Estate Denies Sale of Self-Canceling Installment Note Was Part Gift/Part Sale

Duilio Costanza and his wife operated a restaurant. In the 1980s, the couple built a small retail/office plaza. Costanza and his wife established revocable trusts for the property. Their son, Michael, is the trustee and residual beneficiary of Costanza's trust. In 1992, Costanza consulted his attorney John Spath about retiring. Following Spath's advice, Costanza and Michael went forward with a transaction in late 1992 and early 1993 in which Michael executed a SCIN in exchange for the trust's properties. The SCIN provided Michael would make monthly payments, for an increasing interest rate, and that no more payments would be required if Costanza died before the payments were complete.

After Costanza's death, a federal estate tax return was filed indicating no tax due. The return identified the SCIN and included a copy, but indicated the value of the SCIN was zero, under the terms of the note, because the note was cancelled on Costanza's death. The IRS issued a deficiency notice increasing the estate by $803,868, stating that the sale between the trust and Michael's trust was not recognized because it wasn't a bona fide sale for full and adequate consideration. Alternatively, the IRS argued that if the sale transaction was valid, it was a bargain sale and Costanza's adjusted taxable gifts should be increased under section 2001(b)(1)(B) by the bargain component.

The Tax Court first noted that all the documents for the transfer were executed after December 15, 1992, but backdated to suggest they were signed in 1992. The court noted there was no evidence that the SCIN was executed before January 6, 1993, the date Michael was to make the first payment. Michael did make three payments on the note, but backdated them, and failed to make other payments. Thus, the court was persuaded that the conveyance of the properties from Costanza's trust to Michael's trust wasn't a bona fide transaction for full and adequate consideration. The court rejected the IRS's argument that Costanza retained the power to revoke the transfer, which would require inclusion of the trust property in Costanza's estate under section 2038. The court found that the documents give no evidence supporting such a power. However, the court agreed with the IRS's second argument that the transfer was a part-gift/part-sale to Michael. (For a summary, see Tax Notes, June 11, 2001, p. 1877; for the full text, see Doc 2001-15771 (26 original pages) [PDF] or 2001 TNT 108-15 .)

The estate argues that the Tax Court erred in concluding that it failed to make an affirmative showing that there was a real expectation of repayment and intent to enforce the collection of the note at issue. It further contends that the court erred in finding that the provisions of section 2512(B) are dispositive in this case because the sale was a bona bide transaction and as such did not give rise to any federal gift tax liability.

[2] Appellant requests oral argument pursuant to Federal Rule of Appellate Procedure 34. Oral argument will allow counsel to address any factual or legal issues which this Court deems relevant.

STATEMENT OF SUBJECT MATTER AND APPELLATE JURISDICTION

[3] The United States Tax Court had jurisdiction based on 26 USC section 6214.

[4] This Court has jurisdiction pursuant to 26 USC section 7482(a) because Appellant timely filed its Notice of Appeal (R. 38, Notice of Appeal, APX___) from a Final decision of the United States Tax Court, namely, the June 4, 2001 Memorandum Findings of Fact and Opinion (R. 34, Memorandum Opinion APX___) which became final upon the entry of the United States Tax Court's July 18, 2001 Decision (R. 37, Decision, APX___).

STATEMENT OF ISSUES FOR REVIEW

[5] The Tax Court's findings of fact are to be reviewed by the Appellate Court on the clearly erroneous standard. Kearns v. Commissioner of Internal Revenue, 979 F.2d 1176 (6th Cir. 1992), citing Rose v. Commissioner, 868 F.2d 851, 853 (6th Cir. 1989). Further, factual determinations are clearly erroneous if the Appellate Court is left with a definite and firm conviction that a mistake has been made. Kearns, citing Anderson v. City of Bessemer City, 470 U.S. 564 (1985). Appellant asserts that the clearly erroneous standard is applicable to issues I and II. Lastly, the Tax Court's application of the law is to be reviewed using the de novo standard. Kearns, citing Rose v. Commissioner, 868 F.2d 851, 853 (6th Cir 1989).

