Superman’s Diamonds Revisited

Just over two years ago I discussed Superman’s (lack of) tax liability for crushing coal into diamonds and (actual) gift tax liability if he gave those diamonds to another person.  In the comments to that post I mentioned that Superman could theoretically avoid gift tax liability by performing the gratuitous service of crushing coal into diamonds rather than giving a finished diamond.  In this post I’d like to expand on that topic briefly.

I. Form Over Substance

Although it is true that gratuitous services are not taxed, it is also true that the IRS and the courts frown on tax avoidance schemes that attempt to exalt form over substance.  Gregory v. Helvering, 293 U.S. 465 (1935).  So a scheme by which Superman handed someone a piece of coal, fully intending to turn it into a diamond, then did so, would be tantamount to simply giving them a diamond.  The IRS would focus on the substance of the transaction, not the form, and consider it a taxable gift of property.

But if, for example, Superman were at someone’s house for a barbecue and decided to thank them for dinner by crushing a lump of their own charcoal into a diamond, that would be different.  In that case Superman really would be performing a gratuitous service.

This may seem like a fine distinction, but think of it in terms of a famous baseball player.  If the baseball player hands someone a baseball (retail value $3) and then signs it (market value $500), that’s not really a gratuitous service.  They’re really just giving the person a signed baseball.  But if the baseball player signs a baseball that the recipient already owns, then that is more clearly a service rather than a gift of property.

II. Engagement Rings

Superman has crushed coal into diamonds for various reasons, but one of the best known was his gift of a ring to Lana Lang in Superman III.  This raises an interesting question: is an engagement ring subject to gift tax?  There is, subject to certain qualifications, an unlimited marital deduction for gifts between spouses, but what about an engagement ring, which is given in anticipation of marriage?

The law surrounding engagement rings and other pre-nuptial gifts has a long and complex history, dating back to at least the Romans.  Most of the law has to do with who owns such gifts, particularly if the marriage is called off.  But it turns out that none of that matters for tax purposes.  If the donor and donee aren’t married at the time of the gift, then the marital deduction doesn’t apply.  26 U.S.C. § 2523(a).  So an engagement ring is subject to gift tax, even if the donor and donee get married later that same year.  In practice I suspect that few people actually report such gifts, even in the rare case where it would make a difference in their ultimate tax liability, but maybe Superman would actually be moral enough to do so.

III. Conclusion

Crushing coal into diamonds still doesn’t create tax liability for Superman, and he still has some ways to avoid liability if he crushes coal into diamonds for other people, but he has to be careful about it.  And strictly speaking he probably should have reported that ring he gave to Lana.

19 responses to “Superman’s Diamonds Revisited

  1. What if Superman gave me a piece of coal and then a day later crushed it into a diamond? Or a week? Or a year?

    • I suppose what I’m really asking is, after he gives it to me, when does it change from Superman crushing A piece of coal (a gift) into him crushing MY piece of coal (a service)?

      • WideAndNerdy

        I’m sure James can give you a better answer since this is federal income tax law and I was a state sales tax collector but here goes:

        Strictly speaking I believe what matters here is intent. Was it always Superman’s intent to give you a diamond? Is so then gift tax applies. In practice, as James mentioned, transactions that should be taxed are not particularly in situations where its easy to avoid notice.

        A similar situation arises with sales tax and repairs of tangible personal property. If a mechanic were to fix the timing belt on your car by slipping it back into place or cleaned dirt off your spark plugs so that they made better contact with your sockets, he is performing a pure labor service and his bill for labor is not subject to sales tax. But if he replaces the timing belt with a new one from his shop, the entire repair is subject to sales tax (last I checked, its been a few years) both what is billed for labor and what is billed for the belt. There is no getting around this, even if the mechanic were to charge nothing for the belt and bill it purely as labor. I believe however if you were to buy a timing belt on your own from another shop then go to a mechanic and pay him to take your old belt off and put your new belt on, that is purely labor and not subject to sales tax. I am not speaking on authority here but that’s how it was where I live back when I was a collector. I won’t say which state or who I am. This is just an example.

