author: Artjndell :

text:
    Walter B. Green, Administrator of the Estate of Millard D. Olds, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78511.
    Promulgated March 31, 1937.

      Raymond II. Berry, Esq., Ralph W. Barbier, Esq., and Arthur L. Evely, Esq., for the petitioner.

      John W. Bigg, Esq., for the respondent.
   OPINION.

Artjndell :

The petitioner is executor of the estate of Millard D. Olds, deceased, who, prior to his death, filed the original petition herein to review an income tax deficiency amounting to $4,335.83 for the year 1930. The issue is whether or not the respondent erred in his application of the “first in, first out” rule to determine profit from the sale of corporate stock carried on margin with a broker so as to include other shares of the same stock deposited with the broker to support that margin account.

The decedent was a member of the partnership of M. D. Olds & Co., which was engaged principally in the coal business at Cheboy-gan, Michigan. This firm also engaged extensively in stock market trading. Its business was conducted on the basis of a fiscal year ending July 31. On June 15, 1929, the partnership owned outright 7,186 shares of the stock of the United States Steel Corporation which it had acquired at a cost of $77,464 per share. Prior to September 30, 1929, the partnership carried no account in stock of the United States Steel Corporation with, its broker, but on that date it purchased upon margin through the brokerage firm of Bennett, Smith & Co., of Detroit, 2,800 of such shares in lots and at prices as follows: 1,000 shares, $224^300; 100 shares, $22,492.50; 400 shares, $90,020; 500 shares, $112,650; 300 shares, $67,665; 500 shares, $112,775. Following these purchases, the partnership delivered to its brokers certificates representing 700 shares of United States Steel stock on November 15, 1929, and certificates for 1,000 additional shares of the same stock on December 27, 1929. These deliveries were made for the purpose of supporting the partnership margin account. These shares were drawn from the partnership purchases made prior to June 15, 1929, and the certificates representing them were endorsed in blank by the partnership. The partnership account was not in need of support at the time of these deliveries, but the shares were so deposited with the understanding that they were to be used in support of the partnership account at such time as, and provided, such support was required. Upon receipt, the certificates were placed in the brokerage firm’s vault for safekeeping. Subsequently, on or about March 25, 1930, the partnership account became in need of some support, but to what extent the record fails to show. On March 25, 1930, Bennett, Smith & Co. delivered to a New York brokerage firm the 1,700 share certificates deposited by the partnership. That delivery was made in response to a call from the New York firm for additional margin to support Bennett, Smith & Co.’s account. In the meantime, the brokers made certain sales and purchases from and to the account of the partnership’s marginal account carried with it. The first transaction consisted of two sales of 1,000 shares, each made on the respective dates of February 5 and 18,1930, at lot prices of $184,710 and $188,710, respectively. A third sale of 1,000 shares at the price of $193,710 was made on March 31, 1930. These sales were followed with purchases of 3,000 shares of the same stock made as follows: On February 19 two lots of 1,000 shares each were bought at $187,250 and $186,250, respectively; on February 20, 1,000 more shares were purchased at the price of $184,250; on April 9, 500 shares were purchased at $97,125; and on April 29, 1,000 shares were purchased for $185,250. The sales were made without specific direction or order from the partnership identifying the shares to be sold.

In computing the partnership profits from the sales made from its marginal account the respondent applied the first in, first out rule to determine the basis for the shares sold. In applying this rule to the 1,000 shares sold on March 31,1930, the respondent treated the partnership’s 1,700 shares deposited as collateral with the brokers as first in stock, and used the cost of that stock as the basis for the stock sold. The petitioner contends that this treatment of the collateral stock was error. He argues tliat sucli stock was in no sense ever commingled with the margin account so as to lose its identity in that mass from which sales were made. He also contends that, if technically considered that the stock ever was so commingled, it was removed from that mass when taken out of the brokers’ vaults and sent to the New York brokers on March 25,1930.

The respondent concedes that the collateral stock coukl not be subject to sale before March 25, 1930, because prior to that date the partnership account was in no need of support. He argues, however, that on the instant the account became “in need of support” the pledged stock became a mere credit on the brokers’ books and subject to sale in common with the margin stock.

Stated simply, the question for decision is this: Can the 1,000 shares of stock sold on March 31, 1930, be identified as shares other than the 1,700 shares of first in stock which were pledged as security for the margin account, there being no identifying instructions to the brokers ?

The 1,700 shares deposited as security were at the time of deposit owned outright by the Olds partnership and the certificates therefor were not fungible, but were identifiable property. But when they were deposited as collateral, they became fungibles; the right of substitution of certificates then arose; they became subject to the brokers’ lien for repayment of advances, commissions, and interest; they became subject to the right of rehypothecation. If the shares can be regarded as identifiable until March 25, 1930, by reason of the certificates being in the brokers’ vault, they lost their identity at that time. The stipulation is that at that time the margin account needed support. At that time, if not before, the certificates became fungibles and subject to the several rights that marginal security has in the hands of brokers. There are, of course, limitations on the rights of brokers over pledged stock. For instance, the broker can not sell marginal account security without a prior demand for additional margin. White v. Slayback, 179 N. Y. S. 211. However, there is no such situation here. The partnership directed a sale of United States Steel stock without identification of shares. The fact of delivery of the certificates covering the shares deposited as collateral by the partnership’s broker to a New York broker does not operate to preserve the identity of those shares. To so hold would indeed require not merely the preservation of identity, but reestablishing it after it -was lost through use of the shares by the partnership’s broker as collateral for the margin account. There is no showing that the partnership’s broker did not sell those shares through the New York broker when the partnership gave the order to sell. Those shares, equally with the other shares then in the partnership account, were available for sale and no segregation was made either by the partnership in its instructions to the brokers or by the brokers in making the sale. There was, then, no identification and the first in, first out rule applies.

The petitioner further contends that if the first in, first out rule is to be applied at all, it should be applied according to the separate deposit theory of the case of Bancitaly Corporation, 34 B. T. A. 494. That is, where the evidences of share ownership are in different de-positaries, that upon sale from any particular depositary the first in stock in that depositary should be treated as the first sold. The principle of the Bancitaly case does not extend as far as the petitioner contends. The respondent has applied here the principle for which the case stands, namely, he has separated the stock held by the partnership from that held by its broker. He has treated the sales made in 1930 through the broker as being made from shares held by the broker and not from the earlier acquired shares the certificates for which were in the hands of the partnership. It is pointed out in the Bancitaly case that the respondent had attempted to treat all sales as though made from a common location. Here he has not done so; he has given effect to the physical separation of the blocks of securities. We accordingly sustain the respondent in his treatment of the 1,000 shares sold on March 31, 1930, as being part of the 1,700 shares of first in stock deposited by the partnership with its brokers.

Decision will he entered under Buie 50.

       See Meyer’s Law of Stock Brokers and Stock Exchanges, pp. 297, 313, 322, 331.


source: Caselaw Access Project

author: Aenold : Murdock, Mellott,

license: Public Domain

text:
    Security-First National Bank of Los Angeles, Executor of the Estate of Milton Sills, Decedent, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 64737.
    Promulgated April 2, 1937.

      Joseph D. Brady, Esq., for the petitioner.

      E. G. Smith, Esq., for the respondent.
   OPINION.

Aenold :

This is a proceeding .for the redetermination of a deficiency in estate tax in the amount of $6,796.43. The issues are (1) whether respondent erred in determining the value at which the decedent’s remainder interest in a certain trust should be included in his gross estate, and (2) whether respondent erred in determining that the amount of a refund of income tax of the decedent for the year 1928, together with the interest thereon, should be included in the gross estate.

Petitioner’s decedent, Milton Sills, died testate at Los Angeles,. California, on September 16, 1930.

Gwladys Edith Sills was born on November 5, 1886, and on September 15, 1925, was the wife of decedent. Dorothy Gardyne Sills, daughter of decedent and Gwladys Edith Sills, was born on April 19, 1911.

On September 15, 1925, decedent entered into a written agreement with the Guaranty Trust Co. of New York, whereby decedent transferred to the trust company, as trustee, and to its successors in trust, certain property and securities. Said trustee accepted the trust, and on September 16, 1930, held the trust property subject to the terms and conditions of the agreement of September 15, 1925.

The trust agreement provided that the trustee was to receive, hold, manage, sell, invest, and keep invested the trust property and securities, and to collect the income therefrom, and, after deducting the necessary expenses of administration, to pay over the net income, to the extent of $5,000 during the first year, $10,000 during the second year, and $15,000 during each of the remaining years of the trust, in equal monthly installments, to Gwladys Edith Sills, during her lifetime, and to pay over all the net income in excess thereof, at the end of each year of the life of the trust, to decedent or his estate.

The trust instrument further provided that at the death of Gwladys Edith Sills, if the daughter, Dorothy Gardyne Sills, be then deceased, all the principal of the trust should revert to, and be conveyed, transferred, and paid over by the trustee to the decedent or his estate, and that if the said daughter should survive her mother, property and securities having an actual market value of $100,000 should be retained by the trustee under the terms and conditions of the trust instrument and the net income therefrom paid over to the daughter during her lifetime; and, further, that the balance of the principal should, in the event of the daughter’s surviving her mother revert to and be transferred by the trustee to decedent or his estate at the death of his wife, and that part of the principal so retained. in trust for the daughter should revert to and be transferred to decedent or his estate at the death of the daughter.