STATEMENT OF THE CASE

[6] Duilio Costanza (the "Decedent") died on May 12, 1993. His United States Estate Tax Return, Form 706, was timely filed on August 15, 1994 indicating that no estate tax was due (R.25, Stipulation of Facts, Ex. 1-J, APX___). On April 29, 1997 Appellee issued a timely Notice of Deficiency (R. 25, Stipulation of Facts, Ex. 2-J, APX___). proposing a substantial increase in the Decedent's gross estate on the grounds that the sale of real estate by the Decedent to his son was not "bona fide". On July 28, 1997 Appellant filed a timely Petition challenging the Notice of Deficiency (R. 1, Petition, APX___). On September 22, 1997, Appellee timely filed its Answer (R.3, Answer, APX___). On March 13, 2000, Appellee filed an Amended Answer (R. 21, Amended Answer, APX___).

[7] On April 24, 2000 the case was tried before the Honorable David Laro, United States Tax Court. On June 4, 2001, Judge Laro issued his Memorandum Finding of Fact and Opinion holding that the transaction at issue in this case was not "bona fide" (R. 34, Memorandum Opinion, APX___). On July 18, 2001 Judge Laro entered his final Decision holding that there was a deficiency in estate tax due from Appellant in the amount of $185,577, and a deficiency in gift tax due from Appellant for 1993 in the amount of $77,679 (R. 37, Decision, APX___).

[8] Appellant filed its Notice of Appeal 43 days thereafter (R. 38, Notice of Appeal, APX___).

STATEMENT OF FACTS

[9] Duilio Costanza ("Decedent") was born in Italy on October 21, 1919. He immigrated to the United States and worked as a welder for General Motors, Inc. ("GM") until 1966. Following his retirement from GM, Decedent and his wife, Mary Ann Costanza ("Mrs. Costanza"), opened an Italian restaurant called Latina Restaurant and Pizzeria, Inc. on property they owned in Flint, Michigan, at 1370 Bristol Road West ("Latina Restaurant"). During the early 1980's, Decedent and his wife built a small retail/office plaza, called Bristol West, on property they owned in Flint at 1388 Bristol Road West ("Bristol West").

[10] The Decedent and his wife established Revocable Trusts in 1986, into which the Latina's Restaurant and Bristol West properties were transferred. Their son, Michael J. Costanza ("Mr. Costanza") was named as the Trustee and Residual Beneficiary of each Revocable Trust. The terms of the Decedent's Trust permitted the Decedent to remove and replace Mr. Costanza as Trustee at any time(R. 25, Stipulation of Facts, Ex. 1-J Attachment 2, APX___).

[11] Mrs. Costanza died on May 24, 1991. In the process of settling her estate, appraisals (R. 25, Stipulation of Facts, Exs. 5-J and 6-J, APX___) were performed which indicated that the Latina Restaurant and the Bristol West properties were worth $830,000 at the time of her death. Her interest in the properties transferred to the Decedent.

[12] On February 24, 1992, ("Black Monday" per the local press), (Petitioner's Ex. 33-P, p. 78, APX___). GM announced plans to close its V-8 Engine plant in Flint, Michigan. The plant employed over 4,000 persons and was located approximately one-half mile from the Latina Restaurant and Bristol West properties. The Decedent and Mr. Costanza both believed the plant closing announcement decreased the value of the Latina Restaurant and Bristol West properties to approximately $650,000 - $700,000. (R. 28, Michael Costanza, 5-25-00, TR., p. 67-86, APX___); (Petitioner's Ex. 33-P, p. 78, APX___).

