source: Caselaw Access Project

author: Matthews : Arttndell,

license: Public Domain

text:
    Richard M. Cadwalader, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71800.
    Promulgated August 8, 1935.

      James P. Smith, Esq., for the petitioner.

      J. R. Johnston, Esq., for the respondent.
   OPINION.,

Matthews :

The respondent determined a deficiency in petitioner’s income tax for 1930 in the amount of $19,709.41. The petitioner has acquiesced in all changes made by the respondent except the addition to income of $142,707.88 on account of executrix’s commissions received by the petitioner’s wife from the estate of Charles G. Roebling, which amount the respondent has determined to be taxable income for 1930.

In an amendment to the answer filed by the respondent a plea of estoppel was set out, it being alleged that, after the respondent had made a tentative determination that the sum of $142,707.88 was income taxable to Emily R. Cadwalader in 1925, it was represented to the respondent that this sum of money was only a loan or advancement to her in the year 1925 and had not been received by her as income in that year; that the respondent had acted upon those representations and had reversed his tentative determination with respect to that item so that it was not included in the taxpayer’s income for 1925; that no additional assessment for 1925 may now be made with respect to this item because of the running of the statute of limitations ; and that the petitioner herein should not be heard to say that the executrix’s commissions in the sum of $142,707.88 were taxable income to Emily R. Cadwalader in 1925, as that would amount to a reversal of the position previously taken by the petitioner’s wife with respect to this item and would result in material damage to the United States.

The parties entered into a stipulation of facts 'and attached thereto as exhibits certain documents, all of which were received in evidence. The attorney who represented the executrices of the estate of Charles G. Roebling gave oral-testimony with respect to the payment of the executrices’ commissions and the circumstances under which an adjustment was made of the income tax liability of the petitioner’s wife for the year 1925.

The petitioner and his wife, Emily R. Cadwalader, filed a joint income tax return for 1930, which was made upon the basis of cash receipts and disbursements. Petitioner’s wife and her sister, Helen R. Tyson, were executrices of the estate of their father, Charles G. Roebling, who died testate in 1918 leaving an estate amounting to more than $11,000,000. The final account filed by the executrices was allowed as reported, by the judge of the Orphans’ Court of Mercer County, New Jersey, under date of June 6, 1930, and thereunder the sum of $422,144.19 was determined to be the entire amount payable to the executrices as commissions and compensation for services. Emily R. Cadwalader was entitled to one half of this sum, or $211,072.10, and having already received payment in the amount of $142,707.88, there was paid to her the balance, or $68,364.22, which latter amount was duly reported as income on the joint return for 1930 filed by her and her husband, the petitioner herein. The respondent has added to income for 1930 the sum of $142,707.88, being one half of $285,415.76, which amount was estimated in 1925 to be the amount to which the executrices were entitled as commissions and compensation for services. This sum of $285,415.76 was borrowed by the estate from Emily E. Cadwalader and Helen E. Tyson in order to enable the estate to pay the estimated commissions and to take a deduction therefor in computing the net estate subject to the Federal estate tax. Notes were executed by the estate in favor of Emily E. Cad-walader and Helen E. Tyson to cover this loan, which notes were paid in full, with interest, in 1930. The estimated commissions were paid by two checks of the estate, dated February 16, 1925, issued to and endorsed by the two executrices, in the amount of $142,707.88 each. No tax has ever been paid by Emily E. Cad-walader on the commissions received in the amount of $142,707.88.

The circumstances under which Emily E. Cadwalader and the other executrix were paid commissions of $142,707.88 each, in 1925, the treatment of the amount received by Emily E. Cadwalader in her income tax return for 1925, and the treatment of the amount by respondent upon audit of her return for that year are as follows: On February 21, 1925, there was filed a claim for abatement of Federal estate tax assessed against the estate of Charles G. Eoebling in the sum of $75,728.94, which claim stated that this assessment of additional tax was made because the estate had not paid out to the executrices their commissions amounting to $285,-415.76, which amount had been deducted in computing the net estate. There was attached to the claim an affidavit executed by the attorney for the executrices in which it was stated that each of the two executrices had received a check for $142,707.88 in full payment of the commissions due each of them. Upon the showing that the commissions had been duly paid to the executrices the assessment of the additional Federal estate tax was abated.

Emily E. Cadwalader filed a separate income tax return for 1925, which was made upon the basis of cash receipts and disbursements, and did not include in the income reported this sum of $142,707.88. There was attached to her return a memorandum, as follows:

There was received during 1925, $142,707.88 by way of advance for commissions as executrix of the estate of Charles G. Roebling, deceased, 115 Broadway, New York City, which is not reported as income as the court has not yet allowed same and as the Solicitor of Internal Revenue reported in Cumulative Internal Revenue Bulletin IV-1, January-June 1925, page 125, S. M. 1929, advised that such a commission is not income until it has been allowed by the court.

In a revenue agent’s report dated August 22, 1927, addressed to the revenue agent in charge at Philadelphia, it was recommended that an additional tax of $34,825.10 should be assessed against Emily R. Cadwalader for 1925 for the following reason:

In accordance with the ruling of the Solicitor of Internal Revenue, OB IV-1 page 125, S. M. 1929, the income received during 1925 as commission as executrix of the estate of Chas. G. Roebling, deceased, 115 Broadway, New York, has not been reported on the 1925 return since the commissions had not been allowed by the court during 1925.
The taxpayer stated that the commissions have not yet been reported or a tax paid thereon in any return filed since receipt of the money, therefore they are being included in 1925, the year in which received.
It is believed that the Solicitor’s memo #1929 is for the special case cited and has no bearing on this case, therefore the $142,707.88 commission has been included in this report as income in 1925.

A copy of this report was transmitted to the taxpayer by letter from the revenue agent in charge, dated October 15, 1927. A protest against the assessment of this proposed additional tax for 1925, signed by Emily R. Cadwalader, was filed with the internal revenue agent in charge on November 10, 1927, which protest reads in part as follows:

On February 16, 1925 the executors executed for the Estate of Charles G. Roebling a note to the taxpayer in the sum of $142,707.88, which sum represents the estimated commissions due the taxpayer as executor. The taxpayer in making out her income tax return for the year 1925 attached thereto a statement which reported the above transaction and relied on the fact that the Court which has jurisdiction over the administration of this estate has not yet allowed the commissions and as the Solicitor of Internal Revenue reported in Cumulative Revenue Bulletin IV-1, January-June 1925, page 125, S. M. 1929, that such a commission is not income until it has been allowed by the Court.
The taxpayer protests against the action of the Revenue Agent in including as taxable income to her for the taxable year 1925 said sum of $142,707.88 upon the ground that this sum was not received by her during the said year. The said taxpayer keeps her accounts and makes her income tax returns upon a cash receipt and disbursement basis.
The taxpayer relies on the above mentioned opinion of the Solicitor and therefore maintains that for the purposes of the income tax the receipt by her of the note representing estimated commissions due her is not income to her in the year 1925.
The taxpayer requests that a hearing be granted to determine the subject of which this protest is made.

A conference was held in the office of the revenue agent in charge at Philadelphia on December 5, 1927, at which the taxpayer was represented by her lawyer, who held power of attorney to represent her. Under date of December 14, 1927, her attorney was requested to submit an affidavit from the taxpayer regarding the executrix’s commissions and on December 17, 1927, there was accordingly filed with, the revenue agent in charge at Philadelphia an affidavit in support of the protest, which was signed by Herbert Noble, one of the taxpayer’s attorneys who had represented the executrices at the time the estate tax matter was pending, and which reads in part as follows:

On or about February 16, 1925, tbe Executors, being desirous to pay to themselves the estimated amount of the commissions then due, caused a check to be drawn to the said Emily R. Oadwalader in the sum of One Hundred Forty-two Thousand Seven Hundred Seven and 88/100 Dollars ($142,-707.88), that being the amount of the estimated commissions .then due her. There not being sufficient funds at that time in the bank account of the Executors to pay such commissions, Mrs. Emily R. Oadwalader advanced to the Executors by making deposit to the account of the Executors in the same sum of One Hundred Forty-two Thousand Seven Hundred Seven and 88/100 Dollars ($142,707.88), taking therefor the Executors’ note for the same amount.
The said note is due and still remains unpaid to Mrs. Oadwalader and no part of the said amount of One Hundred Forty-two Thousand Seven Hundred Seven and 88/100 Dollars ($142,707.88) represented by it has been paid. The Estate is still in the process of administration and there has been no final accounting or any allowance by the Court having jurisdiction over the administration of this Estate of any Executors’ commissions.
I therefore advised Mrs. Oadwalader that, pursuant to a decision by the Solicitor of Internal Revenue and reported in Cumulative Internal Revenue Bulletin IV-1 January-June 1925, page 125, S. M. 1929, estimated commissions advanced to an executor prior to their allowance by the Court should be included in the year in which allowed by the Court.

