Seggerman Farms, Inc. v. Commissioner

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 01-3638
SEGGERMAN FARMS, INCORPORATED,
CRAIG SEGGERMAN, LINDA SEGGERMAN,
MICHAEL SEGGERMAN, RONALD SEGGERMAN,
and SALLY SEGGERMAN,
Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
____________
Appeal from the United States Tax Court.
Nos. 16269-99, 16271-99, 16272-99,
16273-99—Mary Ann Cohen, Judge.
____________
ARGUED SEPTEMBER 4, 2002—DECIDED OCTOBER 24, 2002
____________
Before BAUER, ROVNER, and EVANS, Circuit Judges.
BAUER, Circuit Judge. Petitioners-Appellants Ronald
and Sally Seggerman, Craig and Linda Seggerman, and
Michael Seggerman (collectively, “the Seggermans”) appeal
from deficiency judgments entered against them in the
United States Tax Court upholding the deficiency deter-
minations of Respondent-Appellee Commissioner of Inter-
nal Revenue (“Commissioner”) for the taxable years 1993
and 1994. The Seggermans challenge the Commissioner’s
recognition of certain transfers of property to Petitioner-
Appellant Seggerman Farms, Inc. (hereinafter, “the Corpora-
2 No. 01-3638
tion”), as taxable gains under 26 U.S.C. § 357(c),1 where
such transfers were made subject to liabilities in excess
of the taxpayer’s basis in the property. Specifically, the
Seggermans argue that no gain should be recognized where
they personally guarantied the debts to which the trans-
ferred property was subject. We disagree and affirm the
Tax Court’s deficiency judgment.
BACKGROUND
Ronald and Sally Seggerman, their sons, Craig Segger-
man and Michael Seggerman, and Craig’s wife, Linda
Seggerman, are grain and cattle farmers residing in Illi-
nois. In March 1993, at the behest of the Seggermans’
secured creditors, Ronald Seggerman incorporated Segger-
man Farms, Inc., an Illinois corporation, which the family
previously operated as a joint venture in Minonk, Illinois.2
The stock of the Corporation was distributed as follows: 100
preferred shares and 38 common shares to Ronald Seg-
german; 4 common shares to Sally Seggerman; 30 common
shares to Craig Seggerman; 3 common shares to Linda Seg-
german; and 25 common shares to Michael Seggerman.
In exchange for the stock they received in the Corporation,
Ronald, Craig and Michael Seggerman each transferred
assets to the Corporation subject to liabilities. The Cor-
poration also assumed various farm-related liabilities of
1
We refer, hereinafter, to Title XXVI of the United States Code
as the Internal Revenue Code, or I.R.C.
2
The Seggermans’ creditors, the Federal Land Bank and the
Minonk State Bank, conditioned the extension of additional credit
for the following crop year upon incorporation of their farm-
ing operation. The banks also wanted to ensure that the family’s
farm loans met government loan guarantee requirements.
No. 01-3638 3
the three men.3 In each case, the dollar amount of liabil-
ities transferred to the Corporation exceeded the trans-
feror’s adjusted basis in transferred assets. The amount
by which Ronald’s transferred liabilities exceeded his ad-
justed basis in transferred assets totaled $332,702. For
Craig, this excess amount equaled $91,394; for Michael,
it amounted to $82,594.
Some time thereafter, the Corporation refinanced a
portion of the transferred debt, incurring debts totaling
$330,000, and the Corporation, with the Seggermans as co-
makers, borrowed an additional $407,000.
Though no family member ever directly received any
loan proceed disbursements, the Seggermans remained
secondarily liable as guarantors on all of the transferred
debt. Specifically, Ronald executed a commercial guaranty
and Sally, Craig, Linda and Michael executed unlimited,
continuing personal guaranties of the Corporation’s debt.
In July 1999, the Commissioner issued notices of defi-
ciency of federal income tax to the Corporation and to
the Seggermans for the taxable years 1993 and 1994. The
deficiencies resulted, in part, from the Seggermans’ fail-
ure to report as income on their federal tax returns the
amount by which liabilities transferred to the Corpora-
tion exceeded the adjusted basis in the transferred assets.
