Arnes v. United States
Arnes v. Commissioner
Judges: Hug, Fay
981 F.2nd 456
102 T.C. 522
Petra Durova
Facts:
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John and Joann Arnes formed Moriah Corporation to
operate McDonald’s franchise. They were the sole
shareholders.
1987 couple agreed to divorce; McDonald’s Corporation
required no joint ownership after divorce.
Agreement to have Moriah redeem Joann’s 50% interest
in the outstanding stock for $450,000. Moriah paid
$178,042 in 1988 and reminder in monthly installments
over 10 years.
Agreement incorporated into decree of dissolution of the
marriage in January 1988. Joann surrendered her 2,500
shares and Moriah cancelled her stock certificate and
issued another 2,500 shares to John.
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On her Federal Income Tax return Joann reported
receiving $178,042 in 1988. She treated $177,045 as a
long-term capital gain and the reminder as recovery of
portion of her basis.
On December 1989, she filed a claim for refund of
$53,053 for 1988 claiming she was not required to
recognize any gain as the transfer was made pursuant to
divorce instrument (§1041).
IRS didn’t allow the claim for refund.
Joann initiated suit.
The district court found that:
 Redemption of stock required by divorce instrument, John
Arnes benefited.
 Although stock transferred directly to Moriah, it was made
on behalf of John.
 Following Section 1041, transfer qualified for
nonrecognition of gain pursuant to exemption for transfers
made to spouses due to divorce settlement.
 Joann won.
Government appeals:
 Joann does not qualify for 1041 as shares transferred to
Moriah, not to John.
 Although Joann should be taxed, if district court’s ruling
upheld, John should be taxed on a dividend (or $450,000
would be taken out tax-free).
Court held:
 Moriah relieved John of obligation, constructive transfer to
John.
 District court’s ruling affirmed.
John has tax liability, sues in Tax Court
Issue:
Was Moriah’s redemption of Joann’s stock a constructive
dividend to John?
 According to Rev. Rul. 69-608, tax liability if obligation of
remaining shareholder is both primary and unconditional.
 Situation 5 in Rev. Rul. 69-608 supports Johns case.
 Court concluded John’s obligation was not primary and
unconditional.
 Joann’s stock not a constructive distribution / dividend to
John.
Conclusion:
The courts ruled in favor of both Joann
and John and $450,000 were taken out of
Moriah Corporation tax-free.