author: Kern :

text:
    Safe Deposit and Trust Company of Baltimore, Trustee under Wills of R. J. Reynolds, and Katharine S. Johnston, and Deed of Katharine S. Johnston and Decree of Superior Court of Forsyth County, N. C., etc., Petitioner, v. Commissioner of Internal Revenue, Respondent. Estates Administration, Inc., Administrator of the Estate of Zachary Smith Reynolds, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 86394, 86395.
    Promulgated June 19, 1940.

      Charles McH. Howard, Esq., for the petitioners.

      Brooks Fullerton, Esq., for the respondent.
   OPINION.

Kern :

Kespondent has determined the deficiency on the theory that the interest of the decedent, Smith Beynolds, in the corpora of the three trusts here in question, the first, a testamentary trust created by liis father, B. J. Beynolds; the second, an inter vivos gift in trust made by his mother; and the last a testamentary trust created also by his mother, is includable in his gross estate either under section 302 (a) of the Bevenue Act of 1926, set out in the margin, a catch-all provision including everything in decedent’s estate to the extent of his interest, or under section 302 (f), also set out, which includes property passing under a general power of appointment exercised by decedent and intended to take effect at or after his death. Since the assertion of the deficiency under subsection (a) raises a novel question, the consideration of it may be deferred until subsection (f) has been discussed, for should the transaction constitute a transfer of property under a general power exercised by decedent, a question fully considered in numerous cases by this Board and the courts, it will not be necessary to consider the first question.

1. Power of appointment. — It is said by respondent that the property passed to decedent’s brother and sisters through the exercise by decedent in the will which he executed in New York on August 21, 1931, of a general power of appointment; that the Supreme Court of North Carolina passed upon and denied only the validity of the will and not the validity of the exercise of the power; that the exercise was valid under state law; and that, in the alternative, those who took under the posthumous compromise settlement did so in compromise of their rights as appointees under the power and therefore as appointees under the doctrine of Lyeth v. Hoey, 305 U. S. 188. The argument on this last point is not entirely clear, but we shall consider it in due course.

To sustain respondent’s contention, it must appear that the power of appointment was general, that it was exercised, and that the property passed under it. It does not seem to be disputed that the power conferred by the three instruments was general. Under “item fourth” of his will, B. J, Eeynolds left the residue of his estate to his wife and his children on trust, the latter to receive a two-thirds share of the whole, and, after providing for the distribution in part and accumulation of the rest of the income of each child until he should reach the age of 28, directed that at that time “each of them shall become entitled to and shall respectively receive from said trustee his * * * share of the corpus of the estate”; with the provision added, which is important here, that “should any of my children die before he ⅜ * * shall arrive at the age of twenty-eight (28) years, then the share * ⅜ * which would have been payable to him * * ⅜, had he * * * arrived at that age, shall be continued to be held by my said Trustee for the use and benefit of his * * * devisees by Will until the time that such child would have arrived at the age of twenty-eight years * ⅜ * when the said trust shall cease and the estate shall then become payable to such devisees, the Trustees, however, paying in the meanwhile the income from said share to them * *

There can be no doubt that the power here was general.

The power conferred by the trust deed of 1923, executed by decedent’s mother, provided that the trustee should hold the shares of the several children for the life of each “and upon its death shall distribute, transfer and deliver the same to and among or hold the same for such person or persons, objects or purposes, in trust and otherwise, as such child shall by its Last Will nominate and appoint to take the same ⅜ *

There is no doubt that this power was likewise general.

Finally, under decedent’s mother’s will, made in 1924 and proba! ed the same year, the trustee is directed to hold the share of each child for life, and upon its death to distribute it to “such person or persons, objects or purposes, in trust or otherwise, as such child shall by its Last Will nominate and appoint to take the same * * Here, again, the power was general.

The decedent at least attempted to “exercise” the power given him by the three instruments within the meaning of the Federal act. He did so in August 1931 by a purported will executed in New York, the effect of which we shall examine under the next head. Unless “exercise” is to be interpreted as an effective exercise, we do not think petitioner would deny that decedent exercised the power of appointment; and the effectiveness of the exercise we can best consider under I he third requisite.

We pass then to the final question, whether the property “passed” under the will in question. The Supreme Court, in Helvering v. Grinnell, 294 U. S. 153, held clearly that the property must pass under the power to bring it within the gross estate. The Grinnell case is further significant in this relation in that it indicated clearly that the passing of property under a power of appointment is to be determined by local law, and where, as here, the power was exercised by a minor in a jurisdiction foreign to his domicile of origin, it is to be determined under the general rules of conflict of laws. We turn then to that question.

Professor Beale states that the “power to appoint personal property by will may be exercised either (a) by a will valid by the proper law or (b) by an instrument which would be a will by the law of the donor’s domicile.” Conflict of Laws, § 287.1, p. 1010, See also American Law Institute, Restatement, Conflict of Laws, § 287. In the instant case, therefore, a will executed according to the formalities either of New York (assuming that the decedent had the capacity to execute a will), or of North Carolina law would validly exercise the power. We may assume that the New York will, if decedent had acquired a domicile there, was valid and sufiicient to exercise the power, and, even further, that whether it was a will or not by New York law, if he had acquired a domicile in New York the power could be validly exercised by an instrument executed there if it would have been a will under North Carolina law. Of course, if the decedent still retained his North Carolina domicile, the law of that state alone would determine whether the power was properly exercised and in such an event would determine the capacity of the decedent to execute it. We shall discuss first the will’s validity under North Carolina law before taking up the question of his change of domicile.

Petitioner’s counsel points out that the effect of an appointment depends upon the law that created the power; and if it was created by will, as here, its effect would be determined by the law of the donor’s domicile. Beale, op. cit. § 285.1. While this is true, it adds nothing, for the appointment by the decedent to his brother and sisters would seem to need no construction to make it clear. Petitioner’s counsel also points out that whether or not a general power to appoint personal property by will is executed if it is exercised by a general residuary bequest not specifically mentioning the power, is likewise determined by the law of the donor’s domicile at the time of the creation of the power, which is here North Carolina’s law. Beale op. cit. § 288.1; American Law Institute, Restatement, Conflicts § 288. This principle, however, has no bearing here, for decedent in his purported will referred expressly to the power of appointment given him in each of the three donating instruments, his father’s will, his mother’s trust, and his mother’s will. We must not lose sight of the qualification of the rule stated above as to the law which controls the effect of the appointment, for the trust res was under all three instruments held in Maryland where the trustee, the Safe Deposit & Trust Co. of Baltimore, was likewise present and doing business. That qualification is that “generally the validity of the appointment as affecting the title of goods situated in a state as creating a valid title is determined by the law of the state of situs of the goods.” Beale, op. cit. § 285.1. The law of Maryland, therefore, may conceivably limit the effect to be given the appointment under North Carolina law. We may call attention here to another question which it may not be necessary to decide, and that is whether, assuming that the decedent donee of the power had acquired a new domicile in New York and had in age and otherwise the capacity to make a valid will under the law of that state, it would be effective, notwithstanding the law of the donor’s domicile required a greater age for testamentary purposes than the donee had then attained, in the absence of any indication of intent in the instruments creating the power to allow exercise of it over movables at such lesser age. Petitioner’s counsel confesses that he has found no cases on this specific point, but argues that the principle of comity would not extend so far as to require the state of the donor’s domicile to recognize as valid the exercise of a power by a nonresident donee in such circumstances. If the general rule which we have stated is correct, that the power may be exercised by a will valid in the donee’s domicile, we fail to see how the policy of the donor’s state may limit its exercise unless, as appears to be suggested, the policy of the donor’s state is in some way a limitation inherent in the power itself because created under its jurisdiction, or the intent of the donor of the power is to be construed as limited by a like consideration. As said before, we may leave these questions, however, until we have examined the North Carolina law and if necessary also the acquisition by decedent of a new domicile in New York.

We turn now to the North Carolina law. The laws of the state, by section 4128, provide that “No person shall be capable of disposing of real or personal estate by will until he shall have attained the age of twenty-one years.” Code, Annotated (1935). The North Carolina laws further provide, by section 4132:

No appointment, made by will in exercise of any power, shall be valid unless the same be executed in the manner by law required for the execution of wills; and every will, executed in such manner, shall, so far as respects the execution and attestation thereof, be a valid execution of a power of appointment by will, notwithstanding it shall have been expressly required that a will made in exercise of sueh power should be executed with some additional or other form of execution or solemnity.

The decedent here had not attained the age of 21 at the time when he executed the New York will in August 1931, nor, for that matter, at the time of his death on July 6,1932. Since he was born on November 5, 1911, in August 1931 he was nearing the end of his twentieth year.

