Academic journal article Journal of Accountancy

Cancellation of Debt as a Gift

Academic journal article Journal of Accountancy

Cancellation of Debt as a Gift

Article excerpt

When parents are asked to help their children financially, they frequently respond with gifts and loans. Sometimes, the loans may be to businesses the children own. What is the tax effect if a parent cancels or forgives a loan made to a child's corporation?

On June 17, 1981, Lavonna Stinson sold property to a corporation owned by her children and grandchildren. In exchange, she received cash and a corporate note. From 1982 through 1985, Stinson forgave $147,000 of the corporate debt. She paid gift tax on that amount as if it were a gift of a present interest. Following her death, the IRS audited the estate and determined the gifts were not of a present interest but, instead, of a future interest, which meant additional gift taxes were due. The estate paid the taxes and sued for a refund.

Result. For the IRS. The district court said neither the code nor the regulations address gifts to corporations. In addition, there was no binding precedent the court could apply. However, other courts have dealt with gifts to corporations, and revenue ruling 71-443 also covers the issue.

The regulations define the gift of a present interest as "an unrestricted right to the immediate use, possession or enjoyment of property or the income from property." Previously, the Ninth Circuit Court of Appeals ruled that a gift of land to a corporation was not a present interest because the individual donees could not enjoy the land unless the corporation declared a dividend or liquidated itself. The court based its ruling on a U.S. Supreme Court decision that a gift to a trust was a future interest because it took joint action by two trustees for the beneficiary to gain possession of the property; the Tax Court and the Court of Claims reached similar conclusions about gifts to corporations. In revenue ruling 71-443, the IRS adopted this reasoning in holding that gifts to corporations were gifts of future interests. …

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