the risk of reliance on prior administrative practices of theI.R.S. even if case law supports the taxpayer position.35 Id. at 509.

Dickman v. Commissioner: Loans as Property Transfers

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Dickman v. Commissioner: Loans as Property Transfers

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