Decedent agreed in the trust instrument that if at any time after October 1,1927, by reason of the depreciation or default of any of the property or securities held in the trust, the total market value of the principal should be less than $300,000, he wrould, if his wife should then be living, deliver additional property and securities equal in market value to such deficiency to the trustee to be held under the terms and conditions of the trust agreement. Decedent further agreed that he would at all times have provision made by his last will and testament to the effect that if his wife survived him and if at the date of his death the total market value of all the property and securities held in the trust was less than $300,000, property and securities equal to the amount by which the said total market value should be less than $300,000, belonging to his estate, should be by his executor taken from his estate and delivered to the trust to be held under the terms and conditions of the trust instrument and to become a part of the principal of the trust.

As determined by respondent, and as alleged in the petition, the properties and securities in said trust had a total market value on September 15, 1930, of $309,733.92. The par value was $316,000, as disclosed by the list of securities in evidence.

Respondent determined that the fair market value, at the time of . death, of decedent’s interest in the annual net income of the trust in excess of $15,000 was $30,000, and included that value in the gross estate.

Respondent determined the value of decedent’s interest in the excess net income by assuming that the average earnings of the trust during the lifetime of Gwladys Edith Sills in excess of $15,000 would be $1,500 per annum and that such excess should be capitalized at 5 percent.

Respondent determined that the value at the time of death of the interest of decedent in the principal of the trust, subject to the life tenancies of Gwladys Edith and Dorothy Gardyne Sills, was $82,325.47.

Petitioner, in the return filed for the estate of decedent, included in the gross estate all of the several interests of decedent in the trust at the time of his death at the total value of $21,500, which respondent, in determining the deficiency, increased to $112,325.47.

On or about November 20, 1930, petitioner, as executor of the decedent’s estate, filed with the collector of internal revenue at Los Angeles, California, a claim for refund of a part of the Federal income tax paid by decedent for the year 1928. On or about March 3, 1931, respondent determined that the corrected income tax liability of the decedent for the year 1928 was $16,541.28 and that decedent had made an overpayment for that year in the amount of $22,212.14. Subsequently, during the month of October 1931, respondent refunded the overpayment of $22,212.14, together with interest thereon in the amount of $1,617.73. In determining the deficiency respondent included said overpayment of tax, together with the interest thereon, as a part of the decedent’s gross estate in the full amount of $23,829.87.

Of the amount so refunded, $17,599.32 represented tax paid by the decedent on his wife’s share of his community earnings as determined by the respondent. This amount was credited against the corresponding deficiency found by the respondent against decedent’s wife in making the adjustment. The remainder of the refund, including interest thereon, was paid to petitioner in the amount of $6,471.79, as executor of the estate.

Under the first issue petitioner contends that the fair value at the date of death of all of the decedent’s interests in both the income and corpus of the trust was not in excess of $21,500, and that respondent erred in determining the value to be $112,325.47.

That decedent’s interest in the excess income and his reversionary interest in the corpus, subject to the rights of the beneficiaries to receive the specified income for life, constituted valuable property rights is admitted by both parties. That the fair value of such property rights at the date of death should be included in the decedent’s gross estate is also conceded by the parties. And it is further agreed that the proper method of determining the amount of such value is to reduce the value of the property rights to their present worth at the date of decedent’s death on the basis of the life expectancies of the life tenants as ascertained by the generally recognized mortality tables. The use of such method is provided for in respondent’s Regulations 70, article 13, and has been approved by both the Board and the courts in many cases. See Simpson v. United States, 252 U. S. 547; Ithaca Trust Co. v. United States. 279 U. S. 151; William Huggett, 24 B. T. A. 669, 675; James Klein Bowen, 27 B. T. A. 824, 828; Fidelity-Philadelphia Trust Co. et al., Executors, 27 B. T. A. 972, 979.

Tlie sole controversy here on this point relates to the interest or discount factor. Respondent used the rate of 5 percent, while petitioner argues that in order to determine the fair market value of the decedent’s property rights a discount rate of 10 percent should be used. In support of its contention petitioner offered the testimony of two valuation experts, who expressed the opinions that the fair market value of the decedent’s interest in the trust at the date of his death was $20,000 to $21,500. These estimates were based ■upon a discount rate of 10 percent.

When witness Creer was asked on direct examination how he arrived at the value placed on the interest, the Member who heard the case expressed the opinion that that was a matter for cross-examination. Attorney for petitioner thereupon withdrew the question.

When witness Meloth stated as his opinion that the fair market value as of September 16, 1930, of the interest was approximately $20,000, attorney for petitioner stated, “I would like Your Honor to know his reasons for that determination but if you think otherwise, I won’t question him further.” The Member replied that when an expert qualifies and then gives his opinion he did not see the necessity of bolstering him up any further; to which petitioner’s attorney replied, “All right, I will just ask one or two questions with respect to the value of any of the claim for refund.”

We do not think petitioner has any cause for complaint on account of these statements of the presiding Member at the hearing, especially in view of the fact that witness Meloth did give the basis of his determination in fixing value.

An examination of the testimony of petitioner’s expert witnesses in the light of other facts in the record convinces us that their opinion as to the value of the decedent’s interest in the trust on September 16, 1930, can be given very little weight. It appears evident from their testimony that the value placed by them is not the fair market value of the interest, but a highly speculative value. Witness Creer testified that, in 20 years’ experience in the trust department of a bank which had the administration of about $400,000,000 of trust funds, he had only known of three or four instances of transfers of such interests. In one of these, the only specific instance he gave, he testified that “the transfer of the interest was upon a basis which, under any contingency, would have been highly profitable to the purchaser.” Petitioner’s return was prepared under the supervision of this witness and, upon being asked on direct examination how he arrived at the value of $21,500 reported in the return, he said:

A. An asset of that kind is, of course, hard to value. The market for it is restricted. No one will buy an interest of that kind where it is based on contingencies of lives, except on a basis that is going to work out a good profit, no matter what contingency happens. * * *

It seems evident from this testimony that the witness had in mind a price that would yield the purchaser a good profit, “no matter what contingency happens.” This, we think, has no relation to the fair market value.

Witness Meloth characterized the interest of the decedent in the trust as not being “bankable”, or having any collateral value; as not being liquid. He testified that it would find a very small, if any, market value; and, further, that he thought a purchaser would rather buy something he would have in his possession to do with as he pleased than to purchase something in which he had only a very theoretical interest, running over a long period of time.

Measured by this yardstick the interest of the decedent was no different from any other estate in remainder. Such estates are not generally considered “bankable” in the ordinary acceptation of that term or as havifig collateral value. Certainly they are not “liquid”, since they can come into possession only at the termination of the intervening estate, but, notwithstanding these facts, the Board and the courts have repeatedly sustained the Commissioner’s method of computing their value bj^ the use of the mortality tables at a rate of 4 percent.

In Simpson v. United States, supra, the taxpayer objected to the assumption by the trial court of a rate of 4 percent as the value of money in computing the tax, and in disposing of this contention, the Supreme Court said :

* * * we take judicial notice of the fact that at the time this tax was collected, 4 per cent was very generally assumed to be the fair value or earning power of money safely invested. Both the method and rate adopted in this case have been assumed by this court, without discussion, as proper in computing the amount of tax that has been collected * * *.

Meloth further testified that as of September 16, 1930, the fair return of money safely invested in the highest grade bonds was 4y2 percent, which would increase to between 5 and 6 percent in the more speculative grades, and that the securities in the trust ranged from a high grade to a medium grade or speculative character.

An examination of the list of securities in the trust, which is in evidence, shows their average market value on September 15,1930, to be approximately 97%, and more than 50 percent of them were above par. This was approximately a year after the crash of the stock market in 1929, and, we think, justifies the conclusion that the securities were generally of a high and medium grade, with, perhaps, a relatively small portion of a more speculative character. The securities all consisted of bonds except 100 shares of $6 preferred stock which had a market value of $92 per share. To say that securities of this type having par value of $316,000 and a market value of $309,733.92 sliould be treated as so highly speculative as to require a factor of 10 percent in determining then-present worth under the mortality tables would ignore the facts in the record and take us far afield in determining the value of the remainder interest under the revenue law and the regulations of the Commissioner.

It is common knowledge that residuary interests, such as we have here, are family interests, not regularly dealt in by investors, and seldom sold. It is evident that such interests have no readily ascertainable market value that can be established by sales. Therefore the regulations of the Commissioner, which have the force and effect of law, cf. Maryland Casualty Co. v. United States, 251 U. S. 342; Crocker v. Lucas, 37 Fed. (2d) 275, require that the value of such interests be determined by the use of the mortality tables, taking as a basis the fair market value of the property included in the intervening estate. This fair market value is treated as cash in computing the value of the interest which is included in the- gross estate for tax purposes. If the trust property here consisted of cash or Government bonds, it could not be seriously argued that the use of a factor of 10 percent would be justified by the law and the regulations or by the decisions of the Board and the courts, in determining the value of the residuary interest of the decedent’s estate. But cash must be invested in securities or other income-producing property in order to carry out the purposes of the trust, and where, as here, the trustees have the power to sell and reinvest, the situations are not materially different. Furthermore under the laws of the State of New York, which is the situs of this trust, there are very strict regulations as to the character of securities in which the trustees may invest. Personal Property Law of New York, sec. 21.

