## Facts

- Fehrs Rental Corporation was a closely held family corporation; Edward and Violette Fehrs constructively owned about 98.2% of Rental’s shares.
- The Fehrs daughters organized Fehrs Finance Company; through attribution rules, Edward and Violette were treated as owning 100% of Finance.
- Finance acquired Edward and Violette’s Rental shares in exchange for unsecured private annuities of $70,000 per year for each of their lifetimes.
- Soon after acquiring the shares, Finance resold the same Rental shares to Rental for $100,000 cash plus an unsecured $625,000 promissory note.
- Evidence showed that commercially priced annuities to discharge Finance’s annuity obligations would have cost substantially less than the $725,000 cash-and-note consideration received from Rental.
- The Commissioner determined an income tax deficiency, treating Finance’s resale as producing taxable capital gain and viewing the overall arrangement as the functional equivalent of a redemption/distribution.
- Finance sought redetermination, arguing the steps should be respected separately and that its “cost” in the stock should reflect the annuity obligation as undertaken.

## Issues

1. Whether Finance’s acquisition of the parents’ Rental stock and immediate resale to Rental should be integrated and treated in substance as Rental’s redemption of the parents’ stock, with Finance acting as a conduit.
2. How to determine Finance’s basis in the Rental stock acquired in exchange for an unsecured private annuity—face amount of expected payments or actuarial present value.
3. Whether Finance realized taxable capital gain on the resale to Rental measured by the excess of the sale price over the actuarial value of the annuity obligation, and whether the arrangement implicated redemption/dividend principles.

## Decision

- The Tax Court largely sustained the Commissioner’s deficiency determination.
- The court treated the steps as a single integrated transaction equivalent to a redemption of the parents’ stock by Rental, rejecting reliance on formal interposition of Finance.
- Finance’s basis in the stock was measured by the actuarial present value of the annuity obligation at issuance, not by the nominal amount of consideration later received from Rental.
- Because Finance resold the stock for $725,000 (cash plus note) and its actuarial “cost” was less, Finance realized taxable gain on the resale.

## Legal Principles

- Federal income tax consequences depend on the substance of a transaction; prearranged, interdependent steps may be collapsed under the step-transaction doctrine.
- When property is acquired in exchange for an unsecured private annuity, the acquirer’s basis generally equals the annuity’s actuarial present value at the time of issuance, not the aggregate of possible future payments.
- Interposing a controlled related corporation will not alter redemption/distribution characterization where the economic effect is a shareholder extraction of corporate value without a meaningful change in ownership.

## Conclusion

The Tax Court recharacterized the family’s stock-annuity plan as, in substance, a redemption/distribution transaction and held that Finance’s basis in the acquired stock equaled the annuity’s actuarial value, causing Finance to recognize taxable gain when it immediately resold the stock to Rental for cash and an unsecured note.


Fehrs Fin. Co. v. Comm’r, 58 T.C. 174 (1972)