Thereafter, on December 19, 1927, the revenue agent in charge advised the taxpayer’s attorney that, as a result of the protest and the conference held thereon, a supplemental report had been made of the income tax liability of Emily R. Oadwalader in which the contention of the taxpayer had been upheld with respect to the taxa-bility of commissions of $142,707.88 in the year 1925. On the same date the revenue agent in charge forwarded to the Bureau in Washington the report on the income tax liability of Emily R. Cadwala-der for the years 1924, 1925, and 1926. Upon review by the Income Tax Unit the report of the revenue agent in charge at Philadelphia was approved so far as it related to the tax liability for 1925, with the exception that an adjustment was made in the capital loss reported. A notice of deficiency dated May 17, 1928, was forwarded to the taxpayer, advising her that a review of her return for 1925 had been made in connection with the report and as a result of the adjustment of the capital loss a deficiency of $250 for 1925 had been determined. The taxpayer having filed a waiver of her right to file a petition with the United States Board of Tax Appeals, this deficiency of $250 was duly assessed and her return for 1925 was closed on that basis.

Respondent contends that, relying on statements made in the taxpayer’s protest that “ this sum was not received by her during the said year ”, and in the affidavit submitted by taxpayer’s attorney to the effect that the sum “ should be included in the year in which allowed by the court”, the proposed deficiency for 1925 was abandoned, and urges that under the circumstances the petitioner is now estopped from denying that the amount is income in 1930, the year in which it was allowed by the court.

Petitioner argues that the amount received by Mrs. Cadwalader as executrix’s commissions in 1925 was legally taxable as income in 1925 and not as income of any subsequent year; that the amount can not be taxed in 1930, whether or not the statute of limitations has run with respect to 1925; and that the principle of estoppel is not applicable in this case.

We are of the opinion that the petitioner herein is not estopped to claim that the income in question was properly taxable in 1925, under the circumstances which have been outlined above. It is clear that the estimated commissions were actually paid to the executrices in 1925 and, therefore, were taxable in the year they were received rather than in 1930, when the court allowed the final account filed by the executrices. North American Oil Consolidated v. Burnet, 286 U. S. 417, affirming 50 Fed. (2d) 752; Board v. Commissioner, 51 Fed. (2d) 73; certiorari denied, 284 U. S. 658. The respondent points out that if the petitioner is permitted to show that his wife’s share of the estimated commissions should have been included in her taxable income for 1925, for which year assessment of a deficiency is barred, income in the amount of $142,707.88 escapes income tax. But the taxpayer’s failure to include the amount received in her income for 1925 appears to have resulted from a mistake of law and there was no false representation of fact or wrongful misleading silence on the part of the taxpayer which may be taken as the basis for the application of the doctrine of estoppel. United States v. Scott & Sons, Inc., 69 Fed. (2d) 728; United States Trust Co. of New York, 13 B. T. A. 1074; Tide Water Oil Co., 29 B. T. A. 1208; A. M. Johnson, 32 B. T. A. 156.

When she filed her income tax return for 1925 Emily R. Cadwala-der gave notice that she had received during the taxable year the sum of $142,707.88 for commissions as executrix but did not include this amount in her reported income for the stated reason that “ such a commission is not income until it has been allowed by the court ”, citing S. M. 1929, C. B. IY-1, p. 125. When this return was audited the transaction whereby she received the commissions, and all details involved therein, were made known to the Commissioner of Internal Revenue, as well as the fact that she had not reported any income on account thereof. Her income tax liability for 1925 was considered by the revenue agent who made the field examination and who recommended that the commissions should be included in income for 1925, the year in which received; by the revenue agent in charge at Philadelphia who granted a hearing to her attorney, after the taxpayer had filed a protest against the assessment of the proposed additional tax for 1925, and who forwarded a supplemental report in which the taxpayer’s contention was upheld with respect to the taxability of this item; and by the auditor in the Income Tax Unit in Washington who reviewed the supplemental report and approved it so far as it related to the commissions received by the taxpayer in 1925. A deficiency of $250 was determined against Emily R. Cadwalader for 1925 as a result of an adjustment in the capital loss reported and her return for 1925 was closed on that basis.

The evidence does not support the respondent’s contention that the. proposed deficiency against Emily R. Cadwalader for 1925 was abandoned because he relied on the statements in the protest that the sum was not received by her during the year 1925, and in the affidavit of her attorney to the effect that the sum should be included in the year in which allowed by the court. There is nothing in the entire record to indicate that the respondent was ignorant of the true facts or that any facts were withheld by the taxpayer which could have any bearing on the issue presented herein. Certainly it can not be said that the taxpayer made a false representation of fact upon which the respondent relied. Estoppel is an affirmative defense and the burden is upon the party asserting it to establish both the facts relied on to support it and the necessity in fairness for its application. Helvering v. Brooklyn City R. R. Co., 72 Fed. (2d) 274. As this Board has held, in Sugar Creek Coal & Mining Co., 31 B. T. A. 344: “ Estoppel does not support a belated assessment merely because the taxpayer has omitted the income from his earlier returns and the statute of limitations has barred the correct assessment.” See also Jamieson v. United States, 10 Fed. Supp. 321, where the District Court for the District of Massachusetts held that the elements of estoppel were not present because the failure to return and pay a tax was due to a mistake of law rather than of fact. The court said:

The cases cited by the government in support of the doctrine of equitable estoppel deal with controversies between the taxpayer and the Commissioner where the taxpayer has assented, or agreed, to some act of the Commissioner. These cases are not in point. No case has been brought to my attention which held that the failure of a taxpayer to return, and the failure of the government to collect, a tax for any taxable period entitled the government to add the income received in the earlier year to that received in the subsequent years.

A similar conclusion was reached by the Circuit Court of Appeals for the Second Circuit in Salvage v. Commissioner, 76 Fed. (2d) 112; certiorari applied for June 25, 1935.

Upon the authority of these decisions we hold that it was due to a mutual mistake of law that the respondent did not assess against Emily It. Cadwalader a deficiency in income tax for 1925 growing out of the payment to her of executrix’s commissions in that year, and that no act was committed which should militate against the petitioner in the instant case. It follows that the commissions in the sum of $142,707.88 should not be included in the petitioner’s income for 1930.

Reviewed by the Board.

Judgment will be entered wider Rule 50.

Arttndell,

dissenting: In every practical sense the petitioner’s wife received the executrix’s commission of $142,707.88 in 1930 and should pay a tax thereon in that year as contended for by the Commissioner. Petitioners were on a cash receipts and disbursements basis. The facts are simple. Emily E. Cadwalader and her sister were executrices of the estate of Charles G. Eoebling, their father. The holding of the Bureau of Internal Revenue at that time required that executrices’ commissions must be paid before a deduction might be had for estate tax purposes. The estate was without ready cash to make the payments. Mrs. Cadwalader and her sister, therefore, advanced the money to themselves as executrices and issued a note to each covering the so-called loan. They immediately took back the money, together with the note. In 1927 this transaction was examined by a revenue agent, who recommended that the executrix’s commission be included in income for the year 1925. Mrs. Cadwalader protested this suggestion on the ground that she in fact had received no income from the estate. The Commissioner accepted her plea and the item was eliminated from taxable income and no tax paid. I believe that this action was correct for she had in effect simply received a note for her claimed commission and the whole matter was one of accommodation in order that the Eoebling estate might secure a deduction for tax purposes. When in fact the commission of $142,-707.88 was allowed by the court and paid in 1930, instead off reporting this sum as income, Mrs. Cadwalader urged that she should have been taxed on it in 1925. As 1930 was the year in which she in fact received the cash commission from the Eoebling estate, that is the year in which the income was received and the tax upon its receipt due. The Commissioner should prevail.

Smith and Sea well agree with this dissent.


author: Smith:

text:
    Irvington Investments Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 77557.
    Promulgated August 8, 1935.

      Simeon Hyde, Esq., for the petitioner.

