Contents

§ 4.8 STEP TRANSACTION DOCTRINEThe IRS argued that the donor employed the university as a tax-free conduitfor withdrawing funds from the corporation and that the redemption payments bythe corporation to the university were in reality constructive dividend payments tothe donor. The court on appeal nicely framed the dispute: “[O]ur aim is to determinewhether [the donor’s] gifts of the [c]orporation’s shares [to the university]prior to redemption should be given independent significance or whether theyshould be regarded as meaningless intervening steps in a single, integrated transactiondesigned to avoid tax liability by the use of mere formalisms.” 78The IRS wanted the court to “infer from the systematic nature of the giftredemptioncycle” that the donor and donee had “reached a mutually beneficialunderstanding.” 79 But the court declined to find any informal agreementbetween the parties; it also declined to base tax liability on a “fictional one” createdby the IRS. 80 The court so held even though the donor was the majorityshareholder of the corporation, so that his vote alone was sufficient to ensureredemption of the university’s shares. The court wrote that “foresight and planningdo not transform a non-taxable event into one that is taxable.” 81In still another instance, an individual donated promissory notes issued by acompany he controlled to three charitable foundations several weeks prior totheir redemption. A court held that he did not realize income in connection withthese gifts or the subsequent redemption of the notes by the company. The courtobserved: “A gift of appreciated property does not result in income to the donorso long as he gives the property away absolutely and parts with title theretobefore the property gives rise to income by way of a sale.” 82In one more instance involving facts of this nature, the court took note of thefact that the concept of a charitable organization originated before and independentlyof the sale, the deed of trust for the property contributed was executedbefore and independent of the sale, and at the time the deed of trust was executed,“no mutual understanding or meeting of the minds or contract existedbetween the parties.” 83There are cases to the contrary, however, holding that the transfer of theproperty to a charitable organization “served no business purpose other than anattempt at tax avoidance.” 84In the end, perhaps the matter of the doctrine comes down to this: “Useful asthe step transaction doctrine may be in the interpretation of equivocal contractsand ambiguous events, it cannot generate events which never took place just soan additional tax liability might be asserted.” 8578 Grove v. Commissioner, 490 F.2d 241, 246 (2d Cir. 1973).79 Id. at 246.80 Id. at 247.81 Id.82 Humacid Co. v. Commissioner, 42 T.C. 894, 913 (1964). This observation is well quoted (e.g., Grove, 490 F.2dat 246; Carrington v. Commissioner, 476 F.2d 704, 708 (5th Cir. 1973)).83 Martin v. Machiz, 251 F. Supp. 381, 390 (D. Md. 1966).84 Magnolia Dev. Corp. v. Commissioner, 19 T.C.M. (CCH) 934, 937 (1960). Also Palmer v. Commissioner, 468F.2d 705 (10th Cir. 1972); Tatum v. Commissioner, 400 F.2d 242 (5th Cir. 1968); Friedman v. Commissioner,346 F.2d 506 (6th Cir. 1965).85 Sheppard v. United States, 361 F.2d 972, 978 (Ct. Cl. 1966). Also Behrend v. United States, 73-1 U.S.T.C. 9123 (4th Cir. 1972); Fox v. Commissioner, 27 T.C.M. (CCH) 1001 (1968). 141