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Harsh result for intra-family notes that cancel at death.

Frane sold stock in his company to each of his four adult children. Each block of stock was worth $140,000. The children signed promissory notes under which the $140,000 principal amount was payable in 20 annual installments, with interest at 12+. The terms of the notes provided they would be "canceled and extinguished as though paid" on Frane's death.

Although Frane's life expectancy at the time of the sale exceeded 20 years, he died less than 3 years later, after two payments had been made on the notes.

Frane had used the installment method to report gain on the stock sale attributable to the two payments he had received. No income from the canceled notes was reported on Frane's final return or the estate's income tax return.

The IRS claimed cancellation of the notes caused recognition of income that had to be reported on Frane's final return.

IRC Section 453B(a) provides: "If an installment obligation is . . . distributed, transmitted, . . . or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and . . . the fair market value of the obligation . . . ." Section 453B(f) treats a canceled installment obligation as if it was "disposed of in a transaction other than a sale or exchange" and provides that if the obligor and obligee are "related," the fair market value of the obligation is deemed to be its face amount.

Result: For the IRS. The facts of the case fall squarely within the statute's language. The gain from the sale of the stock must be reported on the decedent's final return. The gain is the excess of the face amount of the notes over their bases (not stated in the decision) at Frane's death. The face amount is the remaining unpaid principal amount.
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Article Details
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Author:Wagenbrenner, Anne
Publication:Journal of Accountancy
Article Type:Brief Article
Date:Jun 1, 1992
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