We are not bound to accept the opinions as to valuation of expert witnesses as conclusive, particularly where such opinions are predicated upon factors which we conclude are unsound. Their opinions are to be judged in accordance with the soundness of their reasoning which is disclosed. The Board is at liberty to reject such opinions and form its own opinion on the facts presented. Fidelity Title & Trust Co. v. Commissioner, 64 Fed. (2d) 52. Cf. Saxman Coal & Coke Co. v. Commissioner, 43 Fed. (2d) 556; Wessel v. United States, 49 Fed. (2d) 137; H. H. Blumenthal, 21 B. T. A. 901; Uncasville Manufacturing Co. v. Commissioner, 55 Fed. (2d) 893; Dayton Power & Light Co. v. Public Utilities Commission of Ohio, 292 U. S. 290. The Board is not bound by expert testimony solely because there was no witness to contradict it, Old Mission Portland Cement Co. v. Commissioner, 69 Fed. (2d) 676.

Indeed, as we read their testimony as a whole, the truth becomes obvious that the real value of the remainder interest was playing a subordinate role with them and their ultimate appraisal was a forecast, speculative in the extreme. Certainly it had no “such commanding quality as to apply coercion to the judgment of the appointed triers of the facts, and exclude every choice but one.” Cf. Dayton Power & Light Co. v. Public Utilities Commission of Ohio, supra. It is apparent from a consideration of their entire testimony that the value fixed by petitioner’s expert witnesses does not bear any relation to the real value of the residuary estate, but is based upon the assumption that a purchaser would not be interested in buying a remainder interest unless at a price so low that it eliminated all ordinary risks incident to such an investment. It amounts to nothing more than a bid price and has no necessary relation to a fair market value. Moreover, the value as thus fixed does not give any effect, so far as the record shows, to the excess income of the trust which was distributable to the estate.

The computation of the value of the residuary estate under article 13 of Regulations 70 is in accordance with the accepted practice of the Treasury Department, which has time and again been approved by this Board and the courts. Article 13 provides for the use of an interest rate of 4 percent, compounded annually, but because of the fact that the decedent had an interest in the income of the trust over the specified amount to be paid to the beneficiaries, which had averaged up to the time of his death approximately $1,500 a year, and the further fact that the average annual earnings of the trust had been about 5% percent, respondent deemed it proper, in computing the deficiency, to use a rate of 5 percent rather than 4 percent.

The record shows that $170,000, par value of the securities, carried an interest rate of from 6 to 7 percent; that $71,000 par value carried an interest rate of 5y2 percent and $76,000 par value carried an interest rate of 5 percent. While the excess income may have averaged $1,500 in prior years and undoubtedly had some value which should be considered, there is no assurance that it will continue and it must be regarded as very speculative. Considering the whole record, including the speculative character of some of. the securities and the length of time involved in the life expectancy, and the interest rate which they carry, we think a factor of 6 percent is fair and reasonable.

In determining the deficiency the Commissioner considered the average excess income as $1,500 and computed its value at $30,000, which Avas deducted from the value of the trust property before computing its present worth. Since the $1,500 does not represent a fixed annuity, but may fluctuate or cease altogether, we think this treatment is in error. The value of the remainder interest should be computed by determining the present Avorth of the entire trust estate, giving effect to tbe life tenancy of Mrs. Sills and Dorothy Sills, respectively. Since the portion of the principal that will affect Dorothy Sills is $100,000, the computation should be on $209,733.92 for the life of Mrs. Sills and $100,000 for the life of Dorothy Sills. In the factor of 6 percent we have considered whatever value may be attached to the excess income.

At the hearing counsel for petitioner stated that respondent had made a slight error in the selection of one of the factors used in computing the value of the reversionary interest in that part of the trust corpus subject to the life estate of the daughter, and further indicated that respondent conceded such error. However, counsel for respondent did not reply, and no proof was offered on the point. The error, if any, may be corrected on final settlement under Rule 50.

The second issue calls in question the correctness of the respondent’s action in including in the gross estate the face value of a claim for refund of decedent’s income tax for 1928, allowed and paid in October 1931, together with the interest thereon. Inasmuch as the claim for refund arose on account of the decedent having included all of his community earnings in his return instead of only half of them, petitioner contends that since the right to recover the amount of the claim was dependent upon the outcome of litigation then pending in the courts involving the right of married persons in California each to make a separate return of one-half of the community income, which question was settled by the Supreme Court’s decision in United States v. Malcolm, 282 U. S. 792, rendered January 19, 1931, the claim for refund in controversy had no fair market value at the time of decedent’s death and hence should not be included in any amount in the gross estate.

We are of the opinion that the contention urged by the petitioner is not sound. The full amount of the claim was actually due and owing to the decedent at the time he died, and was in fact paid with interest in the following year. The claim was in reality worth its face value, and we think under the circumstances present here so much of it as represented an overpayment on the separate property of the decedent should be included at such value in the gross estate.

The burden of petitioner’s argument is that the claim had no fair market value at the time of decedent’s death for the reason that no prudent person would have purchased such a claim in the face of the uncertainties existing prior to the above mentioned decision-of the Supreme Court in 1931. While it is undoubtedly true that fair market value is the basis upon which property may properly be included in determining the value of the gross estate of a decedent, we think it does not follow that, under the statute, property clearly having a definite intrinsic or actual value may be excluded merely because at the moment of death there may have been no generally recognized market for it. What constitutes fair market value is generally a matter of opinion, and is often if not always difficult to determine with accuracy. As was said by the court in Crawford v. Helvering, 70 Fed. (2d) 744:

It is generally conceded by most of tbe courts which have had to deal with the subject that there is no definite formula by which to determine fair market value as that term is used in the tax statutes. The question, as all agree, is necessarily one of fact to be determined by the evidence, * * *. Actual sales may be shown, as may also intrinsic value; book value may be considered, as also earning capacity. These are all elements which tend to the ascertainment of fair market value, and when considered together or singly, may establish the fact.

It has been held that corporate stock had a fair market value for tax purposes even though it was not listed on the stock exchange, and there was no dealers’ market for it, and there was no evidence of any sales. In such case, the intrinsic or actual value or book value may be taken as the1 equivalent of fair market value. French Dry Cleaning Co. v. Commissioner, 72 Fed. (2d) 167.

The full amount of the claim with interest was paid in 1931, but a portion of the refund appears to have been applied against the deficiency in the income tax of the decedent’s wife for 1928, which deficiency arose on account of adjustments in connection with the returns of herself and the decedent during the taxable year. Petitioner claims in the alternative that only one-half of the amount actually refunded to the estate in cash should be included in the gross estate for purposes of the estate tax.

The action of respondent in including the $17,599.32 in the value of the estate and at the same time using it to pay the deficiency in tax of decedent’s wife is not consistent. The theory on which it might be used to pay the wife’s deficiency is based on the assumption that the community income returned by the husband belonged one-half to the wife and that to the extent of the income tax on the wife’s one-half it was her money used to pay the tax. Cf. Clayton v. United States, 44 Fed. (2d) 427. If this be true then it could not be included in the estate of her husband because under the community property laws of California it never became a part of his estate. Upon the death of the decedent the community was dissolved and one-half of all existing community property belonged to the surviving spouse. The wife’s half undoubtedly included all of the refund applicable to her half of the community property and, even were it refundable to the decedent’s estate under the law governing refunds, it would not be an asset of the estate but a liability existing in favor of the wife and would have been payable to her or the executor as a part of her share of the community property under the law of California.

As to that portion of the refund (in excess of the $17,599.32) ■which was paid to petitioner as executor of the estate, the amount properly attributable to tax paid on community property retains its status as community property, Clayton v. United States, supra, and only one-half of such amount may be included in the gross estate. The amount of such refund, if any, in excess of such tax on community property must also be included in the gross estate, since there is no evidence that it is community property.

What wre have said above applies to the principal amount of the claim and the interest accrued to the date of decedent’s death. That part of the interest which accrued subsequent to decedent’s death represents compensation for the use of the money thereafter and up to the time of payment. It constitutes income to the estate and does not enter into the value of the estate at the time the decedent died. The amount to be included in the gross estate will be modified accordingly.

The memorandum opinion heretofore entered in this case, having been reconsidered, is hereby revoked.

Reviewed by the Board.

Judgment will be entered under Ride 50.

Murdock,

dissenting: I think the petitioner is entitled either to a new trial or else to judgment on the valuation issue. Anything short of one of these two solutions is both unfair and unjust to the petitioner. The effect of the prevailing opinion is to fix a value less than that determined by the Commissioner but far greater than that testified to by the witnesses. I know that my colleagues who support the prevailing opinion have no desire to be either unfair or unjust. Apparently they do not fully realize how inconsistent their action is with what took place at the hearing.

A former Member of the Board, now deceased, heard the evidence in the case. The question was 'to determine, as of the date of death, the value of the decedent’s rights to receive payments in the future under the trust instrument. The petitioner recognized that it had the burden of proof. It called two witnesses to sustain that burden. It qualified each witness to the satisfaction of the Board Member presiding at the hearing. The witnesses expressed their opinions that at the date of his death the value of the decedent’s rights under the trust was between $20,000 and $21,500. Counsel for the petitioner attempted to have each of these witnesses state in full the method by which he had arrived at his valuation figure. But in the case of each witness the Member presiding refused to allow this explanation to come in under direct examination. The brief cross-examination brought out nothing further and the result was that neither of the witnesses was permitted to give a full explanation of how he had arrived at his opinion of value. The respondent offered no evidence.