      A. H. Fast, Esq., for the respondent.
   OPINION.

Smith:

The respondent has determined that the petitioner is subject to tax under section 104 of the Revenue Act of 1928 for the year 1931. This section of the statute reads in material part as follows:

(a) Ii any corporation, however created or organized, is formed or availed of for the purpose of preventing- the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 50 per centum of the amount thereof, which shall be in addition to the tax imposed by section 13 and shall be computed, collected, and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax.
(b) The fact that any corporation is a mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax.
♦ Jfs * if: * #
(d) The tax imposed by this section shall not apply if all the shareholders of the corporation include (at the time of filing their returns) in their gross income their entire distributive shares, whether distributed or not, of the net income of the corporation for such year. Any amount so included in the gross income of a shareholder shall be treated as a dividend received. Any subsequent distribution made by the corporation out of the earnings or profits for such taxable year shall, if distributed to any shareholder who has so included in his gross income his distributive share, be exempt from tax in the amount of the share so included.

The petitioner bases its claim that it is not subject to the tax imposed by section 104 (a) of the Revenue Act of 1928 upon the ground that there was no thought in the mind of the officers of the City Bank Farmers Trust Co. to prevent the imposition of the surtax upon the estate of Burroughs, the petitioner’s sole stockholder, “ through the medium of permitting its gains and profits to accumulate instead of being divided or distributed ”, and that it was not availed of for that purpose in 1931. It submits that the accounts of the estate of Burroughs for 1931 showed a loss; that if the profits of the petitioner for 1931 in the amount of $39,516.89 had been distributed to the estate, the estate would have been subject to an income tax for 1931 of only approximately $603.98; that under the will of Burroughs the net income of the estate was distributable to the beneficiaries; and that the net income of the estate shown on form 1041 for 1931 in the amount of $132,424.18 was distributable and taxable to the beneficiaries.

It should be noted that under section 104 (a) of the Revenue Act of 1928 the tax therein imposed does not apply unless the corporation “ is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed.”

In Cecil B. deMille, 31 B. T. A. 1161, we said:

But the taxes under these statutory provisions are not imposed because of effects; avoidance per se is not prohibited. It is the purpose, the intention motivating a course of conduct, which is made controlling by the very words of the statute. Unless the purpose was to prevent the imposition of surtaxes, the tax may not be imposed. * * *

In United Business Corporation of America v. Commissioner (C. C. A., 2d Cir.), 62 Fed. (2d) 754, the court stated;

* * * A statute which stands on the footing of the participants’ state of mind may need the support of presumption, indeed be practically unenforceable without it, but the test remains the state of mind itself, and the presumption does no more than make the taxpayer show his hand. Pariso v. Towse, 45 F. (2d) 962 (C. C. A. 2); Alpine Forwarding Co. v. Pennsylvania R. R. Co., 60 F. (2d) 734 (C. C. A. 2).

In R. C. Tway Coal Sales Co. v. United States, 3 Fed. Supp. 668 (Dist. Ct., W. Dist. Ky.), in construing section 220 of the Revenue Act of 1926, which is similar to section 104 of the Revenue Act of 1928, the court said:

A careful study of section 220 discloses that before there can be an assessment under its provisions, in a case such as the one presented here, there must be not only an accumulation of gains and profits beyond the reasonable business needs of the corporation, but such accumulation must have been permitted by the corporation with the intention and for the purpose of enabling its stockholders to evade the payment of surtaxes on dividends which otherwise would have been distributed to them. Even if it should clearly appear that the accumulations were in excess of the reasonable needs of the corporate business, section 220 would not apply unless it further appears that the accumulations were intentionally permitted for the express purpose of enabling the stockholders to evade the surtax. It is true the statute provides that the certificate of the Commissioner that in his opinion the accumulations are unreasonable for the purposes of the business is prima facie evidence of a purpose to evade the tax; but in a suit for a refund of taxes collected under this section, the plaintiff always has the right to overcome this prima facie presumption by proof. This, it seems to me, the plaintiff has successfully done * * *. [Italics supplied.]

The evidence in this proceeding is conclnsive to the effect that the failure of the petitioner to distribute its earnings to its sole stockholder, the estate of Burroughs, during 1931 was not due to any purpose to evade the payment of surtax. The estate showed a considerable loss for the taxable year in question. In the absence of the purpose of preventing the imposition of the surtax upon its stockholder through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, the extraordinary tax imposed by section 104 (a) of the Revenue Act of 1928 does not apply. The action of the respondent in holding that the tax is assessable and collectible is reversed.

Reviewed by the Board.

Judgment will be entered for the petitioner.


author: Smith :

text:
    Carolina Contracting Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 77638.
    Promulgated August 8, 1935.

      F. A. McGleneghan,., Esq., and J. L. Elliot, G. P. A., for the petitioner.

      Thos. F. Gallaban, Esq., for the respondent.
   OPINION.

Smith :

The respondent has determined a deficiency in petitioner’s income tax for the fiscal year ended February 29,1932, in the amount of $3,608.05. The principal part of such deficiency, and the only part which the petitioner is contesting in this proceeding, is due to the respondent’s action in adding to the petitioner’s income the amount of $25,418.59, representing the unreported profits on construction contracts completed by the .petitioner in the taxable year 1932. The facts have been stipulated.

The petitioner is a contracting company, engaged in building highways. In reporting its income for Federal income tax purposes it has adopted and followed the method of reporting income on the completed contract basis.

In February 1930 the petitioner began work on certain highway projects under contracts with Richland County, South Carolina, which work was completed and accepted during the taxable year. The first payment on the contracts was received by the petitioner during March 1930, and the last payment during October 1931, with an adjustment of filial .payment during November 1931.

A certain part of the work on these contracts was sublet by the petitioner to one F. W. Simpson, who furnished bond in the principal amount of $25,000 with the Standard Accident & Insurance Co. The bond contained a clause providing for increase of the principal sum not to exceed 50 percent of the total cost of work done in case of change in specifications, the premium to be adjusted and the balance to be paid at completion of the project. Early in 1931 the subcontractor became in arrears in his payments to his creditors who had furnished him with materials and supplies to be used in the projects, with the result that the petitioner was forced to complete the work which the subcontractor had undertaken. The subcontractor became insolvent and remained insolvent during the entire year.

As a result of the subcontractor defaulting his creditors brought suit against him and his surety, the Standard Accident & Insurance Co. Suit was subsequently brought against the petitioner and its surety, the Consolidated Indemnity & Insurance Co., and the causes Were consolidated for hearing and decision. Hearings were held by a special master for the United States District Court for the Eastern District of South Carolina, who rendered his report on September 4, 1931. On February 9, 1932, the United States District Court gave judgment that the Standard Accident & Insurance Co., the subcontractor’s surety, was liable for the sum of $51,601.90 (50 percent of the cost of work completed by the subcontractor) plus interest and costs, but that the subcontractor’s creditors might present and prove their claims against the petitioner and its bondsman, the Consolidated Indemnity & Insurance Co., who were held compelled to pay said claims but who in turn should have judgment against the subcontractor and his bondsman for payment so made not to exceed a total of $51,601.90. The petitioner was also held entitled to retain a balance of $7,165.18 due the subcontractor for work completed by 'him.

The above decision of the United States District Court was reversed by the United States Circuit Court of Appeals for the Fourth Circuit on April 4, 1933, and a writ of certiorari to the United States Supreme Court was denied on November 6, 1933.

The Standard Accident & Insurance Co. acknowledged liability to the extent of $25,000, which amount it paid into court, and which the court applied against proven claims aggregating $55,443.28. The balance of the claims, plus court costs and attorney fees, was paid by t)he petitioner during the fiscal year 1934. Some of the claims were settled at amounts less than the amounts originally claimed, so that the final result on the contracts, as shown on the petitioner’s books in 1934, was a profit of $2,011.88. This gain in 1934 was predicated on no gain or loss in the taxable year 1932 and the petitioner’s return for 1932 showed no gain or loss on the contracts. In his audit the respondent added to the petitioner’s income the amount of $25,418.59 representing the profit on the contracts, exclusive of the amounts paid out by the petitioner as a result of, and upon termination of, the litigation.

At the hearing of this proceeding counsel for the respondent stated that his position was:

* * * that the contracts were completed and satisfied during the taxable year ended February 29, 1932, that under the law and the regulations a determination of the profit or loss should have been made at that time and that subsequent events which we now know should not be taken into the computation of the net income for the fiscal year 1932, which must stand on its own feet, and any liability which the Carolina Contracting Company has set up on its books during the taxable year ending February 29, 1932, they would have to set up a contra-asset at the same time by reason of the District Court’s opinion which held that the Carolina Contracting Company was liable but that they had recourse against the bonding company for the $51,000.

