UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT
decided: February 14, 1975.
BENJAMIN AND ALICE FOX, APPELLANTS,
THE UNITED STATES OF AMERICA
Appeal from the United States District Court for the Eastern District of Pennsylvania. (Civil Action No. 73-1653).
Aldisert, Adams and Hunter, Circuit Judges.
Opinion OF THE COURT
ALDISERT, Circuit Judge.
The question for decision is whether a husband settling a sum of $1,000,000 on his wife, pursuant to a divorce-related property settlement agreement, is entitled to a deduction under Section 483 of the Internal Revenue Code of imputed interest in the installment payments. The district court denied taxpayers' claims for refund. This appeal followed. We affirm.
The facts giving rise to this dispute are neither complicated nor controverted. On March 20, 1967, Benjamin Fox and his then wife, Juliette, contemplating divorce, entered into a written agreement providing for the division of personal property, real property, and securities. Additionally, Benjamin agreed to pay Juliette the sum of $1,000,000 of which $300,000 was to be paid upon the entry of a final decree of absolute divorce; the remainder was to be paid in quarterly installments*fn1 extending over a period of nine and one-half years.*fn2 In the district court, the taxpayers and the Commissioner stipulated that "the payment of interest on the deferred installments was not intended by the parties at the time the settlement agreement was signed, since it stated that the payments were to be 'without interest'."
Taxpayers argue here, as they did in the district court, that Section 483 applies to this property settlement agreement, and, accordingly, Benjamin is entitled to a deduction equal to what is described in his brief as the "unstated interest portion of each deferred payment he has made to his former wife during the taxable years here involved. This unstated interest is commonly referred to as 'imputed interest'. Under the statutory scheme of Section 483*fn3, imputed interest exists when deferred payments, which meet the requirements of Section 483(b) [sic] . . ., do not provide for interest at a designated minimum rate." Appellants' Brief at 9 (footnotes omitted).
The cornerstone of taxpayers' argument is the provision in Section 483(a) stating that "for purposes of this title, in the case of any contract for the sale or exchange of property," a part of the payment shall be treated as unstated interest. They argue that the payments at issue are not excepted by Section 483(f) and build upon United States v. Davis, 370 U.S. 65, 8 L. Ed. 2d 335, 82 S. Ct. 1190 (1962), holding that, for purposes of calculating taxable gains, a transfer by a husband to a wife of shares of appreciated stock, pursuant to a voluntary property settlement and separation agreement, was a taxable event. There, the Court endorsed our previous decision in Commissioner v. Mesta, 123 F.2d 986 (3d Cir. 1941), see 370 U.S. at 71; accepted the government's contention that the transaction "resembles a taxable transfer of property in exchange for the release of an independent legal obligation," ibid. at 69; and stated that for purposes of determining the amount of gain recognized, "the 'property received' [by the husband] was the release of the wife's inchoate marital rights." Ibid. at 72. With this underpinning, the taxpayers would have us construct the conclusion that, inasmuch as capital gains in Mesta and Davis were assessed on the basis of "gain from the sale or other disposition of property," 26 U.S.C. § 1001, Benjamin's 1967 settlement agreement qualified as a "contract for the sale or exchange of property" under 26 U.S.C. § 483(a), thus entitling taxpayers to deductions for unstated interest. Capsulized, the argument is that if the Commissioner treats a property settlement agreement as a taxable event for purposes of recognizing gains under Section 1001 because it is a "sale or other disposition of property," the Commissioner must give a similar agreement like treatment for "unstated interest" purposes under Section 483.
The Commissioner's response takes two tracks. First, in response to the Mesta-Davis argument, he asserts that the issue presented in those cases was not whether the accretion of value to stocks transferred by a husband to his wife in a divorce settlement was taxable; the sole issue was when. The contest in Davis was whether "the economic gain be presently assessed against taxpayer [husband], or should this assessment await a subsequent transfer of the property by the wife?" 370 U.S. at 68.*fn4 Thus viewed, the Commissioner continues, Davis is only an application of the rule that one who transfers appreciated property to satisfy a monetary obligation at the appreciated value will recognize gain to the extent of the appreciation. That is, Davis focused on the marital agreement only as it related to the disposition of securities by the husband; it did not focus on the nature of the wife's participation in the transaction.*fn5 Second, the Commissioner contends that it is improper to apply Section 483 to written agreements concerning divorce or separation because Congress specified the tax consequences of these agreements in 26 U.S.C. § 71*fn6 and 26 U.S.C. § 215.*fn7
At first blush, taxpayers' analysis appears meritorious. It has the appeal of charging the Commissioner with wanting the best of two worlds: a marital settlement is a "sale or other disposition of property" thereby constituting a taxable event when an assessment of additional tax results, as in a transfer of appreciated stock, but not a "sale or exchange of property" when the husband seeks to obtain a deduction, and thereby a reduction in tax liability. But as one considers the criticism in the context of the Internal Revenue Code as a whole, the initial hue wanes.
Our analysis begins not with the general capital gains statutes which by their terms apply to all transactions involving capital assets, see, e.g., 26 U.S.C. §§ 1001, 1002, 1221, but with the specific provisions Congress has enacted to cover the precise factual complex present in the Fox settlement agreement.