[13] Following Mrs. Costanza's death, the Decedent sought the advice of an estate planning attorney, John M. Spath. The Decedent informed Mr. Spath that he intended to return to Italy and remarry, and that he needed to receive payments to support himself in Italy, but did not want Mr. Costanza to have to make payments to his new wife after his death. (Petitioner's Ex. 35-P, p. 200, p. 12, 27-28 of dep. trans, APX___); (R 28, Michael Costanza, 5-25-00, TR. p. 80-82, 151, APX___). The Decedent was unwilling to gift the properties to Mr. Costanza because he needed income from the properties. (Petitioner's Ex. 35-P, p. 200, p. 12 of dep. trans., APX___); (R. 28, Michael Costanza, 5-25-00, TR. p. 82, 83, 87, 91, 148, 149, APX___). Mr. Spath suggested that the Decedent's Trust sell the Latina Restaurant and Bristol West properties to Mr. Costanza in exchange for a promissory note containing a cancellation upon death provision (the "Note"), which would be cancelled if the Decedent died before it had been paid in full. On October 24, 1992, after the Decedent and Mr. Costanza had negotiated an agreement, Mr. Spath and his staff were instructed to prepare a Note in the amount of $830,000 which provided for payment by means of monthly installments over a period of eleven (11) years (Petitioner's Ex. 35-P, p. 200, p. 24-25 of dep. trans., APX___); (R. 25, Stipulation of Facts, Ex. 10-P, APX___); (R. 25, Stipulation of Facts, Ex. 13-J, APX___). Mr. Costanza and the Decedent understood and believed that Mr. Costanza was agreeing to pay more than the value of the properties in consideration of the cancellation on death provision of the Note properties in consideration of the cancellation on death provision of the Note (Petitioner's Ex. 35-P, p. 200, p. 12-13 of dep. trans., APX___); (R. 25, Stipulation of Facts, Ex. 10-P, APX___); (R.28, Michael Costanza, 5-25-00, TR. p. 84-85, 91, APX___). Although Mr. Costanza had sufficient net worth to pay off the Note (R. 28, Michael Costanza, 5-25-00, TR. p. 88, APX___), he was concerned that the cash flow from the properties might be insufficient to cover the Note payments (Petitioner's Ex. 35-P, p. 200, p. 14 of dep. trans., APX ___), so the Note provided for interest at a rate which increased every twenty-four (24) months. (R. 25, Stipulation of Facts, Ex. 13- J, APX___).

[14] Mr. Spath and his staff also prepared quit claim deeds by which the properties would be transferred from the Decedent's Trust to Mr. Costanza as Trustee of his own Revocable Trust, (R. 25, Stipulation of Facts, Exs. 15-J and 16-J, APX___) and a mortgage on both properties securing Mr. Costanza's obligations under the Note. (R. 25, Stipulation of Facts, Ex. 14-J, APX___).

[15] To prepare an amortization schedule, Mr. Spath and his staff used December 15, 1992, as the date of the Note (R. 25, Stipulation of Facts, Ex. 13-J, APX___). The Note (R.25, Stipulation of Facts, Ex. 13-J, APX___) and related documents were mailed to Mr. Costanza on December 21, 1992 (R. 25, Stipulation of Facts, Exs. 11-P, 12-J, APX___), signed by Mr. Costanza in his capacities as Trustee of the Decedent's Trust and Trustee of his own Trust, and returned to Mr. Spath's office sometime on or before January 6, 1993. On January 7, 1993, Mr. Spath instructed his staff to "record the deeds" (R. 25, Stipulation of Facts, Ex. 15-J, 16-J, APX___) and to return the mortgage (R. 25, Stipulation of Facts, Ex. 14-J, APX ___) to Mr. Costanza because he had inadvertently failed to sign it. (R. 25, Stipulation of Facts, Exs. 17-P, 18-P, APX___). On January 27, 1993, the mortgage was mailed back to Mr. Costanza to be signed (R. 25, Stipulation of Facts, Ex. 20-P, APX___). The deeds and mortgage were recorded in early February (R. 25, Stipulation of Facts, Ex. 21- J, 22-J, APX). On March 10, 1993, the executed and recorded Note and Mortgage were sent to the Decedent (R. 25, Stipulation of Facts, Ex. 24-P, APX___).