The respondent claims that he correctly computed the petitioner’s income from the contracts in question in accordance with article 334 (b) of Regulations 77, which reads as follows:

(5) Gross income may be reported in the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such income, provided such method clearly reflects the net income. If this method is adopted there should be deducted from gross income all expenditures during the life of the contract which are properly allocated thereto, taking into consideration any material and supplies charged to the work under the contract but remaining on hand at the time of completion.
A taxpayer may change his method of accounting to accord with paragraphs {a) and (&) of this article, only after permission is secured from the Commissioner as provided in article 322.

Both the respondent and the petitioner cite and rely upon our decision in John Thatcher & Son, 30 B. T. A. 510. There, the taxpayer, a contractor, secured a building contract and let out a part of the work to subcontractors. The subcontractors subsequently defaulted and the taxpayer, as required by his original contract, completed the project in 1919 at a cost of $63,785.60 over and above the amount received by him on the contract. He then brought suit against the subcontractors and their sureties and the litigation was concluded adversely to the taxpayer in 1928. We held that the taxpayer was entitled to deduct the amount of $63,785.60 as a loss of the year 1928 when the litigation was finally settled. Our decision was reversed by the Circuit Court of Appeals for the Second Circuit in Commissioner v. John Thatcher & Son, 76 Fed. (2d) 900, the court holding that the amount claimed as a loss was a part o.f the cost of completing the project and should have been accounted for in the prior year 1919. In its opinion the court said:

* * * The deduction was allowed under section 23 (f) of the Revenue Act of 1928 (45 Stat. 800) which permits the deduction of “ losses sustained during the taxable year and not compensated for by insurance or otherwise.” It is as a loss which first became fixed and definite when its suit was lost in 1928, that the taxpayer now seeks to sustain the deduction. The Commissioner, on the other hand, contends that the deduction should have been taken when the work of completing the subcontractors’ contracts was performed by the taxpayer, that is, during or prior to the year 1919, since the entire building was finished in that year.
In our opinion the Commissioner’s position is correct. The cost of doing the work was necessarily paid or accrued in the years in which it was done, and was then deductible under section 214 (a) of the Revenue Act of 1918 (40 Stat. 1066) as “ ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” In completing the work sublet to the defaulting contractors, the taxpayer was performing its own contract with the owner of the building. We cannot doubt, therefore, that the expenditures made and liabilities incurred in such performance constituted ordinary and necessary expenses paid or incurred in its business. Compare Wadsworth Mfg. Co. v. Commissioner, 44 F. (2d) 762, supra (C. C. A. 6). So far as this record discloses such expenses may have been deducted in those years. If they were, to allow the deduction in 1928 would be a duplication; but if they were not, the taxpayer’s error in failing to claim a permissible deduction cannot be rectified by permitting it to be taken in a later year. See United States v. Ludey, 274 U. S. 295, 304, 47 S. Ct. 608, 71 L. Ed. 1054 [6 Am. Fed. Tax Rep. 6754]; Darling v. Commissioner, 49 F. (2d) 111, 113 [9 Am. Fed. Tax Rep. 1291] (C. C. A. 4), cert. denied, 283 U. S. 866. The fact that the taxpayer expended some $63,000 in excess of what it received for completing the work of the defaulting subcontractors reduced its taxable income for the years when the expenditures were made. Had it succeeded in recovering damages from the subcontractors or their sureties, such recovery would have been income in the year when received. Burnet v. Sanford & Brooks Co., 282 U. S. 359, 51 S. Ct. 150, 75 L. Ed. 383 [9 Am. Fed. Tax Rep. 603]. Its failure to collect such income was not a loss of a sort permitted to be deducted in computing taxable income — it was no different from a failure to receive expected income such as dividends or interest payments. In our opinion the Sanford & Brooks case governs the case at bar, though there the precise issue before us was not directly involved.

In an earlier case, T. E. McShaffrey Construction Co., 18 B. T. A. 750, the Board took the same view, apparently, as did the court in the Thatcher case. We there held that an amount paid.in settlement of the debts of a defaulting subcontractor and in the completion of a building project undertaken by the taxpayer was not a loss deductible in a subsequent year when paid, but was a part of the cost of construction and should be carried into the computation of profit or loss on the entire contract in the year when completed. In that case we said:

* * * The respondent urges (1) that the loss, if any, on the contract was not sustained in 1920, because payment to the Standard Sanitary Manufacturing Co. was not made until 1921 and subsequent years, and (2) that the amount in question constituted part of the cost to the petitioner of constructing the Marne Hotel and is, therefore, a part of the basis for computing profit or loss on that contract.
* * * The obligation of the petitioner under its contract was to construct a hotel, including the plumbing and heating, for a certain sum. It chose to install the plumbing and heating fixtures through a subcontractor, and on account of the default of the subcontractor, after he had received practically the maximum amount that might become due him under the subcontract, was required to pay for certain materials for which the subcontractor should have paid, and to complete and pay for their installation. The petitioner was primarily liable to furnish and install these plumbing and heating fixtures, and the amount they finally cost the petitioner, was, in our opinion, a part of the total cost to it of constructing the hotel, and the total cost is the basis for computing gain or loss on the contract with McShaffrey. We are unable to agree with the petitioner that the amount it paid for the plumbing and heating fixtures and for their installation in excess of the maximum amount it had contracted to pay Russell should be considered as a loss separate and apart from any profit or loss arising under the original contract. * * *

Applying the same principle in the instant case, the total amount expended by the petitioner in completing the contracts in question, including the amounts paid on the debts of the subcontractor for materials furnished and work done on the contracts, constituted a part of the petitioner’s cost of completing the contracts and must be so computed. The respondent was therefore in error in computing a profit on the completed contracts in the taxable year 1932 of $25,418.59 without making any allowance for the additional cost which the petitioner had to bear on account of the default of the subcontractor.

At the close of the petitioner’s taxable year 1932, the situation was that the contracts had been completed at a total cost in excess of the amount received by the petitioner, counting in the expenditures the amounts already paid out by the petitioner and the obligations incurred, but not paid, by the subcontractor. Assuming, then, as the respondent contends, but as we do not decide, that the contracts were completed within the meaning of article 334 above in the year 1932, when the work was accepted and the last payment on the contract price made by Richland County, the total result was a loss to the petitioner and not a gain. The error of the respondent was his failure to take into account the additional amounts which the petitioner, under its original contract, was obligated to pay for the materials furnished and other debts of its subcontractor. It is true that at the close of the year, under the ruling of the United States District Court, the petitioner, although being found liable for the subcontractor’s debts, was entitled to recover these amounts from the subcontractor and his bondsman, but the liability of the subcontractor and his bondsman was still being contested in the courts and it was uncertain what amount, if any, the petitioner would ever be able to recover from them. The court said in Commissioner v. John Thatcher & Son, supra:

But if it were conceded that the excess expenditures should be deemed a “ loss ” rather than ordinary and necessary expenses, the result would be no different. The loss occurred when the expenditures were made and was then deductible unless it was compensated for by insurance or otherwise. We think that the taxpayer’s claim for damages against the subcontractors and their sureties was too contingent and uncertain to be treated as compensation by “insurance or otherwise” for the loss. It is clear from the authorities that the subcontractors and their sureties sustained no deductible loss because of the taxpayer’s assertion of a claim, which they disputed. Lucas v. American Code Co., 280 U. S. 445, 50 S. Ct. 202, 74 L. Ed. 538 [8 Am. Fed. Tax Rep. 10278); Burnet v. Huff, 288 U. S. 156, 53 S. Ct. 330 [11 Am. Fed. Tax Rep. 1386). If the liability of the obligor is too contingent to be accrued as a loss to him, it would seem to follow that the claim of the obligee is likewise too contingent to be considered compensation for a loss already realized by the latter. See Commissioner v. Highway Trailer Co., 72 F. (2d) 913 [¶1548 of P.-H. Fed. Tax Service for 1934] (C. C. A. 7); Commissioner v. Southeastern Empress Co., 56 F. (2d) 600 [10 Am. Fed. Tax Rep. 1357] (C. C. A. 5). * * *

The petitioner reported no gain or loss on the contracts in 1932 but held them open until 1934. We believe that under the completed contract basis of reporting the petitioner properly held the contracts open until 1934. Certainly it was not ascertainable definitely until that year just what the ultimate gain or loss would be. The year 1934 is not before us, however, and for the purpose of our determination in this proceeding it suffices to say that in our opinion the petitioner realized no gain from the contracts in question in the taxable year 1932.

