## Facts

- John A. Arnes and Joann Arnes formed Moriah Valley Enterprises, Inc. (“Moriah”) to operate a McDonald’s franchise, and together they owned all of Moriah’s stock.
- McDonald’s required the franchise operator to own 100% of the equity and receive 100% of the profits, which affected how the couple could divide their ownership after divorce.
- In connection with their divorce, John and Joann entered into an agreement (incorporated into the state dissolution decree) under which Moriah would redeem Joann’s 50% stock interest for $450,000, payable in monthly installments.
- Because Joann’s basis in her shares was low, the redemption price would have produced substantial gain if treated as a taxable redemption.
- Joann reported gain on her 1988 federal return for amounts received that year, then filed a refund claim asserting that the redemption was a nonrecognition transfer incident to divorce under I.R.C. § 1041 because it was made “on behalf of” John.
- The IRS disallowed the refund; Joann sued in federal district court and won. The government appealed and the appellate court affirmed, leaving in place the determination that Joann recognized no gain under § 1041.
- While Joann’s refund litigation was pending, the IRS issued John a “protective” notice of deficiency for 1987 and 1988, asserting that if Joann did not recognize the gain, John should be taxed on the redemption instead.
- John petitioned the U.S. Tax Court. The case came to the court on cross-motions for partial summary judgment under Tax Court Rule 121.

## Issues

1. Whether the Commissioner could sustain a protective deficiency against John by taxing him on gain from the same divorce-related stock redemption after federal courts had already held, in litigation with Joann, that the transaction was a nonrecognition transfer under I.R.C. § 1041.
2. Whether, on the undisputed record, summary judgment should be entered for John because the government could not relitigate the tax consequences of the redemption by shifting the tax to the other spouse.

## Decision

- The Tax Court granted summary judgment for John and denied the Commissioner’s motion.
- The court held that the Commissioner could not impose tax on John for gain from the redemption under the circumstances, given the prior final federal-court determination that Joann’s transfer was a § 1041 nonrecognition transfer made on John’s behalf.
- The court rejected the attempt to collect tax on the same economic gain by taking an inconsistent position in a separate proceeding against the other former spouse.
- As a result, the deficiencies asserted against John for 1987 and 1988, to the extent based on taxing him on the redemption gain, could not be sustained on the summary-judgment record.

## Legal Principles

- I.R.C. § 1041 generally provides nonrecognition for transfers of property between spouses or former spouses if incident to divorce, and can apply when a transfer is structured through a third party (such as a corporation) if the transfer is made on behalf of a spouse.
- When the government has fully litigated the tax treatment of a specific transaction and lost, it cannot, in a later case, seek to tax the same transaction’s gain to a different taxpayer by advancing an inconsistent theory aimed at collecting the same tax again.
- “Protective” notices of deficiency may be issued to protect the revenue while related litigation is pending, but they still must stand on a valid legal basis when the Tax Court resolves the case.
- Summary judgment is appropriate under Tax Court Rule 121 when there is no genuine dispute of material fact and the moving party is entitled to judgment as a matter of law.

## Conclusion

Arnes v. Commissioner holds that, after federal courts determined in Joann Arnes’s refund case that the divorce-related corporate stock redemption was a § 1041 nonrecognition transfer made on John Arnes’s behalf, the IRS could not sustain a protective deficiency that attempted to tax John on the same redemption gain; the Tax Court entered summary judgment for John and refused to let the government shift the tax after losing on the transaction’s treatment.


Arnes v. Commissioner, 102 T.C. 522 (1994)