In October 1999, the Seggermans filed Petitions in the
United States Tax Court for a redetermination of the
deficiencies. The Seggermans argued that, as guarantors
of the Corporation’s debt, they were not relieved per-
sonally from any debt that the Corporation assumed or to
which the transferred property was subject or that was
3
Although neither Sally nor Linda Seggerman transferred any
assets or liabilities to the Corporation, the facts indicate that for
the taxable years 1993 and 1994, Ronald and Sally, as well as
Craig and Linda, filed joint federal income tax returns.
4 No. 01-3638
refinanced pursuant to restructuring of corporate debt,
and therefore they should not have to recognize any gain
on the amount of the liabilities that exceeds the adjusted
basis of the transferred assets. The Tax Court, after con-
solidating the Petitions, upheld the Commissioner’s de-
terminations of deficiency, concluding that the Segger-
mans must recognize a gain on the transfer of assets
to the Corporation under I.R.C. § 357(c). Seggerman Farms,
Inc. v. Comm’r, T.C. Memo 2001-99 (2001). The Seggermans
now appeal from the decision of the Tax Court.
ANALYSIS
This Court retains exclusive jurisdiction to review de-
cisions of the Tax Court pursuant to I.R.C. § 7482(a)(1).
The parties submitted this case fully stipulated to the Tax
Court for adjudication without a formal trial pursuant
to Rule 122 of Practice and Procedure of the United
States Tax Courts, and the facts are not in dispute. The Tax
Court’s determination that I.R.C. § 357(c) requires the
Seggermans to recognize a gain on the transfer of prop-
erty to the Corporation involves a question of law, sub-
ject to de novo review. Eyler v. Comm’r, 88 F.3d 445, 448
(7th Cir. 1996). As we have noted repeatedly, “we owe
no special deference to the Tax Court on a legal question,
but when we consider the application of the legal prin-
ciple to the facts we will reject the Tax Court decision
only if it is clearly erroneous.” Whittle v. Comm’r, 994
F.2d 379, 381 (7th Cir. 1993). See also Gunther v. Comm’r,
909 F.2d 291, 294 (7th Cir. 1990); Prussner v. United States,
896 F.2d 218, 224 (7th Cir. 1990).
As a general rule, “[n]o gain or loss shall be recognized
if property is transferred to a corporation by one or more
persons solely in exchange for stock in such corporation
and immediately after the exchange such person or per-
No. 01-3638 5
sons are in control (as defined in [I.R.C.] section 368(c))4 of
the corporation.” I.R.C. § 351(a). However, I.R.C. § 357(c)(1)
provides the following exception to the non-recognition
provision of § 351(a):
[I]f the sum of the amount of the liabilities assumed
exceeds the total of the adjusted basis of the property
transferred pursuant to [a § 351] exchange, then such
excess shall be considered as a gain from the sale or
exchange of a capital asset or of property which is not
a capital asset, as the case may be. I.R.C. § 357(c)(1).
The Seggermans’ theory can be summarized as follows:
Because they remained liable as guarantors on the debts
assumed by the Corporation or debts to which property
transferred to the Corporation was subject, the amount
by which the transferred liabilities exceeded transferred
assets should not be recognized as taxable gain. The Seg-
germans acknowledge that § 357(c) provides on its face
that the excess amount must be recognized as a gain
and that the case law in this jurisdiction favors such
recognition. Nevertheless, they contend that the Tax
Court erred in reaching a result that is entirely consis-
tent with both statutory and case law. They urge this
Court to disregard a long line of controlling precedent
because, though it has not been overruled, it is somehow
“outdated.” They analogize to cases which are factu-
ally distinguishable from this one and then suggest that
it was reversible error for the Tax Court “mechanically
4
I.R.C. § 368(c) defines “control” as “the ownership of stock
possessing at least 80 percent of the total combined voting power
of all classes of stock entitled to vote and at least 80 percent of
the total number of shares of all other classes of stock of the
corporation.” Notwithstanding the distribution of shares in the
Corporation to individual Seggerman family members, the
Seggermans’ collective ownership and control of the Corporation
clearly satisfy the 80 percent control requirement of § 368(c).