No specific finding of fact as to value is inadé, but the author of the prevailing opinion, who neither heard nor saw the witnesses, casts their opinions aside and directs that a factor of 6 percent be used in determining the value of the interests in question as of the date of the decedent’s death. This will result in the fixing of a value less than that determined by the Commissioner but almost four times as great as that testified to by the witnesses. I am not concerned for the moment with the question of whether or not there is evidence in the record supporting the use of a 6 percent yield or discount factor. The point I make is that, since the Member who presided at the hearing was satisfied with the qualifications of the witnesses to express opinions and refused to allow their methods to be disclosed under direct examination, it is unfair and unjust to the petitioner for another Member of the Board to cast aside and disregard the opinions of those witnesses on the ground that they did not give convincing reasons supporting their opinions. Yet that is what is being done. The opinions of the witnesses are cast aside and that action is justified as follows:

We are not bound to accept the opinions as to valuation of expert witnesses as conclusive, particularly where such opinions are predicated upon factors which we conclude are unsound. Their opinions are to be judged in accordance with the soundness of their reasoning which is disclosed. The Board is at liberty to reject such opinions and form its own opinion on the facts presented.

Thus the petitioner has been trapped by the Board.

It is another question whether the Board should order a new trial to give counsel for the petitioner a chance to have his witnesses explain their methods of valuation or whether their opinions as expressed should control. The rules of evidence governing in proceeding before the Board are the rules of evidence applicable in the courts of equity in the District'of Columbia. I believe those rules required the Member who presided at the hearing to allow counsel for the petitioner to have his witnesses fully explain their methods of valuation. But, if the Board is not now satisfied to accept the opinions of the only witnesses called, clearly the petitioner is entitled to a new trial and should not receive an adverse decision on the present record. If, however, the Member presiding at the hearing was correct in his ruling, then the Board should find as a fact that the value was $21,500. The opinions of the witnesses were certainly not weakened by the meager cross-examination. It is true that the record contains a partial disclosure of the factors, method and reasoning used by one of the witnesses. But that evidence does not afford a fair basis upon which to hold that the opinions of these witnesses are not entitled to weight. They were denied the right to explain in full. They never made a full explanation and their opinions should not be judged and found wanting upon the fragments of their explanations contained in this record.

The Board, rejecting both the determination of the Commissioner and the value testified to by the witnesses, directs that a value be determined by the use of a 6 percent discount factor. Ordinarily the Board is not bound by opinions of witnesses. But it should have good reasons if it is to disregard their testimony. Here I think the Board has misunderstood the effect of various factors and has expressed inadequate and unsound reasons for its action. This is, of course, aside from the more serious mistake discussed above.

The petitioner agrees that some amount may properly be included in the gross estate representing the value at the date of death of the decedent’s rights to receive future payments of income and corpus under the trust instrument. The parties are in agreement that the uncertainties in regard to the element of time involved -in the valuations may be resolved by the use of mortality tables. The decedent’s rights under the trust instrument involved certain risks dependent upon future earning power of the trust property, the safety of the trust investments, and perhaps other factors. Those uncertainties can not be resolved by the use of mortality tables, and the parties are in disagreement as to the proper factor to be used in making allowance for the risks involved. The Commissioner has set forth in his regulations a table for use in determining the present value of future payments. No doubt that table is useful in many ways to the Commissioner, particularly for the guidance of subordinates in the Bureau of Internal Revenue, but the promulgation of such a table in the Commissioner’s-regulations was never intended to have and does not have “the force and effect of law.” Safe Deposit & Trust Co. of Baltimore, Executor, 35 B. T. A. 259. Neither does it establish a rule of evidence. There is no evidence and no authorities are cited to show whether, or to what extent, such a table, or some modification of it, might be properly used in a case like the present one. The Commissioner did not use the table in determin--ing the deficiency and does not urge its use now. The table is based upon a 4 percent discount factor. The Commissioner computed the value in question on the basis of a 5 percent discount or yield figure instead of the 4 percent used in the table. Since the securities in the trust were yielding in excess of 5 percent it may be fair to conclude that the Commissioner erred in valuing the reversionary interest on only a 5 percent yield basis. But what justification is there in the record for the selection by the Board of a 6 percent discount factor?

The record contains a description of the securities in the trust at the date of the decedent’s death, with certain other information in regard to the value and earnings of those securities. But this evidence neither weakened the opinions of the witnesses nor established a basis for the determination by the Board of a- different value from that given by the witnesses. They gave their opinions in the light of that evidence. The function of the Board is to hear the evidence and determine the facts from that evidence. The Board has no expert knowledge of its own relating to values. If it had any special knowledge bearing upon this case it could not properly use that knowledge in the decision of the case. The facts must come from the record, not from the mind of the Board. Value is a question of fact. The facts which demonstrate value or lack of it must be proven. The Members of the Board have no way of determining from the present record that 6 percent is a proper factor of discount or yield to be used in the valuation of this particular property. The prevailing opinion is open to further criticism because therein fault is found with the opinions of the witnesses without good reason, the current earning power of money safely invested is confused with the percentage of yield which a purchaser of the rights in question might expect and demand, and at one place the present worth of the securities in the trust is discussed as if that were the question in issue. Those securities had been placed in a trust. The decedent had neither possession nor control. A possible purchaser of the decedent’s interest would have no more than he had. Such an investment might well be unattractive from the standpoint of possession, control, liquidity, and current earnings. These and other characteristics of the rights might be expected to have an important bearing upon the value of this interest at the time of the decedent’s death. Counsel for the petitioner apparently obtained the best qualified witnesses that were available. Yet these men knew of only a few instances where there had been transfers of interests such as those involved herein. The Board Members probably have no independent knowledge of any such transfers, and, if they have, they have no right to use it in deciding this case. Yet the opinions of the witnesses are cast aside and there are substituted the opinions of persons less well informed on the subject of the value of the particular interests in question.

Mellott,

dissenting: The parties seem to agree that the fair value of the interest of the estate in the excess income and in the corpus of the trust can best be determined by reducing them to their present value by tlie use of the actuarial or combined experience tables of mortality. The prevailing opinion, however, rejects this method entirely, in so far as the right to receive the excess income is concerned, and substitutes therefor a mere statement that “whatever value” it has, has been considered in fixing the factor of 6 percent to be used in valuing the right to receive the corpus of the trust. If the method used has resulted in a reasonably close approximation to the correct value of the interest in the excess income, that is a mere fortuitous circumstance; for it falls far short of being scientific or exact enough to achieve the same result in similar cases which will arise. The use of actuarial or mortality tables, on the other hand, at least enables taxpayers and the Government to approach the complex and difficult problem of valuing such estates in the most scientific manner that has been devised; and until a better formula than that set out in the prevailing opinion is worked out, I think Ave should continue to use such tables.

I agree with the víoavs of Member Murdock, expressed in the dissenting opinion, to the effect that the witnesses should have been allowed to explain their methods of valuation, and, since they were not permitted to do so, I also feel that a new trial should be granted. I am of the opinion, however, that the preesnt record does not justify us in overturning the determination which the respondent made upon the valuation issue.


author: Mellott:

text:
    Christian H. Droge, Petitioner, v. Commisioner of Internal Revenue, Respondent.
    Docket No. 79632.
    Promulgated April 2, 1937.

      Hugh Satterlee, Esq., William B. Green, Jr., Esg., and I. Herman Slier, Esq., for the petitioner.

      I. Graf, Esq., for the respondent.
   OPINION.

Mellott:

The facts set out in the findings will not be repeated. It may not be amiss, however, to set out herein a portion of the testimony relied upon as furnishing the basis for claiming that the amount paid to the wife constituted income to her rather than to petitioner.

Petitioner, called as a witness in his own behalf, testified that the understanding which he had with his wife was “that whatever we would get out of it [the investment in sweepstakes tickets] we Avould share it half in half. The arrangement was that we would go half and half on it, like we always have done in business and in other enterprises.” Upon cross-examination he was asked if it was his understanding with his wife “that if any ticket wTon each would get one-half of the proceeds”, to which he responded, “Yes, whatever would come out of the four, no matter which one it was, wTe would go half and half on it. That was the understanding.” The petitioner’s wife expressed it in this wise: “We bought four tickets. So my husband paid for two and I paid for twro. Even money, and we made this agreement: whoever wins it is on a fifty-fifty basis. If my husband wins, share with me, and if I win, I share with him. That was the understanding. * * * I thought my husband might have better luck than I. That is why we made that agreement.”

Nothing in the manner or demeanor of the witnesses indicated that they were not telling the truth and there is no reason to disbelieve them. This leaves, then, only a question of law to be determined. The respondent has filed no brief. In the brief filed by petitioner it is claimed: (1) That the petitioner and his wife wore joint owners of the winning ticket and of the proceeds derived therefrom; that hence petitioner is taxable only upon one-lialf of the proceeds; and (2) that even if it should be found that petitioner was the sole owner of the winning ticket, nevertheless he is taxable upon only one-half of the proceeds; for he specifically complied with his agreement to share the winnings with his wife. These contentions will be considered in the order stated.