Thus, we find a broad statutory general rule enunciated in 26 U.S.C. § 71(a)(1): if a wife is divorced, her gross income includes "periodic payments" "received after [the] decree in discharge of . . a legal obligation which, because of the marital or family relationship, is . . incurred by the husband under the decree or under a written instrument incident to [the] divorce". Had Congress stopped with the general rule, Juliette would have been charged with receiving income under the Fox agreement and the taxpayers probably would have had the benefit of a deduction. But Congress went further and enacted two significant subsections. Section 71(c)(1) excludes from the definition of "periodic payments" those installment payments which discharge a part of an obligation the principal sum of which is specified in the agreement incident to divorce. Congress also added Section 71(c)(2) which renders the exception in Section 71(c)(1) inoperative when the terms of the agreement permit the principal sum "to be paid over a period ending more than 10 years from the date" of the agreement. In such event, the installment payments are to be treated as "periodic payments" under the general rule of Section 71(a)(1). The corollary to inclusion or exclusion in the recipient wife's gross income of amounts received under an installment payment divorce settlement is set forth in 26 U.S.C. § 215: "There shall be allowed as a deduction [to the husband] amounts includible under section 71 in the gross income of his wife." Thus, includibility determines deductibility.
Having established the statutory groundwork, we turn to the agreement at issue. Only the most naive would assume that astute federal tax planning did not figure in the million dollar cash settlement between Benjamin and Juliette Fox. The Fox agreement appears to have been written with one eye on the typewriter and the other on the Internal Revenue Code.
A principal sum was set forth in the agreement which specifically was made contingent upon obtaining the divorce decree. The sum was made payable in installments. Obviously, Juliette Fox insisted that the payments be tax free to her -- free of the Scylla of Section 71(a)(1), the general rule imposing tax liability upon the recipient. The payments were also to be made over a period of nine and one-half years -- thus freeing Juliette from the Charybdis of Section 71(c)(2), which renders the section's exception inoperative. The agreement steered a course midway through the legal Straits of Messina -- safe on the waters of the exception Section 71(c)(1) provides. All of this was "clear and specific" and permissible under the Code. Fashioning a divorce agreement in accordance with tax consequences is an appropriate and legitimate practice. "After all, the parties may for tax purposes act as their best interests dictate . . .." Commissioner v. Lester, 366 U.S. 299, 306, 6 L. Ed. 2d 306, 81 S. Ct. 1343 (1961).
As noted above, it is now axiomatic that the Code defines deductibility to the husband in terms of includibility of the amounts received in the wife's income. Faber v. Commissioner, 264 F.2d 127, 128 (3d Cir. 1959); Cosman v. United States, 194 Ct. Cl. 656, 440 F.2d 1017, 1019 (1971); 5 J. Mertens, The Law of Federal Income Taxation § 31A.01, at 3-4 (1969). Accordingly, it would follow that appellants would not be entitled to the deduction they claim.
And thus we come to the consideration crucial to the resolution of the question before us. We must reject taxpayers' invitation to begin with the statutory language describing "sale or exchange of property" and treat deductions under Section 483 in vacuo. Although an analogy may be drawn from the language in the legislation on recognizing gains to that of the imputed interest section, this is of no help to taxpayers because the analogy may not properly proceed further. Since taxpayers claim deductions for parts of payments Benjamin made on account of a divorce-related property settlement agreement, the appropriate starting point for consideration of the deduction perforce must be Section 215. Here, the start is also the finish. By precise terms the Internal Revenue Code has limited the deductions a husband may claim on payments made under Section 71 to the specific limitations of Section 215. The Code goes no further. Nor need we.
Moreover, nothing in the legislative history of Section 483 indicates a congressional design contrary to the result we reach. Nothing in the legislative history discloses that Congress intended, via the vehicle of Section 483, to modify the statutory scheme that had existed for more than twenty years.*fn8 Rather, an examination of this history discloses that the House and the Senate agreed the purpose of the bill was to eliminate "undesirable" "manipulation of the tax laws"*fn9 by sellers and purchasers of capital assets under installment sales agreements which did not specifically provide for interest. In articulating the "General reasons" for the section, the Senate stated:
Your committee agrees with the House that there is no reason for not reporting amounts as interest income merely because the seller and purchaser did not specifically provide for interest payments. This treats taxpayers differently in what are essentially the same circumstances merely on the grounds of the names assigned to the payments. In the case of depreciable property this may convert what is in reality ordinary interest income into capital gain to the seller. At the same time the purchaser can still recoup the amount as a deduction against ordinary income through depreciation deductions. Even where the property involved is a nondepreciable capital asset, the difference in tax bracket of the seller and buyer may make a distortion of the treatment of the payments advantageous from a tax standpoint. The House and your committee believe that manipulation of the tax laws in such a manner is undesirable and that corrective action is needed.*fn10
Furthermore, as a practical observation, the application of Section 483 to an agreement like the instant one would not seem to further the conceptual framework of the statute. That is, it is highly unlikely that, in negotiating the property settlement agreement, the husband "purchaser" party would tolerate augmentation of the cash "sales price" to reflect "unstated interest".
Thus, faced with the limitations on deductibility by the husband contained in Section 215 -- the fountainhead of permissible deductions for payments pursuant to Section 71 -- and the legislative history of Section 483, we will reject taxpayers' innovative contentions.
The judgment of the district court will be affirmed.