Reviewed by the Board.

Judgment will T)e entered under Rule 50.

Matthews concurs in the result.


author: Seawell:

text:
    May Rogers, Petitioner, v. Commissioner of Internal Revenue, Respondent. Horace S. Tuthill, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent. Edna May Thrall, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 45051, 52448, 52449, 55546.
    Promulgated August 8, 1935.

      Hugh Batteries, Esq., and I. Kerman Sher, Esq., for the petitioners.

      Mason B. Leming, Esq., for the respondent. ■
   SUPPLEMENTAL OPINION.

Seawell:

In the income tax return petitioner Tuthill filed for 1925 he computed the tax on gain realized from the sale in November 1925 of 2,574 shares of stock of the Sheffield Farms Co. at the net capital gain rate of 12% percent. In his determination of the deficiency the respondent taxed the profit in the same manner.

Excepting 234 shares acquired in July 1924 at a cost of $100 per share by the exercise of stock rights issued on the basis of one right for each 10 shares of stock held, all of the stock sold was held for a period in excess of two years. In our report in these proceedings, 31 B. T. A. 994, we determined, among other things, the fair market value of 1,280 shares of the stock acquired by gift and bequest, the basis for the remaining shares not being in controversy. Neither party raised the question of whether the profit was taxable at the net capital gain rate or as ordinary income.

On January 31, 1935, the respondent moved that the Board reconsider its findings of fact and opinion and hold that the profit derived by petitioner Tuthill from the sale of the 234 shares of stock he acquired by exercise of stock rights be taxed as ordinary income. At the hearing had on the motion counsel for petitioner Tuthill consented to the allowance of the motion, provided there be a further hearing as to the value of the old stock at the time of issuance of the stock rights. Such a hearing was had, but neither party offered any evidence on the point. Pursuant to leave granted at the hearing, the respondent has amended his answer to raise the question of whether the gain derived from the sale of the 234 shares of stock acquired by the exercise of the stock rights is taxable at the net capital gain rate or as ordinary income, and to claim an increased deficiency.

In Rodman E. Griscom, 22 B. T. A. 979, we held that stock acquired by the exercise of stock rights and not held for more than two years does not constitute a capital asset within the meaning of section 208 (a) (8) of the Revenue Act of 1924. In Ellen Ayer Wood, 29 B. T. A. 1050, we reconsidered the question at length and reached the same conclusion. The holdings in these cases are in substance that in determining whether stock acquired through the exercise of stock rights is a capital asset the time the old stock was owned may not be added to the period during which the new stock was held. The Commissioner’s rulings are in harmony with the Board. G. C. M. 12942, C. B. XIII-1, p. 78.

The petitioner contends that the proper rule is that announced by the Circuit Court of Appeals for the First Circuit in Wood v. Commissioner, 75 Fed. (2d) 364, reversing Ellen Ayer Wood, supra. In that case the court held that, where stock rights are exercised by the person to whom they were issued, the stockholder acquires a new interest which may not be regarded as a capital asset unless held for more than two years, but that so much of the new stock as is allocable to the “ right element ” constitutes a capital asset if the stock with respect to which the rights were issued was held more than two years prior to the sale of the new stock. In discussing the question the court said:

From it it follows tliat when new capital is added to the assets of an existing corporation each share represented by the certificates issued therefor is not a share in the new capital alone but automatically spreads over and attaches itself to the whole and every part of the corporation and the old certificates likewise automatically come to represent interests in the new as well as the old. Therefore when the petitioner purchased the 82 shares of stock in December, 1927, thus adding to her holdings of 1,056 shares, she had 1,132 shares each of which was a proportional interest in the whole corporation — both the old and the new values — and when she sold a share, whether by delivering an old or new certificate, she transferred a proportional interest in the whole corporation. A part of this interest or property she had held for more than two years and a pari she had acquired within the two years.

The court illustrated its method of allocating the interest between the old and new stock by the following examples:

* * * If the old stock was valued at $150 [at time stock rights were issued] and the subscription price of the new was $100, the two shares (1 new and 1 old) would be valued at $250, and every one of the shares, both new and old, would be worth $125. To this value the old interest contributed 150/250ths (3/5ths) and the new interest contributed 100/250ths (2/5ths) and 2/5ths of $125 or $50 per share would be the value of the new property sold whether the certificates delivered were new or old. The above illustration applies where the stockholder has the right to subscribe for one new share for every share previously held. If, for instance, the right was to subscribe for one share for every two previously held, then the value of the two old shares would be $300 and of the new $100, or $400 for the three, making each share worth $133.33 and 300/400ths or 3/4ths thereof would be the value attributable to the old interest and 100/400ths or 1/4th ($33.33) would be attributable to the new and would be that part of the new property sold when a share was disposed of.

The precise question has never received the consideration of any other court. See Commssioner v. Cummings, 77 Fed. (2d) 670. The Board followed the Griscom and Wood cases, supra, in Samuel Insull, Jr., 32 B. T. A. 47, and in memorandum opinions entered prior to the decision in Wood v. Commissioner, supra. A petition to review was recently filed with the Circuit Court of Appeals for the Second Circuit in one of the memorandum opinions and this proceeding may be taken to the same circuit. With due respect to the court which reversed our decision in the Wood case, it is believed that our conclusion in that case was correct, and we hold the gain taxable as ordinary income.

There remains the question of the proper basis for the 234 shares of stock acquired by the exercise of stock rights.

The respondent has determined a basis of $116.5113 per share by adding to the petitioner’s basis for all of his old stock the subscription price of the new stock, a total of $299,900, and dividing this amount by 2,574, the total number of old and new shares. The method employed is in accordance with article 39 (1), Regulations 65, reading:

(1) If the shareholder exercises his right to subscribe, the basis for determining gain or loss from a subsequent sale of any one of the old or new shares will be the cost or other basis of the old shares plus the subscription price of the new shares divided by the total number of the old and new shares.

The same method of computation was used under the Revenue Acts of 1918 and 1921. Article 39, Regulations 45 and 62, as amended by T. D. 3402 and T. D. 3403, following the decision of the court in Miles v. Safe Deposit & Trust Co. of Baltimore, 259 U. S. 247; C. B. I-2, pp. 63, 64.

The petitioner contends that, following the reasoning of the court in Wood v. Commissioner, supra, the basis for each share of new stock should be computed as follows, assuming the value of the old stock to be $350 per share at the time of the issuance of the stock rights:

Value 10 shares of old stock_$3, 500. 00
Subscription price 1 share of new stock_ 100.00
Value of each share of new and old stock (1/llth of $3,600)_ 327. 2727
Value and cost of new interest (l/36th of $327.2727)_ 9.0909
Sales price of new interest (l/36th of $500)_ 13.90
Ordinary income ($13.90 — $9.09)_ 4.81

By this method of computing the gain the petitioner determines a profit of $12,378.60 taxable as ordinary income. The respondent’s method results in ordinary gain of $89,736.36, with a corresponding decrease in the amount of gain on the old stock taxable at the capital net gain rate.

The Wood and Insull cases involved stock acquired by the exercise of stock rights issued after January 1, 1925. In neither of these cases or the earlier Griscom, case, which involved stock rights exercised in 1924, was it necessary for us to determine the basis for the stock sold.

In Miles v. Safe Deposit & Trust Co. of Baltimore, supra, the Court approved the method adopted by the trial court (273 Fed. 822) in determining the basis for stock rights sold in 1919. The trial court, in arriving at a basis for the stock rights, first determined what would have been the taxpayer’s basis for each share of old and new stock if it had exercised the rights. It determined such basis by dividing the taxpayer’s basis for the old stock, plus 'the subscription price for the new stock, by the total number of shares held. This method has been employed in other cases to determine the basis for the stock with respect to which the rights were issued and exercised, as here, prior to January 1, 1925. Thomas S. Fuller, 4 B. T. A. 992; Frederick Ayer, 6 B. T. A. 152; affd., 25 Fed. (2d) 534; Hewes v. Eaton, 39 Fed. (2d) 917; Kelly v. Anderson, 5 Fed. Supp. 333.