[16] After meeting with Mr. Spath in October, 1992, and instructing Mr. Spath to consummate the sale, the Decedent traveled to California to visit friends. He returned from California on January 25, 1993, complaining of chest pains. Prior to his return, neither Mr. Costanza nor Mr. Spath had any reason to believe that the Decedent's health condition was deteriorating. On February 23, 1993, Mr. Spath was informed for the first time that the Decedent had a "bad heart", but was "still planning on going to Italy" (R. 25, Stipulation of Facts, Ex. 23-P, APX___). Testing resulted in a diagnosis that the Decedent was suffering from congestive heart failure. Bypass surgery was scheduled for May, 1993.

[17] In March, 1993, Mr. Costanza met with his father and made the Note payments for January, February and March, by means of three (3) checks, each in the amount of $8,710 (R. 25, Stipulation of Facts, Ex. 25-J, APX___). While writing the checks, Mr. Costanza revised the dates and completed the "memo" portion of each to reflect payments for the months of January, February and March, 1993 to enable the Decedent and himself to keep track of which Note payments had been made (R. 25, Stipulation of Facts, Ex. 25-J, APX___); (R.28, Michael Costanza, 5-25-00, TR. p. 98, APX___). The Decedent had told Mr. Costanza that he needn't make a payment every month, and had authorized Mr. Costanza to make payments every few months (R. 28, Michael Costanza, 5-25-00, TR. p. 98, APX___).

[18] On May 11, 1993, the Decedent underwent a coronary bypass operation. The Decedent died the following day as a result of a severe, unanticipated toxic reaction to a drug administered during the bypass operation. According to Dr. Farrehi, the Decedent's cardiologist, there was no reason to anticipate that the Decedent would not survive the operation, because 89.3% of similar patients survive such an operation and go on to resume their normal lives (R. 28, Dr. Cyrus Farrehi, 5-25-00, TR., p. 57, APX___). Further, Decedent had previously received the same drug and had suffered no negative reaction.

[19] The Decedent's federal estate tax return indicated that no tax was due. The return indicated that the Note (R. 25, Stipulation of Facts, Ex. 13-J, APX___) was cancelled upon the death of the Decedent and was therefore not included in the Decedent's taxable estate.

[20] Appellee thereafter issued a Notice of Deficiency (R. 25, Stipulation of Facts, Ex. 2-J, APX___) proposing an increase of $803,868 in the Decedent's gross estate due to Appellee's assertion that the sale of the Latina Restaurant and Bristol West properties to Mr. Costanza was not a bona fide sale.

[21] Following trial, the Tax Court ruled, by T.C. Memo 2001- 128 (R. 34, Memorandum Opinion, APX___) dated June 4, 2001, that the sale was not a bona fide transaction. Consequently, the Tax Court ruled, the Note (R. 25, Stipulation of Facts, Ex. 13-J, APX___) provided no consideration for the transferred properties, and the full value of the Latina Restaurant and Bristol West properties, minus only the three (3) payments actually made was a gift from the Decedent to Mr. Costanza. The Tax Court determined that the value of the Latina Restaurant and Brisol West properties totaled $843,000 as of December 15, 1992. After deducting the three (3) payments made in the total amount of $26,130, the Tax Court determined that the value of the gift made to Mr. Costanza was $816,870. By Decision dated July 18, 2001, the Tax Court held that Appellant had an estate tax deficiency of $185,577 and a 1993 gift tax deficiency of $77,679 (R. 37, Decision, APX___). Appellant has paid these deficiencies to Appellee.

[22] Appellant now seeks reversal of the Tax Court's finding that the sale was not bona fide on the grounds that such finding was clearly erroneous.