The language of the three instruments granting to decedent a power of appointment does not indicate any intention on the donor’s part, in any instance, that the power shall be exercised by a will made in accordance with the law of a particular state. Nor does it limit or qualify in any way the exercise of the power given. R. J. Reynolds’s will, executed in 1917 and probated the next year, provides merely that, should any of his children die before he or she shall arrive at the age of 28, when the corpus was to be distributed, then such child’s share would continue to be held by the trustee for the benefit of his “devisees by will”, with remainders over in case of intestacy. While elaborate provisions are made for the payment of the income to the children until they should reach the age of 21, or thereafter and until they should reach the age of 28, and although special provision is made for the event of his wife’s death in either the first or the second of these periods, nothing is said specifically of any disposing power which could be exercised by the children by will or otherwise in either of these periods. There is nothing to indicate, in other words, that the donor of the power intended that it could be exercised before the child was 21. The inter vivos trust of decedent’s mother likewise tells us nothing. It provides that the child may “by its Last Will nominate and appoint”, with a remainder over “in default of such appointment.” Her will uses the same language.

The Supreme Court of North Carolina has construed the language of these settlements in a case which was brought in the Superior Court of Cabarrus County by one of the guardians (a trust company) of Anne Cannon Eeynolds, decedent’s daughter, against the other guardian, the child’s grandmother, to impeach the judgment excluding that child from further participation in the trust estates of decedent in accordance with the forced trust settlement made on the child and decedent’s first wife by decedent during his lifetime. This suit was brought after decedent’s death and after the birth of his posthumous son by his second wife. The lower court sustained the consent judgment of the Forsyth County Court upholding the earlier trust settlement, but the Supreme Court of North Carolina reversed and directed that proceedings be brought to test the validity of the Forsyth County judgment, In re Reynolds' Guardianship, 206 N. C. 276; 173 S. E. 789 (1934). Respondent contends that what is said by the Supreme Court of North Carolina in that case respecting the validity of decedent’s exercise of the power of appointment is obiter dictum, but it would seem that no purpose 'would have been served by that court’s reversing and remanding to the Cabarrus County Court for further proceedings if the effect of the exercise of the power had not been in issue, for if the exercise was valid the child would have taken nothing; if it was not, she was entitled as a remainderman to an interest in all three settlements under the donor’s will' or trust deed, unless the decedent’s inter vivos trust settlement on her and the consent judgment affirming it were binding. We think, therefore, that, while there was no final adjudication of the right of the parties in the North Carolina courts, what the Supreme Court of North Carolina said in regard to the validity of the decedent’s New York will is conclusive of the law of the donor’s domicile. Since the Supreme Court of North Carolina deals not only with the question under local law of the capacity of an infant to make a will, but also with the presumed intent of the donor that his gift of the power shall be read in the light of local law, and with the effect of emancipation by marriage on an infant, we quote those parts of the opinion. Three justices concurred and one dissented, and although one of the concurring judges said that “The New York will was not upon the lap of the Chancellor”, and the chief justice in his opinion made no reference to the will, we are of the opinion that the decision, while not a conclusive adjudication of the question, makes clear the North Carolina rule of law as applied to the facts here. The court, per Clarkson, J., said (173 S. E. at 796-797):

The alleged will of Zachary Smith Reynolds appears to be inoperative and void. When the alleged will was executed in New Tort, he was under the age of 21 years. O. S. § 4128, is as follows: “No person shall be capable of disposing of real or personal estate by will until he shall have attained the age of twenty-one years.” General laws of state, in force at time of execution and performance Of contract, become part thereof. Ryan v. Reynolds, 190 N. C. 563, 130 S. E. 156; Monger v. Lutterloh, 195 N. C. 274, 142 S. E. 12; Steele v. Metropolitan Life Insurance Co. of New York, 196 N. C. 408, 145 S. E. 787, 61 A. L. R. 821. By analogy, to show R. J. Reynolds’ intent, it can be inferred that his will was made with the North Carolina law in view. No language gives the right of appointment under 21 years of age. In this connection, it should be noted that the judgment and decree was signed in Forsyth county superior court on August 4, 3931, which expressly states that Zachary Smith Reynolds “under the Statute law of North Carolina, cannot validly make a will disposing of his share in said estate until he reaches the age of twenty-one years.” And further “that in the event of the death of the said Zachary Smith Reynolds, prior to his reaching the age of twenty-one years, the said infant child, Anne Cannon Reynolds II would inherit his entire estate.”
The wills of R. J. Reynolds and Katherine S. Johnston appear to indicate an intention that Zachary Smith Reynolds could only exercise the power of appointment after he became 21 years of age, and on that account the New York will would appear to be inoperative and void. It appears that his domicile was in North Carolina. In the complaint filed in the Forsyth county proceedings on August 4,1931, just seventeen days before the alleged execution of the New York will, it was alleged: “That the defendant, Zachary Smith Reynolds, is a citizen and resident of the State of North Carolina, and has been such since his birth, and that the defendants, W. N. Reynolds and R. E. Lasater, are the duly, legally and regularly constituted general guardians of and for the said Zachary Smith Reynolds.” In the answer filed on his behalf by his guardian this allegation is admitted.
In Thayer v. Thayer, 187 N. C. 573, at page 574, 122 S. E. 307, 308, it is said: “A domicile of choice is a place which a person has chosen for himself; but an unemancipated infant, being non sui juris, cannot of his own volition select, acquire, or change his domicile.” We do not think that marriage changed his status in this jurisdiction. In some instances, where the right is given him under the statute, the marriage of an infant emancipates the infant as to his rights to earnings. See Wilkinson v. Dellinger, 126 N. C. 462, 35 S. E. 819; Little v. Holmes, 181 N. C. 413, 107 S. E. 577; C. S. § 4134. * * * These settlements are usually between members of families who are sui juris, of full age, with capacity to act, but not so in this case where we are dealing with the rights of an infant. * * *

After quoting with approval from Goodrich on the Conflict of Laws (1927) to the effect that the domicile of a legitimate minor child is that of the father., if the latter is living; that the domicile of origin is that of the father; and that the minor by his own act, while under the disability of infancy, can not establish a separate domicile for himself; the court continued:

* * * We think it unnecessary to consider the threat of Zachary Smith Reynolds’ purpose in going to New York to acquire a domicile to make a will and its illegality in this jurisdiction. It must be borne in mind also that Zachary Smith Reynolds’ guardians under the will of his father were domiciled in Forsyth County.

We are of the opinion that tlie New York will was invalid as a will under North Carolina law because of the disability of the testator’s minority. The respondent insists, however, that even if it was not valid as a will, it was still a proper exercise of the power of appointment under North Carolina law, citing Denson v. Pine State Creamery Co. (N. C. 1926), 131 S. E. 581. We have examined that case and do not find that it supports the proposition claimed; it turned on the proper execution of a power where no direct reference to the power was made in the deed executing it.

If the decedent could not exercise the power under North Carolina law, did he acquire a new domicile in New York, and, if so, did he have the capacity as a minor to make a valid will under the law of that State ? Respondent’s counsel at the hearing referred to the New York doctrine of emancipation of a minor by marriage, but has not discussed the question on brief. Obviously, decedent was not emancipated by marriage for the purpose here concerned by the law of North Carolina. We think it unnecessary, however, to go farther than to inquire whether decedent acquired a New York domicile, for if he did not, the other questions become immaterial.

We are of the opinion that the decedent could not and did not in the circumstances acquire a New York domicile, and the brief relation of a few facts we think sufficient to support this conclusion. His guardians appointed by his mother’s will were her second husband, J. Edward Johnston, and his father’s brother, W. N. Reynolds, with provision for succession. Robert E. Lasater succeeded Johnston. Appointment of guardians by the father, or if he be dead, by the mother, is fully provided for in the North Carolina law. Cods (1935), § 2151. We assume, as petitioner contends, that these guardians were, pursuant to the statute, appointed to take “custody and tuition” of decedent’s person, and not merely of his estate. Their consent would have been necessary for him, while a minor, to change his domicile, and their testimony that such consent was never given is uncontra-dicted. Decedent, having taken advice of counsel, was himself aware of what would be necessary for him to make a will, and suggested in his letter to his uncle, W. N. Reynolds, on June 26, 1931, that his guardians change their residence or allow new guardians to be appointed. There the matter dropped.

Even if we assume in respondent’s favor, however, that decedent could have changed his domicile, we can not find that he had any bona fide intent to do so. It is elementary that the acquisition of a domicile of choice involves actual physical presence at a dwelling place in another state, coupled with the concurrent intent to make it a home. Intention involves the idea of fixity, of some degree of permanence in the new abode, and must be more than the mere intention to acquire a new domicile. Restatement, Conflicts §§ 15, 16, 18, 19. The concept of “home” in the conflict of laws, as distinguished from any other transitory dwelling place, and the factors to be given weight in determining whether any certain dwelling place comes within the definition, are set out fully in the Restatement, § 13, and need not be recited here. The Supreme Court, however,, has examined the whole matter fully in a recent case which has certain similarities to this case. Texas v. Florida, 306 U. S. 398.

