                        T.C. Memo. 2002-37



                      UNITED STATES TAX COURT



ALEXANDRA S. YANKWICH, f.k.a. ALEXANDRA Y. CAPPS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5028-00.               Filed February 8, 2002.



     Donald S. Higley II and Amy Alston Wells, for petitioner.

     Edwina L. Charlemagne, for respondent.



                        MEMORANDUM OPINION


     PAJAK, Special Trial Judge:   Respondent determined

deficiencies of $3,812, $3,588, and $6,222 in petitioner’s

Federal income taxes for the taxable years 1995, 1996, and 1997,

respectively.   Unless otherwise indicated, section references are

to the Internal Revenue Code in effect for the years in issue,

and all Rule references are to the Tax Court Rules of Practice
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and Procedure.

     After concessions by the parties, this Court must decide

whether amounts received from petitioner’s former spouse under a

separation agreement are taxable to petitioner.

     Some of the facts in this case have been stipulated and are

so found.   Petitioner resided in Raleigh, North Carolina, at the

time she filed her petition.

     Petitioner married Robert L. Capps (Dr. Capps), a licensed

dentist, in 1978.   A son, Alexander, was born of the marriage.

Petitioner and Dr. Capps were divorced on May 22, 1995.

     In 1986, Dr. Capps formed Robert L. Capps, D.D.S., P.C.

(Corporation).   Dr. Capps owned 100 percent of the Corporation

until it was dissolved in 1997.

     The Corporation entered into a dental practice partnership

(Partnership) with Mark Bowman, D.D.S. (Dr. Bowman).   On May 1,

1992, Dr. Bowman executed a promissory note (Note) in favor of

the Corporation to acquire his Partnership interest.   The Note

has an original principal amount of $366,677 and is payable in

monthly installments of $4,644.76, including an annual rate of

interest of 9 percent.

     On or about March 31, 1994, petitioner and Dr. Capps entered

into a Separation Agreement and Property Settlement (Separation

Agreement), consisting of 62 pages and a schedule of 9 pages.

Section X.C of the Separation Agreement provides, in part:
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         In connection with the purchase by Mark Bowman,
    D.D.S., of an interest in the partnership, now known as
    Capps and Bowman, Bowman executed a Promissory Note dated
    May 1, 1992 in the original amount of Three Hundred
    Sixty-Six Thousand, Six Hundred Seventy-Seven Dollars
    ($366,677.00) in favor of Robert Capps, D.D.S., PC, which
    said Promissory Note is repayable in monthly installments
    of Four Thousand, Six Hundred Forty-four and 76/100
    Dollars ($4,644.76) on the first (1st) day of each
    calendar month over a ten (10) year period with interest
    at the rate of nine percent (9%) per annum beginning June
    1, 1992 with monthly payments thereafter until paid in
    full. Husband [Dr. Capps] hereby agrees that as and when
    Husband receives payments under the terms of the
    Promissory Note, Husband shall pay to Wife [petitioner]
    the full sum of One Thousand, Seven Hundred Fifty Dollars
    ($1,750.00) until such Promissory Note is paid in full,
    or otherwise is satisfied or becomes uncollectible.

     Although it appears to the Court that the Corporation owned

the Note, that Dr. Bowman made payments to the Corporation, that

Dr. Capps received moneys from the Corporation, and that Dr.

Capps made payments to petitioner, Dr. Capps and petitioner

seemed to treat the Note as owned by Dr. Capps.   Because it makes

no difference in our ultimate resolution of this case, we

generally will consider the matter as did Dr. Capps and

petitioner.

     Dr. Capps testified that he considered the Note to be part

of the “business marital division of the marriage.”   He would

make payments to petitioner only if Dr. Bowman paid him.    Dr.

Capps also said that Dr. Bowman was to continue paying him and

then he (Dr. Capps) would issue a check to petitioner.    The

monthly payments to petitioner were to continue until the

Corporation’s Note was paid in full or otherwise became
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uncollectible.