SUMMARY OF THE ARGUMENT

[23] The Tax Court erred in determining that the sale at issue was not bona fide. Appellant made an affirmative showing at trial that the Decedent expected Mr. Costanza to make the Note payments and that Mr. Costanza agreed and intended to do so. There is simply insufficient evidence to support the Tax Court's conclusion that the Decedent and Mr. Costanza never intended the Note payments to be made.

[24] The only two witnesses with personal knowledge of the intentions of the Decedent and Mr. Costanza were Mr. Costanza and Mr. Spath. Both testified unequivocally that the transaction was bona fide; that the Decedent had no intention of gifting the properties to Mr. Costanza; and that there was every intention that Mr. Costanza would discharge his indebtedness to the Decedent under the Note (R. 25, Stipulation of Facts, Ex. 13-J, APX___).

[25] The Tax Court's conclusion to the contrary was based on a few innocuous "circumstances" which were fully explained by Appellant and which fell far short of substantiating the Tax Court's conclusion. For example, the fact that the Note (R. 25, Stipulation of Facts, Ex. 13-J, APX___) and related documents were dated December 15, 1992, but not signed until sometime before January 7, and the fact that Mr. Costanza made three Note payments at the same time, certainly do not prove that no repayment obligations were intended. To the contrary, these circumstances demonstrate that the sale was properly documented and that payments were made, consistent with the existence of a bona fide debtor/creditor relationship.

[26] Applicable case law provides that to establish that a transaction was bona fide, an affirmative showing must be made that there was an intention to perform. Estate of Van Anda v. Commissioner, 12 T.C. 1158, 1162 (1949), affd. 192 F.2d 391 (2d Cir. 1951). Appellant made such an affirmative showing with the direct, substantiated testimony of Mr. Spath and Mr. Costanza. The Tax Court's reliance on Estate of Labombardi v. Commissioner, 58 T.C., 745 (1972) is misplaced. Comparing the facts in Labombardi to the facts in this case, it is clear that the transaction at issue in Labombardi was not bona fide, and that the transaction before this Honorable Court was bona fide.

[27] Because the sale at issue was bona fide, the Tax Court's assessment of gift tax and estate tax deficiencies should be reversed.

ARGUMENT

[28] The unpaid balance of a self-canceling installment note is not includable in a decedent's gross estate if the note was executed in connection with a bona fide sale. Estate of Moss v. Commissioner, 74 T.C. 1239 (1980); Gen. Couns. Mem., 39, 503 (May 7, 1986). A sale of property from a parent to a child in exchange for an installment note is "bona fide" if there is an affirmative showing that there existed at the time of the transaction a "real expectation of repayment and intent to enforce the collection of the indebtedness." Estate of Van Anda v. Commissioner, 12 T.C. 1158, 1162 (1949), affd. 192 F.2d 391 (2d Cir. 1951).

I. THE TAX COURT ERRED IN CONCLUDING THAT APPELLANT FAILED TO MAKE

"Q. And was it at that time your intention to continue making

" . . . . his objective was to get paid for his property so he

"Q. Was Duilio Costanza willing to simply gift these properties

B. THE EVIDENCE UPON WHICH THE TAX COURT BASED ITS CONCLUSION

[33] 1. In support of its conclusion, the Tax Court noted that although the Note (R. 25, Stipulation of Facts, Ex. 13-J, APX___) and related documents were all dated December 15, 1992, they were executed "late in December, 1992 or early in January, 1993" (R. 34, Memorandum 0pinion, p. 5, APX___). The Tax Court concluded that the documents were "backdated to suggest that they had been signed on that date [December 15, 1992]" (R. 34, Memorandum Opinion, p. 8, APX___). The Tax Court seems to be implying that this was furtive, culpable behavior. The evidence, however, clearly demonstrated that there was a good reason the documents were all dated December 15, 1992, and the fact that they were signed within several weeks thereafter is entirely inconsequential. When Mr. Spath and his staff prepared the Note (R. 25, Stipulation of Facts, Ex. 13-J, APX), they had to pick a date upon which to base an amortization schedule. They chose December 15, 1992, and typed that date onto the face of the Note before mailing the Note to Mr. Costanza for signature and return.

