author: Smith : VaN FossaN,

text:
    James H. Hyde, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 65495, 69952.
    Promulgated October 3, 1934.

      Camfbcll E. Loche, Esq., for the petitioner.

      B. W. Wilson, Esq., for the respondent.
   OPINION.

Smith :

These proceedings, consolidated for report, involve income tax deficiencies for 1929 and 1930 of $5,678.33 and $4,859.01. The allegation of error common to both proceedings is that the respondent erred in including in the income of.the petitioner $27,494.66 for the year 1929 and $27,948.54 for the year 1930, which amounts represented income paid during those years to Martha Leishman Hyde, who, prior to her divorce, had been the wife of the petitioner, from a trust estate created for the benefit of the said Martha Leishman Hyde in and under an indenture of trust dated August 2, 1919, executed by the petitioner.

The parties have stipulated the facts as follows:

(1) On or about the 29th day of October, 1918, the petitioner and Martha Leishman Hyde, who was then the wife of the petitioner, and Walter V. R. ■ Berry, therein called the Trustee, entered into an agreement in writing bearing date that day, a copy of which is hereto annexed marked “ Schedule A” and made a part hereof with like force and effect as if incorporated herein at length.
(2) On or about the 13th day of February, 1919, the said Martha Leishman Hyde obtained a decree of absolute divorce against the petitioner in the Civil Tribunal of First Instance of the Department of the Seine, Republic of France. Said decree contained no provision for alimony or otherwise for the support or maintenance of the said Martha Leishman Hyde.
(3) Thereafter and on or about the 2nd day of August, 1919, the petitioner made and entered into a certain indenture of trust bearing date that day with The Farmers Loan and Trust Company, of the City of New York, in the State of New York, therein called the Trustee, a copy of which is hereto annexed marked “ Schedule B ” and made a part hereof with like force and effect as if incorporated herein at length. Said indenture of trust was not made pursuant to the order or direction of any court or tribunal.
(4) During the years 1929 and 1930, the said Martha Leishman Hyde did not remarry.
(5) City Bank Farmers Trust Company, the successor Trustee under said indenture of trust bearing date the 2nd day of August, 1919 (a copy of which is hereto annexed marked “Schedule B”), paid to said Martha Leishman Hyde out of the net income arising from the trust created by said indenture of trust sums aggregating $27,494.66 during the year 1929 and $27,948.54 during the year 1930.
(6) The respondent determined that said sums should properly be regarded as taxable income of the petitioner and asserted deficiencies in income taxes against the petitioner for 1929 amounting to $5,678.33 and for 1930 amounting to $4,859.01, and in these proceedings the petitioner seeks a redetermination of said deficiencies.

The agreement of October 29, 1918, provided in part as follows:

I.
The wife shall bring an action in divorce before the Tribunal of the Seine, against the husband, based upon grounds of desertion only. * * *
*******
IV.
The husband shall execute a Trust Deed wherein he shall cause to be set aside certain securities belonging to him, for the purpose of creating a Trust Fund sufficient to produce an annual income of thirty thousand dollars, which said income shall be paid annually to the wife in quarterly instalments, during her lifetime. In the event, however, of the remarriage of the said wife, the principal of said Trust shall be reduced so that the annual income therefrom will amount to fifteen thousand dollars (15,000_) payable in the manner and at the times hereinabove specified. Upon the death of said wife, said Trust shall be terminated and the principal thereof shall revert to the husband; or, in the event of his prior death, to his lawful heirs and next of kin, or to such persons as he may have appointed by testament to receive the same.
*******
XII.
The wife agrees to sign at all times and on demand all waivers of dower or other rights, either special or general.

The indenture of trust of August 2, 1919 (Schedule B), provided in part as follows:

This Indenturei made this Second day of August, 19191, between James Hazen Hyde of Islip, Suffolk County, State of New York, United States of America, Party of the first part, Martha Leishman Hyde, of 9, Avenue Bugeaud, Paris, France, Party of the second part, and The Farmers Loan and Trust Company, of 16-22 William Street, in the City and State of New York, hereinafter called “ the Trustee,” Party of the third part,
WITNESSETH !
Whereas the party of the second part did, on the thirteenth day of February 1919, obtain a decree of absolute divorce against the party of the first part, in the Civil Tribunal of First Instance of the Department of the Seine, Republic of France; and
Whereas the party of the second part has agreed to abandon, relinquish and waive all claims she may have against the party of the first part for alimony, dower, support and maintenance in consideration of the party of the first part agreeing to enter into this Indenture.
Now Therefore, in consideration of the premises and of the covenants herein contained, and in consideration of the party of the second part abandoning, relinquishing and waiving all claims she may have against the party of the first part for alimony, dower, maintenance and support, and of the sum of One Dollar ($1.00) lawful money of the United States in hand paid by the party of the second part to the party of the first part, at or before the ensealing and delivery of these presents (the receipt whereof is hereby acknowledged), and for other good and valuable considerations, the Party of the first part has granted, conveyed, assigned, set over and delivered, and by these presents does grant, convey, assign, set over and deliver to the Trustee, its Successors and Assigns, the securities set forth and described in Schedule “A” hereto annexed and made a part hereof, Irr Trust Nevertheless, for the uses and purposes and subject to the terms and conditions, powers and agreements hereinafter set forth:
First. — To hold, manage, invest, reinvest and keep the same invested, to collect, recover and receive the rents, issues and profits thereof and, after deducting the commissions of the Trustee and all proper taxes, and expenses of said trust, to pay over the net income therefrom, in equal quarter yearly instal-ments to the party of the second part during her natural life, and for so long as said party of the second part shall not remarry, Provided However, that the total amount of such net income shall not be less than nor exceed the sum of Thirty Thousand Dollars ($30',000.00) per annum; and at her death, to pay over the principal of said trust fund, together with all accrued rents, revenues and income therefrom, absolutely and forever to the party of the first part, or to his Executors, Administrators, Successors or Assigns; and in the event that at any time the net rents, revenues and income of the said securities after deduction of all proper commission of the trustee, expenses of the trust, and taxes, shall exceed the said sum of Thirty thousand dollars ($30,000.00) per annum, then to pay over such surplus income to the party of the first part.
****** *

Pursuant to the indenture of trust of August 2, 1919, the petitioner turned over to the trustee bonds of a par value of $783,000, the annual interest upon which amounted to $30,000.

In the notice of deficiency upon which the proceeding in Docket No. 65495 is predicated it is stated:

The amount of $27,494.66, representing income from the trust under indenture, August 2, 1919, for James H. Hyde and Martha L. Hyde, is held to be taxable income to you since this amount was paid by you to Martha L. Hyde in lieu of alimony and dower rights. (See cáse of Mary R. Spencer, United States Board of Tax Appeals, volume 20, page 58).

The deficiency notice upon which the proceeding in Docket No. 69952 is predicated stated: “ the income from the Martha Leishman Trust (u/ind 8/2/19), is held to represent income taxable to you.

• Section 161 of the Revenue Act of 1928 provides in part as follows:

(a) Application of taw. — Tie taxes imposed by this title upon individuals shall apply to the income of estates or of any kind of property held in trust, including—
* * * * * * *
(2) Income which is to be distributed currently by the fiduciary to the beneficiaries * * *

Section 162 provides in part:

The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
* * % * sis * *
(b) There shall be allowed as an additional deduction in computing the net income of the estate or. trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. * * *

Section 167 provides:

Where any part of the income of a trust may, in the discretion of the grantor of the trust, either alone or in conjunction with any person not a beneficiary of the trust, be distributed to the grantor or be held or accumulated for future distribution to him, or where any part of the income of a trust is or may be applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23 (n), relating to the so-called “ charitable contribution ” deduction), such part of the income of the trust shall be included in computing the net income of the grantor.

The respondent has determined the deficiency for the year 1929' upon the basis of the opinion of this Board in Mary R. Spencer, 20 B.T.A. 58. The facts in that case were that the petitioner, pending hearing of her action for divorce, entered into an agreement with her husband whereby a trust fund was created from his estate, the income thereof not in excess of $14,000 per year to be paid to her yearly for support of herself and child and for release of her dower rights, the trust to become effective only if and when she secured a decree of divorce. In our opinion we stated:

* * * To the extent that the payments received in the taxable yeaEg by petitioner represent sums in lieu of alimony, we hold they do not represent income to petitioner. S. B. Appleby, Jr., 2 B.T.A. 1061; Jane B. Coates, 3 B.T.A. 429. In so far as they may represent payments in lieu of dower rights, the same conclusion must be reached. Warner v. Walsh, 15 Fed. (2d) 367; United States v. Bolster, 26 Fed. (2d) 760; Jacob W. Frank, 19 B.T.A. 915.

In Helvering v. Butterworth, 290 U.S. 865, the Supreme Court stated:

Prior to Warner v. Walsh, 15 F. (2d) 367, United States v. Bolster, 26 F. (2d) 760, and Allen v. Brandeis, 29 F. (2d) 363, the Commissioner ruled that distributions from the income of a trust estate to the widow who elected to take under her husband’s will in lieu of her statutory interest were taxable to her. These eases held that by relinquishment of her rights, she came to occupy the position of the purchaser of an annuity. They decided that payments to her were not subject to taxation until her total receipts from the trust estate amounted to the value of what she relinquished — her alleged capital. Thereafter, in similar cases, the Commissioner refused to give credit to the trustee for such payments and thus the present causes arose.
We cannot accept the reasoning advanced to support the three cases just cited. The evident general purpose of the statute was to tax in some way the whole income of all trust estates. If nothing was payable to beneficiaries, the income without deduction was assessable to the fiduciary. * * *

If the income of a trust estate is distributed or distributable it is taxable to the beneficiary. If the income is not distributable within the taxable year it is ordinarily taxed to the trust. Where, however, the grantor may revoke the trust during the taxable year or where the income of the trust estate may be utilized by the grantor for the payment of premiums on his life insurance policies or for the satisfaction of other valid claims against him the grantor by special provisions of the statute may be liable to income tax in respect of such amounts.