Petitioner cited Alfred Hafner, 31 B. T. A. 338, as supporting his contention that under the law of the State of New York a married woman may deal separately with her property and may contract with her husband. The case so holds and, if applicable here, would be followed. But the question here is much broader. Recognizing that a husband and wife may contract with each other, there yet remains for consideration the question whether the facts show, or fail to show, that a legal and enforceable contract was in fact made.

It is fundamental that a partnership entered into for the purpose of engaging in gaming transactions or for the prosecution of an unlawful business is illegal. The courts of New York, where petitioner and his wife reside, have recognized and applied this rule of law. Thus in Goodrich v. Houghton, 134 N. Y. 115; 31 N. E. 516, the court denied relief to the plaintiff, who sought to recover from the defendant money which had been paid to him as the holder of a ticket in a lottery, though the evidence showed that she had contributed 50 percent of the purchase price of the ticket. The court held that inasmuch as the contract was a gambling contract, it would not be enforced but the parties would be left where the court found them. (See also Crutchfield v. Rambo, 38 Tex. Civ. App. 579; 86 S. W. 950; and Roselle v. McAuliffe, 141 Mo. 36; 39 S. W. 274.)

Nor does the case of Moskowitz v. Cohen, 286 N. Y. S. 152, cited by petitioner, furnish any real support for his contention. In that case a lottery ticket, upon which the names of both plaintiff and defendant had been placed, was drawn. The automobile, constituting the prize, was delivered to the defendant. Upon his refusal to recognize that plaintiff had any title she brought an action in conversion. The court held that such a transfer could in law vest title in her. The cited case would be more nearly in point if in the case at bar the names of petitioner and his wife had both appeared upon the winning ticket; but that is not a fact disclosed by the evidence. The observations here made also apply to Matta v. Katsoulas, 192 Wisc. 212; 212 N. W. 261, cited by petitioner.

It is apparent that since petitioner purchased the winning ticket with his own money, placed only Ms name upon it and made no legal assignment of any part of it to his wife, she had no rights which could be asserted against the conductors of the lottery nor could she have required the payment of any portion of the prize money to her. It is equally apparent that under the laws of the state wherein she and her husband resided she could not have compelled the payment to her of half, or any part of the money which he collected; for the agreement was void. Goodrich v. Houghton, supra. Under the circumstances it is held that petitioner and his wife were not joint owners of the winning ticket and of the proceeds therefrom and petitioner’s first contention is not sustained.

This brings us to petitioner’s alternative contention which, epitomized, is, that inasmuch as he specifically complied with his agreement to share the winnings with his wife he should not be required to pay the tax upon the portion of the proceeds paid over to her. He relies chiefly upon James P. McKenna, 1 B. T. A 326, and Mitchell M. Frey, Jr., 1 B. T. A. 338.

In James P. McKenna, supra, this Board held that the gross income of a racetrack bookmaker derived from his bookmaking operations should be determined by applying against the total receipts therefrom the sum of the amounts paid to bettors on his handbook, plus amounts returned to bettors by reason of scratches, called-off bets, and lay-off bets.

In Mitchell M. Frey, Jr., supra, it was held that a taxpayer was entitled to offset his gains from illegal gambling transactions against his losses from such transactions.

As the petitioner points out on brief, the respondent acquiesced in these decisions (IY-1 C. B. 2, 3) and embodied the holdings in I. T. 2175, IY-1, C. B. 141. In our opinion the cited cases are authority for petitioner’s alternative contention. Petitioner’s promise to pay his wife one-half of the proceeds of the two tickets purchased by him was made in consideration of a similar promise by her, and was just as much a part of the gambling venture as his investment in the ticket. His promise differs in no material respect from the promise of the bookmaker in the McKenna case to pay bettors in the event certain horses won. Both promises were illegal and unenforceable; but when executed the payments made reduce the amount of the actual gain realized. Under the provisions of section 22 (a) of the Revenue Act of 1932 petitioner is required to include in his gross income “gain or profits, and income derived from any source whatever.” His actual gain from the gambling venture was the amount he received from the operators of the Sweepstakes less the amount he agreed to pay and did pay to his wife.

The conclusion here reached is in accord with other Board decisions though no court decisions have been found in which the precise question was involved. Thus in George L. Richard, 15 B. T. A. 316, a prize fight promoter made and distributed motion pictures of a prize fight in violation of the law. He had a partner in the illegal venture, to whom, pursuant to agreement, he paid one-half of the profits. The Board approved the respondent’s determination “that such profits [i. e. the amount retained by Rickard] were taxable”, the issue being whether or not the taxpayer could await the outcome of various civil and criminal proceedings and the payment of fines and lawyers’ fees before reporting the profits so received.

In A. L. Voyer, 4 B. T. A. 1192, tickets in the lottery had been purchased by a group under a “pooling” arrangement, the agreement between the purchasers being that if any of the tickets won the other members of the group should share proportionately. The petitioner as the owner of four of the eleven tickets comprising the block, received four-elevenths of the prize money. It was held that the amount he received should have been included in his gross income, though the ticket stood in the name of another.

The rationale of the Voyer case seems to be sound and in accordance with such cases as United States v. Sullivan, 274 U. S. 259, holding that gains from an illegal enterprise must be reported as income. We are this day applying it in a case wherein the petitioner, like petitioner’s wife in the case at bar, received one-half of the winnings of the sweepstakes ticket. See Samuel L. Huntington, 35 B. T. A. 835. In other words, though we do not have petitioner’s wife before us for determination of her tax liability, we are deciding, under facts almost identical with those set out above with reference to her, that the recipient of a portion of the proceeds of a lottery must include the amount received in his gross income. But double taxation should be avoided unless required by express words. United States v. Supplee-Biddle Hardware Co., 265 U. S. 189. Nothing in the general statute defining gross income (sec. 22, Revenue Act of 1932) seems to require that the sum received by petitioner’s wife should be taxed as income twice, once to her and once to her husband, and we decline to so hold.

The respondent erred in determining the above deficiency.

Reviewed by the Board.

Judgment will loe entered for the petitioner.


text:
    Samuel L. Huntington, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78916.
    Promulgated April 2, 1937.

      J. W. Davern, Esq., for the petitioner.

      I. Graf, Esq., for the respondent.
   OPINION.

Mellott:

Petitioner apparently concedes that the portion of the winnings actually received by him constituted gross income to him, when received. Even in the absence of any such concession by him it would be so held; for such amount was clearly “gains or profits and income” within the purview of section 22 of the Revenue Act of 1932. Nor is it material that such sum was received in an illegal enterprise; for profits derived from an unlawful business are nevertheless subject to taxation. United States v. Sullivan, 274 U. S. 259.

The case at bar, with respect to the portion of the winnings which petitioner received, is not unlike A. L. Voyer, 4 B. T. A. 1192. In that case the taxpayer had purchased four tickets in a block of eleven, it being agreed among the purchasers in the pool that if any one of them held the winning ticket the others in the pool should share in the prize proportionately. The winning ticket being held by a member of the pool, petitioner received four-elevenths of the prize money. It was held that the amount received constituted income to him. Cf. George L. Richard, 15 B. T. A. 316, and Christian H. Droge, decided this date, 35 B. T. A. 829. A similar holding is made here as to the sum actually received by petitioner.

But respondent contends that petitioner should have included as part of his gross income not only the portion of the winnings which he actually received but also the portion retained by his wife. We do hot agree with this contention.

The evidence shows that, while petitioner purchased the ticket with his own money, he registered it in the name of his wife, turned it over to her for safekeeping and at that time made an agreement with her that the proceeds received, if any, would be divided equally. The operators of the sweepstakes recognized her as the owner of the prize money; the money was sent to her, and she was required to sign the receipt therefor. Petitioner’s right to receive any portion of it arose out of the collateral agreement between him and his Avife Avhich, though void and unenforceable (Goodrich v. Houghton, 134 N. Y. 115; 31 N. E. 516; Crutchfield v. Rambo, 38 Tex. Civ. App. 579; 86 S. W. 950; Roselle v. McAuliffe, 141 Mo. 36, 39 S. W. 274), was nevertheless specifically complied with. We .are not called upon to adjudicate the rights of petitioner and his wife under the void contract, nor do we have petitioner’s wife before us for determination of her tax liability, if any. The evidence shows, hoAvever, that she paid the Federal income tax upon the portion of the winnings which she retained after complying with the agreement which she made with her husband. We do not believe that the same amount should be taxed twice as income — once to the wife and once to the husband — and we decline to so hold. It follows, therefore, that the respondent erred in determining any deficiency against the petitioner.

The section of the revenue act, providing for the imposition of the-fraud penalty, is section 293 (b) of the Revenue Act of 1932. It reads as folloAvs:

(b) Fraud. If any part of any deficiency is due to fraud with intent to evade tax, then 50 per centum of the total amount of the deficiency (in addition to such deficiency) shall be so assessed, collected, and paid, in lieu of the 50 per centum addition to the tax provided in section 3376 of the Ee\dsed Statutes, as amended.

It is obvious that, inasmuch as we have found that there is no deficiency in tax for the year in question, no fraud penalty can be imposed.

RevicAved by the Board.