  2. Huh. And I guess that if the fiancee returned the ring prior to marrying (By US law, unless it’s a “traditional gift giving holiday”, the person who proposed can demand the ring back if one side breaks the engagement off), it would get taxed a second time as it changed hands again.

    Isn’t there a one-time gift rule? I remember mention of it in The Shawshank Redemption, and my parents took advantage of something of that sort to receive a one-time gift from my grandparents to buy their house.

    • Martha L. Voelz

      I do not recall the year Shawshank Redemption took place, as there may have been different tax rules at the time. However, most of the basics of gift tax law has been consistent. There are several things people can do without incurring gift tax in this day and age.

      First is the annual exclusion amount. You can give anyone a gift, up to the annual exclusion amount, during the year and not have to pay or report the gift. This year the exclusion amount is $14k. So I can stand on a street corner and pass out checks to random people for that amount without having to pay or report it. I cannot give the same person two checks as that would trigger a taxable event.

      Then, spouses can make unlimited gifts to each other without having to report or pay taxes.

      Finally, what people confuse with the “one-time gift” rule is actually the lifetime gift tax credit amount. Everyone can gift up to this amount to people over their lifetime and not have to pay tax, but there is reporting to the IRS. This lifetime credit is also related to estate tax, but that’s another story.

      As of this year, the lifetime exemption amount is $5.25 million. You can make it as one big gift or several gifts over the course of your life. If you are married, then a married couple can pool their gifting power and pass $10.5 million as they see fit.

      This latter giving vehicle may be what your parents used. Because your grandparents gifted more than the annual exemption amount they used some of their lifetime credit to gift money to your parents.

  3. My problem with this entire scenario is that it assumes a subjective value that may not even exist. The only reason natural diamonds are valuable is because they’re rare, and the only reason they’re rare is because De Beers manipulates the supply. Then when you consider man-made diamonds, their value is based on production costs and materials. So the question is, how could the IRS or anyone else accurately determine the value of a Superman diamond? It’s basically just a man-made diamond that Superman made with his bare hands instead of a giant machine. All it cost Superman to make is a lump of coal. If anything, it would gain greater value from its association to Superman rather than the fact that it’s a diamond. And if the IRS ever gave Superman any trouble, he could just start making diamonds at super-speed until there were so many that they were all virtually worthless.

    • how could the IRS or anyone else accurately determine the value of a Superman diamond?

      Its value would be appraised, just like any other rare thing.

      It’s true that Superman’s ability to make diamonds more or less at will could greatly devalue diamonds, but he evidently refrains from doing so, and so diamonds—whether natural or man-made—remain valuable. The reasons for their value are debatable, but their value is not: people will clearly pay a great deal of money for a diamond. Since Superman does not create a huge number of diamonds, his diamonds are, if anything, likely to be more valuable than normal because of their association with Superman, as you point out.

      And if the IRS ever gave Superman any trouble, he could just start making diamonds at super-speed until there were so many that they were all virtually worthless.

      In doing so he would cause significant economic harm to a lot of people. I’m not sure that fits Superman’s character. In any case, that wouldn’t work. The value of the gift would be based on the value at the time of the gift, not the later depreciated value. 26 U.S.C. § 2512(a) (“If the gift is made in property, the value thereof at the date of the gift shall be considered the amount of the gift.”) (emphasis added).

      • WideAndNerdy

        What about in Superman True Brit?

        In that comic, Superman was called on to perform great deeds, one of which was to pay off the British national debt. To do this, Superman made a huge quantity of diamonds and handed them to the government all at once.

        The ploy failed due to the obvious devaluing (he also, incidentally caused an energy crisis and a spike in unemployment among coal miners but that is beside the point here) and he was indebted to pay tax on their original market value prior to his having devalued the entire market.

        Would that work in either the US or Britain? If Superman’s gift of a bulk of diamonds to the government was the cause of the devaluing of the market, would he be subject to tax based on their old value or new value?

