Carol M. Read, et al. v. Commissioner
Carol Read and William Read, who were married, owned Mulberry Motor Parts, Inc. (MMP), a corporation in the business of selling automobile parts. In 1985, Ms. Read filed a petition for dissolution of her marriage to Mr. Read. Carol Read owned 48% and William Read owned 52% of all voting and nonvoting stock of MMP when Ms. Read filed the divorce petition. Based on the divorce agreement, Mr. Read had the options to require Ms. Read to transfer her stock directly to him or to the corporation at his election. On February 5,1986, Mr. Read elected to have the corporation redeem Ms. Read’s stock. The fair market value of Ms. Read’s MMP stock at that time was $838,724. The stock purchase agreement between Ms. Read and the corporation MMP provided that the corporation should pay a down payment of $200,000 in cash and issue to Ms. Read an installment promissory note of $638,724 with 9% annual interest from 1987 to 1989. Mr. Read guaranteed the company’s promissory note in payment for the stock.
Ms. Read didn’t report the down payment of $200,000 and principal payments she received from MMP in her tax return, except for including the interest income from MMP’s installment promissory note in her tax return for 1988, 1989 and 1990. On Mr. Read’s side, he did not report any income with respect to Ms. Read’s transfer of MMP stock.
The IRS treated the stock redemption as a sale exchange and claimed that the principal payments from MMP created a long-term capital gain on Ms. Read’s tax return. The IRS had no concerns about Ms. Read’s interest income under the installment promissory note reported in her tax return. IRS also claimed that the principal and interest payments MMP made to Ms. Read were constructive dividends to William. In addition, the Service determined in the notice issued to MMP that the interest payments made to Ms. Read for 1988, 1989 and 1990 were not deductible. The purpose of all determinations above...