The decedent knew, on the advice of his lawyers, that his attempt to obtain a new domicile in New York would be futile, as his letter to his uncle in June 1931, already referred to, indicates. His widow testified that he had told her as much. He leased quarters in New York for a few months only in the summer of that year, and did not retain them after Elizabeth Holman, a professional singer whom he later married, left New York to go on tour. He apparently had no belongings in New York beyond his personal clothing. He wanted to acquire a new domicile for a special purpose — that is clear; but he did not want to acquire a new home, and the special intent to obtain the benefit of certain legal results which would flow from a change of domicile can not, as we have said, be considered as evidence of a general intent to change his permanent place of abode. We do not think that decedent had a bona fide intent to establish a new home in New York.

Even if this point could be conceded, however, the law governing the validity of the New York will over movables would be that of his domicile at death. See 2 Beale, op. cit. § 306.1, p. 1034; and cases there cited, which include many New York decisions. And New York was clearly not his domicile when he died in 1932. Decedent left New York in the fall of 1931 and never returned except for temporary purposes. His registration at a New York City hotel and at a New York City hospital where he went for treatment afterwards, gave Winston-Salem, North Carolina, as his residence; and he actually returned to Winston-Salem in May 1932 to live. That summer he contemplated taking a course in aviation in the fall at a New York college, but such an intent does not ordinarily work a change of domicile, and this appears to be the law of New York. 1 Beale, op. cit. § 22.8, p. 176. And in any event, decedent would not have acquired a New York domicile by going to a New York college until he entered that jurisdiction. Here he had leased an apartment in New York City for a term beginning in the fall of the year in which he died. When he died the only personalty which he had in New York was a watch left by his second wife for mending at a jeweler’s there. Throughout the whole period before the making of the will until his death he had rooms in the paternal house in North Carolina and practically all his belongings were in those rooms.

We do not enter here on all the secondary facts pertinent to discover decedent’s intention, such as his frequent references to “Keynolda”, the family farm in North Carolina, as home, for we think the facts already stated clearly establish that the decedent died domiciled in North Carolina, his domicile of origin, and that he never acquired a domicile elsewhere. It follows, therefore, that, since his capacity to exercise the power of appointment is dependent on the law of North Carolina, and since as a minor under that law he did not have the requisite capacity, no property passed by the exercise of the power of appointment within the meaning of the revenue act.

Since under North Carolina law, which we have held is the proper law to be applied under the accepted doctrine of conflict of laws, no property “passed” by the exercise of the power, we need not concern ourselves with any limitation on the disposition which the law of Maryland, as the situs of the trustee and the trust res might impose. See 2 Beale, op. cit. § 285.1, p. 1010. Nor need we inquire whether the power exercised would have been a “general power” in Maryland under the somewhat questionable doctrine of Leser v. Burnet, 46 Fed. 756. See Griswold, Powers and The Federal Estate Tax, 52 Harvard Law Review 929, 941, which would construe that phrase of the Federal statute in terms of local law, for that question has now been put at rest by Morgan v. Commissioner, 309 U. S. 78. It would seem, however, that if Maryland, rather than North Carolina, law were the proper law to determine the power’s effect, its exercise in the circumstances here present would have been ineffective in view of the common law rule still holding in that jurisdiction, to the effect that marriage and birth of issue, including posthumous issue, works a revocation of the will. See Karr v. Robinson, 167 Md. 375; 173 Atl. 584; Cunningham v. Cunningham, 158 Md. 732, 735; 148 Atl. 444. In any event, the Circuit Court of Baltimore County in Maryland, in its decision in a proceeding to which all interested persons, including the executor named in the New York will and the administrator there appointed were constituted parties, by its decree entered March 12, 1936, held that the “alleged will was not effective or operative to dispose of or affect any of the property or estate held by the plaintiff as trustee under any of said instruments; but was altogether void and without effect as an exercise of any power of appointment or disposition which the said Zachary Smith Reynolds would have possessed or had, if he had attained lawful age at the time of his death.”

We hold that under the Federal taxing statutes no property passed by decedent’s exercise of his power of appointment.

We leave on one side until we shall have considered the second principal question raised — respondent’s alternative contention based on the doctrine of Lyeth v. Hoey, supra, that 37½ percent of the three trust estates was taxable as having passed to decedent’s brother and sisters under the compromise settlement approved by the North Carolina court in right of their status as appointees of the power— since the pertinence of that doctrine is there raised again and need not be decided unless the respondent’s second proposition shall be found untenable.

2. Respondent contends that the decedent’s interest in the three (rusts is includable under subsection 302 (a) of the Revenue Act of 1926, which provides that:

The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
(a) To the extent of the interest therein of the decedent at the time of his death.

The resolution of this question depends first upon whether the provision was intended to include in the decedent’s gross estate all and sundry property interests of the decedent existing at the moment of death not included under the several specific subsections which follow subsection (a); or for that matter, all interests of the decedent of every character, whether included or not under the following subsections. In the second place, assuming that subsection (a) is such a “catch-all” clause and intended by Congress to cover all interests in property at death bearing any cognate relation to the preceding phrase “gross estate”, and that it does not merely subsume the subsections which follow, wo must then determine whether decedent’s interest in the several trusts at the time of his death was vested and not contingent or a mere expectancy, so as to constitute it part of his estate at death. Since the word “interest” connotes property rights which Congress has not otherwise defined except in the specific subsections which follow, we assume that it is to be construed in terms of local law.

The answer need not detain us long. We must suppose that Congress intended to exert its power to the full in enacting subsection (a), and to include in the gross estate any and every interest of the decedent at the time of his death. The other subsections do not limit, but enlarge, this definition by extending the act to other interests of the decedent which at common law or under the usual statutory law of the several states might not be included in the estate. The legislative history of these provisions from the first enactment of the tax in 1916 bears this out, and is so familiar that it need not be reviewed here. Nor can the legislative removal in the 1928 Revenue Act of the limiting definition originally imposed on this subsection, to whieh petitioner calls attention, be taken to limit in any way the subsection as it now stands or to constitute it a new enactment wider in scope than that originally laid down, or make it retroactive in application. The courts’ construction of the earlier section that the limiting definitions should be read conjunctively, see United States v. Field, 255 U. S. 257, led inevitably to the result that land in certain states was not includable in the gross estate, see Crooks v. Harrelson, 282 U. S. 55, and therefore made Congressional clarification of the section necessary, so that, in the language of the House Committee “the gross estate shall include the entire interest of the decedent at the time of his death in all the property.” (Italics supplied.) 69th Cong., H. Rept. No. 1, p. 15. The only question, then, is whether decedent’s interest in any or all of these three trusts, since no such interest was includable under any later specific subsection of the act, was a part of his gross estate under local law. If so, we think it would be a part of his gross estate under the Federal statute. We shall consider the several trusts separately.

(a) Respondent contends that the interest of decedent in his father’s trust was vested. The lower court in the second North Carolina case (Superior Court of Forsyth County, North Carolina), in considering the intervening complaint of the State of North Carolina which set forth a claim for inheritance and estate taxes, found as a fact that the will of R. J. Reynolds and the will and deed of Katharine S. Johnston did not bequeath, devise, or confer to or upon decedent any vested interest in the various trust estates, but only gave him the right to receive payments from the income thereof. However, the court in the same proceeding authorized and directed the settlement of this claim of the state for the sum of $2,000,000. The only party to appeal from this part of the order of the lower court was the trustee, and its appeal did not allege error based upon the finding that decedent did not have a vested interest in the various trust properties. The Supreme Court of North Carolina affirmed the compromise of the tax claims of North Carolina, but did not consider the question of whether decedent received any vested interest in the various trust properties. The lower court in its order expressly pointed out: “This judgment is based upon and entered in conformity with the offer of settlement filed in this cause by Richard J. Reynolds, Mary Reynolds Babcock and Nancy Reynolds Bagley, and is entire and indivisible.”

Petitioner asserts that the determination of the state court on this question is binding upon us and determinative of the issue, relying on Blair v. Commissioner, 300 U. S. 5; Sharp v. Commissioner, 303 U. S. 624 (reversing Sharp v. Commissioner, 91 Fed. (2d) 802); and Freuler v. Helvering, 291 U. S. 35. There are two peculiarities present in this case, however, which offer a possible distinction from the cited cases: (1) The judgment of the lower court was expressly stated to be “based upon and entered in conformity with” an offer of compromise, so that it is questionable whether any of the issues, although joined by the pleadings, were actually subject to litigation; (2) there is a glaring inconsistency between the court’s finding that decedent had no vested interest in the various trusts and its authorization of a payment to the State of North Carolina of $2,000,000 in settlement of a claim for inheritance taxes. Under the peculiar circumstances of this case, we consider it proper and advisable for us to consider the questions raised on their merits without being foreclosed from such inquiry by the rather anomalous finding and judgment of the Forsyth County (North Carolina) Court.

