Those interest-free loans - includes other tax information - column

Nation's Business, May, 1984 by Gerald W. Padwe

We have always known there is no such thing as a free lunch. Now the Supreme Court has extended the rule so that there is no such thing as an interest-free loan--at least when gift taxes are involved.

In late February, the Court handed down its much-awaited decision in Dickman V. Commissioner, sustaining the Internal Revenue Service's position that intrafamily demand loans, on an interest-free or low-interest basis, include a gift element--the value of the use of money to the debtor, less the amount of interest paid to the lender.

Chief Justice Warren Burger, writing for the 7-2 majority, also allowed IRS' valuation of the interest element in dickman: IRS imputed the statutory interest rate--currently 11 percent--on tax deficiencies or refunds to the face amount of the loan.

In a relatively short paragraph that may cause significant problems for some taxpayers, the Court also held it perfectly proper for IRS to attack intrafamily loan relationships retroactively. Thus, if no gift tax return has been filed for such loans in the past--because a taxpayer believed no gift was involved--IRS can go after whay may be some very old years.

The great majority of taxpayers will not be affected by the Dickman decision. Since 1982, a taxpayer has been allowed to give up to $10,000 apiece annually to any number of donees without having to file a gift tax return. (If a husband and wife elect to treat a gift as two gifts of equal size, one made by each of them, there is an effective $20,000 annual exclusion.)

Even when the $10,000 exclusions are exceeded, no tax need be paid until such transfers, cumulatively, exceed an exemption that is available against either gifts during life or bequests after death. The amount in 1984 is $325,000.

further, even though the Dickman decision allowed IRS to use the statutory interest rate, the Court recognized that the value of the loan's gift element could be reduced because it is payable on demand rather than at a fixed point in the future.

Using the IRS approach, today's 11 percent interest rate would still permit a loan balance of $90,000 before the gift element exceeded the donor's annual gift tax exclusion of $10,000. For combined husband-wife gifts, a $180,000 loan could come within the exclusions.

In other words, interest-free loans as intrafamily planning devices are not dead. For many they still represent an excellent planning opportunity.

Warning: Congress also is scrutinizing interest-free loans, those among family members and those from a corporation to an employe or shareholder. If any tax legislation is passed in 1984, some provision affecting such loans is likely to be included. AT&T Divets: Round Two

Last month's column provided some guidance for those of you deciding how to handle fractional share distributions from old American Telephone & Telegraph, made as a result of its Jan. 1, 1984, divestiture. Involved were fractional shares in the new regional holding companies for pre-1984 AT&T shareholders owning betwen 10 and 500 shares. The article listed the relative fair market value of the regionals on January 1 and explained how to allocate tax cost in the original AT&T shares to any interest in the regionals (including fractional shares) that might be sold.

There is an additional complicating factor that must be considered. In a 56-page, single-spaced private ruling, IRS has spelled ot its view on most of the tax consequences of the AT&T divestiture. One of the points made in the ruling: A yet-to-be-determined percentage of the Pacific Telesis stock received in the distribution to olkd AT&T shareholders represents a taxable divident to those shareholders, even if none of the Pacific Telesis stock is sold.

In IRS' view, an earlier transaction involving old AT&T and Pacific Telephone & Telegraph--Pacific Telesis' predecessor company--makes a small part of the Pacific Telesis distribution taxable, even before fractional share sales.

Counsels for AT&T disagrees with the IRS position and argues that the entire original distribution is tax-free. But the company estimates that, even if the IRS position prevails, only about 7 percent of the Pacific Telesis stock will be treated as a divident. The remaining 93 percent will still be tax-free.

Should the IRS position ultimately be upheld--and an IRS ruling is only an opinion, not a final decision--a new calculation would be required as to the relative fair market values on Jan. 1, 1984, of the tax-free part of the distribution of Pacific Telesis. If 7 percent of that stock is a dividend, only 93 percent of its January 1 market value, rather that 100 percent, goes into the allocation formula.

Assume a shareholder has 100 shares of old AT&T. He receives 10 shares of each regional as a result of the divestiture. Average market value per share of Pacific Telesis of Jan. 1, 1984, was $55.78. Thus, of the $557.80 market value of those 10 shares, 7 percent (or $39.05) is a taxable dividend rather than a tax-free distribution--if IRS is correct.