In the instant proceeding there is no claim made by the respondent that the trust of August 2, 1919, was revocable. Nor is any claim made that the income could be applied to the payment of premiums on insurance policies on the life of the grantor. Where, then, is there any valid claim that the grantor, the petitioner herein, is taxable upon the income of the trust fund ?

We think that no question can be raised but that a husband may make a valid gift of property to his wife and that thereafter the income from the donated property is the taxable income of the wife and not of the husband. We likewise think that it is plain that where a husband in good faith and not for the purpose of avoiding taxes creates a trust, the income from the trust fund to be paid currently to the wife, and the husband does not retain a power of revocation, the husband is not taxable upon income paid to the wife. We can not see how the rule is any different where the husband creates a trust fund for the benefit of his divorced wife. Nor do we think it makes any difference that the divorced wife in the proceedings at bar relinquished all claims for alimony, dower rights, maintenance, and support in connection with the creation of the trust fund. See Reginald Brooks, 31 B.T.A. 70. She did not thereby acquire the right to receive the income from the fund by purchase for a valuable consideration. Helvering v. Butterworth, supra. In Reinecke v. Smith, 61 Fed. (2d) 324, the Circuit Court of Appeals for the Seventh Circuit held:

The power of Congress as to the taxation of the income of trusts which are under the unfettered control of the grantor or which may be created in the future is broad. Corliss v. Bowers, 281 U.S. 376, 50 S.Ct. 306, 74 L.Ed. 916; Milliken et al. v. United States, 283 U.S. 15, 51 S.Ct. 324, 75 L.Ed. 809; Taft v. Bowers, 278 U.S. 470, 49 S.Ct. 199, 73 L.Ed. 460, 64 A.L.R. 362; Purity Extract Co. v. Lynch, 226 U.S 192, 33 S.Ct. 44, 57 L.Ed. 184; Jacob Buppert v. Caffey, 251 U.S. 264, 40 S.Ct. 141, 64 L.Ed. 260; Lambert v. Yellowley, 272 U.S. 581, 47 S.Ct. 210, 71 L.Ed. 422, 49 A.L.R. 575. All measures reasonably necessary to prevent escape from taxes or surtaxes may be adopted.
When an attempt is made to apply those measures to past lawful transactions by which the grantor has parted with control over the trust fund and has made it impossible to regain such control by his own act, a different question arises. Under the broadest conception of legislative powér, that which is not the income of the taxpayer and which it it impossible for him to make a part of his income may not be required arbitrarily to be included in his income. Such an attempt amounts to confiscation, and offends the Fifth Amendment. Nichols v. Coolidge, 274 U.S. 531, 542, 47 S.Ct. 710, 71 L.Ed. 1184, 52 A.L.R. 1081; Heiner v. Donnan, 285 U.S. 312, 326, 327, 52 S.Ct. 358, 76 L.Ed. 772.

The Supreme Court reversed the judgment o.f the Circuit Court of Appeals in the foregoing case (Reinecke v. Smith, 289 U.S. 172) on the ground that the word “ beneficiary ” in section 219 (g) of the -Revenue Act of 1924 did not include a trustee, but did not disturb the fundamental proposition of law enunciated by the Circuit Court of Appeals.

The subsequent cases of Burnet v. Wells, 289 U.S. 670, and DuPont v. Commissioner, 289 U.S. 685, are distinguishable from Reinecke v. Smith, supra, in that in those two cases there was involved the construction of an entirely different and distinct provision^ of the Revenue Acts of 1924 and 1926, subdivision (h) of section 219, providing for the taxation to the creator of a trust of such part of the income thereof as is applied to the maintenance o.f insurance on his life. We have not the same situation before us.

In Frank Turner, 28 B.T.A. 91, we held that where there was a deposit of stock to trustees under a separation agreement the deposit of collateral was to insure the performance of petitioner’s obligations under the contract and was not an irrevocable assignment of title and ownership of the stock. That case was affirmed by the Circuit Court of Appeals for the Second Circuit without opinion June 27, 1934. That case is clearly distinguishable from the present one upon its facts.

In Douglas v. Willcuts, decided by the United States District Court for the District of Minnesota, and reported at paragraph 9483 of Commerce Clearing House Federal Tax Service for 1933, Yol. Ill, it was held that income in 1927 and 1928 from property previously irrevocably transferred by the petitioner in trust for his divorced wife pursuant to an agreement for compensation to her in lieu of alimony was not taxable to the grantor, the petitioner, but was taxable to his divorced wife. To the same effect is /S'. A. Lynch, 23 B.T.A. 435. We think that the same rule should apply here.

Reviewed by the Board.

Judgment will be entered under Rule 50.

Goodeioh and Adams concur in the result.

VaN FossaN,

dissenting: I am unable to agree with -the ruling of the majority of the Board. It seems clear that the trust in question brings the instant case within the reasoning of the Court of Appeals for the Eighth Circuit in Willcuts v. Douglas, 73 Fed. (2d) 130, where the court held that such a trust relieved the trustor of the payment of legal obligations he was bound to meet and thus directly benefited him. Any other decision points the way to the evasion of taxes justly due.


source: Caselaw Access Project

author: Smith :

license: Public Domain

text:
    Helen V. Kelchner, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71197.
    Promulgated October 3, 1934.

      FrederieJe G. Weisser, Esg., for the petitioner.

      T. M. Mather, Esq., and E. 0. Adams, Esq., for the respondent.
   OPINION.

Smith :

The respondent has determined a deficiency in petitioner’s income tax for 1930 in the amount of $8,692.88. The petitioner alleges that the respondent erred in computing the gain upon the sale-of certain shares of stock. Briefly stated, the facts, over which there is no serious dispute, and the question in issue are as follows:

The petitioner in 1930 was the owner of 3,200 shares of stock of the Delaware, Lackawanna & Western Railroad Co. She had acquired 1,600 of such shares from her husband’s estate on December 31, 1929, and the other' 1,600 shares at different dates previous to that time. In the fall of 1930 sbe decided to sell 1,200 of the last acquired shares and instructed her attorney who had charge of her affairs to do so. She had been advised by the attorney that a deductible tax loss would result from the sale of the last acquired shares, whereas a taxable gain would result from the sale of the previously acquired shares. The attorney thereupon, on November 6, 1930, gave orders to a brokerage firm “ for the sale of 1,200 shares of Delaware, Lackawanna & Western Railway stock.” A day or two later the attorney was notified of the sale by the brokerage firm and was asked to make delivery of the shares. He then went to the safe-deposit box where all of the shares in question were kept, together with other securities, and selected certificates for 1,200 shares which he delivered to the brokers. When the transaction was completed the attorney caused entries to be made in petitioner’s record book showing the sale of 1,200 of the 1,600 shares of Delaware, Lackawanna & Western Railroad Co. stock acquired on December 31, 1929, and the amount of the loss sustained thereon. Soon thereafter the attorney wrote the petitioner a letter advising her that a sale- had been made of the 1,200 shares of the Delaware, Lacka-wanna & Western Railroad Co. stock acquired on December 31,1929, with a resulting loss of $55,589. The attorney later assisted in making the petitioner’s income tax return for 1930, in which a deduction was claimed for the above amount of the alleged loss.

About two years after the above described sale took place it was discovered, in connection with an income tax investigation, that the certificates which were delivered to the brokerage firm were not for the shares which the decedent had acquired from her husband’s estate in 1929, but were the certificates for previously acquired shares. In selecting the certificates from the safe-deposit box the attorney had inadvertently withdrawn the wrong ones. The cost basis of the last acquired shares being less than the selling price, a deductible loss would have resulted from their sale, whereas on the cost bases of the earlier acquired shares a taxable gain was realized. The issue thus presented is whether the petitioner actually sold the last acquired shares with a resulting loss, notwithstanding that, the certificates for the earlier acquired shares were mistakenly delivered to the purchaser.

The petitioner relies strongly upon the case of Howbert v. Penrose, 38 Fed. (2d) 577. In that case the Circuit Court for the Tenth Circuit sustained the lower court in holding that where the taxpayer intended to sell certain shares of stock acquired in 1916 and 1911 but, by mistake, an employee of the trust company acting for the taxpayer delivered certificates for shares acquired prior to 1913, there was nevertheless a sale of the shares acquired in 1916 and 1917.

It is readily apparent that the facts in Howbert v. Penrose, supra, in so far as they go to the merits of the question, are not materially different from those in the instant case. However, a possible distinction between the cases is to be found in the ruling of the court in that case that it was bound to accept the finding of the trial court, the finding being supported by the evidence, that the taxpayer intended to sell, and did sell, the shares acquired in 1916 and 1917, although certificates were delivered for other shares.

In our opinion the evidence before us does not warrant the finding that the petitioner here sold the shares acquired in 1929. Admittedly, she intended to do so, but we do not understand that a mere intention on the part of one of the contracting parties determines the character of a sale. The petitioner simply offered for sale 1,200 shares of the Delaware, Lackawanna & Western Railroad Co. stock and, after the sale was made, delivered to the broker certificates for that number of shares. There was no agreement that the broker was to sell or that the petitioner was to deliver specific shares or certificates. Presumably the matter was of no interest to the buyer. The delivery of any certificates for the requisite number of shares of that stock would have satisfied the sales contract. Not until the delivery was made was there any identification of the shares in relation to the sales agreement. How can it be said, then, that there was either a contract to sell or a sale of the particular shares which the petitioner had acquired in 1929 ?

Another more recent case than Howbert v. Penrose, supra, which involves facts almost identical with those in the instant case, is Cole v. Helburn, 4 Fed. Supp. 230, decided in the District Court for the Western District of Kentucky on March 24, 1933. The court there said:

I cannot sustain plaintiffs contention with, reference to the sale of the Atlantic Coast Line 31ailroad Company stock. He dicl not direct his broker to sell any particular stock. He simply directed him to sell three hundred shares, and, when the time came for plaintiff to deliver the property sold, he delivered certificates representing the stock purchased by him on February 24, 192S. There is no claim that plaintiff and the purchaser of this stock had any agreement or understanding as to the particular shares of stock involved in the transaction. Therefore, there can be no contention successfully made that the minds of the parties were in agreement as to the particular shares of stock bought, and that by mistake other and different shares were delivered. The only mistake was made by the plaintiff himself, and for this he must suffer. As it is beyond question that he actually sold and delivered the three hundred shares bought on February 24, 1928, the price paid for these shares on that date must be treated as the cost in computing plaintiff’s profit on the sale of these shares.