After a close study of the will of R. J. Reynolds, we are inclined to agree with respondent’s contention that the interest of decedent vested in the trust created thereunder. But we do not agree with respondent’s contention that decedent had a vested fee simple estate in one-third of the property included in the trusts created by the will of R. J. Reynolds. Respondent ignores the trust established for this property which is to continue until the year when decedent should attain the age of 28 years, characterizing it as an “administrative trust”, and dismisses the limitation over in the event decedent died before such year intestate and without surviving issue by saying: “Where there is a clear gift of a fee, a limitation over is void for repugnancy, and therefore, cannot' cut down a fee into a lesser estate.” This latter statement and the cases cited by respondent in support of it rest on the common law rule with regard to conveyances. The rules interpreting wills, even at common law, gave effect to executory devises to carry out the testator’s intent, even to the extent of allowing a limitation on a fee. Cro. Jac. 590; 10 Mod. 420; Fearne on Contingent Remainders, passim; 4 Kent Com. 257. As we have indicated, however, we do not agree with respondent’s contention that decedent received the fee simple title to such property. Respondent lays great stress on certain parts of the granting-clause in such will, set out in our findings, and would have us disregard other parts of the instrument. This we can not do, since it is axiomatic that a will, like any other instrument, must be construed as a whole, and all its provisions made effective if possible.

Construing the will of R. J. Reynolds in this way, we are of the opinion that decedent was not granted an estate in fee simple, but held, at most, an equitable estate for years, with a remainder in fee of the legal estate free from any trust. Upon his death prior to the vesting of the remainder and without having exercised the power of appointment, there were limitations over by executory devises contained in the will which made complete disposition of the property. The executory devise to his issue was on condition subsequent subject to another executory devise.

Under these circumstances, petitioner contends that, whether decedent’s interest in his father’s trust was vested or not, it was defeasible at death, an “interest * * * which * * * was obliterated by that event”, May v. Heiner, 281 U. S. 238. Cf. Estate of William B. Field, 22 B. T. A. 915. This is in accord with Treasury practice, for article 11 of Regulations 70, Revenue Act of 1926, provides: “Nor should anything be included on account of an interest or an estate limited for the life of the decedent.” Article 13 of Regulations 80 makes the same statement. Petitioner also points out that on decedent’s death all contingencies were provided for by the father’s trust, so that in no event would anything pass from decedent unless under the exercise of his power of appointment, which we have held was ineffective to transfer his interest, but the whole would pass directly from the original testator, R. J. Reynolds, to remaindermen named in the original will. We agree with this conclusion, and would point out here that under the peculiar provisions of the testator’s will, if the decedent should die under the age of 28 and without having exercised his power of disposition “but leaving issue him or her surviving”, the decedent’s share would remain in the trustee’s hands for the benefit of such surviving children of decedent until decedent would have been 28, had he lived, “when the trust shall cease and the estate shall then become vested in his or her children, then surviving’’ [our italics] ; with a limitation over, if the decedent should die without having either exercised the power or “without issue living at the termination of said trust, * ⅜ * on like trusts for my surviving children and the then living issue of my deceased children per stirpes * * It is obvious from this language that the remainder after decedent’s interest was contingent and would not vest in any of his children who survived him until the day which would have been decedent’s twenty-eighth birthday. This would 1 been a little over seven years after decedent’s death. We call attention to this language, for it shows that the birth of issue to decedent did not entitle him to any greater estate than he would have had before, nor make any the less defeasible on his death before reaching the age of 28 any interest which he had held during life. His power of appointment, which gave him a complete power of testamentary disposition during life, did not, as we read the statutes, constitute an “interest” under subsection (a). That a subsequent subsection, (f), should treat it as taxable in certain circumstances we. think is immaterial. We conceive that the word “interest”, as used in subsection (a), refers to a transferable estate, and not something which, like a life estate or power, ceases altogether on the donee’s death. If it includes anything which ceases at the decedent’s death, the inclusion must be in express words. In any event, under our holding on the first point, since petitioner did not have any power of appointment which he could exercise before he was 21 so long as he remained domiciled in North Carolina, he could not, by reason of its possession be said to have an “interest” includable in his gross estate.

We are of the opinion, therefore, that decedent’s interest in the trust estate of his father, R. J. Reynolds, was defeasible in the event of his death; that the remainder thereafter passed by limitations in the original testator’s will; and that, consequently, decedent had no interest therein at death properly includable in his gross estate for Federal estate tax purposes. As we shall point out later, our conclusion on this question is not affected by a consideration of the application of the rule in Shelley’s case.

When we turn to the will of decedent’s mother, Katharine S. Johnston, and tho inter ñivos trust created by her, we find the limitations very differently set out. Since the language used in both these instruments is the same in so far as decedent’s interest and the limitations over are concerned, we quote only from the deed of trust:

The Safe Deposit & Trust Company of Baltimore as Trustee hereunder shall hold the share of each child for such child during its life, and upon its death shall distribute, transfer and deliver the same to and among, or hold the same for such person or persons, objects or purposes, in trust and otherwise, as such child shall by its Last Will nominate and appoint to take the same, and in default of such appointment shall distribute, transfer and deliver the same to the descendants of such child living at its death, per stirpes and not per capita, and in default of such appointment and in default of descendants of such child the said Trustee shall at its death divide and distribute the same among such of said children and their descendants as are then living, per stirpes and not per capita, but the shares of such of her said children as are then living shall be held by said Trustee in trust for them and upon the same trusts that their original shares aro then held.

In tlie testamentary trust the second husband of the testator was included with her children and other descendants as a continuing remainderman. Otherwise there was no difference.

We have here a simple equitable estate for life in decedent, coupled with a complete power of testamentary disposition, with a fee simple in decedent’s descendants living at his death, and a limitation over, in the contingency of no appointment and no issue surviving, to decedent’s brother and sisters. On the birth of issue to decedent, the remainder would vest in his child subject only to be divested by its not surviving the decedent, or, in other words, a vested remainder in fee defeasible on condition subsequent.

Petitioner contends that in these circumstances the claim made by respondent that the decedent had an interest of calculable value, in-cludable in his gross estate at his death, has “no possible application”, since the decedent “had only an interest expressly limited to his life.” If this last proposition, that decedent had only a life interest, is true, obviously that interest would be obliterated at his death, any remainder would pass directly from the settlor (or testator), nothing would descend from decedent, and there would be no “interest” includable in gross estate. Cf. May v. Heiner, supra. But the soundness of this proposition .must be examined in the light of North Carolina property law which petitioner concedes, and we hold, controls the devolution. In the first place, there can be no question that decedent’s estate vested immediately. In the second place, the remainder in decedent’s daughter was vested and subject only to be divested in the event of her death before the decedent’s. In the third place, if the rule in Shelley’s case (1 Co. 104) applies, so that decedent’s estate can be regarded as a fee tail in the ancestor (decedent), and not as a life estate in the ancestor and a remainder over in fee in the children, the state statute of 1784 will convert the ancestor’s fee tail immediately into a fee simple. Sec. 1734, Michie’s N. C. Code, Ann. (1935), p. 763. In other words, the decedent here would have had during life a presently vested fee simple estate, defeasible only on his death without issue surviving, which would be equal in value to the full amount of that portion of the trust res set aside by his mother’s deed, in one instance, or by his mother’s will, in the other, for his benefit; and this substantial amount would undoubtedly constitute a part of his gross estate as property transferred from him at his death.

The rule in Shelley’s case as at common law, still obtains in North Carolina and has never been abolished. Nichols v. Gladden, 117 N. C. 497; 23 S. E. 459; Dawson v. Quinnerly, 118 N. C. 188; 24 S. E. 483. It applies to property devised as well as to property conveyed inter vivos. Leathers v. Gray, 101 N. C. 162; 7 S. E. 657. It is applied to property held in trust. 1 Bogert on Trusts, sec. 187, p. 522; 1 Perry on Trusts (7th ed.), sec. 358, p. 602; Boyd v. Small, 56 N. C. 39; Williams v. Houston, 57 N. C. 277. It applies generally to bequests of personalty, 1 Perry on Trusts, sec. 358, p. 603; Hughes v. Nickles, 70 Md. 484; 17 Atl. 398; Seeger v. Leaken, 76 Maine, 500; 25 Atl. 862; and no cases have come to our attention restricting the operation of the rule in North Carolina to realty. On the contrary this rule of interpretation of estates would seem to apply equally to personalty. See Fairly v. Priest, 56 N. C. 383; discussed in Whitfield v. Garris, 134 N. C. 24; 45 S. E. 904.

It remains to inquire whether the rule in Shelley’s case is properly applicable to the facts here and, if so, the consequence which would flow therefrom. The rule was set out in Hampton v. Griggs, 184 N. C. 13; 113 S. E. 501, as follows:

⅜ * * When an ancestor, by any gift or conveyance, taketli an estate of freehold, and in the same gift or conveyance an estate is limited, either medi-ately or immediately, to his heirs in fee or in tail, the word “heirs-’ is a word marking out the bounds or describing the extent or quality of the estate conveyed to the ancestor, and not a word designating the persons who are to take the estate, other than by descent and as the beginners of a new inheritance.

The requirements for the application of the rule were stated in the same case as f ollows:

In tlie first instance, an estate of freehold in the ancestor or the first taker.
The ancestor must acquire the prior estate by, through or in consequence of the same instrument which contains the limitation to his heirs.
The word “heirs” or “heirs of the body” must be used in their technical sense, as importing a class of persons to take indefinitely in succession, from generation to generation, in the course marked out by the canons of descent.
The interest acquired by the ancestor and that limited to his heirs must be of the same character or quality; that is to say, both must be legal, or both must be equitable, else the two would not coalesce.
The limitation to the heirs must be of an inheritance, in fee or in tail, and this must be made by way of remainder.