     Section X.C of the Separation Agreement also provides, in

part:

             The parties stipulate and agree that Calvin Shearin,
        the Certified Public Accountant of the parties during
        their marriage, shall determine a proportional allocation
        of principal and interest, which is attributable to the
        payment which Husband and Wife receive from time to time
        so that the parties can properly report such receipts on
        their respective income tax returns.

        Petitioner received payments totaling $21,000 in each of the

years 1995, 1996, and 1997 pursuant to section X.C of the

Separation Agreement.     Mr. Calvin Shearin (Mr. Shearin) testified

that he made the allocations of principal and interest for Dr.

Capps and petitioner in accordance with the Separation Agreement.

Petitioner reported the following amounts of interest income on

her respective Federal income tax returns:

                  Year       Interest Income Reported

                  1995                   $9,992
                  1996                    8,960
                  1997                    7,732

     On April 11, 1997, petitioner filed a Form 1040X, Amended

U.S. Individual Income Tax Return, for 1995 to claim a refund of

the 1995 taxes paid on capital gain income of $11,006, which had

been allocated under the Separation Agreement.

     Petitioner contends that she is not liable for any capital

gain income associated with the receipt of the $1,750 monthly

payments for the years in issue.      Additionally, petitioner
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asserts that she is not taxable on the interest income amounts

reported on the returns for the years in issue.   In the notice of

deficiency, respondent determined that petitioner is taxable on

the capital gains associated with the monthly payments received

by petitioner with respect to each of the years in issue.    At

trial, respondent conceded that some portion of each payment

received by petitioner represents a nontaxable return of capital.

Under this Court’s disposition of this issue, this concession is

moot.   Respondent also argues that the interest income is taxable

to petitioner in each of the years in issue.

     Section 1041(a) provides that no gain or loss is recognized

on a transfer of property from an individual to a spouse, or to a

former spouse if made incident to a divorce, and such transfers

are nontaxable gifts under sections 1041 and 102.     Balding v.

Commissioner, 98 T.C. 368, 373 (1992).   A transfer of property is

“incident to the divorce” if the transfer occurs not more than

one year after the date on which the marriage ceases or the

transfer is related to the cessation of marriage.   Sec. 1041(c).

A transfer of property is related to the cessation of marriage if

the transfer is pursuant to a divorce or separation instrument,

as defined in section 71(b)(2), and the transfer occurs not more

than six years after the cessation of the marriage.    Sec. 1.1041-

1T(a), Q&A-7, Temporary Income Tax Regs., 49 Fed. Reg. 34453

(Aug. 31, 1984).   Section 71(b)(2) defines a divorce or
                                 - 6 -

separation instrument as including a decree of divorce or a

written separation agreement.

     There is no question but that the Separation Agreement is

incident to the divorce between petitioner and Dr. Capps.       We

note that the Separation Agreement was referred to in their

divorce decree.    The Separation Agreement qualifies as a

separation agreement within the meaning of section 71(b)(2).         The

transfer of each payment was related to the cessation of the

marriage between petitioner and Dr. Capps, occurred less than 6

years after the cessation of that marriage, and was made to

effect the division of marital property between petitioner and

Dr. Capps.    Therefore, section 1041(a) applies to part or all of

each $1,750 monthly payment from Dr. Capps to petitioner.

     Section 453B(a) provides that if an installment obligation

is satisfied for less than face value, distributed, transmitted,

sold, or otherwise disposed of, gain or loss shall result.

Section 453B(a) does not apply to transfers of installment

obligations between spouses incident to a divorce as described in

section 1041(a).    Sec. 453B(g)(1).     In that case, the same tax

treatment with respect to the transferred installment obligation

applies to the transferee as would have applied to the

transferor.   Sec. 453B(g)(2).   Respondent argues that petitioner

became a transferee with respect to the portion of the Note

represented by the $1,750 monthly payments and that she should be
                                 - 7 -

taxed pursuant to section 453B(g).

     The Note was not assigned or otherwise transferred to

petitioner.    The Corporation was not a party to the Separation

Agreement.    There is nothing in the record to show that the

Corporation, as the payee under the terms of the Note,

transferred any ownership rights to petitioner.    Petitioner had

no rights to enforce the Note between the Corporation and Dr.