The above reasoning of the court seems to us to be sound and in our opinion should be followed in the instant case.

We beld in Louis G. Neville, 29 B.T.A. 450, that when shares oí stock in a corporation are gold from lots purchased at different times and at different prices and the identity of the shares sold can be determined from the certificates delivered, gain or loss must be computed upon the cost or other basis of the shares represented by the certificates delivered. The question there in issue wag whether the shares of stock sold could be identified or whether the rule of first acquired, first sold should be applied in accordance with article 58 of Regulations 74.

In Mickler Holding Co., 29 B.T.A. 300, we held that where there is the mere intention to sell shares of stock or the mere declaration that shares sold were acquired at a certain time and price, without sufficient proof to identify the shares sold with any particular purchases, the rule of first in, first out ” must apply. The Circuit Court of Appeals for the Third Circuit reached the same conclusion in Commissioner v. Merchants & Manufacturers Fire Ins. Co., 72 Fed. (2d) 408, reversing a memorandum opinion of the Board upon which the petitioner chiefly relies. Bee also Marry E. Horner, 28 B.T.A. 360; affd., 72 Fed. (2d) 407.

It is stipulated that the petitioner still owns certificates representing 1,200 shares of the Delaware, Lackawanna & Western Railroad Co. stock which she acquired .from her husband’s estate on December 31, 1929. She sold the other 400 of the 1,600 shares so acquired in 1931 and computed the gain or logs thereon on a basis of $143 per share, the market value of the shares at December 31, 1929.

It is further agreed that the cost of the previously acquired 1,600 shares was as follows:

The determination of the respondent is sustained.

Reviewed by the Board.

Judgment will be entered for the respondent.

       100% stock dividend.


author: Adams:

text:
    The McGinley Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 59471.
    Promulgated October 4, 1934.

      Lawrence Tarlton, Esq., for the petitioner.

      DeWüt M. Evans, Esq., for the respondent.
   OPINION.

Adams:

This proceeding involves income tases and penalties for the years 1927 and 1928 in the aggregate sum of $25,136.01, as follows:

Petitioner is a Delaware corporation, with its principal office in Fort Worth, Texas, and Wm. McGinley is its president.

It alleges that respondent erred in disallowing a loss in margin advances alleged to have been made by it during the year 1927 in the sum of $31,300. It is conceded, however, that the sum of $2,427.23 is unallowable. Petitioner also assigned error in that the respondent disallowed a loss on the sale of stock in the sum of $100,000 during the year 1926. Petitioner assigned certain other errors in the dis-allowance for the calendar year 192.8. It alleged respondent erred in disallowing the claimed deduction of $50,000 for legal expense and in reducing the depreciation claimed in the sum of $1,503.33. Petitioner contests the penalties proposed for both years in question.

At the hearing, petitioner’s claim as to the reduction of legal expense for the year 1928 in the sum of $50,000 was abandoned and respondent admitted that petitioner was entitled to depreciation claimed in the sum of $1,503.33. Respondent waived the penalties proposed.

This leaves two issues for determination, namely, whether respondent erred in disallowing petitioner’s claim for margin advances during the year 1927, and whether he erred in disallowing the loss on the sale of stock in the sum of $100,000 during that year.

During the month of June 1927, dealing through Shearson Ham-mill & Co., brokers, of Chicago, Illinois, there were purchased in the name of Wm. McGinley, as an individual, 2,000 shares of Pan-American B stock, the aggregate price being $113,350. This was a purchase on margin.

Petitioner’s president, Wm. McGinley, testified that the Pan-American B stock was purchased in his name but for the account of petitioner; that the transaction was handled in this way because he was advised by the brokerage firm that the corporation could not legally do business in the State of Illinois. He testified that petitioner paid for this stock in the following manner: On June 14,1927, the corporation issued its check payable to Wm. McGinley in the sum of $10,000, this being the initial payment on 1,000 shares of the Pan-American B stock; on June 28, 1927, petitioner issued its check payable to self in the sum of $10,000. Each of these checks was signed “ Wm. McGinley Corporation, by Wm. McGinley, President ”, and each had a memorandum on the face as follows: “ Shearson Hammill & Company account Pan-Am stock.” On August 25, 1927, Shearson Hammill & Co. made a draft on Wm. McGinley, personally, for the sum of $7,500, which was paid and credited to the Wm. McGinley account. The witness testified that thereafter petitioner paid an additional sum on the transaction of $7,500, but that the check was lost. On December 30,. 1927, Wm. McGinley directed Shearson Hammill & Co. to sell 2,000 shares of Pan-American B stock for the McGinley Corporation, petitioner. This sale was made on that date for the sum of $86,710.

There was introduced upon the hearing a statement of the Mc-Ginley Corporation account with Shearson Hammill & Co. which shows this transaction and has on it this memorandum, “ Short 2,000 Pan-Am B.” On January 3, 1928, there were bought in the name of petitioner 2,000 shares of Pan-American B stock at a price of $87,175, and, on the same date, Shearson Hammill & Co. transferred to Wm. McGinley’s personal account a charge of $465, being the difference between the sale and purchase price of the 2,000 shares of Pan-American B stock sold on December 30, 1927, and purchased on January 3, 1928. It appears from the statement of Shearson Hammill & Co. that on July 20, 1927, a dividend on 2,000 shares of Pan-American B stock in the sum of $3,000 was credited to the account of Wm. McGinley, personally; that on October 20, 1927, there was credited to Wm. McGinley’s personal account $2,000 as a dividend on 2,000 sharés of Pan-American B stock.

Wm. McGinley testified that when he ordered the brokers to sell the 2,000 shares of Pan-American B stock on December 30, 1927, he had overlooked the fact that this stock was in his name and not in the name of the corporation on Shearson Hammill & Co.’s books and that he intended to close the transaction for the corporation by selling the stock purchased in his name in June 1927; that upon receiving the statement from the brokers showing the corporation was short 2,000 shares of Pan-American B stock, in order to relieve the situation, he on January 3, 1928, bought 2,000 shares of Pan-American B stock in his own name, but that such purchase was really for the benefit of the corporation.

At the hearing petitioner did not introduce its books showing how it treated these transactions and there was no testimony save that hereinabove referred to. Wm. McGinley seems to have dominated and controlled the petitioner corporation as its president and he seems to have made no distinction between his personal dealings and those of petitioner. Petitioner’s contention here is this situation grew out of a series of mistakes and misunderstandings on the part of Wm. McGinley, its president.

Petitioner is bound by what it did and not by what it intended to do. Mary E. Horner, 28 B.T.A. 360; affd., 72 Fed. (2d) 407; Commissioner v. Merchants & Manufacturers Fire Insurance Co., 72 Fed. (2d) 408.

Upon the testimony in the record, we do not feel justified in setting aside the Commissioner’s determination. The burden being upon the petitioner to overcome the correctness of the determination and it having failed to meet this burden, the Commissioner is affirmed on this issue.

The remaining question is, Did the Commissioner err in disallowing the deduction of $100,000 loss claimed by petitioner on the sale of certain stock by it which Wm. McGinley held in the McGinley Land Co.? Wm. McGinley, petitioner’s president, testified that he, as an individual, purchased from the petitioner in 1927 what he called $100,000 worth of stock in the McGinley Land Co. The Mc-Ginley Land Co. was a corporation owning farm lands in the State of Missouri. It was organized with an authorized capital stock of $200,000, all of which was paid in by the transfer to it of certain lands in the State of Missouri. Petitioner acquired 100,000 shares of this stock at a par value of $1 per share from the witness Wm. McGinley, but the records fail to disclose what consideration, if any, was paid by petitioner to Wm. McGinley for this stock. The Mc-Ginley Land Co. became indebted to petitioner in the sum of $107,000. During 1927 petitioner transferred to Wm. McGinley 100,000 shares of stock, the consideration being that Wm. McGinley assume the indebtedness of the McGinley Land Co. to petitioner.

The record wholly fails to show the value of the stock when it was acquired by petitioner, what it paid for it, or how it was paid for. Petitioner’s contention that the McGinley corporation purchased the stock of the McGinley Land Co. at a cost of $100,000 is not supported by the record.

We are unable to make a determination as to what was the petitioner’s loss, if any, by reason of the transaction and the Commissioner’s determination on this issue is approved.

Due to the adjustments necessary to be made by reason of the concessions made by both parties upon the hearing,

Decision will be entered wader Rule 50.


author: Muedock: Black,

text:
    Brooklyn Radio Service Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 61229.
    Promulgated October 9, 1934.

      Philip A. Brenner, G.P.A., for the petitioner.

      Frank M. Thompson, Esq., for the respondent.
   OPINION.

Muedock:

The petitioner in this proceeding contends that a deficiency of $3,664.55 for the calendar year 1929 was improperly determined. The Commissioner admits that he erred in disallowing a deduction of $3,300 representing accounting fees. The only issue submitted to the Board is whether or not the petitioner incurred a liability in 1929 to pay its president as part of his salary 2 percent of its net sales so that the amount was an ordinary and necessary expense incurred in that year. No question of the reasonableness of compensation is raised. The material facts were stipulated.

The petitioner kept its books on an accrual basis. Its board of directors passed the following resolution on December 28, 1928:

Resolved: that Mr. Benjamin Ginsberg, the President of this Corporation receive a salary for the year 1929 the sum of Twelve Thousand Dollars ($12,000), payable $1,000 per month, plus 2% of the net sales for the year 1929, with the understanding however,- that such 2% of the net sales be not paid to him as long as the corporation is indebted to Finance Companies on account of its own insufficiency of working capital or to any banks, and in no event until after January 1, 1930, and with the further understanding that said 2% of the net sales to be due to Benjamin Ginsberg be subordinated by him to the indebtedness to all other creditors of this corporation.