Judgment toil,l be entered, for the 'petitioner.


author: Hill:

text:
    Mason L. Dean, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 61205, 69832.
    Promulgated April 2, 1937.

      W. E. Cloud, Esq., for the petitioner.

      Carroll Walker, Esq., for the respondent.
   opinion.

Hill:

The first and principal issue for decision here is whether respondent erred in including in petitioner’s income for 1929 the amount of $9,000 as distributable income of the trust of which petitioner was a beneficiary, and in failing to allow as a deduction from the income reported by petitioner in his return for 1930 the sum of $10,000 alleged to have been erroneously reported as distributable income of the same trust. The applicable provisions of the Revenue Act of 1928 are quoted in the margin.

Petitioner contends that all the income of the trust estate was properly taxable to the trustees, under the statute and the terms of the trust instrument, and therefore the income in controversy is not taxable to him. Respondent has submitted no brief in this case; nor did he in the deficiency letters disclose the theory or reasons upon which his action was based.

The trust instrument involved was construed by the Circuit Court of Jackson County, Missouri, the court having jurisdiction of the trustees and of the trust estate, and by decree entered on January 24, 1980, it was held in substance that payments to the beneficiaries could be made by the trustees only out of income and only at the end of each administrative year beginning with January 3, 1928, the date of the decedent’s death. The decree of the circuit court was affirmed by the Supreme Court of Missouri, in so far as it related to the construction of the trust instrument, and by that construction we are bound. Freuler v. Helvering, 291 U. S. 35; Marguerite T. Whitcomb, 22 B. T. A. 118, 124; McCaughn v. Girard Trust Co., 19 Fed. (2d) 218; Hubbell v. Helvering, 70 Fed. (2d) 668.

During the year 1928, the trustees paid to petitioner the sum of $9,000 from the general assets of the estate rather than from income. On January 4, 1929, the trustees paid to petitioner the sum of $1,000, and on January 4, 1930, the sum of $10,000. Petitioner reported as taxable income in his return for 1929 the amount of $1,000 paid to him by the trustees on January 4 of that year, and respondent in computing the deficiency for 1929 added thereto the sum of $9,000. In his return for 1930 petitioner reported as income the amount of $10,000 paid to him on January 4 of that year, which amount he now contends was erroneously reported and should be deducted in determining his correct tax liability for 1930. Petitioner also assails the action of the respondent in adding to income reported for 1929 the amount of $9,000 aboye mentioned. Petitioner’s contentions, we think, must be sustained.

As has been many times pointed out, tax liability is determinable upon the basis of annual accounting periods. Both- petitioner and the trustees made their returns on the basis of calendar years. The statute imposes a tax upon the net income of a trust estate computed in the same manner and on the same basis as in the case of an individual. It is the clearly expressed intention of Congress to exact a tax upon all the income of a trust estate, but in some instances the tax is payable by the fiduciary, in others by the beneficiary, or a part may be payable by each. In the case of income accumulated in trust for the benefit of unascertained persons or persons with contingent interests, the tax is payable by the fiduciary. Such, in our opinion, is the situation presented here.

As of December 31 of each of the taxable years, it was the duty of the trustees to report all income of the trust estate earned during that year, deducting therefrom, in addition to other deductions, the amount of the income distributed or then .distributable to the beneficiaries, whether or not distribution had actually been made. Any income so deducted, the statute required the beneficiaries to include in their net income.

At the close of each of the taxable years, there was no income of the trust estate distributable to this petitioner. His interest therein was wholly prospective or contingent. The will of the decedent authorized payments of income to be made by the trustees to the beneficiaries only upon their personal receipts, without any power whatever to encumber or dispose of the same by way of anticipation prior to actual payment. Payments were to be made to this petitioner as a beneficiary of the trust estate, so long as he should live. Upon his death, therefore, his interest as beneficiary would cease. In such event he could no longer execute personal receipts for payments, and he was without power to assign, transfer, or otherwise dispose of his interest by way of anticipation. His estate could not acquire any interest in the trust income.

The income earned by the trust during each of the taxable calendar years did not become distributable and could not be distributed by the trustees under the terms of the trust instrument, as construed by the state courts, until on or after January 4 of the following year. Hence, at December 31 of each taxable year, it could not be known what beneficiary would become entitled to receive the accumulated income on the following January 4. If petitioner had died subsequent to December 31 and prior to the later date, neither he nor his estate would have any interest in the income earned during the preceding calendar year, but the will provided that such income should be added to and become a part of the corpus of the trust estate and ultimately be distributed to others, together with the original principal fund.

The income earned by the trust estate from January 1 to 3, inclusive, of each year became distributable and was in fact distributed to the beneficiaries on January 4, within the calendar year. The amount so distributed to petitioner, if any, was deductible by the trustees and should be included by petitioner in his net income. However, the income earned by the trust estate from January 3 to December 31 of each taxable year was not distributable until January 4 of the following year, and this income, in our opinion, was at December 31 of each year income accumulated in trust for the benefit of unascertained persons or persons with contingent interests, within the meaning of the taxing statute. Also, under the express terms of the will as construed by the Missouri courts, the income earned in any calendar year after January 3 was not distributable within such calendar year regardless of any question as to unascertained beneficiaries or contingent interests. Such income was taxable to the trustees, and could not again be taxed to the petitioner as income when distributed to him in the following year, after he had become an ascertained person or his contingent interest had become vested and for the further reason that such income was distributable in no event until January 4 next following the calendar year in which it was earned. While the statute requires a tax to be paid upon all the income of the trust estate, it does not contemplate double taxation, or payment of tax by the trustees and a second payment of tax on the same income by the beneficiaries.

In Augustus H. Eustis, 30 B. T. A. 820, the facts in all material respects were the same as in the present case, and we there held that the income earned by the trust estate from the last distribution date to the close of the taxable year was income accumulated in trust for the benefit of unascertained persons or persons with contingent interests, and was taxable to the trustees. In our opinion beginning at page 825, we said:

The respondent has urged that, since under the will the income of the trust was to be distributed semiannually, it therefore was income to he distributed currently and under the provisions of section 162 (b) [Revenue Act of 1928, supra] was an allowable deduction to the trust and the amount in controversy was taxable to the petitioner. Giving the provisions of section 162 (b) the construction impliedly contended for by the respondent and applying such construction to the facts in the instant case leads to the conclusion that because the petitioner was a beneficiary of the trust he was taxable on a portion of its income even though he had no present right to receive or demand it, and even though it was not known and could not be determined at the end of his taxable year whether either he or his estate would ever receive it Assuming that the respondent’s contention is correct and that on the day following the close of the petitioner’s taxable year the petitioner had died, the tax on the income in controversy would have been payable by the petitioner’s estate, notwithstanding the fact that neither he during his lifetime nor the estate after his death had received or ever could receive the income. It clearly was not contemplated that a beneficiary would be required to pay a tax on income in the hands of a fiduciary when it was not known and could not be known whether he or his estate would ever receive it or ever be entitled to receive it.

And see also Guitar Trust Estate, 34 B. T. A. 857, 865, where we applied substantially the same principle in holding that income credited to the invested capital accounts of the beneficiaries on the books of the trust after the close of the taxable year did not constitute credit in such year, and was not allowable as an additional deduction in computing the net income of the trust.

The case of Mary Clark de Brabant, 34 B. T. A. 951, is clearly distinguishable on the facts from the instant proceeding. There, distributable income of a trust was withheld during the taxable year by the trustee on the ground that a part or all of the amount withheld was corpus and not income, but it was conclusively adjudicated in a later year as distributable income, and we held it was taxable not to the trust, but to the beneficiary for the year when it became distributable, whether or not it was then distributed. In the case at bar no part of the income in controversy (other than the income earned, if any, between the dates of January 1 and 3 of each year) was properly distributed or distributable wfithin the respective taxable years.

On authority of the decisions hereinabove cited, we hold that the income in question, except to the extent before mentioned, is not taxable to petitioner. If any part of the income was earned by the trust estate during the period January 1 to 3, inclusive, of either taxable year, such amount is properly includable in petitioner’s net income for such year. The parties may stipulate the amount so earned, if any, and the stipulation will be given effect in the recom-putation under Rule 50. Otherwise, upon motion of either party, these proceedings will be set down for further hearing, at which time evidence may be offered to establish the necessary facts.

The conclusion reached above renders it unnecessary, at least at this time, to consider the second issue raised by petitioner. Unless it shall be made to appear that some portion of the trust income is taxable to petitioner, he is not entitled to any deduction for depreciation of the trust property.

On brief petitioner argues that he is entitled to an additional deduction of $462.50 from income for 1930 on account of amortization of the gift tax paid by petitioner because of the gift to him out of the estate of his mother. The parties stipulated that such a deduction was allowed by respondent for 1929, but was neither claimed nor allowed for 1930. We have no further information concerning this item, and the stipulation on its face obviously is insufficient to sustain petitioner’s contention. Furthermore, the issue was not raised in the pleadings, and therefore will not be considered by us here. Citizens National Trust & Savings Bank of Los Angeles, 34 B. T. A. 140, 145; Ned Wayburn, 32 B. T. A. 813; Coosa Land Co., 29 B. T. A. 389, 394.

Judgment will be entered under Rule 50.