See also Tiffany on Real Property (3d ed.), vol. a, sec. 346.

Turning our attention to tlie fourth requirement as stated above, there immediately presents itself the question of whether the interest acquired by decedent and that limited to his descendants under the will of Katharine S. Johnston were of the same character or quality. It is obvious that the interest acquired by the decedent was equitable. It seems clear that the interest limited to his descendants must be considered as legal. The only duty of the trustee as to them was to “distribute, transfer and deliver” to them the property held in trust. Immediately upon the death of decedent the trustees would hold the property subject to this obligation, and upon a dry or passive trust. By virtue of the Statute of Uses the descendants of the decedent would obtain the legal title to the property held upon such a use. Cherry v. Power Co., 142 N. C. 404; 55 S. E. 287; Bank v. Sternberger, 207 N. C. 811; 178 S. E. 595. Therefore, this requirement for the application of the rule in Shelley’s case is not complied with and the rule is not operative in the present proceeding with regard to decedent’s interests under the will and deed of his mother. Vogt v. Vogt, 26 App. D. C. 46. This case was affirmed by the Supreme Court in Vogt v. Graff, 222 U. S. 404, on another ground, but the Court, in its opinion, used the following language: “Another condition of the application of the rule [the rule in Shelley’s case] is that the particular estate and the estate in remainder must be of the same quality, both legal and both equitable.” See also Kent’s Commentaries, 12th ed., vol. IV, p. 238. Payne v. Sale, 2 Devereux & Battle’s Equity Reports (N. C.), 455.

Since it is clear that this condition of the application of the rule has not been met, it is unnecessary to consider whether the other requirements for its application have been complied with.

We conclude that decedent had no interest at death in the trust estates created by his mother’s will or deed properly includable in his gross estate for Federal estate tax purposes.

With regard to the interests created by the will of E. J. Eeynolds, it is even more clear that the rule in Shelley’s case has no application. Decedent, at the time of his death, could only be considered, as we have shown, to have an equitable estate for years. The pertinent remainder created was to decedent’s children surviving him. This remainder was a contingent legal interest and followed an equitable term for years. It is obvious that the words “issue then living” and “children” were not used by the testator in the sense of heirs generally.

We now consider respondent’s argument that the case of Lyeth v. Hoey, 305 U. S. 188, supports his determination made herein. His brief mentions this decision twice. We quote these passages in full. On page 11 of his brief appears the following passage:

In view of the foregoing, the varied and conflicting claims and contentions of the parties in interest, and the ultimate composition entered into between the parties, it is also submitted that this ease is controlled by the decision of the Supreme Court in Lyeth v. Hoey, Col. (1938) 305 U. S. 188.

On page 14 appears the following:

* * * What has been stated as to the effect of the compromise settlement between the parties in interest as heirs at law, being controlled by the decision of the Supreme Court in Lyeth v. Hoey, Colr., supra, would apply with equal force to a compromise under the exercise of a power of appointment. Under such circumstances, the widow and issue of the decedent could only take by reason of the relationship and as heirs at law.

The case of Lyeth v. Hoey, supra, had to do with the Federal income tax and was concerned specifically with an interpretation of section 22 (b) (3) of the Eevenue Act of 1932. The taxpayer in that case, was the heir at law of a decedent, who died testate. He filed proceedings contesting the validity of decedent’s will. Subsequently, an agreement was entered into between taxpayer and the devisees under the will, whereby taxpayer was paid certain sums, and in return the will was permitted to be probated, It was held that the taxpayer received these sums because he was heir, and, therefore, they were exempt from the income tax by section 22 (b) (3).

It would seem necessary only to outline the nature of that case and the decision therein to make clear its irrelevancy to the situation we have for consideration in the present proceedings. This case involves the Federal estate tax, and, specifically, section 302 (a) and. (f) of the Revenue Act of 1926. The questions before us, as stated by respondent in his brief, are whether the interest of the decedent in the corpora of the trusts set up under the wills of his father and mother and the trust created by his mother is to be included in his gross estate pursuant to section 302 (a) and (f) above referred to. We have hereto fore held as a matter of law that they are not.

A compromise settlement was made by certain individuals whereby the trust properties subject to the equitable interests of decedent were divided. The claims of these individuals to this property had as possible bases the provisions present in the will of decedent’s briber and (he will and deed oí his mother. it is true Unit the brother and sisters of decedent also had as a basis for their claims the purported will of decedent. However, the North Carolina court held, as we have held, that this will was invalid and that there was no valid exercise by decedent of any power of testamentary disposition. If the question before us involved the income tax liability of decedent’s brother and sisters, then Lyeth v. Hoey, supra, might be pertinent. We do not, however-, conceive that that case stands for a proposition that claimants of property in which, as a matter of law, decedent had no interest can. by a compromise agreement executed among themselves, increase decedent’s gross estate by the amount of the value of such property. Cf. Ithaca Trust Co. v. United States, 279 U. S. 151; Robbins v. Commissioner, 111 Fed. (2d) 828.

Reviewed by the Board.

Decision will he entered under Rule W.

       Sue. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
      (a) To the extent of the interest therein of the decedent at the time of his death;
      * V # * * * •
      (£) To the extent of any property passing under a general power of appointment exercised by the decedent (1) by will, or (2) by deed executed in contemplation of, or intended to take effect in possession or enjoyment at or after, his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth.


source: Caselaw Access Project

author: ARNOLD: MtjRdock,

license: Public Domain

text:
    Alice duPont Ortiz and Julien Ortiz, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93159.
    Promulgated June 21, 1940.

      Simon F. McHugh, Esq., and William L. Hennessy, Esq., for the petitioners.

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

ARNOLD:

The first question presented for determination is the nature of sales of stock made through the short account at times when the petitioner held an equal or greater number of shares of the same kind in her long accounts. The respondent included in the dividend income for 1934 and 1935 the amounts credited as dividends to the petitioner’s long accounts during those years. The petitioner concedes that, as a general rule, dividends so credited constitute taxable income. She contends that the sales made through the short account are ordinary sales, that the dividend credits are mere book entries and do not represent dividends, and that they should be reduced by the amounts charged as dividends to the short account in order to determine the actual dividend income. She further contends that she was engaged in the business of buying and selling securities and commodities, and that, should we hold the sales in question to be short sales, she should be permitted to deduct all of the dividends charged to her short account as ordinary and necessary expenses of that business. The respondent contends that the sales were short sales, that the petitioner was not engaged in the business of buying and selling securities, and that the dividends charged to the short account constitute additions to the cost or other basis of the stock to be used in computing gain or loss upon the covering of the short sales.

The effect of a short sale is to create a debt in terms of goods (stock). The chief differencet between a regular sale and a short sale is that, in the former the seller delivers his own shares to the purchaser and thus closes the transaction, while in the latter he delivers borrowed shares and the transaction is not closed so far as the seller is concerned until he delivers shares to repay the “loan.” If the shares sold are not furnished by the seller at the time of sale but are supplied by the broker, the transaction is a short sale. Frances Bartow Farr, Executrix, 33 B. T. A. 557.

The respondent argues that the present case is controlled by the Farr case and by DuPont v. Commissioner, 98 Fed. (2d) 459; certiorari denied, 305 U. S. 631; and Henry F. duPont, 38 B. T. A. 1317; affd., 110 Fed. (2d) 641. Each of those cases clearly shows that the broker executed the order as a short sale, and an obligation was created to deliver stock in repayment of stock used or boi’rowed by the brokers, and such obligation was discharged by the delivery or transfer at a later date of like shares which, at the time of the sale, were in the possession of the seller or held in his long accounts. If, as the' respondent says, delivery to the purchasers in this case was made from shares belonging to the brokers or their customers or from shares borrowed from other brokers, the sales clearly would be short sales. However, the facts are otherwise.

The orders were executed on the exchange in the regular way and delivery to the purchasers was made on the next full business day from certificates in street names held by the New York correspondents for Laird & Co. It is true that the shares so delivered were not identifiable by certificates as shares belonging to the petitioner, but they necessarily included shares held by the brokers for the petitioner. The understanding between the petitioner and the brokers, the mode of operation, and the manner in which the transactions were reflected on the brokers’ records demonstrate that the deliveries were in effect deliveries from the petitioner’s long accounts. None of the sales orders were labeled as short sales. It was the practice of the brokers, whenever the petitioner’s long accounts contained no shares of the kind sold, to execute the sale as a short sale, with the usual marginal requirement, the charge for the short sale tax, and the delivery from borrowed stock. The proceeds were credited in such cases but were held by the brokers for the protection of the lender. The petitioner concedes that such transactions appeared in the short account and were short sales, but they are not here involved. We are here dealing with shares where those in the long account exceeded those in the short account. In every instance where the long accounts contained shares equal to or greater in number than those sold, it was the practice of the brokers, acting under authority to treat all accounts as a unit, to treat the sales made through the short account as sales of the petitioner’s long shares. They required no margin and charged no short sale tax. They credited the short account with the proceeds, made an entry therein showing delivery of the shares, and made entries in the long accounts reducing the number of shares held therein by the number sold through the short account. All of this was done at the time of the execution of the sale to the purchaser. Interest was allowed on the proceeds. That delivery from the long account was made at the time of the sale is established by the testimony of two employees of Laird & Co. who handled the stock records and dividend collections, and it is further corroborated by what was done when Laird & Co. took over the petitioner’s accounts on October 1, 1932. Laird, Bissell <¾ Meeds did not transfer to Laird & Co. the total shares in the long accounts and an outstanding obligation to repay the shares having a short status, but merely delivered the net number of shares. The witnesses further testified that in every case where the long position exceeded the short position the broker did not borrow any stock from other brokers or other customers for the purpose of delivery.