Two percent of net sales for 1929 amounted to $33,757.61. The record is silent as to any accrual of this amount. Eight thousand three hundred and twenty dollars was drawn in cash by the president in 1929 and on the accounts .receivable ledger he was charged in that year with $3,736.77 representing merchandise and payments for his account. The $3,736.77 was charged in 1930 against the balance due the president for 1929 salary. The balance sheet of the petitioner for the close of the year 1929 shows, inter alia:

Notes payable_$40, 780.97
Accounts payable_ 260,916. 77
Due finance companies_ 261,145.28
Notes receivable discounted_ 7,261. 67
Capital_ 122,800.00
Surplus-:_ 30, 694.16

The petitioner, on its return for 1929, claimed a deduction for salaries including $37,854.28 as salary of its president. The Commissioner allowed $12,000 of that amount and in disallowing the balance of $25,854.28 explained that under the resolution of December 28,1928, the 2 percent of net sales was only a contingent liability which was not to be paid in 1929 and might never be paid because the corporation might always be indebted to finance companies and banks on account of its own lack of working capital. The Commissioner filed no brief.

A deduction in a case like this is proper for the year in which events occur which fix the amount and determine the liability of the taxpayer to pay that amount. United States v. Anderson, 269 U.S. 422. Clearly the amount was definitely fixed in 1929, being 2 percent of net sales for that year, or $33,757.61. Why that amount -was not claimed on the return is not shown. But the Commissioner has made no point of the absence of evidence of how the $33,757.61 was treated on the taxpayer’s books. Cf. Savinar Co., 9 B.T.A. 465. His whole point is that in 1929 this amount represented only a contingent liability. Sunburst Oil & Refining Co., 23 B.T.A. 829. Contingent liabilities are not deductible. Lucas v. American Code Co., 280 U.S. 445. The amount here in question, however, was not a contingent liability in 1929. The time of payment was uncertain, but that fact does not delay an accrual for income tax purposes. Perkins Land & Lumber Co., 9 B.T.A. 528; Oliver H. Van Horn Co., 9 B.T.A. 76; Automobile Insurance Co. of Hartford, 72 Fed. (2d) 265. The liability to pay $33,757.61 at some future time was definitely determined in 1929. Other indebtedness of the corporation were to have priority over this one as to j>ayment, but it was still a definite obligation of the corporation which would have to be paid before the assets of the corporation could be distributed to the stockholders. Payments of salaries in capital stock have been held to be deductible when made, Haskell & Barker Car Co., 9 B.T.A. 1087; Commercial Investment Trust Corp., 28 B.T.A. 143; Package Machinery Co., 28 B.T.A. 980; W. M. Ritter Lumber Co., 30 B.T.A. 231, 274, yet the creditor in this case would receive payment before any stockholder would receive a distribution of capital. Subsequent insolvency of the debtor alone could prevent the creditor from demanding payment eventually. The year 1929 was the proper year for accrual of this liability, which was an expense incurred in and properly attributable to the earning of income for that year. United States v. Anderson, supra; American National Co. v. United States, 274 U.S. 99.

Reviewed by the Board.

Decision will be entered under Rule 50.

Black,

dissenting: The amount of 2 percent commission on annual sales to the president of the corporation, allowed as a deduction of accrued expense to the corporation by the majority opinion, was not payable by the corporation, (1) as long as the corporation was indebted to finance companies on account of its own insufficiency of working capital, (2) as long as the corporation was indebted to any bank. And with the further understanding that “ said 2% of the net sales to be due to Benjamin Ginsberg be subordinated by him to the indebtedness to all other creditors of this corporation.” This latter condition I do not think destroys its accruability. The mere fact that certain other creditors of the debtor are granted priorities of payment does not affect accruability if the obligation to pay is definite and certain. Automobile Ins. Co. of Hartford, 72 Fed. (2d) 265. But I doubt if any expense liability is accruable within the taxable year and can be used as a deduction from income of that year, which has so many contingencies as to' its future payment as are embodied in conditions (1) and (2). Of course it will be readily admitted that where the liability to pay is definite and certain, the mere fact that the time of payment is postponed does not make any difference, such for example, as payment due in two years from the date of the obligation, but in the instant case I am impressed that there is merit in the Commissioner’s contention that “ the 2 percent of net sales was only a contingent liability which was not to be paid in 1929 and might never be paid because the corporation might always be indebted to finance companies and banks on account of its own lack of working capital.”

Under these circumstances, I believe that the conditions attached in (1) and (2) to the agreement for payment of the additional compensation are conditions precedent to the fixing of liability. If the liability does not become fixed until the specified event or events occur, it is contingent. “ Except as otherwise specifically provided by statute, a liability does not accrue as long as it remains contingent.” Brown v. Commissioner, 291 U.S. 193. Whether the condition is one precedent, is a question to be determined by the intent of the parties, which is to be gathered from the contract and the facts, circumstances, and conditions under which it is executed and the situation it is intended to meet. Rannels v. Rowe, 145 Fed. 296; Ketchum v. Belding, 68 N.Y.S. 1099; Blodgett v. Hall, 32 N.Y.S. 788.

It appears to me that the most reasonable construction of the resolution of the corporation set out in the findings of fact is that it expresses an intent that the additional compensation shall become due and payable to this petitioner only if and when the corporate finances are so improved that it has become possible to retire finance company and bank loans in very large amounts.

The case of Blodgett v. Hall, supra, is one resting on facts very similar to the present case. There the defendant, who was the receiver for the business, employed the plaintiff at a specified weekly salary which was duly paid him and agreed to pay him an additional amount for each week’s service, this latter amount to be payable “ as soon as the affairs of the company are straightened up.” The services called for were duly rendered and the amount of the deferred salary was definitely fixed, but on a suit to recover this amount the court held that it was incumbent upon plaintiff to both allege and prove the occurrence of the event of the straightening up of the affairs of' the company, as this condition was one precedent to the fixing of the liability.

The court, in discussing the rule which governs in such a situation, said:

The rule is that, where a promisor obligates himself to pay “ when able to do so ”, the promise is conditional, and, to entitle the promisee to recover thereon, he must plead and prove the fact of such ability. Work v. Beach (Sup.) 12 N.X. Supp. 12, affirmed in 13 N.Y. Supp. 678. And so, too, where the promise is to pay “ the moment he was able.” Tebo v. Robinson, 100 N.Y. 27, 2 N.E. 383. And see Wakeman v. Sherman, 9 N.Y. 85, where the promise was “that at the end of one year, if successful in business, he would commence paying ”; held a condition precedent, and that plaintiff should have been nonsuited, because no evidence had been given to show the result of the year’s business succeeding the promise.

It is my belief that the 2 percent commission involved in the instant case represented only a conditional (contingent) liability of petitioner, and, therefore, cannot properly be used as a deduction by petitioner within the taxable year, and that the ruling of the Commissioner should be sustained.

Aeundell, Matthews, Leech, and TURNER agree with this dissent.


author: Adams :

text:
    Elgin Compress Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Capital Compress Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. San Marcos Compress Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 49302-49304.
    Promulgated October 11, 1934.

      Ghats. A. Perlitz, Jr., Esq., for the petitioners.

      P. A. Bayer, Esq., for the respondent.
   OPINION.

Adams :

These proceedings, which have been consolidated for hearing and decision, are brought by the trustees for three Texas corporations, seeking a review of assessments made by the Commissioner, petitioners contending that such assessments cover the period May 1 to July 30, 1927, only, the respondent contending that such assessments cover the period May 1, 1927, to April 30, 1928. Petitioners present other questions which in view of our holding here it will not be necessary for us to decide. The assessments were made under section 279 (a) of the Revenue Act of'1926, and were for the period May 1 to July 30, 1927. The amounts are as follows:

Elgin Compress Co_$1, 050. 31
Capital Compress Co_ 8, 763.62
San Marcos Compress Co- 6, 409.50

In the case of the Elgin Compress Co. the notice of deficiency included the fiscal years ended April 30, 1926 and 1927, but no deficiency was asserted for those years.

The facts are stipulated as hereinafter set out.

On April 28, 1930, the Commissioner addressed each of the petitioners a notice of deficiency, the notices being identical in each instance except as to the details, that addressed to the Elgin Compress Co. being typical and its material parts as follows:

In accordance with the provisions of Sec. 279 (a) of the Revenue Act of 1926, there has been assessed against you an income and profits tax amounting to $1,650.31 for the * * * period May 1, 1927, to July 30, 1927, the details of which are set forth in the statement attached.

In the statement attached to the latter part of such letter the Commissioner says:

*******
The adjustments recommended by the agent have been approved by this office, with the exception of the computation of tax. Since it is held that the final return filed complies with the requirements of the law and regulations with respect to the period covered, the computation of tax liability has been made on the basis of the period ended July 30, 1927, instead of February 29, 1928, which was the date used by the revenue agent.
*******

Under the heading of “ Explanation of Items Changed ” said statement reads:

1. Omitted profit on sale of land, buildings and machinery on September 27, 1927, added to taxable income,
*******
2. Adjustment has been made under article 112, Regulations 69, for income and expenses after July 30, 1927, not on boohs, received from successor from accrued charges and prepaid expenses, insurance, etc., * * *
3. Discount on notes received for sale of plant has been allowed as a deduction from taxable income under Art. 561 of Regulations 69.
*******

On December 8, 1933, petitioners filed a second amended petition, in which they make the following allegation:

(3) That the deficiency letter marked Exhibit “A”, covered the taxable period May 1, 1927, to July 30, 1927, and the tax sought to be assessed is based upon a profit, if any, from a sale of properties which was consummated on September 27, 1927, according to the deficiency letter, and the Commissioner erred in assessing income tax for the period covered in the deficiency letter when the letter itself shows if any profit was realized it was subsequent to the taxable period covered in the letter.

The stipulation of facts may be summarized as follows:

Petitioners, and each of them, were incorporated under the laws of Texas, and for many years prior to May 1927 had been engaged in the business of operating cotton compresses in that state.