[34] Mr. Spath's December 21, 1992 letter and the Federal Express receipt clearly demonstrate that the documents were mailed to Mr. Costanza by Federal Express (R. 25, Stipulation of Facts, Ex. 11- P, 12-J, APX___) on December 21, 1992. Mr. Spath's January 7, 1993 handwritten notes (R. 25, Stipulation of Facts, Ex. 17-P, APX ___), clearly demonstrate that on January 7, 1993 Mr. Spath instructed his staff to record the deeds. This clearly indicates that the documents had been returned to Mr. Spath by January 7, 1993. The quit claim deeds and mortgage were dated December 15, 1992 simply to maintain consistency with the date typed on the face of the Note (R. 25, Stipulation of Facts, Ex. 13-J, APX___)

[35] The Tax Court seems to be suggesting that Mr. Costanza and Mr. Spath were aware that the Decedent's health condition had seriously deteriorated when the Note was signed, so they nefariously "backdated" the Note to a date before they became aware of the Decedent's health problems. Any such insinuation would be absolutely false. The evidence clearly demonstrated that neither Mr. Spath nor Mr. Costanza became aware that the Decedent was experiencing health problems until the Decedent returned from California on January 25, 1993. Mr. Costanza testified that the Decedent was "fine and in good spirits" when he left for California, and that the Decedent did not mention any health problems while he was in California (R. 28, Michael Costanza, 5-25-00, TR., p. 95, APX___). Mr. Spath testified that when he met with the Decedent in October, 1992, the Decedent appeared to be in good health:

"Q. When you prepared the SCIN documents, health wise, how did

2. The Tax Court notes in its Opinion (R. 34, Memorandum Opinion, APX___) that although the Note (R. 25, Stipulation of Facts, Ex. 13-J, APX ___) provided for monthly payments to be made on or before January 1, 1993, February 1, 1993 and March 1, 1993, these three payments were not made until March 8, 1993. Here again, there was a perfectly legitimate reason for this "circumstance". Mr. Costanza testified that the Decedent told him that he needn't make a payment every month, but could bring the note current every several months.

"Q. Monthly. Did you make monthly payments each and every month?

[38] 3. The Tax Court noted that in an affidavit signed by Mr. Costanza, he indicated that payments were not to be made every month "to limit the number of bank transactions." The Tax Court then noted that when Mr. Costanza brought the Note (R. 25, Stipulation of Facts, Ex. 13-J, APX___), current on March 8, 1993, he executed three separate checks, "all of which were separately processed by the drawee bank." Apparently, the Tax Court is suggesting that the reason given in the affidavit was false because three separate checks were actually used. The fact, however, is that Mr. Costanza deposited all three checks on the same day, thereby making one trip to the bank instead of three.

[39] 4. The Tax Court notes that the dates on two of the three checks were "altered". The Tax Court insinuates that this was done to create the false appearance that the checks had actually been written on January 1, February 2 and March 1, 1993, respectively, instead of all at once. Again, the evidence demonstrated otherwise. Mr. Costanza testified that when he met with his father on March 8, 1993 he re- dated two of the checks so as to clearly document the months for which Note payments had been made. It is abundantly apparent from the checks themselves (R. 25, Stipulation of Facts, Ex. 25-J, APX___), that Mr. Costanza made no attempt to hide the fact that he had re- dated two of the checks. If he had been attempting to hide the truth, he would have done a much better job of "altering" the two checks. He was obviously not trying to hide anything.