Article 39 of Regulations 69, promulgated under the Revenue Act of 1926, is cited by the petitioner as prescribing the method for ascertaining gain or loss on the sale of stock acquired through the exercise of rights. Such regulations are not applicable to sales of stock acquired in the exercise of rights issued prior to January 1, 1925. As to such sales, article 39 of Regulations 65 applies. T. D. 4018, C.B. VI-1, p. 36, as amended by T. D. 4145, C.B. VII-1, p. 59; G. C. M. 11743, C.B. XII-2, p. 31.

The fact that the regulations promulgated under the 1926 and subsequent acts provide a different method for computing the basis is not of itself controlling. Ayer v. Commissioner, supra; Kelly v. Anderson, supra.

Subsequent regulations were followed in Edward Stephen Harkness, 21 B. T. A. 1068, due to the fact that the regulations promulgated under the governing statute produced an absurd result and no better method was suggested.

We think the method employed by the respondent for determining the basis for the stock produces a reasonable and just result. Accordingly, we hold that the basis for each share of the new stock is the quotient of the basis for the old stock, plus the subscription price of $23,400 for the new stock, divided by 2,574, representing the total number of the old and new shares.

Reviewed by the Board.

Decision will he entered wider Rule 50.

Trammell dissents.


author: Leech: Matthews,

text:
    The Bridgeport-City Trust Company, Surviving Trustee of the Estate of I. DeVer Warner, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 44072, 48318.
    Promulgated August 9, 1935.

      Arthur M. Marsh, Esq., for the petitioner.

      J. M. Leinenhugel, Esq., for the respondent.
   OPINION.

Leech:

The question in this case is whether the petitioner, surviving trustee of the testamentary trust established by the will of I. DeVer Warner, is entitled to deduct that portion of the income of the trust which was distributed to Eva Follett' Warner, widow of testator, under the provisions of the will.

The provisions of the Revenue Acts of 1924 and 1926 here applicable are contained in section 219 and are identical. They are quoted in the margin.

Petitioner contends that under the will here involved the gift to the widow by item fifth of the will was a gift of income to be derived from a particular fund, which fund was earmarked for that purpose, composed of securities named by the will and codicils, and that the provision in item ninth is a separate, secondary, and subordinate gift and a bequest of capital intended to be effective only in case the income from the fund in any year is less than $50,000. Irwin v. Gavit, 268 U. S. 161; Heiner v. Beatty, 17 Fed. (2d) 743; affd., 276 U. S. 598, on authority of Irwin v. Gavit; and Helvering v. Butterworth, 290 U. S. 365, are cited as most closely resembling this case and as supporting petitioner’s contention.

Kespondent contends that under the terms of the trust established by the testator for the widow, the latter was an ordinary legatee since the payment of $50,000 per annum to her was to be made at all events and was not dependent upon income, citing Helvering v. Pardee, 290 U. S. 370.

We agree with respondent. The disposition of our single inquiry is obviously controlled by the intent of the testator. This is to be ascertained here, not from item fifth, item ninth, or any other separate provision of the decedent’s will, but from that will construed as one entirety. Travers v. Reinhardt, 205 U. S. 423; Hardenbergh v. Ray, 161 U. S. 112. Items of the will, other than the fifth and ninth, provide a home for decedent’s widow, ample provision for his children, by the bequest to them of the residue of his large estate, and, in addition thereto, bequeath, share and share alike, the income, as such, if the trust estate should have income in excess of the amount of payments to be made to decedent’s widow. The ninth item describes the bequest to the widow as an annuity. Both the fifth and ninth items deal entirely with the same trust estate and, together, declare the testator’s intention that his widow shall be paid a specified “ sum and amount ” annually “ at all events ” as a charge upon the whole trust estate, regardless of whether the latter had income or not. Clearly, an annuity of $50,000 to the widow, payable at all events, was thus intended and granted. Helvering v. Pardee, supra; Burnet v. Whitehouse, 283 U. S. 148.

Neither the fact that the widow elected to accept the provisions of the will, by virtue of which the disputed payments were made, in Jieu of her statutory rights, nor the present adventitious circumstance of actual payment, wholly from income, during the pending tax years, affects that conclusion. Helvering v. Pardee, supra. Nor does the fact that the present trust corpus did not include all of the testator’s estate, change its character as corpus here, and so, does not disturb that result. Burnet v. Whitehouse, supra; Boston Safe Deposit & Trust Co. v. Commissioner, 66 Fed. (2d) 179; certiorari denied, 290 U. S. 700; Warner v. Commissioner, 66 Fed. (2d) 403; certiorari denied, 290 U. S. 688.

We conclude that the widow was the legatee of an annuity, a charge upon the whole trust estate, both income and corpus; that the payments in question to her were made by the trustee, not as a payment of income, as such, but in discharge of that legacy, and, accordingly, upon the authority of the Pardee and Whitehouse cases, supra, were not deductible from the gross income of the trust estate in computing its taxable income.

Eeviewed by the Board.

Decision toill be entered pursuant to Rule 60.

Matthews,

dissenting: It is elementary that the intention of the testator governs as to the character of testamentary gifts. Although the terms of the will of I. DeVer Warner are not identical with the terms of either will before the Supreme Court in Helvering v. Butterworth, 290 U. S. 365, and Helvering v. Pardee, 290 U. S. 370, it is my opinion that the provisions of the Warner will creating the trust are more nearly like those of the Butterworth will. By item fifth the testator established a trust and directed the trustees “ from the dividends, interest, income and increase thereof, to pay over to my wife during the term of her natural life, annually, in quarterly payments, the sum and amount of ” $50,000. Then after accumulating from the excess income the sum of $50,000 which was to be added to the corpus of the trust, the trustees were to pay the balance of the income annually to the testator’s three children, share and share alike. At the death of his wife, the principal and accumulations of the trust fund were to be disposed of as part of his residuary estate which was to go to his three children. By another provision, item ninth, the testator reiterated that “ It is my will that the annuity provided for my wife in the Fifth item of this will shall be paid to her out of the income of the trust property held for that purpose, if it be sufficient ”, but if insufficient the trustees were directed to take from the principal a sufficient amount to make up the deficiency, “ so that, at all events, and every year, my said wife shall receive the full sum and amount of ” $50,000. In my opinion the testator’s intention or “ will ” to make his wife a beneficiary of the income of the trust, to the extent of $50,000 each year, could not be more clearly expressed. The fact that in item ninth the testator provided for the payment of a part of the corpus to his wife in any year in which the income of the trust should be less than $50,000, thereby making what we may designate as a conditional bequest of a part of the corpus, does not change the nature of the gift made by item fifth, which is a gift of income. Helvering v. Butterworth, supra; Heiner v. Beatty, 17 Fed. (2d) 743; affd., 276 U. S. 598, on authority of Irwin v. Gavit, 268 U. S. 161.

It is to be noted further that although the testator herein refers to his gift as an “ annuity ”, he did not give his wife outright an annuity of $50,000, such as was given by Calvin Pardee to his wife, and the amount payable to the widow by virtue of item fifth is not payable without regard to income but is payable wholly out of income. Under the undisputed facts of this case, the amounts paid by the trustees to the widow in the taxable years before us were paid solely by virtue of item fifth. Except in the first year after the testator’s death the income of the trust has been greatly in excess of $50,000, and such excess has been distributed to the other beneficiaries. Furthermore, it is only in the event that the income of the trust is less than $50,000 that there will be paid to her any amount from the corpus, by virtue of item ninth, and if it should be necessary to make up the deficiency, as directed, such amount will be a bequest and not taxable. It appears to me that this conditional bequest should not be so construed as to constitute the testator’s gift to the widow a legacy of corpus.

For the reasons set out herein I am strongly of the opinion that the widow in the instant case is a beneficiary of the income of a testamentary trust created by the will of I. DeVer Warner, within the intendment of the statute, and that the petitioner is entitled, under section 219 (b) (2) of the Revenue Acts of 1924 and 1926, to deduct the income of the trust which was distributable and distributed to her m the taxable years.