The evidence further shows that the brokers collected dividends only on the number of shares actually held for their customers, which consisted of the difference between the shares appearing on their books in long accounts and the shares appearing in the short accounts. They credited the petitioner with dividends on the number of shares shown in her long accounts and charged her with dividends on the number shown in her short account, but in those instances where her long position equaled her short position no dividends were collected or available for the petitioner.' We think that the sales in question were intended to be and were actually executed as ordinary sales, or sales of shares held in the petitioner’s long accounts. See James Cunningham, 29 B. T. A. 717; C. B. Ferree, 32 B. T. A. 725; affd., 84 Fed. (2d) 124; Dee Furey Mott, 35 B. T. A. 195; affd., Commissioner v. Mott, 103 Fed. (2d) 1009; C. R. Dashiell, 36 B. T. A. 313; affd., 100 Fed. (2d) 625. Cf. William R. Tracy, 38 B. T. A. 1366. The true dividend income, therefore, should be determined by offsetting against the dividend credits the amounts of $145,338.60 for 1934 and $23,470 for 1935.

As indicated above, the petitioner urges that the entire amounts charged as short dividends constitute ordinary and necessary business expenses. She claims a deduction of those amounts only in the event of a holding that the sales in question were short sales. In considering the second issue herein, we have concluded upon the evidence that the petitioner was engaged in the buying and selling of securities as a business. By reason of that fact, the petitioner would be entitled to deduct the short dividends as ordinary and necessary business expenses. Dart v. Commissioner, 74 Fed. (2d) 845, and the rule requiring that they be treated as additions to the cost or other basis of the stock sold, as set forth in Gladys G. Terbell et al., Executors, 29 B. T. A. 44; affd., 71 Fed. (2d) 1017; Henry F. duPont, supra, would not apply. Cf. Deputy v. duPont, 308 U. S. 488. Therefore, if we are in error in failing to hold the sales to be short sales, the petitioner’s alternative claim would be valid.

The second question presented for determination is whether the petitioner is entitled to deductions of the amounts paid to her brokers as commissions on sales of securities and commodities. The Circuit Court of Appeals for the Second Circuit held in Winmill v. Commissioner, 93 Fed. (2d) 494, that commissions paid on purchases and sales of securities are deductible under section 23 (a) of the Revenue Act of 1932, provided the taxpayer was engaged in purchasing and selling securities as a business. That case was taken to the Supreme Court on the sole question of the deductibility of commissions on purchases, and it was held that such commissions are not deductible even by a trade, 305 U. S. 79. The Circuit Court of Appeals thereafter announced its adherence to its decision in the Winmill case in so far as it involved commissions on sales. Neuberger v. Commissioner, 104 Fed. (2d) 649. If the petitioner’s activities constituted a trade or business, she is entitled under the authority of the Winmill and Neuberger cases to deduct commissions.

An investor may be considered to be carrying on a business “if the transactions concerning his investments are substantial and frequent as distinguished from occasional or isolated.” Miller v. Commissioner, 102 Fed. (2d) 476. Whether his activity constitutes a trade or business has been variously answered under various circumstances, and must be viewed in the light of the facts involved in each case. We have pointed out that the decisions turn upon whether the taxpayer’s activities are those of what is styled a “passive investor”, doing only what i.s necessary from an investment point of view, or whether they go beyond that point and involve active association in the, enterprises in which he is financially interested or devotion of a substantial part of his time to such work as a matter of business. Eugene Higgins, 39 B. T. A. 1005; affd., Higgins v. Commissioner, 111 Fed. (2d) 229. In the recent case of Sam J. Reckford, 40 B. T. A. 900, we said that the extent of the market operations may be an important factor in determining whether ®r not the taxpayer is merely a passive investor, but beyond that point the extent of such activities tends only to define the difference between a large and a small trade or business, and that a factor of more decisive importance than the volume of transactions lies in whether or not the market activities consisted in dealing for speculative purposes or for investment purposes. In some cases emphasis is placed upon the amount of time devoted to the business. In others it is said to be a factor but not conclusive. In many of them the factor of time is not mentioned and the conclusions are rested entirely on the volume and number of transactions entered into during the year.

The facts herein show that petitioner was a housewife and had income from trusts and other sources. Her business activity was confined exclusively to the purchase and sale of stocks and commodities through her brokerage accounts. It was not limited to doing merely what was necessary from an investment point of view. The transactions were substantial and frequent rather than occasional or isolated. They were not limited in number or confined to a single security, as in the Henry F. duPont and Terbell cases. The purchases and sales ranged from 15,000 to 190,000 shares annually, involving a total cost or selling price of from $500,000 to $6,0000,000, and the petitioner’s books and those of the broker reflect dealings in a variety of securities and the handling of many transactions in the course of a single day. They show purchases and sales, in most instances, in lots of from 100 to 500 shares, made regularly and continuously throughout the taxable years.

The petitioner’s purpose, as indicated by the transactions reflected on the brokers’ records, and as testified to by her, was to buy and sell for profit. She was an active trader and made many short sales. She gave active attention to all purchases and sales. She consulted Ellis, Weymouth, and Jones and relied to a large extent upon their advice. She studied market reports and financial periodicals. The less important transactions were entered into without first consulting her, but they were afterwards brought to her attention and approved. In most instances, and particularly during the taxable years, she directed the purchases and sales to be made. She spent time at the brokers’ offices, and regularly held consultations with her agents at her home and by telephone every day, except for brief periods when she was abroad. While these matters required but an hour or two each day, we think this is unimportant in view of the extent and purpose of her operations. The petitioner’s activities constituted the carrying on of a trade or business within the meaning of section 23 (a) of the (Revenue Act of 1934. Ignaz Schwinn, 9 B. T. A. 1304; E. M. Elliott, 15 B. T. A. 494; Richard D. Wyckoff, 19 B. T. A. 263; William A. Hodgson, 24 B. T. A. 256; George P. Sacks, 25 B. T. A. 415; affd., 66 Fed. (2d) 308; Harriet Pullman Schermerhorn, 26 B. T. A. 1031; J. A. Dart, 29 B. T. A. 125; L. T. Alverson, 35 B. T. A. 482; Austin D. Barney et al., Executors, 36 B. T. A. 446; Cornelia W. Roebling, 37 B. T. A. 82; Harry H. Neuberger, 37 B. T. A 223; modified and affirmed, 104 Fed. (2d) 649; Eugene Higgins, supra; Foss v. Commissioner, 75 Fed. (2d) 326; Winmill v. Commissioner, supra; Miller v. Commissioner, supra; Kales v. Commissioner, 101 Fed. (2d) 35; In re Mackey, 110 Fed. 355; John Marsch v. Commissioner, 110 Fed. (2d) 423.

The final question is whether the petitioner is entitled to any deduction as a result of the satisfaction of the deficit existing in her husband’s brokerage accounts at the end of the year 1934. The petitioner claimed a deduction in her return of $163,781.83 for a debt ascertained to be worthless and charged off in that year. She now concedes that this amount should bo reduced by the value of the summer residence conveyed to her ($25,000) and the value of the Kendall stock transferred to her regular account ($890), which leaves a balance of $137,891.83.

We understand respondent’s argument to be that the satisfaction of the deficit in Julien Ortiz’s accounts under the contract of guaranty did not create a debt. He denies the existence of a debt because, he says, under the evidence a gift was intended. On the contrary, we think the evidence establishes the lack of any donative intent. Prior to the market crash Julien Ortiz’s stock market transactions had been profitable, and Ms wife believed that profitable operations in his accounts would be resumed. Before executing the contract of guaranty she consulted with her financial adviser and her husband, who assured her that she would suffer no loss under the guaranty. Each of them believed that the market would go up and there would be no occasion to respond under the contract of guaranty. If the wife had been motivated by a donative intent, there would have been no hesitancy. She would have been ready and willing to give her husband any necessary funds. That no such dona-tive intent existed is demonstrated by her act in taking over the security remaining in his accounts and requiring him to convey to her the real property in his name. These acts are inconsistent with donative intent. Cf. Elizabeth N. C. Hetherington, 20 B. T. A. 806; Edward H. Moore, 22 B. T. A. 366; appeal dismissed, 59 Fed. (2d) 1069; William M. Fleitmann, Jr., et al., Executors, 22 B. T. A. 1291; Roy Nichols, 17 B. T. A. 580.