[40] By citing this circumstance, the Tax Court seems to be suggesting that Mr. Costanza made these three payments only because he had become aware that his father would be undergoing surgery in May, 1993. Any such suggestion is illogical. If Mr. Costanza never intended to make Note payments to the Decedent, why would he do so upon learning of the Decedent's need for surgery? If it was because Mr. Costanza believed his father was about to die and was afraid the IRS would audit the estate tax return and challenge the Note (R.25, Stipulation of Facts, Ex. 13-J, APX___) if no payments had been made, he would certainly have made the April and May payments on time. ¹ Furthermore, the evidence clearly indicates that no one had any reason to believe that the Decedent would not survive the scheduled surgery:

"The coronary artery disease that he had is not considered an

[41] After discussing the facts of the case at bar, the Tax Court concluded that the situation at hand is "analogous" to the situation in Estate of Labombarde v. supra., the Court held that a transfer of real estate from a mother to her children, to compensate them for having supported her for the past 15 years, was not bona fide because there was no intention to create a debt. Appellant respectfully submits that the situation in Estate of Labombarde v. Commissioner, supra., is entirely distinguishable from, and not at all analogous to, the case at bar.

[42] Following the death of their father, the Labombarde children, concerned for their mother's welfare, agreed amongst themselves to provide for her support. Over a fifteen year period, the children advanced either indirectly or by the provision of necessities, approximately $150,000.00 for their mother's welfare. Absolutely no records were maintained reflecting the advances.

[43] After having supported their mother for fifteen years, the children consulted a tax attorney and began questioning as to what tax consequences would transpire upon their mother's death. Learning of the support which had been provided, the tax attorney drafted a letter from the mother acknowledging that all of the funds the mother had received over the past fifteen years were loans, not gifts. The letter went on to indicate that the mother did not know if she would be able to repay the loans during her lifetime. Concurrently, the mother also signed acknowledgements in favor of each child bearing the amount each child estimated he or she had provided over the prior fifteen years. Shortly after the letter was written, the mother, also upon the advice of tax counsel, deeded her only asset (worth only $12,500.00) equally to the children. In response, the children drafted a letter acknowledging receipt of that asset and forgiving the entire $150,000.00 debt.

[44] For obvious reasons, the Tax Court held the transaction was not bona fide. In its opinion, the Court noted the following: (1) When the children initially agreed to begin advancing funds to their mother, the mother was not even present; accordingly, the Court reasoned that there could not have been any agreement to repay or intent to repay on the mother's part; (2) absolutely no records of the monies advanced were maintained; (3) neither the letter nor the acknowledgements contemplated payment prior to mother's death; (4) neither the letter nor the acknowledgements contained terms for repayment; (5) the mother never had the ability to repay the purported loans; and, lastly, (6) there was no consideration given for the advances as the letter and acknowledements were signed fifteen years after the funds had been provided!

[45] The facts of the case at bar, when contrasted against the facts in Estate of Labombarde v. Commissioner, clearly demonstrate an intent to create a bona fide debt.

[46] Other decisions which have found transactions between family members to be non-bona fide are also clearly distinguishable. For example: In Estate of Musgrove v. United States, 33 Fed. Cl. 657 (1995), the United States Court of Federal Claims addressed the issue of whether a $250,000.00 transfer by the taxpayer to his son, less than one month before the taxpayer's death, in exchange for an interest free demand note with a cancellation on death provision was bona fide. The taxpayer in Musgrove was a sickly 84 year old man suffering from angina, arteriosclerosis and hypertension. The need suddenly arose for taxpayer's son to borrow approximately $300,000.00. To assist, the taxpayer offered to loan the required funds to his son, in exchange for a demand note with a cancellation upon death provision. When consummating the transaction, THE TAXPAYER INDICATED THAT, ABSENT A FINANCIAL EMERGENCY, HE DID NOT BELIEVE HE WOULD EVER NEED TO MAKE A DEMAND FOR REPAYMENT. LIKEWISE, THE SON INDICATED THAT HE DID NOT KNOW IF OR WHEN HE COULD EVER REPAY THE DEBT. Sensing that his death was imminent, the taxpayer urged his son to seek counsel to have the note drafted.

[47] Like Labombarde, this decision, also relied upon by the Tax Court, involved a purported loan wherein it was well known at the inception of the debt that there was no ability to repay. Also, as in Labombarde, the debt was unsecured.