The stock in each of the corporations was controlled by W. T, Caswell, E. H. Perry, D. C. Beed, and D. T. Iglehart. Iglehart died in May 1927. On July 7,1927, resolutions were adopted by the board of directors of the three companies authorizing the dissolution of the companies.

On July 16, 1927, agreements and consents in writing to the dissolution of the companies were executed by the officers and stockholders of the companies, and on July 30, 1927, these consents in writing were filed with the Secretary of State of the State of Texas, and he certified on that date that the corporations were dissolved. At the time of the dissolution there were no debts owing by the corporation, except a few minor expenses. The directors, acting as trustees, continued to operate the presses, and negotiations for the sale of the three corporations, which had been started prior to dissolution, were continued.

On August 17, 1927, Caswell, Perry, and Reed, as trustees, entered into a contract for the sale of the properties of the three companies to the Aransas Compress Co., a corporation, and they executed deeds transferring all of the assets of said companies, such deeds being executed in the name of the corporation, acting by its officers, and also signed by Caswell, Perry, and Reed as trustees for the creditors and stockholders of the corporations. The sale was actually consummated on September 27 and 28, 1927, and there was received as consideration for such properties $40,000 in cash, $84,000 in capital stock, and $111,000 in promissory notes, payable over a period of five years. Immediately after the sale was closed the notes were sold by the trustees at a small discount and all the cash received in the sale, as well as that derived from the sale of notes and stock, was immediately paid and delivered to the stockholders of the three corporations according to their stock interest therein. These payments of cash were made by checks dated October 11, 1927, and signed by D. B. Johnson, secretary and treasurer, for the trustees of each of the corporations. Each of the three companies kept its books and filed a separate Federal income tax return on a fiscal year basis, ending April 30 of each year.

On or about October 15, 1927, each of the three companies filed a corporate income tax return for the period beginning May 1, 1927, and ending July 30,1927. The sale of the properties above referred to was not reported in these returns. No income tax returns were filed subsequent to that time by the three corporations, or by the trustees acting for the corporations.

Petitioners contend that the assessments of the deficiencies as set out in the Commissioner’s letters are void by reason of the fact that they wholly fail to cover any period during which gain could have possibly occurred from the transaction, and that no deficiency letters have been issued covering any period after July 30, 1927, the date when the transfer of the assets was accomplished. They contend that under the sections of the revenue act the Board does not have before it a case in which it can determine any deficiency for the period in which the transaction occurred from which respondent contends additional income was received.

Respondent admits that he was in error in using the dates May 1, 1927, to July 30, 1927, in the notices of deficiency, but' contends that regardless of the period asserted in the deficiency letters the assessments of the deficiencies were computed on the basis of the incomes for the full fiscal year of the petitioners and were not confined to the period stated in the letter. He contends that his error in dates was not a misleading one, that the letters purported obviously to cover all transactions occurring in the fiscal year May 1, 1927, to April 30, 1928. To sustain this proposition he cites many authorities which he contends are applicable here, among the number being Fred A. Hellebush, 24 B.T.A. 660; affd., 65 Fed. (2d) 902. In that case the deficiency letter covered the period January 1 to April 19, 1927, and included therein gain from the sale of corporate assets occurring subsequent to April 19, although according to the findings of fact no final negotiations for the sale of the assets had occurred prior to April 20. We do not believe that any of the cases cited by respondent are in point, when their facts are examined, except the Hellebush case. In that case the question here presented does not seem to have been presented, discussed, or considered.

The case of Mrs. Grant Smith, 26 B.T.A. 1178, was that of a dissolved corporation, dissolution having occurred on January 12, 1925. The trustees in dissolution filed a return covering the period January 12 to December 31, 1925. The Commissioner computed a deficiency for the period January 1 to January 12, 1925. Liquidation of the corporation was not completed by January 12, but extended throughout and beyond 1925. In that case we said:

Under section 239(a), Revenue Act of 1926, and article 622, the trustees in dissolution of the Smith Securities Company should have filed a return for the corporation covering the entire calendar year 1925. Instead, the stipulation of facts shows that the return which they filed on Form 1120 covered the period January 12, 1925, to December 31, 1925. This was wrong. But there is no warrant in law for the Commissioner’s action in computing a deficiency for the period January 1 to January 12, 1925, liquidation of the corporation not having been completed by January 12, 1925, but extending throughout and beyond 1025. If there is any deficiency for 1925 it must be for the entire calendar year, and the Commissioner has made no such determination. Of course, if we had sustained the Commissioner’s contention that liquidation of the Smith Securities Company was completed January 12, 1925, his action in computing a deficiency for that period would be correct. But, where a corporation is dissolved during a particular calendar year and its affairs remain in the hands of liquidating trustees for the remainder of the year, we know of nothing in the applicable revenue act and the Commissioner’s regulations thereunder which warrants dividing up the calendar year into two taxable periods, viz., the first period covering the time prior to the date of dissolution of the corporation ancl the second period covering from the time when trustees in liquidation took charge to the end of the calendar year.
In .O.D. 821, O.B. 4, p. 270, it was said:
Section 1764, Wisconsin Statutes (1915) provides that the corporate existence of a dissolved corporation shall be continued for the purpose of liquidating its assets and winding up its affairs. It is held, therefore, that profit resulting from the sale of assets of a Wisconsin corporation in process of liquidation is subject to income and excess profits taxes in the same manner as profits derived from the active operation of the corporation.
*******
Therefore, the responsibility for filing appropriate returns for the corporation and paying taxes shown thereby to be due devolves upon the trustees in liquidation or such other legal administrators as have charge of the property and affairs of the corporation during the period of liquidation. They must make returns of income for such corporation in the same manner and form as an active corporation. Conversely, they are not required to file returns as fiduciaries.
See also O.D. 73, C.B. 1, p. 235; O.D. 873, C.B. 4, p. 308; I.T. 1814, C.B. 11-2, p. 210.
The above citations are in conformity with the applicable statutes, we think, and hence we hold in favor of petitioners * * *.
If the Smith Securities Company owes a deficiency for 1925, the Commissioner must determine it for the entire calendar year 1925 and not for the 12-day period January 1 to January 12, 1925.

These taxpayers made the returns covering the period May 1 to July 30., 1927, evidently upon the theory that the taxable period of the corporations closed on July 30 by reason of their dissolution. They were in error as to this. The stipulation of facts shows that the officers and directors of the corporations filing these petitions continued as trustees in liquidation at least until October 1927, and to that extent, at least until that time, and for that purpose the corporations continued in existence until liquidation was completed.

It follows that the returns filed by the petitioners for the period May 1 to July 30,1927, were not authorized by law. They were not legal returns and should not have been considered as such.

Petitioners contend that the return filed by them was legal and proper. As held above, they were in error in this.

Article 1388 of the 1925 Revised Statutes of Texas reads as follows :

.Liquidation T>y ojjseers. — Upon the dissolution of a corporation,■ unless a receiver is appointed by some court of competent jurisdiction, the president and directors or managers of the affairs of the corporation at the time of its dissolution shall he trustees of the creditors and stockholders of such corporation, with power to settle the affairs, collect the outstanding debts, and divide the moneys and other property among the stockholders after paying the debts due and owing by such corporation at the time of its dissolution, as far as such money and property will enable them after paying all just and reasonable expenses; and for this purpose they may in the name of such corporation, sell, convey, and transfer all real and personal property belonging to such company, collect all debts, compromise controversies, maintain or defend juridical proceedings, and exercise full power and authority of said company over such assets and property. Said trustees shall be severally responsible to the creditors and stockholders of such corporation to the extent of its property and effects that shall have come into their hands.

Under this provision of the Texas statutes it has been held in many cases that the corporate entity continues for the purposes set forth in the article above set out. See Taylor Oil & Gas Co. v. Commissioner, 47 Fed. (2d) 108.

Petitioners contend that under article 651 of Regulations 69 the returns were proper and were duly filed. In this petitioners are in error.

Article 651 reads as follows:

Time a/nd place for filing rehvrns. * * * A corporation going into liquidation during any taxable year may upon the completion of such liquidation prepare a return covering its income for the fractional part of the year during which it was engaged in business and may immediately file such return with the collector. * * * [Italics supplied.]

As shown above, liquidation had not been completed on July 30, 1927, but, indeed, according to the facts as stipulated, had only begun.

We conclude that the returns filed by petitioners for the period May 1 to July 30, 1927, were not such returns as are required by the revenue act, and that the deficiencies determined on the basis of such returns and for that period by the respondent were not authorized by law.

Reviewed by the Board.

Judgment will be entered for the 'petitioners.


author: ÁRundell :

text:
    Francis V. duPont and Alice duPont, Coexecutors, Estate of Thomas Coleman duPont, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 72772.
    Promulgated October 12, 1934.

      E. F. Golladay, Esq., and Wilton H. Wallace, Esg., for the petitioners.

      S. L. Young, Esq., and R. Sears Garnett, Esq., for the respondent.
   OPINION.

ÁRundell :

Section 112 (f) of the Revenue Act of 1928, which is applicable to this case is set out in the margin.

Petitioners make two contentions. First, that in the computation of taxable gain there should be included as an expenditure the sum of $24,250, representing the basis of the Valley Garden property which was used by the decedent as the site of partial replacement. We can neither find in the statute any warrant nor deduce from it any logical reason for so treating the basis of the Valley Garden property. The statute provides for nonrecognition of gain in respect of proceeds of involuntary conversions which are expended in replacement. Here it is plain that no part of the proceeds were expended for the acquisition of the Valley Garden as replacement property. It might be that an expenditure in anticipation of involuntary conversion, where such conversion is imminent, might be found to be closely enough related thereto to come within the nonrecognition provisions. That, however, is not the situation here, for it is stipulated that a portion of the Valley Garden property was acquired prior to March 1, 1913, more than 15 years before negotiations opened for the acquisition of the Old Mill, and it is not shown that the remainder was acquired with any thought of using it as replacement property.