6 No. 01-3638
[to have] distinguished away” those precedents. Finally,
the Seggermans argue, in the alternative, that this Court
should exercise its equitable power to craft a judicial
exception to the plain statutory language of § 357(c). These
arguments are unavailing.
The Seggermans first contend that the Tax Court’s
reliance on Rosen v. Commissioner, 62 T.C. 11 (1974), and
Testor v. Commissioner, 327 F.2d 788 (7th Cir. 1964), was
misplaced because the “strict” and “mechanical” interpre-
tations of the Rosen and Testor courts reflect “outdated”
precedent. In Rosen, the Tax Court stated that “there is no
requirement in section 357(c)(1) that the transferor be
relieved of liability” for a gain to be recognized in a trans-
fer of liabilities in excess of assets, noting that the provi-
sion “may produce a harsh result [and] . . . may even re-
sult in the realization of a gain for tax purposes where
none in fact exists.” Rosen, 62 T.C. 18, 19. In Testor, this
Court held “that both the language and the legisla-
tive history indicate that § 357(c) is meant to apply wher-
ever liabilities are assumed or property is transferred
subject to liability.” Testor, 327 F.2d at 790. That the
interpretations adopted in Rosen and Testor were either
restrictive5 or mechanical takes nothing away from their
precedential value. After all, statutory interpretation is
precisely the business of the judiciary. It is well within
the ambit of this (or any other) Court to interpret statu-
tory language as restrictively or mechanically as it deems
appropriate, so long as it respects the bounds of control-
5
With respect to Testor, the Seggermans’ conclusion that this
Court’s interpretation of § 357(c) was too restrictive is simply
wrong. In fact, this Court stated in response to the petitioner’s
argument in that case that “[w]e cannot agree that 357(c) should
be given such a restrictive interpretation.” 327 F.2d at 790. Thus,
our interpretation was less—rather than more—restrictive than
that suggested by the petitioner.
No. 01-3638 7
ling precedent and the Constitution. Nor does the age of
the Rosen and Testor holdings diminish their precedential
weight, contrary to the Seggermans’ assertion that the
Tax Court relied on “outdated Court of Appeals decisions,
including a 1964 case from this Seventh Circuit Court of
Appeals.” There is simply no merit to the proposition that
precedent somehow becomes less binding solely with the
passage of time.6 In short, the Seggermans provide no
controlling case law that overrules Rosen and Testor, and
the Tax Court properly relied on that precedent in reach-
ing its decision.
The Seggermans urge this Court to depart from the law
of this jurisdiction in favor of what they term “the emerg-
ing equitable interpretation of section 357(c).” They rely
on Lessinger v. Commissioner, 872 F.2d 519 (2nd Cir.
1989), and Peracchi v. Commissioner, 143 F.3d 487 (9th Cir.
1998), cases in which taxpayers were permitted to avoid
§ 357(c)(1) gain recognition despite liabilities transferred
in excess of assets, as illustrative of this so-called emerg-
ing equitable interpretation.
In Lessinger, a loan receivable owed by the taxpayer
equal in amount to the excess of liabilities transferred
over assets was recorded on the corporate books of the
transferee corporation. Lessinger, 872 F.2d at 521. The
Second Circuit held that the loan receivable represented
a genuine debt, and thus the taxpayer realized no gain
on the transfer under § 357 because liabilities transferred
equaled assets transferred. Id. at 524-28. In Peracchi, a tax-
6
Such flawed logic flies in the face of not only the basic principle
of stare decisis, but also our common law tradition generally, and
calls into question the well-established authority of such land-
mark but decades-old Supreme Court decisions as Marbury v.
Madison, 5 U.S. 137 (1803), and Erie Railroad Company v.
Tompkins, 304 U.S. 64 (1938), solely on the basis of their ages.