       SEC 161. IMPOSITION OP TAX.
      (a) Application of taro. — The taxes imposed by this title upon individuals shall apply to the income of estates or of any kind of property held in trust, including—
      (1) Income accumulated in trust for the benefit of unborn or unascertained persons or persons with contingent interests, and income accumulated or held for future distri-tíhtion under the terms of the will or trust;
      (2) Income which is to be distributed currently by the fiduciary to the beneficiaries, * * *
      SEC. 162. NET INCOME.
      The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case-of an individual, except that—

      (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, * * * but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. * * *


author: Leech:

text:
    Mary Ink, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 75731.
    Promulgated April 6, 1937.

      Albert B. Arbaugh, Esq., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Leech:

Our inquiry is resolved by the correct legal characterization of the contested receipts. If those receipts aré bequests, they are not taxable income to petitioner. Kevenue Act of. 1928, sec. 22 (b) (3)

Respondent now concedes the $4,000 payment received from the executor was a bequest, but denies that status to the $20,000 received from the lessees of the theatre property. He cites Helvering v. Pardee, 290 U. S. 365; Bridgeport-City Trust Co., Trustee, 32 B. T. A. 1181; Bay Trust Co., Trustee, 34 B. T. A. 233; Arthur U. Crosby et al., Executors, 34 B. T. A. 433, as supporting that conception. We think those authorities and others characterize both receipts Us bequests.

Whether the receipts. in dispute are bequests depends upon the intent of the testator, as expressed in his will, to permit their payment from either corpus of the estate or its income. Helvering v. Pardee, supra; Bridgeport-City Trust Co., Trustee, supra; Bay Trust Co., Trustee, supra; Arthur U. Crosby et al., Executors, supra; Burnet v. Whitehouse, 283 U. S. 148.

The present will permitted the payment of the amounts in question either from corpus or income. This will consistently designated the interest of the petitioner thereunder as an “annuity” and, not only did not limit its source of payment to income, but expressly made the “annuity a specific charge against my theatre property * * *.” See Arthur U. Crosby et al., Executors, supra.

Item four is as follows:

ITEM FouR: I hereby Will and Bequeath unto my wife, Mary Ink, the sum of Twenty-Four Thousand Dollars ($24,000) per year, payable in monthly payments of Two Thousand Dollars ($2000.00) each, said annuity to be received by her in full of her dower, distributive share, year’s support, and any and all other claims or demands whatsoever that she may or might have against my estate, and I hereby make said annuity a specific charge against my theatre property hereinafter referred to.

The adventitious circumstance that the questioned payments to petitioner were actually made from income is not material. Helvering v. Pardee, supra. That the source of the payments of petitioner’s annuity was limited to a specific part of the corpus does not change the controlling fact that the contested distributions could be made legally from corpus. Burnet v. Whitehouse, supra; Boston Safe Deposit & Trust Co. v. Commissioner, 66 Fed. (2d) 179; certiorari denied, 290 U. S. 700; Warner v. Commissioner, 66 Fed. (2d) 403; certiorari denied, 290 U. S. 688. Nor is our conclusion disturbed by the termination of the testator’s trust during the taxable year and the fact that, thereafter, $20,000 of the disputed payments were made by the lessees of the theatre property. Helvering v. Pardee, supra; Commissioner v. Smiley, 86 Fed. (2d) 658, reversing 33 B. T. A. 198; Hanes v. Munger, 40 Ohio St. 493, and Yearly v. Long, 40 Ohio St. 27. Despite the termination of the trust, the distribution of the testator’s personal property and the provision in the will that the theatre property, upon wThich petitioner’s annuity was a specific charge, “which is leased for a period of Thirty Years (30) after its completion, shall not be sold prior to the termination of said lease,” clearly, under the last cited authorities, petitioner still had a lien on the theatre property, itself, for her annuity, and could enforce its.payment therefrom. And, in our opinion, that conclusion is not affected by item six or item ten of the will. In the face of the provision in item four, quoted above, making petitioner’s annuity “a specific charge against [the] theatre property” and its reiteration in item ten, those first-mentioned statements are no more than expressions of expectation, hope, .and belief that the income would be sufficient to meet the annuity. Such expressions are not enough to restrict the source of payment of the annuity here to income alone. Arthur U. Crosby et al., Executors, supra, and cases cited therein. The distribution of the testator’s personal property, at the expiration of the five-year period, as required by item ten of the will, only limited the source of petitioner’s bequest, to the theatre property and the devisees of that property. Commissioner v. Smiley, supra; Hanes v. Munger, supra, and Yearly v. Long, supra.

We conclude that the payments in question were received by petitioner as bequests and that they are, therefore, not taxable income to her. Revenue Act of 1928, sec. 22 (b) (3), supra; George D. Harter Bank, Executor, 29 B. T. A. 926.

Decision will be entered for the petitioner.

         SEC. 22. GROSS INCOME.
      *****"«*
      (b) Exclusions from gross income.- — The following items shall not be included in gross income and shall be exempt from taxation under this title:
      *******
      (3) Gifts., bequests, and devisfs. — The value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income).


author: AeuNdell :

text:
    Muskegon Motor Specialties Company, a Delaware Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 68783, 75475.
    Promulgated April 6, 1937.

      Laurence A. Masselink, Esq., for tlie petitioner.

      E. C. Algire, Esq., and Joseph P. McMahon, Esq., for the respondent.
   OPINION.

AeuNdell :

In computing depreciation allowances on the properties acquired by the petitioner from the two Michigan corporations, the respondent has used as a basis the cost of the properties to those two corporations. The petitioner says that the proper basis is the cost to it. The respondent originally had alternative theories for his position: First, that the assets were acquired in a nontaxable reorganization, and, second, that they were acquired through liquidation of subsidiaries during a consolidated return period. He has abandoned the first one.

The law and regulations cited by the respondent to sustain his position are section 113 (a) (12) of the Bevenue Act of 1928 and sections related thereto by cross-reference and article 38 of Regulations 75. The statute and regulations, in so far as material here, provide that during a consolidated return period the basis for depreciation shall be the same as if the corporations were not affiliated and that such basis shall not be affected by reason of a transfer of property during the consolidated return period. The supposed fact situation underlying the respondent’s view is that the period January 1 to J anuary 23,1929s was a “consolidated return period” within the meaning of the regulations. It is on this point that the parties differ.

The filing of a consolidated return is a matter of election, by affiliated corporations. Oklahoma Contracting Corporation, 35 B. T. A. 232, 237. The regulations lay down detailed instructions as to the formalities to be complied with by corporations seeking the privilege of making a consolidated return. Among other things, the consolidated return must be made by the parent for the group. The parent must prepare and file form 851 and the subsidiaries must prepare and file form 1122 consenting to the regulations and authorizing the parent to file for them. These formalities were not met. Each corporation filed its own return and neither form 851 nor form 1122 was filed. What is more important is that according to the evidence these matters were considered and a deliberate election was made not to file a consolidated return and not to meet the conditions which were necessary to the filing of such a return. On the contrary, it was intended that separate returns be filed and that was done. Consequently, it can not be held that a consolidated return was filed.

The remainder of the argument rests largely on the assumption that there was a consolidated return period for which a consolidated return was filed. It is in substance that the petitioner’s acquisition of stock of the two Michigan corporations was separate and distinct from the acquisition of the assets and that until the liquidation of the Michigan corporations they were separate and taxable entities. The original plan of consolidation devised and adopted by the officers and directors of the two Michigan corporations was not, as far as the record shows, reduced and outlined in detail in any one writing. What such plan was must be gathered from all the agreements, minutes, transactions and testimony of the parties who assisted in formulating and in carrying out the plan. Considering all the evidence, it is our opinion that the dissolution of the two companies and the acquisition of their assets by the petitioner were all a part of the original plan of consolidation which was made effective as of J anuary 1, 1929. That the acquisition of the assets of the two companies and their dissolution were not specified in the agreements and other writings as absolutely necessary to the plan of consolidation is not decisive. The writings disclose that such action was within the scope of the plan and the companies were in fact dissolved and their assets were transferred to the petitioner and the petitioner assumed the responsibility of operating and carrying on the combined businesses of the two companies. It appears from the evidence that the formalities incident to the transfer of the properties and the dissolution of the companies were delayed through; the absence of counsel, which necessitated the submission of such matters to him. by mail for. his approval. However, as conceded on brief by the respondent, the element of time elapsing between the date the stock was acquired and the date of dissolution is not so important. The plan of consolidation, though not completed in form, was put into practical effect as of January 1, 1929. Although the two companies were, until January 23, 1929, legally existent, they were inactive; mere form without substance.

In view of the above, we hold that petitioner does not come within section 113 (a) (12) of the statute and article 38 of Regulations 75. It is, therefore, entitled to use as its basis the cost to it of the depre-ciable properties. Cost in this case is agreed to be the value of the properties when acquired. The parties have also agreed upon the subsequent additions. ' Rates are not in dispute except as to one group of buildings and on that point there is no evidence to show error in the respondent’s computation.

Reviewed by the Board.

Decision will be entered under Rule 50.


author: Akundbll :

text:
    Jacob F. Schoellkopf, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 76377.
    Promulgated April 6, 1937.

      Ralph M. Andrews, Esq., and Arthur E. Surdam, Esq., for the petitioner.