  4. What about jurisdictions that impose a VAT?

    And the scenario where Superman needs some cash, so he takes some coal (that he’s mined himself, superfast), compresses it into a diamond, and accepts cash in exchange. I’d that variation would create not just income tax liability, but self-employment tax as well. (It ain’t going to be pretty when he starts suffering from Super-Alzheimer’s, and forgets that he’s strong enough to crush the average nurse’s aide with one hand, so he really should be paying into the Medicare fund.)

    • And if he went into space and crushed a carbonaceous meteorite into a gem… he’s be liable for import duties as well!

      • James Pollock

        Maybe not, if he flies straight up from a point within the U.S.

      • Generally things in orbit over a nation aren’t held to be in that nation’s territory. A few nations along the equator have tried taxing satellites put up above them without much success.

        Of course this could get considerably complicated in later years if space travel becomes more practical.

      • Actually, no.

        Space is a commons, without any sovereign exercising jurisdiction over it. (See Outer Space Treaty, which is ratified by US without reservations.) Thus, flying to space from the surface area of the United States is, for customs duties, equivalent to sailing to international waters.

        Mining in space and returning to the US is no different from mining or drilling on international waters outside the US economic zone and returning to US afterwards. Provided that you are an American vessel and have not gone to foreign ports, you are not importing anything and are not liable for customs duties.

  5. Huh, I for some reason had it in my head that engagement rings often weren’t actually given, as in transfer of ownership, but given in safe keeping , each holding a token of the other as a symbol of intent. Is there something dodgy about that (assuming the rings are returned if the wedding is called off and become joint property when the wedding actually happens)?

  6. Pingback: Superman’s Diamonds Revisited | Law and the Multiverse | scrapbook

  7. Pingback: Paul Boccaccio › Tweet: @ken_schneyer : have you seen this?…

  8. I believe your discussion on the marital exclusion misses an important point in the analysis. The gift tax does not apply until you have made a completed gift. I ring given in contemplation of marriage (in most states) must be returned to the giver if the marriage does not occur. As such, there is no completed gift until after the marriage. At the moment of marriage, Code Section 2523(a) will apply. Thus, (again, in most states) there should not at any time be a gift tax liability on an engagement ring.

    • If you really want to get into the weeds about this… “As to any property, or part thereof or interest therein, of which the donor has so parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or for the benefit of another, the gift is complete. But if upon a transfer of property (whether in trust or otherwise) the donor reserves any power over its disposition, the gift may be wholly incomplete, or may be partially complete and partially incomplete, depending upon all the facts in the particular case.” Reg. § 25.2511-2(b). In the case of an engagement ring, the donor may break off the engagement, but in so doing, in many jurisdictions he or she would then give up any claim to the return of the ring. In those jurisdictions the donor has not reserved any power over the disposition of the ring: either the marriage proceeds (and the donee keeps it) or the donor breaks it off (and the donee keeps it). Thus, in those jurisdictions employing the ‘fault’ rule (still described as the majority rule, though that description is now questionable), I think the gift of an engagement ring is effectively completed for gift tax purposes at the moment it is given. It is hard to say for certain, however, because I do not think there are any court cases on this subject in any jurisdiction.

      Alternatively, in any case where the ring is kept by the donee as a result of the marriage being called off, it would certainly be a completed gift at that point.

  9. Perhaps off-topic but in a way I thought might be interesting to you. I had a chiropractor in Pasadena for a while who adjusted dogs on Saturdays. Over the years more and more people were bringing their showdogs and injured animals to him – even a vet I knew was referring to him – until he got a cease and desist letter from the CA Veterinarian Association.
    He looked into the law a bit (with help, I presume) and found that while it wasn’t necessarily legal for him to adjust other people’s dogs in CA without a vet license, it was legal for him to adjust his own dog. Solution:
    “Hi Dr. George, I hereby give Mitzy to you.”
    “Thanks, Alice, I gratefully accept your gift.”
    -adjusts dog-
    “Here, Alice, I officially give my dog Mitzy to you.”
    “Thanks, Dr. George.”
    The Association left him alone….

Leave a Reply

Your email address will not be published. Required fields are marked *