## Facts

- Robert E. Frane owned stock in his closely held business, Sherwood Grove Co.
- In four separate agreements, Frane sold stock to each of his four children.
- Each child gave Frane a 20-year installment note with principal of $141,050.
- Each note was a “death-terminating” (self-canceling) installment note: if Frane died before final payment, the unpaid principal and interest would be “canceled and extinguished” as though paid at death.
- The notes carried an unusually high stated interest rate of 12%.
- At the time of the sales, Frane was 53 years old and had a life expectancy longer than the 20-year note term.
- Frane received two annual payments and reported gain using the installment method under I.R.C. § 453.
- Frane died in 1984. After his death, the children made no further payments because the notes terminated under their terms.
- In 1986, Sherwood Grove Co. liquidated its assets.
- Two children reported a capital loss on the liquidation, using a basis equal to the amounts actually paid on their notes rather than the notes’ face amounts; the other two children reported no gain or loss from the liquidation.
- Neither Frane’s final income-tax return nor the estate’s return reported income from the notes’ cancellation at death.
- The Commissioner issued deficiency notices asserting that the note cancellation triggered recognition of the remaining deferred installment-sale gain and that the gain was taxable to Frane (on his final return), not the estate.
- The Tax Court ruled for the Commissioner, treating the obligations as canceled under I.R.C. § 453B(f) and taxing the resulting gain to Frane on his final return.
- The estate and personal representative appealed.

## Issues

1. Whether the automatic termination of related-party installment notes at the seller’s death is a “cancellation” or event making the obligation “unenforceable” under I.R.C. § 453B(f), requiring recognition of the remaining deferred installment-sale gain.
2. If § 453B(f) applies, whether the resulting gain is reportable by the decedent on the final individual return or by the decedent’s estate.

## Decision

- The court held that the notes’ automatic termination at Frane’s death was a cancellation (or becoming unenforceable) within the meaning of I.R.C. § 453B(f), triggering recognition of the remaining deferred gain.
- The court rejected the argument that “cancellation” under § 453B(f) must be an event independent of the original bargain; a cancellation clause built into the notes still produces a cancellation when the condition occurs.
- The court held that the accelerated gain was taxable to Frane on his final income-tax return (rather than as income of the estate).
- The court affirmed the Tax Court’s judgment on the core tax consequences of the death-terminating notes, while issuing a mixed disposition (“affirmed in part and reversed in part”) on other aspects not changing that bottom-line result.

## Legal Principles

- Under I.R.C. § 453B(f), if a related-party installment obligation is canceled or otherwise becomes unenforceable, the obligee must recognize income measured by the difference between the obligation’s basis and its face amount, accelerating unreported installment-sale gain.
- A self-canceling (“death-terminating”) installment note can become unenforceable by its own terms at the seller’s death, and that event falls within § 453B(f).
- The fact that the parties priced mortality risk into the transaction (including by using an above-market interest rate) does not prevent § 453B(f) from applying when the obligation terminates at death.
- For these related-party installment obligations, the gain accelerated by the death-triggered cancellation is includible on the decedent’s final income-tax return rather than being shifted to the estate.

## Conclusion

Frane’s sale of stock to his children using death-terminating installment notes produced taxable income when Frane died and the notes automatically became unenforceable: I.R.C. § 453B(f) treated the termination as a cancellation that accelerated the remaining deferred installment-sale gain, and the Eighth Circuit held that the gain had to be reported on Frane’s final income-tax return, not by his estate.


Frane v. Commissioner, 998 F.2d 567 (1993)