The other point urged by petitioner is that the recognizable gain should be determined by first allowing a deduction of the basis from the gross proceeds and then allowing a credit against the gain so computed of an amount represented by the ratio which the amount actually expended bears to the gross proceeds. The actual' computation for which petitioners contend is as follows:

Gross proceeds-$236,000.24
Basis (3/1/13 value plus additions)- 96,753.24
Tentative gain- 139,247. 00
Credit for partial replacement: $126,526.70 (expended) y $236,000.24 (gross proceeds) 74, 654.42
Tentative gain- 139,247.00
Credit for partial replacement_ 74, 654. 42
Taxable gain- 64,592.58

The respondent computed the taxable gain to be $109,478.54 by deducting the $126,526.70 expended in replacement from the $236,-000.24 received for the Old Mill property.

The fundamental rule under the gain or loss provisions of the taxing statutes is to recognize all gain or loss on the sale or exchange of property. In certain excepted cases, all enumerated in the statute, the general rule of recognition is limited. One of the excepted cases is that of involuntary conversion. Whether the conversion of property is voluntary or involuntary, if the price received exceeds the basis there is a gain, which, without an applicable limitation or exception, is subject to tax. By listing involuntary conversion among the cases excepted from the general rule of full recognition of gain, Congress has sought to give some measure of relief to taxpayers who are compelled to take a profit without regard to their own wishes. Although these are relief provisions (Paul Haberland, 25 B.T.A. 1370), it was obviously not intended to extend them to all involuntary gains, but rather to condition the extent of the relief upon the taxpayer’s own actions after realizing the gain. In other words, while recognizing the inequity of taxing involuntary gains in all cases to the same extent as voluntary gains, once the gain is realized the taxpayer has several avenues open to him, any one of which he may voluntarily take and thus by his own action place a limit on the amount of tax he will be required to pay. He may elect to pocket his gain and subject it to tax in its entirety. He may, under the respondent’s regulations, replace the converted property at a cost at least equal to the proceeds of the conversion, or if this is not practicable, he may establish a replacement fund and thus escape any tax. Or he may replace in part and become subject to tax on a part of the gain realized. The proper method of determining the taxable part is the question here.

The 1921 Act directed the use of a proportionate method of determining the taxable gain in cases of partial replacement. It allowed “ as a deduction such portion of the gain derived as the portion of the proceeds so expended bears to the entire proceeds.” Sec. 214(a) (12). Congress was aware of that situation and evidently intended to change the method in the Revenue Act of 1924. Section 203(b) (5) of that act is the same, except in one unimportant particular, as section 112(f) of the 1928 Act. In the Committee Reports accompanying the bill which became the Revenue Act of 1924 it is stated:

Under the existing law if only a portion of the proceeds from an involuntary conversion is used in the replacement, then only a corresponding part of the gain or toss is not recognized. In the bill the gain from the transaction is recognized, but in an amount not to exceed tho unexpended portion of the proceeds. This rule is the same as the one set forth in subdivision '(d) (1) of this section in the case of exchanges of property in connection with which there is “boot” transferred. (House Ways and Means Committee Report, p. 14; Senate Finance Committee Report, p. 15.)

Using as an analogy the exchange provisions of the statute referred to in the Committee reports, it seems clear that in the case of partial replacement the taxpayer should be subject to tax on the excess of the proceeds over his replacement cost where such cost exceeds the basis. See articles 513 and 514 of Regulations 74, dealing with the receipt of “ boot ” on an exchange. In the Senate Committee Print of the changes made in the Revenue Act of 1921 the above quotation is repeated and the following example given:

Example: A vessel purchased by A for $100,000 is destroyed and A receives insurance in the amount of $200,000. If he invests the entire $200,000 in a new vessel similar to the one destroyed, no gain from the transaction is recognized. If, however, he invests only $150,000 in the new vessel, he has realized taxable gain to the extent of the $50,000 which was not reinvested. (Report dated March 6, 1924, p. 6.)

In view of the quoted statements it is our opinion that Congress deliberately intended to change the rule theretofore applied in computing the amount of taxable gain in cases of partial replacement, and thereafter to tax all gain not used either to replace the converted property or held in a replacement fund for that purpose. To hold otherwise would require us to say that the change in language was meaningless despite its consideration by the responsible Congressional Committees.

It cannot be said that the respondent’s continued use of the method prescribed by the 1921 Act has received legislative sanction. In the first regulations issued following the enactment of the Revenue Act of 1924 the language of the statute is repeated verbatim, and has been repeated in all subsequent regulations. See art. 1579, Regulations 65 and 69; art. 579, Regulations 74. The proportionate method of computation under the 1921 Act and article 261 of Regulations 62 was omitted from the later regulations and, as far as we know, there have been no published rulings holding the use of the proportionate method permissible under any of the revenue acts later than that of 1921. Furthermore, the respondent’s power to promulgate regulations is limited by the statute to directing the use of the proceeds to replace or establish a replacement fund, and does not extend to the prescription of a method of computing the amount of taxable gain.

It is accordingly our view that the method used by the respondent in this case affords the petitioners the full relief to which they are entitled under the applicable statute.

Decision will be entered for the respondent.

       (f) Involuntary conversions. — If property (as a result of its destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation, or the threat or imminence thereof) is compulsorily or involuntarily converted into property similar or related in service or use to the property so converted, or into money which is forthwith in good faith, under regulations prescribed by the Commissioner with the approval of the Secretary, expended in the acquisition of other property similar or related in service or use to the property so converted, or in the acquisition of control of a corporation owning such other property, or in the establishment of a replacement fund, no gain or loss shall be recognized. If any part of the money is not so expended, the gain, if any, shall be recognized, but in an amount not in excess of the money which is not so expended.


author: GoodRich :

text:
    Allie M. Turbeville, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 43733, 47900, 55553, 64334, 64560.
    Promulgated October 12, 1934.

      John B. King, Esq., for the petitioner.

      S. S'. Faulkner, Esq., for the respondent.
   OPINION.

GoodRich :

In these proceedings, which upon motion were consolidated, petitioner seeks redeterminations of the following deficiencies in income tax:

1925_$2,376.93
1926_ 57, 653. 05
1927_ 43, 973. 57
1928_ 17, 588.18
1929_ 6, 095. 91

The principal controversy involves amounts received in each year as bonuses and royalties under oil and gas leases granted by petitioner. Respondent determined that these amounts, in their entirety, were the income of and taxable to petitioner. Petitioner contends the bonuses and royalties were community income and should therefore be divided and taxed equally between herself and her husband. She contends further that even though these amounts were not community income, still one half of these payments belonged to her husband either by reason of her assignment thereof to him, or as compensation for his services rendered in managing her separate properties and negotiating the leases.

She alleges also that respondent erred (a) in treating the amounts received as bonuses as income for the year in which received and failing to spread the same over the life of the leases; (b) in failing to tax the bonuses received as capital net gains, subject to the 12% percent limitation; (c) in failing to allow as a deduction from income an allowance for depletion of bonuses amounting to 27% percent thereof; (d) in failing to allow as deductions from income the full amount of certain items of business expense incurred in connection with the receipt of the bonuses and royalties; (e) in failing to allow as deductions from income the full amount of state, county, and school district ad valorem taxes levied and paid on account of her retained royalty interest in the leased lands; and (f) in failing to allow as a deduction from her income in 1929, $12,500, being one half of an amount claimed lost on a bank deposit.

The facts were submitted upon stipulation which we adopt as our findings. A briefer statement will serve for the purposes of this report.

At the times here material petitioner was a resident of Archer City, Texas. She married J. H. Turbeville on April 22, 1919. She had been married previously to S. M. Cowan, who died, a resident of Texas, in 1917, leaving him surviving petitioner and their four minor children. At the time of Cowan’s death he and petitioner owned a substantial amount of community property, including a ranch of about 8,000 acres near Archer City, constituting one body or tract of land, known as the Copper Mine Nandi. Petitioner qualified as community administratrix of Cowan’s estate, and thereafter on October 28, 1922, acquired from her children their one-half interest in the ranch. Shortly before her marriage to Turbeville, petitioner, individually and as administratrix, granted to him an oil and gas lease covering the Copper Mine Banch, reserving a one-eighth interest of the sale proceeds of oil and gas. The lease was for a five-year term and so long thereafter as oil or gas might be produced, but required that, unless production was obtained within a year from date of grant, annual delay rentals should be paid for the privilege of extending the drilling time. A few months after his marriage to petitioner this lease was assigned by Turbeville to others.

Before and at the time of her marriage to Turbeville, petitioner had no business experience, nor had her children. At her request, Turbeville took over complete management of the properties belonging to petitioner and her children, and handled them along with and as his own. Because of petitioner’s lack of business experience and Turbeville’s assumption of the management of her properties, they reached a verbal agreement and understanding that one half of all income from the property of either should belong to the other.

In the fall of 1921 petitioner and her husband, and two of her sons, formed a partnership to engage in the cattle and ranching business and purchased a large ranch upon which they assumed a substantial indebtedness. Due to unfavorable conditions arising in the cattle business, the financing of the ranch purchase became a difficult problem, the burden of which fell on Turbeville, who, up until 1925, was forced to use every available means of credit to meet this obligation. As a means of saving their properties, and in consideration of Turbeville’s labor and efforts, he and petitioner further verbally agreed that all their income from whatever source should be considered community income and be used by him to pay community obligations and to carry on the business of the partnership. Pursuant to that agreement all income from Turbeville’s separate property, from petitioner’s separate property, and from their community properties went into a common fund and was used by Tur-beville, without reference to its source, as the community income of himself and petitioner.