       Sec. 21Í). (a) The tax imposed by Parts I and II of this title shall apply to the income of estates or of any kind of property held in trust, including — ■

      (2) Income which is to he distributed currently by the fiduciary to the beneficiaries, * * *
      *******
      (b) Except as otherwise provided in subdivisions (g) and (h), the tax shall be computed upon the net income of the estate or trust, and shall be paid by the fiduciary. The net income of the estate or trust shall be computed in the same manner and on the same basis as provided in section 212, except that—
      ***♦*♦♦
      (2) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, * * * but the amount so allowed as a deduction shall be inoluded in computing the net income of the beneficiaries whether distributed to them or not. ♦ * *

         The dissenting opinion of Chief Justice Hughes expresses the contrary view on the latter point, which is answered in the majority opinion.


author: Muedoce :

text:
    Doric Apartment Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 44655.
    Promulgated August 9, 1935.

      E. J. Wells, Esq., and Nathan Kahn, Esq., for the petitioner.

      A. E. Fast, Esq., for the respondent.
   OPINION.

Muedoce :

Each party to this proceeding called a number of witnesses to express opinions as to the total fair market value of the second mortgage notes which the petitioner received from the sale of the Willow Terrace Apartments property. The values given by the witnesses called by the petitioner ranged downward from 30 percent of the face value of the notes. One witness for the respondent stated that in his opinion the notes were worth 80 percent of their face value. Another stated that in his opinion the notes maturing within the first five years were worth 80 percent of their face value while those maturing thereafter were worth 70 percent of their face value. There was other evidence bearing upon the question of the value of these notes. The evidence clearly shows that the notes had some fair market value, but that it was not as much as 85 percent of t'heir face value. Since the determination of the Commissioner was incorrect the Board must determine, as best it can from the evidence, the total fair market value of the notes. Cf. Cohan v. Commissioner, 39 Fed. (2d) 540; Helvering v. Taylor, 293 U. S. 507. This has been done. The decision on this question of fact is set forth in the findings of fact above.

The Commissioner determined that the petitioner is liable for a penalty under section 275 (b) of the Kevenue Act of 1924, which provides, “ if any part of any deficiency is due to fraud with intent to evade tax, then 50 per centum of the total amount of the deficiency (in addition to such deficiency) shall be assessed, collected and paid * * The burden of proof on this issue is by statute placed upon the Commissioner. Section 601 of the Kevenue Act of 1928, amending section 907 (a) of the Kevenue Act of 1924, as amended. The Commissioner, in determining the deficiency, increased the amount of cash and the value of the notes over the figures used by the petitioner in reporting its profit from the sale of the apartment house and included in the basis the cost of furniture and fixtures and trustees’ services. The deficiency is due to the fact that the Commissioner increased the value of the second trust notes from $93,750, as reported by the petitioner, to $265,825, and he contends that the deficiency is due to fraud with intent to evade tax.

The petitioner was required by statuté to report the gain from the sale of the apartment house. That gain was the excess of the amount realized over the basis. The amount realized is “the sum of any money received plus the fair market value of the property (other than money) received.” Sec. 202. The Commissioner contends that the petitioner understated the value of the notes received and misled him by failing to indicate the face value of the notes. There is nothing in the statute requiring the petitioner to report the face value of the notes. It was only required to report their fair market value. The petitioner indicated on its return that “ notes ” were part of the consideration. Not only was the Commissioner thus put on notice that it was fair market value rather than face value which was being reported, but his action in investigating the fact and determining the deficiency belies his statement that he was in any way misled. The petitioner made at least a reasonable effort to discover the fair market value of the notes and reported what it believed to be their fair market value. This was a question of fact upon which opinions vary widely, as evidenced by the opinions of the witnesses in this case. The fact that the petitioner used $93,750 as the value of the notes on its return certainly does not show a fraudulent intent to evade tax.

The Commissioner also argues that fraud with intent to evade tax in connection with the amount reported as the fair market value of these notes is shown by all the surrounding circumstances. He calls particular attention to the way in which the notes were divided into series and amounts, to the transfer of the notes to the partnership and the two corporations, and to the distribution of the notes to the petitioner’s stockholders in proportion to their stockholdings. There is, however, a plausible explanation of these transactions unrelated to the matter of income tax. There was no reason for the continued operation of Doric after the sale of the apartment. It therefore retired at par all but a relatively small amount of its capital stock. In order to do this it used most of the cash received from the sale of the apartment house and $93,150 obtained through the disposition of the notes. The evidence as a whole is not sufficient to sustain the burden of proof cast by statute upon the Commissioner, and, therefore, that no part of the deficiency was due to fraud with inteni to evade tax has been found as a fact.

Decision will be entered under Rule 50.


author: MttRdock :

text:
    Oscar G. Joseph, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 47345, 53509.
    Promulgated August 13, 1935.

      E. J. Wells, Esq., and Nathan. Kahn, Esq., for the petitioner.

      ArtTvwr Garnduf, Esq., for the respondent.
   OPINION.

MttRdock :

The first question is, Did the petitioner realize a gain from the liquidation or partial liquidation of Doric in 1924, and, if so, how much was his gain? He reported no gain of that kind. The Commissioner added $44,331.25 to his income as a gain from the liquidation of Doric. He computed this gain by assigning to the Matz notes a value of 85 per cent of their face value and by holding that the petitioner was the owner of 500% shares of the Doric stock at the time of the distributions. The value of the Matz notes at that time was only 60 percent of their face value. Doric Apartment Co., 32 B. T. A. 1187, a case heard with the present case and others. The petitioner owned only 50% shares of the Doric stock at the time of the distributions in question. This finding is required not only by the uncontradicted testimony of several witnesses, but by the respondent’s Exhibit D. That exhibit was offered and admitted in evidence without qualification. It shows that the petitioner “ owned ” 50% shares and the remaining shares were all “ owned ” by others.

The petitioner received as his own Matz notes of the face value of $7,812.50. He claims that he purchased them and therefore the Commissioner erred in treating the receipt of them by him as a liquidating dividend from Doric. However, the evidence does not support this contention of the petitioner. The record contains many contradictions on this point. It clearly shows that none of the Doric stockholders bought, or paid anything for, the notes which they received and that they received all of the Matz notes in exact proportion to their respective stockholdings in Doric. Doric did not transfer the notes directly to its stockholders. It transferred series 1 and 2 to Joseph & Joseph, series 3 to Stitzel Distilling Co. and series 4 to H. H. Newmark Co. These transferees held the notes in trust for the Doric stockholders and almost immediately transferred the notes to the Doric stockholders without receiving any consideration directly from those persons. Joseph & Joseph, the Stitzel Distilling Co., and the H. II. Newmark Co. gave certain checks to Doric at the time they received the Matz notes from Doric. However, the cash distributions from Doric apparently were used to repay to Joseph & Joseph, the Stitzel Distilling Co., and the H. H. Newmark Co. the amount each had advanced to Doric in the checks referred to above. But even if the circumstance of these checks is not entirely consistent with the theory upon which the Commissioner has determined the deficiency, it is not sufficient, when taken with all of the other evidence, to entitle the petitioner to judgment upon this point, The amount of the checks was only one half of the fair market value of the notes. The Commissioner has deducted the amount of the checks from the liquidating distributions. He concedes that that amount should be deducted in computing the amount of the liquidating distributions so that the stockholders will only be taxed on the excess of the sum of the cash and value of the notes over the sum of the basis and the amount put back into Doric through the checks. The stockholders of Doric did not acquire the notes in proportion to or because of their interests in the makers of the checks. They did not acquire the notes as gifts. They did acquire them as stockholders of Doric indirectly from Doric. The net amount received exceeded the basis. Therefore the Commissioner did not err in taxing the petitioner with gain from the partial liquidation of Doric. Sec. 201 (c) and (g), Revenue Act of 1924. He did err in computing the amount of that gain. The basis of the Doric stock for gain or loss to the petitioner is not in dispute and therefore the parties can compute the correct gain in accordance with this opinion.

The Commissioner erred in taxing the petitioner in 1924, 1925, 1926, and 1928 upon interest and gains on the Matz notes which belonged to his wife and the Fuhrmans. Another question is whether the petitioner continued to own the Matz notes of the face value of $7,812.50 which he received as his own. He claims that in 1924 he gave these notes to his wife. He likewise claims that in 1924, 1925, and 1926 he gave other securities, consisting of stocks, bonds, and notes, to his wife and the Commissioner erred in taxing him upon the interest and dividends from those securities. There is no dispute about the amounts involved. The only question is whether the petitioner has shown that he made the alleged gifts. A number of the essential elements of a bona fide gift have been established. Cf. Adolph Weil, 31 B. T. A. 899. Yet two of the essential elements of a completed gift are not satisfactorily established. The evidence does not show (1) a clear and unmistakable intention on the part of the donor to absolutely and irrevocably divest himself of the title, dominion, and control of the subject matter of the gift, in praesenti, and (2) an irrevocable transfer of the present legal title and of the dominion and control of the entire gift to the donee, so that the donor could exercise no further act of dominion or control over it. Cf. Jackson v. Commissioner, 64 Fed. (2d) 359. The Board said in Theodore C. Jackson et al., Administrators, 32 B. T. A. 470:

The transfer and delivery, of property, including corporate stock, are not conclusive upon the question of intent where change of title is involved from the standpoint of taxation; and surrounding circumstances, including subsequent acts of the taxpayer, often establish intent more clearly than parole evidence.

