Frane v. Commissioner

Robert Frane sold stock in his business, Sherwood Grove Co., to his four children by four separate agreements. The principal amount due from each child of $141,050 was spread over a 20-year note. Each note was a death-terminating installment note—meaning a note with a clause cancelling and extinguishing the note should Frane die before the final payment was due. The notes also provided for an unusually high interest rate of 12 percent. Frane was 53 years old and his life expectancy exceeded the durations of the notes. But after two years (and after receiving two payments), Frane died. His children did not make any additional payments. Two years after Frane’s death, Sherwood Grove Co. liquidated its assets. Two of Frane’s children reported a capital loss at that time, claiming a basis of the amount actually paid to Frane rather than the face value of the notes. Frane’s other two children did not report any loss or gain from the termination of the business. Meanwhile, in neither the income-tax returns filed by Frane nor those filed by his estate (plaintiff) was any income reported from the cancellation of the notes to the Frane children. The Commissioner of Internal Revenue (the commissioner) (defendant) issued a deficiency notice saying that gain had been recognized by Frane himself (not the estate) on cancellation of the notes. The Internal Revenue Code provided that in a transaction between family members, when an installment loan was cancelled, the person cancelling the transaction had income of the difference between the face value of the note and the basis in the obligation. The estate argued that having the note payable on death was not the same as cancellation, as cancellation should be said to apply to events subsequent and independent from the original transaction. The government meanwhile argued that Frane’s death did not change the cancellation of the notes and that the income had been realized by Frane himself. The Internal Revenue Code also provided that a cancellation caused by the obligee’s death would be treated as a transfer by the obligee’s estate. The estate filed suit, the United States Tax Court ruled for the government, and the estate appealed.