[48] In holding that the transaction was not bona fide, the trial court focused on the following factors: The note was unsecured, failed to schedule regular payments and provided for no interest. Also of significance to the Court were the fact that: (1) son acknowledged at the time the note was signed that he didn't know if he could ever repay it; (2) the taxpayer indicated that he did not expect to be repaid absent a financial emergency, and, lastly, (3) following execution of the note, the father maintained control over the funds by limiting the purpose for which they could be put to use.

[49] The foregoing cases relied on by Judge Laro involve transactions where the purported creditor agreed up front that he would not collect on the debt. Moreover, they involve situations where the purported debtor was incapable of repaying the debt.

[50] In cases with facts more analogous to those before this Honorable Court, transactions between family members have held to be bona fide. For example, In the case of Wilson v. Commissioner, T.C. Memo. 1992-480, 64 T.C.M. (CCH) 583 (1992), the Tax Court addressed the issue of whether a demand note, containing a cancellation upon death provision, given by the taxpayer's children in exchange for the transfer of certain real estate, was a bona fide transaction. Concurrent with transferring the real estate to her children, the 68 year old taxpayer took a promissory note, signed by the children, which note required payment within 120 days of demand. In the absence of a repayment demand, the note required repayment within fifteen years following execution of the note. The note was secured by the real estate. The note also provided that in the event of taxpayer's death, the obligation would cease.

[51] The IRS attacked the transaction as being non-bona fide. However, the Tax Court found that there was insufficient evidence to find the transaction was not bona fide. In finding the note to be bona fide, the Court emphasized all of the factors which are present in the case at bar: the note contained terms for repayment, was secured by valuable real estate and was entered into with an intent to repay. Accordingly, the note was held to be bona fide despite the fact that no payments were ever made.

II. THE TRIAL COURT INCORRECTLY RULED THAT THE PROVISIONS OF 26

III. THE SALE WAS A BONA FIDE TRANSACTION.

[53] For the reasons argued above, Appellant respectfully submits that the sale between the Decedent and Mr. Costanza was a bona fide transaction in every sense of the term. The transaction was negotiated and properly documented with a fully enforceable Note and Mortgage (R. 25, Stipulation of Facts, ex. 14-J, APX___); the Decedent needed and expected to receive payments; Mr. Costanza agreed and intended to make payments; and Mr. Costanza had the ability to pay and did in fact make payments per his father's instructions.

IV. BECAUSE THE SALE WAS A BONA FIDE SALE, IT GAVE RISE TO NO

[55] If this Honorable Court agrees that the sale was bona fide, free from any donative intent, then it follows that it could not give rise to any gift tax liability. Trial testimony established that the Decedent was unwilling to gift the Latina Restaurant or Bristol West properties to Mr. Costanza because he needed income to support himself in Italy. Trial testimony also established that the Decedent and Mr. Costanza fully negotiated the terms of the Note, including the cancellation clause, and agreed upon an $830,000 purchase price. Even if they were incorrect in their assessment of value, no gift tax liability would arise because no gift was intended and the terms of the transaction were fairly negotiated.

CONCLUSION

[56] If this Honorable Court agrees that the transaction at issue was a bona fide sale, not a gift, then the Tax Court's July 18, 2001 Decision (R. 37, Decision, APX___) assessing estate and gift tax deficiencies should be reversed.

Charles L. McKelvie

[57] I hereby certify that one copy of the foregoing Proof Brief has been served, via ordinary U.S. Mail, upon:

Robert J. Branman, Esq.

² Thus, the Tax Court determined that the properties were worth MORE than the $830,000 face amount of the Note. If this transaction were a scam (either because Mr. Costanza knew his father was about to die or because Mr. Costanza never intended to make Note payments), it would only stand to reason that the face mount of the Note would have been set at an amount much higher than any arguable value of the properties. This would have strengthened Appellant's position in the event of an audit.