During this time Turbeville was endeavoring to secure exploitation and development of the Copper Mine Ranch under the oil and gas lease previously granted to him, and by him assigned. His repeated efforts to get the assignees to comply with the terms of the lease having failed, he and petitioner brought suit in the local court seeking cancellation of the lease and its assignments. The suit was removed to United States District Court for the Northern District of Texas, which, on December 3,1928, decreed the cancellation of the lease as to 490 acres, revesting the title thereto in petitioner and her husband, and allowing the defendants limited additional time within which to commence drilling upon the remaining acreage. Development was not begun within the time fixed, and the lease as to the remaining acreage was forfeited in April 1924. Thereupon, Turbe-ville, continuing his efforts to have the property exploited, succeeded in making a number of leases during the years 1925, 1926, 1927, and 1929 covering various portions of the Copper Mine Ranch. These leases were executed by petitioner and her husband, and reserved one eighth of the oil as royalty. As a result of development under one or more of these leases, oil was discovered on the Copper Mine Ranch on July 12, 1926. Bonuses upon the granting of the leases and royalties upon production thereunder were received in the following amounts:

These amounts were received by Turbeville and placed to his credit in banks of which he was a customer, and under the preexisting agreement between him and petitioner, they belonged one half to petitioner, and one half to him, “ the said agreement being that in consideration of the services of the said Turbeville to manage, look after and control their properties and to secure oil development on the properties of petitioner or her husband, that all royalties, revenues and bonuses received therefrom should equally belong to petitioner and to the said Turbeville.”

When these leases were granted and the bonuses paid, there was no production of oil upon the acreage covered by the several leases, but from and after July 12, 1926, there was oil produced continuously from the Copper Mine Eanch.

The business expenses directly attributable to the receipt of the bonuses and royalties and the amounts of state and local taxes paid on the retained royalty interest in the Copper Mine Eanch are as follows:

With respect to the last issue, the facts are stipulated as follows:

That petitioner and her husband in 1929 had on special deposit with the Power Bank Company of Archer City, Texas, the sum of $60,000.00 which deposit was secured by the pledge to petitioner and her husband of Class B American Refining -Properties Certificates of the par value of $98,000.00. That the Power Banking Company became hopelessly insolvent in 1929 and by December 31, 1929, it was ascertained that petitioner and her husband must look alone to the Class B Certificates of the American Refining Properties for the recovery of their deposit or any part thereof. That said Class B American Refining Properties Certificates on December 31, 1929 had a fair market value and were worth only the sum of $35,000.00. That petitioner and her husband kept no books of account except a memorandum cash journal. That no charge-off was made on such books of the petitioner and her husband with reference to this transaction nor any deduction claimed therefor in the petitioner’s income tax return for the year 1929.

EesponcLent has determined that, since the leases under which the bonuses and royalties here in controversy arose were all upon her separate lands, the payments were therefore her separate income. Petitioner contends that these amounts, even though the leases under which .they arose covered her separate property, belonged to the community because:

(a) Community funds and labor were employed to produce them and, consequently, they are not the separate property of petitioner;
(b) Under her agreement with her husband, one half of them belonged to him; and
(c) They are rents and revenues, and not proceeds from sales of land.

In support of the first ground urged, petitioner reminds us that in Texas a wife’s separate property includes not only that owned or claimed by her before marriage and that afterward acquired by gift, devise, or descent, but also, with respect to her real property, “ the increase of all lands thus • acquired,” if fruotus naturales, or such increase as is spontaneous growth or output of the soil. She argues that the bonuses and royalties, however, do not fall within the statutory definition of separate income because profits from the sale of leases are fruotus industriales, and belong to the community estate. In other words, she contends that the making of the leases was a business enterprise into which were put community funds and community labor and that the segregation of the minerals under the lands was a result thereof, with the result that the profits from the leases belonged to the community.

The facts as stipulated are that these leases were negotiated through the efforts of petitioner’s husband, who undertook the task at her request, and that the expense incurred in connection therewith ran from between $5,000 to $8,000 each year. Whether the funds by which the expenses were paid were separate or community, the record does not disclose. We think it clear, however, that the granting of the leases was not such a segregation of the “ increase of the land” as to make the profits derived therefrom fruotus indus-triales. The segregating was done by the lessees who sunk the wells, extracted, transported, and sold the oil and gas.- Under the laws of Texas, a lease is regarded as a present sale of the oil and gas in place, and, consequently, any community funds or labor expended in negotiating leases were directed toward effecting such sales. Thus petitioner sold a part of her separate estate, namely, the oil and gas underlying her separate real estate, and the proceeds of those sales remained her separate property.

Nor do we think that the granting of the leases was such an enterprise as would constitute for either petitioner or her husband a “ trade, speculation or venture ” (see footnote 4, supra) as petitioner contends both here and in an alternative argument. There is nothing to indicate that they proposed to buy and sell leases as a business. No doubt, as petitioner argues, the negotiation of the leases called for good business judgment and consistent effort. But there is nothing remarkable in that. Turbeville had something to sell and was doing his best with it. We disagree with petitioner’s view that the fact that leases on her separate property were negotiated by her husband impressed the bonuses and royalties received thereunder with the community character. Stephens v. Stephens, 292 S. W. 290; Evans v. Purinton, 34 S. W. 350 (as to royalties).

Eespecting the second reason advanced, which she repeats in slightly different form in an alternative argument, petitioner points to the agreement between herself and her husband that in consideration of his efforts in managing her properties, including the securing of oil development, one half of all income from the separate property of each should belong to the other, and contends that such an arrangement changed the character of the bonuses and royalties received under leases negotiated by her husband in the course of his management and control of her separate properties.

We are not impressed by this argument. Petitioner does not show us, nor do we find that, under the law of Texas, such an agreement between husband and wife respecting the .division of income upon its receipt serves to change its character or that of the property from which it arises. The agreement was, in effect, “ If you, my husband, will take charge of my properties and manage them, I will give you half of the income from them.” As we see it, the agreement was no more than an assignment of future income; it transferred no interest in petitioner’s properties and therefore under the well established rule that the assignment of income, or the mere right to receive it, without transfer of the property right from which the income arises, does not relieve the assignor of the burden of the tax on the income, the full amount of bonuses and royalties received belonged to petitioner. Lucas v. Earl, 281 U.S. 111; Saenger v. Commissioner, 69 Fed. (2d) 631; 69 Fed. (2d) 633, affirming.28 B. T. A. 377; W. L. Shore, 26 B. T. A. 389 (where the leases themselves contained an assignment of income); John Leo Stack, 22 B. T. A. 707.

Petitioner’s third argument we discard likewise. She contends that, under the decision in Burnet v. Harmel, 287 U. S. 103, the bonuses and royalties received were rents and revenues, and not proceeds from sales of land, and so considered are community property.

In Burnet v. Harmel, supra, the Supreme Court considered whether, under Texas law, bonuses and royalties received under oil and gas leases were income or gain from the sale or exchange of capital assets ” within the meaning of section 208 (a) (1) of the Revenue Act of 1924. The Court held that even though under the law of State of Texas oil and gas leases effect a present sale of oil and gas in place, the payments under the leases were not proceeds of “ sale ” as that term is used in the provision of the taxing act relating to capital gains, but should be taxed as ordinary income. The Court did not have before it the question of whether royalties and bonuses arising under leases belonged to the community or to the spouse whose separate estate embraced the leases. That question, in this case, is to be determined by the law of Texas. Poe v. Seaborn, 282 U. S. 101; Hopkins v. Bacon, 282 U. S. 122. Since that law declares an oil and gas lease to effect a sale of oil and gas in place, the proceeds of such a sale, whether they be bonuses or royalties, are not rents and revenues, but are the consideration received for the minerals. Stephens v. Stephens, supra. They take the place of the property sold and remain the separate property of the wife where, as here, the leases are made upon her separate property. E. Michna, 24 B.T.A. 715.

As an alternative ground, should we hold adversely to petitioner’s claim that one-half the bonuses and royalties received belonged to her husband (as we have done), petitioner contends that a seven-eighths interest in the minerals underlying the lands covered by the leases here involved was community property because at the date of her marriage to Turbeville she neither owned nor claimed that interest. She argues that the lease she delivered to Turbeville a few days before their marriage, and which he thereafter assigned, granted to the lessee a determinable fee to seven-eighths of the minerals in place, operated as a severance, and left petitioner with only a possibility of reverter, and that when the leasehold estate was subsequently recovered it became community property because it reverted not by virtue of the original instrument, but by decree of court.

We disagree with petitioner. As we see it, the right to cancel the original lease and assigmnents thereof upon failure of compliance with its terms, and so to recover the lands and all interests therein, had its origin and inception when the original lease was made, which was before petitioner married Turbeville. At that time this interest was petitioner’s separate property and upon its recovery it reassumes that same status. Neither Turbeville nor the marital community acquired any interest in the property by reason of his joinder in the suit to cancel the lease and quiet title. He was a necessary, but only a nominal, party to the suit relating to his wife’s separate property, and in aiding the prosecution of it served as her agent. Since petitioner’s right of recovery of the leased lands had its inception prior to her marriage to Turbeville, the title to the seven-eighths mineral estate, when reacquired through court decree, related back to that time and was again her separate property. Cf. E. Michna, supra; John M. King, 26 B. T. A. 1158; affd., 69 Fed. (2d) 689.

Petitioner alleges as error respondent’s failure to treat the bonuses received as gain from sale of capital assets within the meaning of section 208 of the Bevenue Act of 1926, and subject to the tax limitation of 12% per centum. This issue is not urged upon brief, and has been decided adversely to petitioner’s contention in Burnet v. Harmel, supra. So also has been her contention that the amounts received as bonuses should not be treated in their entirety as income in the year in which received but should be spread over the respective periods of the leases. Nelson Land & Oil Co., 3 B. T. A. 315; R. H. Hazlett, 10 B. T. A. 332; O'Day Investment Co., 13 B. T. A. 1230; A. P. Schiro, Inc., 20 B. T. A., 1026; W. M. Scott, 21 B. T. A. 951.

Petitioner’s next contention is that one half of the total bonuses and royalties received should be deducted from her income as amounts paid her husband as compensation for his services in managing her properties and in negotiating the leases, and points to her agreement with her husband to that effect. Section 214 (a) (1) of the 1926 Act provides for a deduction from gross income of all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered. The reasonableness of the amount paid as compensation and claimed as a deduction must be proved, and the burden of so doing is upon the claimant. Memphis Linotype Printing Co., 9 B. T. A. 666; appeal dismissed, 34 Fed. (2d) 1022; Toledo Grain & Milling Co., 62 Fed. (2d) 171; L. Schepp Co., 25 B. T. A. 419. We have no evidence showing the amount paid petitioner’s husband to have been a reasonable compensation or from which we could determine the reasonable value of his services. For lack of such evidence, without reference to the other statutory requirements, we disallow the deduction claimed.