In the case of the stock certificates formal assignments were made on separate pieces of paper. Apparently this was done for the purpose of enabling the petitioner to detach the separate assignments and destroy them whenever he desired to sell any of the stock or place it as collateral for his own borrowings. He thus was able to use the stock as his own after the dates of the alleged gifts. He actually did use the certificates for his own purposes without consulting his wife. Cf. P. B. Fouke, 2 B. T. A. 219. She said that she knew nothing about the actual transactions hut left all of such affairs to her husband. She could remember no details but expressed confidence in her husband and said he had her permission to use the securities as he saw fit. The fact that he had access to the box in which they were kept might not be particularly important were it not for the added fact that he removed them at will. Cf. Jackson v. Commissioner, supra; Marshall v. Commissioner, 57 Fed. (2d) 633; certiorari denied, 282 U. S. 61; Richard Tuffli, 13 B. T. A. 1255. He also sold some of the securities and reported the gain or loss in his own return. He likewise reported the dividends on the stock for 1926 while he had it up as collateral on his borrowings. The stock was never transferred to his wife’s name on the books of the various corporations until after the Commissioner had raised a question about the alleged gifts. Cf. Marshall v. Commissioner, supra. The notes were never endorsed by the petitioner. Some of them could be negotiated only by his endorsement. See sec. 3720 b-30, Carroll’s Kentucky Statutes 1930. The dividends were paid to and received by the petitioner. He also received the interest and all proceeds from sales. He claims that he did not receive such funds for his own benefit, but the evidence is far from convincing on that point. His wife had a separate bank account, but none of the money was deposited in that account. Some of the money was deposited in the petitioner’s account. The wife had power to draw on that account, but she never exercised her power. He said he purchased additional securities for his wife from the income and proceeds which he received. But he kept no records and could show no specific instances of such use of the funds. Although the securities were worth many thousands of dollars, yet the record does not show one instance where she received income or proceeds from them. The implication from all of the evidence is that the petitioner used the income and proceeds for his own purposes.

Although the forms executed and the acts done by the petitioner at the dates of the alleged gifts would ordinarily show that gifts had been made, nevertheless subsequent acts of the petitioner indicate that he did not actually divest himself of title, dominion, and control so as to relieve himself from tax on the securities. The parties make no point of the difference between the facts relating to the stock and the facts relating to the notes and bonds. The Commissioner has held that the petitioner did not make present gifts of any of the securities in 1924, 1925, and 1926 and the income and profits were his during those years and during 1928. The evidence fails to show a valid gift of any of the securities. The interest and dividends for the four years were properly included in the income of the petitioner.

The petitioner is taxable in 1928 on interest and gains upon any of the original $7,812.50 face value of the Matz notes which drew interest or were paid in that year. His profit was the excess of the amount received on a note, exclusive of interest, over 60 percent of its face value.

The petitioner was not entitled to a deduction for 1928 representing accrued interest on the amount which he owed the Fuhrmans. He kept no complete books. He was not entitled to use an accrual method in reporting his income. He paid no interest to the Fuhr-mans in 1928 on the balance which he then owed them. The Commissioner correctly disallowed that deduction on the ground that the petitioner was on a cash basis.

The remaining issue is whether any part of the deficiency for one or more of the years 1924, 1925, 1926, and 1928 was due to fraud with intent to evade tax. Sec. 275 (b), Revenue Acts of 1924 and 1926; sec. 293 (b), Revenue Act of 1928. The burden of proof upon this issue is by statute placed upon the Commissioner. Sec. 601, Revenue Act of 1928, amending sec. 907 (a), Revenue Act of 1924, as amended by sec. 1000, Revenue Act of 1926.

The Commissioner in his brief urges that the petitioner’s failure to report his full share of the income of the partnership of Joseph & Joseph for each year indicates fraud. The Commissioner introduced no evidence in respect to those items. The notices of deficiencies show that the Commissioner increased the petitioner’s share of the partnership income for each year, but they completely fail to show that the failure of the petitioner to return the proper amount was done with fraudulent intent, or even knowingly. Cf. American Ideal Cleaning Co., 30 B. T. A. 529; Henry S. Kerbaugh, 29 B. T. A. 1014. The petitioner did not contest the adjustments. of partnership income, but he certainly did not admit fraud thereby. Failure to contest an adjustment made in determining the deficiency is not proof of fraud. The Commissioner can not sustain his burden of proof on a fraud issue by statements made in his notice of deficiency. James Nicholson, 32 B. T. A. 977. Those items must be disregarded in so far as the fraud issue is concerned.

The above items and also the Fuhrman interest item for 1928 ($1,698.85 claimed as a deduction) were not properly pleaded by the Commissioner as facts upon which he relied to support the fraud issue. The only reference to them in the answers is in the references therein to the notices of deficiencies. This did not properly notify the petitioner and the Board that the Commissioner relied upon those items to show fraud. Furthermore, the answer for 1928 affirmatively indicates that the Commissioner relies upon the failure of the petitioner to report certain income, rather than upon any unwarranted deduction taken. The facts showing fraud should not only be proven, but they should be clearly pleaded. The items mentioned in this paragraph will be disregarded in so far as the fraud issue is concerned. See Bules 14 and 15; L. Schepp Co., 25 B. T. A. 419, 438; American Ideal Cleaning Co., supra.

The petitioner’s failure to report interest and gain on the Matz notes and Doric stock which actually belonged to his wife and the Fuhrmans is, of course, no evidence of fraud. The fact that the Matz notes were valued at only 3i0 percent of their face value instead of being valued higher does not evidence fraud under the circumstances. Doric Apartment Co., supra.

There remain for consideration the circumstances surrounding the failure of the petitioner to report for 1924, 1925, and 1926 the interest and dividends upon the securities which he alleges he gave to his wife (including $7,812.50 face value of the Matz notes), his inconsistency in reporting gains and loss from the sale of some of those securities, his failure to report any profit in 1928 on his share of the Matz notes, and his failure to report a profit of $2,971 on the sale of Kansas City Southern stock in 1928. The latter item was reported on his wife’s return. The petitioner made up that return. He testified that he had made a mistake in reporting that profit in the way he did and that he could not account for the mistake. This omission indicates negligence, but, standing alone, is not a sufficient basis for imposing the fraud penalty. His failure to report a profit for 1928 on the Matz notes is like his failure to report the interest and dividends on the whole lot of securities involved in the alleged gifts and need not be discussed separately. The respondent contends that the alleged gifts were mere shams, planned to mislead the Commissioner as to the ownership of the securities and thus to evade tax lawfully due from the petitioner on the income from those securities. We have already held that the petitioner has failed to establish the fact that actual gifts were made. But the question now is, Does the evidence affirmatively show that the alleged gifts were shams designed to evade tax? Doubts and omissions are now to be held against the Commissioner, upon whom rests the burden of proof. The evidence is not clear and convincing on this point and the petitioner must receive the benefit of the doubt. It is not clear that the petitioner used the income and proceeds from the securities for his own benefit after the dates of the alleged gifts. The obvious errors which he committed in his returns may have been due to carelessness rather than to a deliberate intent to evade tax. While at times his errors tended to reduce his tax, at others he included in his return items which, had he been consistent, he would have omitted. His very inconsistency and indifference to the result indicate negligence and carelessness rather than fraudulent intent. The proof is not clear and convincing that a part of any deficiency was due to fraud with intent to evade tax.

The respondent contends in the alternative that a part of the defi.ciency for 1928 was due to negligence or intentional disregard of rules and regulations but without intent to defraud, and, therefore, the penalty provided in section 298 (a) of the Eevenue Act of 1928 should be imposed. He made no such claim in the proceeding relating to the other years. The petitioner was negligent in failing to include in his return the profit upon the sale of the Kansas City Southern stock.

Decision will be entered umder Bule 50.