Bowman.   Dr. Capps paid petitioner $1,750 monthly with funds he

received.

     Respondent argues that the legal effect of the Separation

Agreement was to transfer to petitioner a beneficial ownership

interest in that portion of the Note represented by her receipt

of the $1,750 monthly payment.    Respondent relies on Friscone v.

Commissioner, T.C. Memo. 1996-193, which found that beneficial

ownership of stock owned by a former spouse had been transferred

to a spouse by a divorce court award of 55 percent of any and all

proceeds derived from the sale of stock where the stock could not

be transferred directly to the wife due to a buy-sell agreement.

     Friscone is distinguishable, because among other things,

there was no divorce court award of a percentage of the Note to

petitioner.    Moreover, in Urbauer v. Commissioner, T.C. Memo.

1997-227, this Court distinguished Friscone on its particular

facts and determined that a spouse’s 75-percent interest in the

proceeds from the sale of a house under the terms of a property
                               - 8 -

settlement did not result in the spouse becoming the beneficial

owner of 75 percent of the house.   The Court in Urbauer v.

Commissioner, supra, noted there was no impediment to a division

by the divorce court of the ownership of the house, but the

divorce court chose not to effect a change in ownership.    Like

Urbauer, in this case there was no restriction on the transfer of

the Note from the Corporation to petitioner, but no such transfer

was made.   The Note specifically provided for subsequent payees.

Although the Note provided that the Corporation was the original

payee, the term also included “any party who may subsequently

hold an interest in this Note.”   There actually was no change in

the Corporation’s ownership of the Note.    We hold that there was

no beneficial ownership by petitioner in the Note executed

between the Corporation and Dr. Bowman.    Since there was no

transfer of the Note or of a beneficial interest in the Note,

section 453B(g) is not applicable in this case.

     Petitioner’s receipt of $1,750 each month from Dr. Capps

falls under section 1041.   As discussed above, under section

1041(a), no gain or loss is recognized on the transfer of

property from an individual to a spouse, or to a former spouse if

the transfer is incident to divorce.   Balding v. Commissioner, 98

T.C. 368 (1992).   But there is another factor to consider.     In

Gibbs v. Commissioner, T.C. Memo. 1997-196, this Court held that

the nonrecognition provided in section 1041 does not apply to
                                  - 9 -

interest income received by a spouse.        We noted that section 1041

“does not provide for the exclusion of income; it provides for

the nonrecognition of gain or loss under the circumstances

described therein.”     Id.   In Gibbs, the taxpayer recognized that

each payment she received under the terms of the divorce decree

consisted partially of principal and partially of interest.        The

Court held that the principal portion and interest portion of the

installment payments the petitioner received were “two distinct

items that give rise to separate Federal income tax

consequences.”    Id.   The principal portion was subject to section

1041, but the interest portion was not.        Id.

     The Separation Agreement provided that Mr. Shearin would

ultimately determine the division between principal and interest

for both petitioner and Dr. Capps.        We conclude that Dr. Capps

agreed to pay petitioner monthly payments which included unstated

interest to compensate petitioner for payments made over time,

and, pursuant to the Separation Agreement, Mr. Shearin was

delegated and performed the task of “stating” such interest for

tax purposes.    Petitioner acquiesced in the allocation made by

Mr. Shearin as is evident by the fact that she included the

amount of her proceeds allocated to interest on her respective

Federal income tax returns.

     We hold that the portion of petitioner’s monthly payments

which was allocated by Mr. Shearin to principal is not taxable to
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her.   Sec. 1041(a); Balding v. Commissioner, supra.     We also hold

that the portion of the monthly payments which was allocated to

interest under the terms of the Separation Agreement is taxable

to petitioner.    Gibbs v. Commissioner, supra.

       One other matter needs to be addressed.    Respondent

determined that petitioner did not qualify for the filing status

of head of household for 1997.     The petition failed to address

the issue, and the record is silent on this point.      We deem this

issue conceded by petitioner.

       To reflect the foregoing,

                                           Decision will be entered

                                      under Rule 155.