      R. P. Hertzog, Esq., for the respondent.
   OPINION.

Akundbll :

This proceeding involves a deficiency for the year 1931 in the amount of $10,369.08. It is alleged that the respondent erred (1) in disallowing a loss to the extent of $101,351.70 claimed by the petitioner in the liquidation of a certain corporation and (2) in increasing income by an amount of $13,866.25 as a gain x-ealized from an exchange of securities of a Maryland corporation for the securities of a New York corporation plus cash.

This proceeding, with the exception of four exhibits relating to the first issue, was presented upon a stipulation of facts.

The petitioner is a resident of Buffalo, New York.

(1) On or about November 7,1928, the petitioner acquired at a cost of $30,551.51 ten shares and 1,520 bearer share warrants, entitling him on surrender thereof to 1,520 shares of the capital stock of Shell-grafton, Ltd., hereinafter referred to as Shellgrafton, a Canadian investment security holding corporation, located at Fort Erie, Ontario, having an authorized capital of 5,000 shares of a par value of $100 per share.

On October 9, 1931, the petitioner surrendered to Shellgrafton the bearer share warrants owned by him in exchange for 1,520 shares theretofore represented by the warrants.

On various dates from December 3,1928, to October 22,1930, Shell-grafton obtained loans from the Marine Trust Co., a banking corporation located in Buffalo, New York, hereinafter referred to as the bank, in varying amounts aggregating $600,000 on October 22,1930. Shell-grafton gave the bank its demand notes to cover the loans. On that date ail the assets of Shellgrafton, of a fair market value of $579,-992.50, other than cash and accounts receivable not in excess of $35,000, were pledged with the bank to secure its demand notes. Such notes were not endorsed by the petitioner.

On the same date the petitioner and two other stockholders of Shellgrafton, each to the extent of one-third, were jointly indebted to the bank in an amount of $300,000 on an account carried by the bank in the name of “J. F. Schoellkopf, Jr. Special”, hereinafter referred to as the special account, secured by certain securities having an aggregate fair market value on that date of $615,185.88, some of which were owned jointly in equal shares by the parties and some by each individually.

On the same date, at the request of the bank and upon its representation that the notes of Shellgrafton were insufficiently secured and to prevent a sale by the bank of the assets of Shellgrafton pledged as collateral for its notes, the petitioner caused to be written, with the consent and acquiescence of the other two stockholders, a letter to the bank in part as follows:

This letter will be authority for you to apply any excess collateral on the loan made to J. F. Schoellkopf, Jr., Special, toward any deficiency in the collateral on the loan made by Shellgrafton Limited, this authority to continue until such time as it may be changed in writing.

No change was ever made in the above authority.

On various dates between October 22, 1930, and October 8, 1931, upon the insistence of the bank that the value of the collateral securing the notes in the special account and of Shellgrafton had greatly depreciated, the petitioner and the other stockholders deposited with the bank individually owned securities as additional collateral for such notes.

The indebtedness of Shellgrafton to the bank was reduced on January 7,1931, by $5,000 to $595,000.

On October 8, 1931, pursuant to an agreement between the bank, petitioner, and the other two stockholders, the accounts in the bank of the petitioner and the other two stockholders were charged by the bank with an aggregate amount of $575,000, the account of the petitioner being charged with the amount of $221,111.65; the account of Shellgrafton in the bank was credited with an amount of $575,000. The bank marked the note of Shellgrafton paid and surrendered it to Shellgrafton, at the same time advising it by letter that its indebtedness to the bank of $575,000, and interest, had been fully paid and satisfied. Demand notes were given to the bank by the petitioner and the other stockholders for the amounts charged to their individual accounts. The note of the petitioner remained unpaid on December 31,1931. At the time the account of Shellgrafton was credited with the amount of $575,000, an amount of $20,000 was charged to its cash deposit account in the bank by an entry of a charge slip, making a total credit of $595,000.

On the same date the petitioner wrote a letter to Shellgrafton as follows:

Tour company is indebted to me in tbe sum of $221,041.50 and interest as I have assumed an indebtedness to The Marine Trust Company in that amount against which the Marine Trust Company has discharged you from the corresponding amount of your indebtedness to it. If it is agreeable to you I am prepared to accept in full settlement of your indebtedness the transfer to me or my nominees of the following shares. Please advise me of your decision at your early convenience.
77 Shares American Home Products Com.
8 Shares Copeland Products Com. A.
39 Shares Consolidated Gas (N. Y.) Com.
1730 Shares Eastern States Power Com. B.
77 Shares Hazeltine Products Com.
500 Shares Marine Midland Cap.
17444 Shares Niagara Share of Md. Com.
193 Shares Taggart Com.

Similar letters were written by the other stockholders. Pursuant to such letters, all the securities deposited by Shellgrafton with the bank as collateral for its loans to Shellgrafton, constituting all of the remaining assets of the latter, were, subject to their indebtedness to the bank, distributed to them in proportion to the amounts of the demand notes given by each of them to the bank. The petitioner’s share of such securities had a fair market value of $120,369.11. On December 31, 1931, Shellgrafton was dissolved.

In his income tax return for the year 1931, made on a cash receipts and disbursement basis, the petitioner claimed a loss of $131,-903.21 as a result of the liquidation and dissolution of Shellgrafton, computed as follows:

Cost of stock_¿_$30, 551. 51
Note to Marine Trust Co. of Buffalo of Oct. 8, 1931_1221, 720. 81
Total_ 252,272. 32
Assets received_ 120,369.11
Loss claimed_ 131,903.21

The respondent allowed the claimed loss only to the extent of the cost of the stock, or $30,551.51, and disallowed the balance of $101,351.10.

The petitioner contends on brief that he is entitled to an additional loss deduction in the amount of $100,742.54 upon the ground that the payment or discharge of the indebtedness of Shellgrafton to the bank constituted a capital contribution to that company and hence increased the cost of his stock. The amount claimed is the difference between the amount of his note, $221,111.65, and the $120,369.11 value of the securities received in 1931.

Section 41 of the Revenue Act of 1928 provides that the net income shall be computed upon the basis of the taxpayer’s annual accounting period in accordance with the method of accounting regularly employed in keeping the books of such taxpayer. The petitioner herein employed the cash receipts and disbursements basis. In Hart v. Commissioner, 54 Fed. (2d) 848, affirming Francis R. Hart, 21 B. T. A. 1001, the court stated:

It is inconsistent with the cash receipts and disbursement method of accounting that the petitioner he permitted to claim a deduction where there has been no actual payment of cash. This basis of accounting requires that he report only actual receipts and deduct only actual disbursements.

It has been held that the amount of a note given by a stockholder, on a cash receipts and disbursement basis, in settlement of his liability as an endorser on the corporation’s notes is not deductible from gross income, no cash having been paid on the note in the taxable year. A. James Eckert, 17 B. T. A. 263; affd., Eckert v. Commissioner, 42 Fed. (2d) 158; affd., Eckert v. Commissioner, 283 U. S. 140. In that case, as in the instant proceeding, the taxpayer gave his note in discharge of corporate notes, and, in both, the corporations Avere dissolved in the year that the individual notes Avere given in discharge of the corporate notes. The petitioner herein, hoAvever, Avas not an endorser of the notes of Shellgrafton. Whether the giving of a note by a stockholder in discharge of corporate indebtedness is founded on liability as endorser, as in the Echert case, or is a voluntary assumption by the stockholder of corporate indebtedness, is not decisive of the question herein. If no loss was sustained under the circumstances in the Echert case, it is hard to see why the conclusion should be otherwise here. In neither case did the taxpayer pay out any cash; he merely agreed to pay an indebtedness at some future time. ■ Cases cited by the petitioner are to the effect that the assumption, payment, or cancellation by a stockholder of corporate indebtedness constitutes a capital contribution and serves to increase the cost of the shares to the stockholder. See Menihan v. Commissioner, 79 Fed. (2d) 304; certiorari denied, 296 U. S. 651; Park v. Commissioner, 58 Fed. (2d) 965; Kistler v. Commissioner, 58 Fed. (2d) 687; Burns v. Commissioner, 31 Fed. (2d) 399; W. F. Bavinger, 22 B. T. A. 1239; B. Estes Vaughan, 17 B. T. A. 620. But what Avas said in those cases must be taken in connection with the fact situation in each case. The petitioner here did not assume the debts of Shellgrafton as a part of the plan to save his investment in the corporation. The debt was assumed in connection AAÚth the liquidation and dissolution of Shellgrafton, and it may not be said that the petitioner has presently suffered a loss until the note given by him is paid. It may Avell be that the securities received from Shellgrafton and held as collateral by the bank may so appreciate in value that the petitioner in fact may never be out of pocket. We think the principle of the Echert case is controlling. It follows that the respondent correctly disallowed the claimed deduction in excess of the amount of $30,551.51 representing the cost of the stock.

(2) The remaining issue involves the exchange by the petitioner of shares of stock of the General Baking Corporation, a Maryland corporation, for stock and bonds of a New York corporation of the same name, plus cash in the amount of $791.25. The question here is the same as that in H. B. Leary, Sr., 34 B. T. A. 1206, Avhich grew out of the same transaction. Following our decision in that case, we hold here that the exchange of securities was nontaxable under the reorganization provisions of the [Revenue Act of 1928, and that-the cash dividend of $750 received by the petitioner and reported in income Avas an ordinary dividend.

Decision will be entered under Rule SO.

       Discrepancy as to amount of this note not explained.