Furthermore, respondent’s argument ignores the legal consequences that flow from the contract of guaranty. Where a guarantor is forced to answer for the debt or default of another the law implies a promise on the part of the principal debtor to reimburse his guarantor. Howell v. Commissioner, 69 Fed. (2d) 447, and cases cited; certiorari denied, 292 U. S. 654. When Alice cluPont Ortiz was forced to respond under her guaranty, the law implied a promise by Julien Ortiz to reimburse her. The guarantor’s payment did not extinguish the debt; it merely substituted the guarantor for the creditor, and thereafter she was entitled to assert any rights that the creditor may have had against the principal debtor or against any security held for the debt, 24 American Jurisprudence 955; 60 Corpus Juris 740, and the facts show that she exercised the rights so acquired against the principal debtor and against the security held for the debt. As a matter of law, therefore, a debtor-creditor relationship existed between husband and wife immediately upon her payment of the deficit in his accounts pursuant to her contract of guaranty.

The facts and circumstances under which this debt was created are so similar to the facts and circumstances existing in Shiman v. Commissioner, 60 Fed. (2d) 65, and the arguments advanced in the two cases are so alike, that a detailed analysis of the Circuit Court’s decision will be helpful in disposing of the present issue. In July 1920 Shiman guaranteed a brokerage account of his brother-in-law, Oppenheim, who was speculating in stocks. At the time Shiman guaranteed the account Oppenheim was solvent, but thereafter he fell into financial straits and became insolvent. In October 1924 the brokers forced Shiman to pay $10,000 into the account under his guaranty in order to keep the account open for the balance of the year. In 1925 the account was closed out and Shiman had to pay an additional sum of more than $26,000 under his guaranty. In his 1924 return Shiman claimed the $10,000 payment as a loss, or a worthless debt, but the Commissioner and this Board denied the deduction. The Circuit Court, however, reversed. The Commissioner’s argument, that the payment created no debt because it was a gift, was rejected, as was the argument that in any event Shiman was entitled to no deduction because the debt was worthless the moment it arose, as Oppenheim was then insolvent and known to be. The court likewise rejected the argument that until the account was closed out the debt was not ascertained to be worthless, and the argument that the charge-off was insufficient.

The respondent relies upon our decisions in J. Edgar Davidson et al., Executors, 26 B. T. A. 754, and Florence O. R. Lang et al., Executors, 32 B. T. A. 522, as controlling in the present issue. In the Davidson case we considered the Shiman case, supra, and distinguished it upon the ground that a substantially different situation was presented by the latter case. Factually, the instant proceeding is much nearer the Shiman case than the Davidson case. The Lang decision is distinguishable on its facts and is not, in our opinion, applicable.

The present facts are more nearly comparable to the situations which existed in H. Rodney Sharp, 38 B. T. A. 166; Daniel Gimbel, 36 B. T. A. 539; Whitcher v. Welch, 22 Fed. Supp. 763; and the Shiman case, supra. These cases hold that a taxpayer is entitled to deduct as a worthless debt an amount paid under a guaranty where the principal debtor was unable to reimburse the guarantor. The principal debtor here was clearly unable to reimburse the guarantor except in the amounts shown, and in view of the cited authorities we hold that respondent erred in disallowing the deduction to the extent of the reduced amount thereof.

Reviewed by the Board.

Decision will be entered irnder Rule 50,

MtjRdock,

concurring: The petitioner’s brokerage accounts were combined in such a way that the sales involved in the first issue were not accounted for as short sales. Those sales were not made as short sales have to be made on the Exchange. It follows that they were not short sales. It is immaterial here that they were partially accounted for in an account called a short account.

Mellott concurs in the above.

       Tile respondent included $146,008.60 in the income for 1934 and $23,922.50 in the income for 1935. It is stipulated that the correct amount of the credits for 1934 is $146,017.35.

       The petitioner claims that of the dividends charged the amounts to be used as offsets are $145,338.60 for 1934 and $23,470 for 1935.

       The amounts charged to the short account were $145,958.60 for 1934 and $25,128.75 for 1935.

       The petitioner in the present case accordingly has abandoned her claim to a deduction of commissions paid on purchases.


author: Murdock:

text:
    Louis F. Timmerman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96317.
    Promulgated June 25, 1940.
    /. Richard Riggles, Jr., Esq., for the respondent.
   opinion.

Murdock:

The Commissioner determined a deficiency of $610.48 in the income tax of the petitioner for the calendar year 1986. The Board adopts the stipulation of the parties as its findings of fact.

The Gas Utilities Co. was dissolved on July 16,1936. The petitioner was the owner of shares of stock of that company on that date. The corporation distributed to its stockholders of record as of that date, a partial liquidating dividend consisting of common stock of the Oklahoma Natural Gas Co. The distribution resolution provided that the Oklahoma stock was not to be distributed until the liquidating corporation had received from its counsel an opinion in regard to taxation. The opinion was received after the close of the stock market on August 7, 1936. The certificates of Oklahoma stock received by the petitioner were dated August 8, 1936, and were mailed to the petitioner at some time on Saturday, August 8, 1986. They were received by the petitioner in the ordinary course of the mail on August 14,1936. The petitioner reported his income upon a cash basis. He computed and reported a gain upon the exchange of his Gas Utilities Co. stock by taking the market value of the Oklahoma shares for the day upon which he received them. The Commissioner, in determining the deficiency, used the market value of the shares on August 8. The only question for decision is whether the value of the shares on August 8 or the value of the shares on August 14 should be taken.

Both parties have proceeded in accordance with section 116 (c) of the Revenue Act of 1936, which provides that amounts distributed in liquidation of a corporation shall be treated as payment in exchange for the stock. Section 115 (j) provides that if a dividend is paid in any medium other than money, the property received shall be included in gross income at its fair market value at the time as of which it becomes income to the shareholder. The petitioner reported his income upon the basis of actual receipts. See sections 41 and 42. A taxpayer', upon the cash basis, may not turn his back upon income and may not postpone its receipt beyond the time when it is unquali-fiedly subject to his demand. This petitioner, however;, has not refused to accept income or to recognize it at his first opportunity. He has acted as any reasonable man would under similar circumstances.

Taxation is an eminently practical matter and the statute should be given a reasonable interpretation. The petitioner did not know and had no way of knowing when the opinion of counsel would be received by the Gas Utilities Co. or when the Oklahoma shares would be distributed. While it is true that he might possibly have sold his Oklahoma shares or exercised some dominion over them prior to the receipt of the actual certificates, had he learned in some way that a certain number of shares had been mailed to him on August 8, nevertheless the respondent does not contend that the petitioner could have or should have anticipated when the certificates were going to be mailed to him. No one expected the many stockholders of the distributing corporation to arrive at its place of business on the 8th and demand their Oklahoma shares. The petitioner lived at a great distance from the place where the certificates were mailed. The corporation adopted the most practical and usual method of making the distribution, that of mailing the certificates. The petitioner had no reasonable means of avoiding loss from a reduction in the value of his shares between August 8 and 14. Furthermore, it should be borne in mind that this rule works both ways. If the shares had increased in value during the period, the interests of the parties would be just the reverse of what they are now. A strained unusual construction would be required to hold that this petitioner was in receipt of income from the exchange of his old stock for the Oklahoma stock on August 8. Cf. Avery v. Commissioner, 292 U. S. 210. Furthermore, there is no necessity or reason for adopting such a holding.

The case of Commissioner v. Scatena, 85 Fed. (2d) 729, affirming 32 B. T. A. 675, is distinguishable. The court there said that, although generally a dividend is taxable when received rather than when declared, “Here, however, the parties have failed to enlighten us of the date of the actual delivery of the certificates for the dividends ; we must, therefore, look to facts given us for the date when the dividends were unqualifiedly made subject to the demand of the stockholder.” The period between the day upon which the certificates left the hands of the distributing corporation and the day upon which certificates reached the distributee was very much longer in that case than it is in this case. The question depended upon whether the distributee received income from the distribution in 1928 or whether it was in 1929. The court, not knowing when the certificates were actually mailed to or received by the distributee, held that the income was received in 1928. Here we have been supplied with the evidence which was missing in that case and our question is slightly different. The value of the shares on August 14,1936, should be used.

Reviewed by the Board.

Decision will he entered for the petitioner.


author: Sternhagen :

text:
    Sanford Cotton Mills, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95218.
    Promulgated June 25, 1940.

      E. R. Zane, C. P. A., for the petitioner.

      E. L. Corbin, Esq., for the respondent.
   OPINION.

Sternhagen :

The Commissioner determined a deficiency of $2,853.24 in petitioner’s income tax for 1935, by disallowing the deduction of $22,468.12, saying:

The Bureau holds that no liability existed in 1935 to refund processing taxes to customers, as such liability arose January 6, 1936 when the Court rendered its decision invalidating the Agricultural Adjustment Act. This is in accordance with I. T. 3143, Internal Revenue Bulletin XVI-50, 1937, page 28. The amount of $22,468.12 has, therefore, been disallowed as a deduction.