8 No. 01-3638
payer transferred encumbered real property to his wholly-
owned corporation, and liabilities transferred exceeded his
adjusted bases in the transferred property by $566,807.
Peracchi, 143 F.3d at 488. The taxpayer also contributed
a $1,060,000 note to the corporation. Id. at 489. The Ninth
Circuit held that the taxpayer had a basis of $1,060,000
in the note, that the note represented genuine indebted-
ness, and that, therefore, the aggregated basis of trans-
ferred property exceeded transferred liabilities. Id. at 494-
95.7 Therefore, no taxable gain was recognized on the
transfer.
In the instant case, the Seggermans assert that the
personal liabilities they retained as guarantors of the
Corporation’s debt are analogous to the loan receivable
and promissory note involved in Lessinger and Peracchi,
respectively. The Tax Court disagreed, and so do we. As
the Tax Court explained, the Seggermans’ “personal guar-
anties of corporate debt are not the same as incurring
indebtedness to the corporation because a guaranty is
merely a promise to pay in the future if certain events
should occur. [Their] guaranties do not constitute econ-
omic outlays.” Seggerman, T.C. Memo. 2001-99 at 11 (cit-
ing Estate of Leavitt v. Comm’r, 875 F.2d 420, 422 (4th
Cir. 1989) (holding that taxpayers experienced no call
as guarantors, engaged in no economic outlay, and suf-
fered no cost), aff’g. Leavitt, 90 T.C. 206 (1988); Brown v.
Comm’r, 706 F.2d 755,756 (6th Cir. 1983) (“the courts
have consistently required some economic outlay by the
guarantor in order to convert a mere loan guaranty into
an investment”), aff’g. Brown, 42 T.C.M. 1460
(1981)). Thus, to the extent that any such “emerging equi-
table interpretation” can be gleaned from the cases upon
7
The $1,060,000 note offset the $566,807 excess liabilities,
resulting in an aggregate transfer of assets to the corporation
in excess of liabilities in the amount of $493,193. Ibid.
No. 01-3638 9
which the Seggermans rely, those cases are entirely dis-
tinguishable from this one. Accordingly, we hold that
where a taxpayer retains liability as a guarantor on debts
transferred pursuant to I.R.C. § 351, the plain language
of § 357(c) nonetheless requires that the amount by which
transferred liabilities exceed the taxpayer’s basis in the
transferred assets be recognized as taxable gain.
Lastly, we are unpersuaded by the Seggermans’ sug-
gestion that this Court ought to exercise its general equi-
table power to fashion a case-specific exception to the
clear and unambiguous provisions of § 357(c). While we
recognize that the practical effects of § 357 subject the
Seggermans to harsh tax consequences—indeed, conse-
quences that they may not have contemplated in the plan-
ning stages of the incorporation and property trans-
fer transactions—we decline to disregard the plain language
of the tax code. For this Court to “aid the legislative
amendment process by pointing out the unjust dilemma
facing the Petitioners [by] reversing the Tax Court in this
case,” as the Seggermans would have us do, would be
to exceed the scope of our judicial function. Absent any
ambiguity on the face of a statute, it is the province of
the legislative branch, rather than the judiciary, to safe-
guard the taxpayer from undue hardship resulting from
its application.8 Thus, the Tax Court correctly applied
I.R.C. § 357(c) to the Seggermans’ transfers of property
to the Corporation.
8
An intrusion by the judiciary into what is constitutionally a
function within the exclusive scope of the legislature would raise
serious issues relating to the separation of powers. For that
reason we are, as was the Rosen court, “loath to find that the
result[ing recognition of gain] exceeds the constitutional powers
to tax vested in Congress.” Rosen, 62 T.C. 19.
10 No. 01-3638
CONCLUSION
The Tax Court correctly upheld the deficiency deter-
minations of the Commissioner for unreported recogniz-
able gain related to the Seggermans’ transfers of property
to the Corporation. We therefore AFFIRM the decision of
the Tax Court.
A true Copy:
Teste:
________________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—10-24-02