filed: April 14, 1994; As Corrected April 20, 1994.
On Appeal from the United States Tax Court. (Docket Nos. 90-24635, 90-26795).
Before: Stapleton, Cowen and Alito, Circuit Judges.
Vincent Yonadi (Vincent) and Nancy Yonadi appeal from a United States Tax Court order determining a deficiency in their federal income tax due for 1986. The Tax Court held that Vincent was liable for the capital gains tax attributable to the portion of the sale proceeds of certain appreciated assets distributed to his former wife Mollie E. Yonadi (Mollie) pursuant to a divorce settlement agreement entered under New Jersey state law. The Commissioner of Internal Revenue (Commissioner) appeals from a separate order of the Tax Court holding that Mollie was not liable for the tax. A stakeholder entitled to tax from either Vincent or Mollie, the Commissioner asks us to affirm both or reverse both orders. We conclude that Mollie received an ownership interest in the appreciated assets upon her divorce. She therefore must pay taxes on the appreciation realized. We will reverse both orders.
For thirty-eight years Vincent and Mollie were husband and wife. That long union came to an end on March 19, 1982 when the Superior Court of New Jersey entered a judgment of divorce (the judgment). Incident to the divorce, Vincent and Mollie divided their marital property pursuant to an agreement between them. This agreement was incorporated as part of the judgment. At issue in this case are the tax consequences of the division and subsequent sale of the ownership of VAY, Inc. (VAY) and a sole proprietorship doing business as Vincent A. Yonadi (together the "VAY assets").
VAY was formed in 1970 by Vincent as a New Jersey corporation. The stock had a basis of $300,000. Shortly afterwards VAY bought land and certain buildings in Neptune, New Jersey and improved the property into a thriving country club, commonly known as Jumping Brook Country Club and Restaurant. Vincent also formed a sole proprietorship doing business as Vincent A. Yonadi to operate the restaurant and golf course on the VAY property. The judgment dividing the marital property provided, in part:
3. The plaintiff [Mollie] shall also receive a one-third interest in VAY, Inc., which is a corporation of the State of New Jersey which holds land commonly known as Jumping Brook Country Club and Restaurant. This land also includes the buildings and improvements thereon. The plaintiff shall also receive a one-third interest in the business operation of the sole proprietorship known as Vincent J. Yonadi. . . . The interest will be a non-management interest and is solely held for the purposes of receiving the plaintiff's one-third interest at the time the property may be sold.
4. The property shall be sold at the discretion of the defendant [Vincent] so long as he is [in] active management of that place. In the event the defendant at any time is not [in] active management then a sale shall take place. The defendant, prior to any sale and during the time that he is in active management, may receive all of the funds from the operation of Jumping Brook Country [Club] and VAY, Inc., respectively. He shall be responsible, however, to pay all expenses in connection with the sole proprietorship and the aforesaid corporation. Said expenses would include all incidental expenses in connection with the operation of the two business including mortgage, taxes, principal, utilities, repairs and maintenance. The defendant shall indemnify and hold the plaintiff harmless from any obligations in the operation of [the VAY assets].
5. In the event that Jumping Brook Country Club and/or the corporation shall be sold, the plaintiff shall receive one-third of the net selling price less the sum of $500,000.00. . . .
7. The defendant shall not further encumber the premises without the consent of the plaintiff which consent shall not be unreasonably withheld.
Vincent was anxious to retain control over the country club, while Mollie was eager to ensure that she would receive a "legal interest." At the hearing on the entry of the judgment, the following colloquy took place:
MR. DONAHUE [counsel for Vincent]: . . . Just a few matters by way of clarification. I don't believe I have any more additions[.] The one-third ownership that Mrs. Yonadi will have is not an active ownership. The ownership takes effect in essence upon the sale of the property when she receives her interest in it. Mr. Yonadi will operate the business without any interference from Mrs. Yonadi until such time as a sale occurs, or he no longer is involved in it.
THE COURT: I guess what you are really saying, she has a one-third beneficial interest at the time that the property is sold. Is that right, Mr. Abrams?
MR. ABRAMS [counsel for Mollie]: I thought it was going to be a legal interest.
THE COURT: She has a vested interest, it is [a] vested beneficial interest now and to be paid out at the time that it is sold. How does that language sound to you?
MR. ABRAMS: I want to make sure that we have legal title, more than just a beneficial interest. It is inactive, and we agree, and we will not interfere with the operation. But, it is our understanding that it has to be a legal interest, not just a ...