The facts are stipulated.

The petitioner was a cotton processor and used an accrual method of accounting. On December 31, 1935, it had on its books liability for processing tax for 1935 of $64,599.25. By contracts with its vendees it was to readjust its sale prices by relieving the vendee of so much as represented the passing on of processing tax if and when the processing tax were held invalid. The tax was held invalid on January 6, 1936, United States v. Butler, 297 U. S. 1.

In closing its 1935 accounts, which it did early in 1936, petitioner canceled the aforesaid accrual of $64,599.25 (which it had not paid) as its liability to the United States for tax on cotton processed in 1935, and substituted $22,468.12, which was the amount of its contractual liability for readjustment to its vendees. This contractual liability it actually discharged in the first seven months of 1936.

On its return for 1935 it deducted the $22,468.12, and the Commissioner disallowed the deduction.

The argument turns on the effect of the Supreme Court decision of January 6, 1936, on the contingent liabilities to the vendees in 1935. The respondent holds to a strict regard for the date of the decision and refuses to recognize it as having any effect on the accrual of 1935, despite the fact that the petitioner and its vendees had expressly provided for the possibility of the nullification of the tax and the consequent readjustment of the price. In this the respondent was in error. An accrual of either income or outgo which is clearly in doubt may and often should be adjusted when shortly thereafter in the next year the doubt is removed. Inland Products Co. v. Blair, 31 Fed. (2d) 867; Gould-Mersereau Co., 21 B. T. A. 1316; dismissed, C. C. A., 2d Cir. The question is a practical question of clear accounting. It is more convenient and is no sacrifice of accuracy to treat such a contingent accrual as flexible enough to be modified before the books are closed to conform to the outcome of the contingency. An attempted adjustment of the books to reflect an event occurring an appreciable time after the books have been closed for the taxable year would require consideration of circumstances which would probably variously affect the rule. Cf. North American Oil Consolidated v. Burnet, 286 U. S. 417; Commissioner v. Brooklyn Union Gas Co., 62 Fed. (2d) 505, affirming 22 B. T. A. 507; Case Co. v. United States, 32 Fed. Supp. 754.

Here tbe petitioner in 1935 included in its income the accrued sale price of its goods and agreed to repay such part of the amount as would be excessive if the processing tax were obliterated. The obligation to repay was contemporaneous and of equal force with the inclusion in the sale price. The accrual of the one should go hand in hand with the accrual of the other, particularly so long as the books are open. Either the accrual of so much of the sale price should be eliminated from income or the accrual of the obligation to repay should be deducted. It is immaterial which.

The Commissioner’s disallowance of the deduction of $22,468.12 is reversed.

Reviewed by the Board.

Decision will he entered wider Rule 50.


text:
    Cox Motor Sales Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96097.
    Promulgated June 25, 1940.

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

      B. M. Coon, Esq., for the respondent.
   OPINION.

Kern :

The applicable provision of the Revenue Act of 1936, section 27, provides:

(a) Dividends Paid Credit in General. — For the purposes of this title, the dividends paid credit shall be the amount of dividends paid during the taxable year.

The Treasury Regulations 94, article 27 (a)-l (5) and (<?), provide in part as follows:

(5) When dividends are considered paid. — A dividend will be considered as paid when it is received by the shareholder. A dividends paid credit can not be allowed unless the shareholder' receives the dividend during the taxable year for which the credit is claimed.
* * * * * * *
If a corporation, instead of paying the dividend directly to the shareholder, credits the account of the shareholder on the boohs of the corporation with the amount of the dividend, the credit for a dividend paid will not be allowed unless it be shown to the satisfaction of the Commissioner that such crediting constituted payment of the dividend to the shareholder within the taxable year.
*******
(c) Methods of accounting. — The determination of whether a dividend has been paid to the shareholder by the corporation during its taxable year is in no way dependent upon the method of accounting regularly employed by the corporation in keeping its books or upon the method of accounting upon the basis of which the net income of the corporation is computed. See section 43.

We may assume on the evidence and have so found that the corporate taxpayer declared the dividend in question to its three stockholders on December 24, 1936. This basic fact does not appear to be disputed, although the evidence shows that the resolution was not recorded in the corporation’s minute book until six months later and until after the revenue agent had examined the books in connection with the petitioner’s return for the taxable year. It also appears to be certain that the taxpayer could not in the circumstances have determined before January 9,1937, the exact amount of the dividends payable, and that this delay in time was always necessary in closing its accounts for each preceding month. The only other significant facts are that the stockholders were informed of the declaration of the dividend at the time that it was made, since they were also directors; that there were ample funds in the taxpayer’s bank with which it could have paid the dividends in cash when declared; that in its financial statement to the General Motors Corporation at the close of the year petitioner reflected the dividends as paid out of its profits; and that the individual shareholders severally returned the amount of dividends in their tax returns for the year 1936. The taxpayer stresses the fact that it was upon the accrual basis. For reasons to be stated hereinafter we do not regard this as significant.

Section 27 (a) is categorical in its requirement that no dividend credit shall be allowed except for “dividends paid”, and the Treasury regulations interpreting this section, the pertinent portions of which we have quoted above, are equally insistent in requiring actual payment. In the face of this requirement the taxpayer is asking us to treat the payment of dividends as constructively made in 1936 on the theory, it is assumed, that they would have constituted constructively received income for the shareholders in that year and by corollary must be considered as constructively paid by the corporation at the same time. This theory involves an assumption as to the facts and also a symmetry of the statute neither one of which is to be taken for granted.

The only case which has been called to our attention or which we have found having any true relation to the problem here is Sanford Corporation, 38 B. T. A. 139; affd., 106 Fed. (2d) 882 (C. C. A., 3d Cir.). In that case we were construing a different section of the statute which is in its phraseology, however, very similar to the section before us. Section 351 (b) (2) (C) of the Bevenue Act of 1934, dealing with personal holding companies’ deductions, provides that in determining the undistributed adjusted net income a deduction may be made of “dividends paid during the taxable year.” In that case a personal holding company on a cash basis declared a dividend one day before the close of its fiscal year, but its sole stockholder who alone had authority to pay out funds was not informed of the dividend until after the close of the fiscal year, when he wrote and cashed a check for the dividend. We held that the dividend was not paid during the taxable year, and the Court of Appeals affirmed, saying (p. 884):

It will be observed that in both the undistributed profits surtax act and the one under consideration, the dividends credit provision employs the word “paid.” To relieve from tax under the circumstances of the case at bar, it is necessary to interpret the verb against its literal meaning by adding thereto the adverb constructively. Generally speaking, any extension of the unreal doctrine of attaching consequences by the fiction * * * is embarrassing to a proper development of the law.

We do not think that case is distinguishable in principle from this and that the unambiguous words of the statute as applied to personal holding companies will apply equally to general corporations under section 27.

The petitioner objects that it was on the accrual basis, but this fact we think is immaterial, for in the first place we are not concerned with whether the right of the stockholder has accrued or the liability of the corporation, but with the question of whether the right has so matured as to subject the dividend credited on the corporation’s books to the complete control of the stockholder and thereby to remove it from the control of the corporation. The doctrine of constructive receipt here involved implies complete dominion of the property in question and therefore goes far beyond the mere accrual of the right to such property. It is obvious on the facts that the shareholders here could not have had any absolute control of the cash dividend until the final accounting was completed on January 9, 1937. The cases relied upon by the taxpayer to support its thesis of constructive receipt by the shareholders have been for the most part overruled by the Supreme Court’s decision in Avery v. Commissioner, 292 U. S. 210, where it was held that a corporation’s dividend declared payable on or before December 31, but not received by the stockholder until the first business day of January, was not “un-qualifiedly made subject to the demand of the stockholder” under section 201 (e) of the ftevenue Act of 1921. On the authority of that case we are unable to say here that there was any constructive receipt of the dividends by the petitioner’s several shareholders in the year 1936.

Even if we assume in petitioner’s favor, however, that the Commissioner should have taxed to the shareholders the dividends as constructively received in 1936 it does not follow as a matter of law, however inevitable the conclusion of the syllogism would be in logic, that within the meaning of section 27 the dividends should be considered “paid” in the earlier year by the corporation. See Black Motor Co., 41 B. T. A. 300, 305. The asymmetry of the taxing statutes has been the subject of frequent comment by the courts. See Helvering v. City Bank Farmers’ Trust Co., 296 U. S. 85. However desirable it may be thought on logical grounds that constructive receipt by the stockholder should imply its correlative, constructive payment by the corporation, see Paul and Mertens, 1 Law of Federal Income Taxation, 1939 Supp., § 32A.24; we are not at liberty on that account to construe the section before us in a way that would obviously pervert the intent of Congress that actual payments should be made by the corporation to justify the deduction of the dividend claimed.

We conclude, therefore, that petitioner’s theory is untenable both on fact and theory and that the Commissioner must be sustained.

Decision will be entered for the respondent.