The next issue relates to an allowance for depletion. Petitioner contends that, under section 204 (c) (2), of the Bevenue Act of 1926 and section 114 (b) (3) of the Bevenue Act of 1928 (the provisions of which are identical), she is entitled to deduct from her income, as depletion, 27% per centum of the total bonuses received under the leases in each of the years when received.

That an allowance for depletion of bonuses received under a lease may be made under proper circumstances is well settled, but, unless there is production from the leased property so that depletion is in fact sustained within the same taxable year as the receipt, the bonuses, as income, may not be reduced by an allowance for depletion. Lizzie H. Glide, 27 B. T. A. 1264, followed in William E. Herring, 'and Eula Day Herring memorandum opinions entered June 29, 1933; affd., 70 Fed. (2d) 785 and 70 Fed. (2d) 790; J. T. Sneed, Jr., 30 B T. A. 1121. See also Aubrey Umsted, 28 B. T. A. 176; affd., 72 Fed. (2d) 328.

Here the parties have stipulated as follows :

At the time of execution of tire several leases scheduled in Exhibit H to various portions of the Copper Mine Ranch and at the time of the receipt of bonuses therefor, there was no production of oil upon the particular acreage covered by such several leases, but from, and after July 12, 1926, there was oil produced continuously from the property known as the Copper Mine Ranch.

For the purpose of determining whether petitioner should be permitted to deduct an allowance for depletion from income received as bonuses on these several leases, they may be divided, from the list thereof in evidence, as follows:

1. Leases made either before or after discovery of oil on the Copper Mine Ranch; no production from the tracts so leased in taxable year in - which bonuses therefor- were received.
2. Leases under which production from the lands embraced was obtained in same taxable year when bonuses thereunder were received.

Following our decisions above cited we hold that no allowance for depletion may be deducted with respect to the bonuses upon leases falling in the first group, but that such allowance, the amount of which may be determined upon settlement, should be deducted with respect to the bonuses received under the leases in group 2. Respecting leases made after the discovery of oil on the ranch but under which no production was obtained in the year the bonuses were paid, petitioner argues that an allowance for depletion should nevertheless be made since there was production from “ the property ”, being the whole ranch, which, it is stipulated, was one tract. With this we disagree. The term “ the property ” applies to the particular acreage covered by each of the several leases. Vinton Petroleum Co. of Texas, 28 B. T. A. 549; affd., 71 Fed. (2d) 420.

The parties stipulate that the amount of state, county, and school district ad valorem taxes assessed and paid on the retained royalty interest'totaled $7,692.92 in 1927, $9,197.28 in 1928, and $4,659.26 in 1929, and that petitioner was allowed to deduct only one half of these amounts in these years. In view of our decision that the royalty interest was the separate property of petitioner, the deduction of the entire amount of these taxes should be allowed. So also respecting expenditures totaling $7,652.99 in 1926, $8,044.32 in 1927, $5,833.36 in 1928, and $5,762.63 in 1929. Respondent has allowed as deductions in each of these years one half of the respective amounts, admitting that the whole thereof should be allowed should we hold (as we have done) that the leased properties were petitioner’s separate estate.

Petitioner claims as a deduction from income for the year 1929, $12,500, being one half of the amount claimed as lost upon an obligation of the Power Banking Co., of Archer City, Texas. The stipulation respecting this transaction we have set out in full.

Petitioner makes no reference to any statutory provision under which she seeks the allowance of a deduction on this transaction. The pleadings refer to it as a “ loss on a deposit ” and since a relationship of creditor and debtor is established by the deposit of money in bank, we assume that the deduction is claimed as upon a debt determined to be worthless in whole or in part under section 23 (j) of the Revenue Act of 1928. Its provisions make the allowance of a deduction from income for bad debts dependent upon satisfactorily meeting certain precedent requirements. As to debts claimed in their entirety, the taxpayer must ascertain them to be worthless and must charge them off. As to debts claimed only in part, the Commissioner “must be satisfied that the debt is recoverable only in part and until he is there can be no charge-off, and then only with his permission.” But this ruling may be reviewed and reversed. if it appears that in disallowing the charge-off to be made he abused his discretion. Liberty Bank & Trust Co. v. Commissioner, 59 Fed. (2d) 320 (reversing 14 B. T. A. 1428).

We are of opinion that the charge-off should be made and deduction of the loss allowed. The fact that the bank was determined to be hopelessly insolvent would have been sufficient evidence of the worthlessness of petitioner’s claim — see Egan & Hausman Co., 1 B. T. A. 556; John E. Saddler, 2 B. T. A. 1305 — had not petitioner been secured by the pledged certificates. But the then value of the certificates is stipulated — $35,000—and it was stipulated also that any recovery of petitioner’s deposit could come only from them. That, we think, is a sufficient determination of petitioner’s loss, for “ the collateral security to a debt need not be liquidated to establish the worthless portion of the debt;” see Ross v. Commissioner, 72 Fed. (2d) 122, reversing 27 B. T. A. 1062), citing Murchison National Bank v. Griscom, 50 Fed. (2d) 1056. See also article 191 of respondent’s Regulations 74, relating to the deduction of the uncol-lectible portion of a debt.

There should be deducted from petitioner’s income one half the difference between the amount of the lost deposit and the stipulated value of the security, or $12,500.

It is further stipulated that petitioner’s income for 1925 shall be reduced by $1,956.01 on account of the deduction allowable for interest paid, and that $12,262.32, being one half of an alleged profit from the sale of cattle, should be excluded from income for 1928. Effect to these agreements will be given upon settlement.

Reviewed by the Board.

Judgment will be entered under Bule 50.

Arutstdell and Leech dissent from the result reached on the issue involving depletion allowance.

Seawell dissents from the result reached on the issue involving compensation paid the husband for services rendered.

      Art. 16, see. 15, Constitution of Texas; art. 4614, Revised Civil Statutes of Texas, 1925.

       Speer, 23 Texas Jurisprudence, par. 52.

        Ibid. But when in the act of segregating there is to any substantial extent an employment of community funds or labor, such things become impressed with the community character and by common consent are classed with the community estate. The increase then becomes fructus industriales. The conclusion of community in such cases is hastened by the universal rule requiring one who asserts the separate character of a fund claimed to trace the same, a matter of impossibility in such cases as are instanced.

        Idem, par. 102. Whatever is acquired by husband or wife, by trade, speculation or venture, whether with the community funds or the separate funds is community property. * * * It is difficult to cast a rule, but it would appear to be that where the profits are the result of a purpose and plan to buy and sell as a business, such profits are community. But where the}' are the mere gains arising from the ordinary changes and mutations in the form of the property or fund, there will be no change in the status.

       Since the wife’s separate property may be alienated in the manner prescribed by law, the inquiry immediately arises, whether or not the proceeds of the same, when sold, assume the same status as such property. But one answer can be given. Where the statute nowhere declares that her rights are forfeited by an alienation (if, indeed, such restriction could be lawful) the right to own would carry with it the incidental right of disposition. The proceeds arising from such disposition cannot, by any process of reasoning, be said to be converted from the separate into the community fund. They will stand in lieu of the thing given for them, and occupy precisely the same status as property as they did. If her separate estate consists of land or money, she may sell the one and invest the other; and in either case the new acquisition will belong to her. (Speer, Law of Marital Rights in Texas, 3d ed., p. 514.)
      Cash considerations paid for the granting of leases upon separate property are the separate income of the owner of the property. James R. Parkey, 16 B. T. A. 441; John O’Neil, 16 B. T. A. 614 ; W. P. Ferguson, 20 B. T. A. 130 ; affirmed as to this issue, 45 Fed. (2d) 573 ; Oscar Chesson, 22 B. T. A. 818; petition to review denied, 57 Fed. (2d) 141; B. Michna, 24 B. T. A. 715 ; J. T. Sneed, Jr., 30 B. T. A. 1121.

       See art. 4614, Revised Civil Statutes oí Texas, providing that rents and revenues from separate property of wife should likewise be her separate property. This legislation was rejected on constitutional grounds; Arnold v. Leonard, 273 S. W. 799; and in Texas the rents and revenues of the separate property of either spouse are community income. Brittain v. O’Banion, 56 S. W. (2d) 249; Hawkins v. Britton State Bank, 52 S. W. (2d) 243; Wheeler v. Lee, 53 S. W. (2d) 648; Frame v. Frame, 36 S. W. (2d) 152; Willcut v. Willcut, 278 S. W. 236.

       In Jaokson v. Jackson, 258 S. W. 231, the Texas Court of Civil Appeals, among other things, said:
      “ The character of the title to property with reference to being separate or community depends upon the existence or non-existence of the marriage at the time of the in-cipiency of the right by virtue of which title is Anally vested, and when title is so vested it relates bach to that time, Creamer v. Briscoe, 101 Tex. 490, 109 S. W. 911, 17 L. R. A. (N. S.) 154, 130 Am. St. Rep. 869 ; Welder v. Lambert, 91 Tex. 510, 44 S. W. 281.”
      To the same effect see Price v. McAnelly, 287 S. W. 77; Evans v. Ingram, 288 S. W. 494; Stiles v. Hawkins, 207 S. W. 89 ; Sauvage v. Wauhop, 143 S. W. 259.
      See also Speer, Law of Marital Rights in Texas, 3d ed., p. 254:
      “ The status of the property of marital partners is determined by the time and circumstances attending its ‘ acquisition.’ It is therefore helpful to keep in mind what is meant by ‘ acquired.’ The term signifies the origin or inception of the right, rather than its later ripening or fruition.”

         Hugo v. Seffel, 92 Tex. 414, 49 S. W. 369; Boese v. Parkhill (Civ. App.), 202 S. W. 120 ; Pullman Co. v. Cox, 220 S. W. 599, 602.

        Burnet v. Harmel, supra; Murphy Oil Co. v. Burnet, 287 U. S. 299: Palmer v. Bender, 287 U. S. 551; Dahota-Moniana Oil Co. v. United States, 288 U. S. 459.