author: Love :

text:
    John M. King, Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket No. 41549.

    Promulgated October 11, 1932.

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

      John E. Pigg, Esq., and B. B. Oannon, Esq., for the respondent.
   OPINION.

Love :

We are asked to decide whether petitioner is taxable on the entire fee of $52,000, or on only one-half thereof. Petitioner contends that, under the community property laws of the State of Texas, the fee, when received, was community property belonging one-half to himself and one-half to the estate of his deceased wife, and that he was taxable only on his one-half. The respondent, however, argues that since the fee was conditioned upon the successful outcome of the lawsuit in question, and petitioner’s wife having died before that condition was fulfilled, the fee can not be said to have been “ acquired * * * during marriage ” of petitioner and his wife, and was not, therefore, so impressed with the character of community property that one-half of the fee was taxable to the estate of petitioner’s deceased wife instead of to petitioner.

In Hopkins v. Bacon, 282 U. S. 122, the Supreme Court decided that “the interest of a wife in community property in Texas is properly characterized as a present vested interest, equal and equivalent to that of her husband, and that one-half of the community income is therefore income of the wife.” It further decided that She and her husband are entitled to make separate returns, each of one-half of such income.”

If petitioner’s wife had lived, there can be no doubt but that each would have been permitted to have returned one-half of the $52,000 fee in separate income-tax returns. Hopkins v. Bacon, supra. Our problem, then, is to determine what effect the death of petitioner’s wife had upon the taxability of the fee which became fixed and was paid to petitioner after the death of his wife. Was the entire amount “ income ” to petitioner ?

Sections 210 and 211 of the Revenue Act of 1926 imposes a normal and surtax, respectively, upon the “ net income of every individual.” These sections were construed and applied by the United States Supreme Court in Poe v. Seaborn, 282 U. S. 101, in which the court said in part:

The use of the word “ of ” denotes ownership. It would be a strained construction, which, in the absence of further definition by Congress, should impute a broader significance to the phrase.
The Commissioner concedes that the answer to the question involved in the cause must be found' in the provisions of the law of the State, as to the wife’s ownership of or interest in community property. What, then, is the law of Washington as to the ownership of community property and of community income including the earnings of the husband’s and wife’s labor?
The answer is found in the statutes of the State, and the decisions interpreting them.

If, then, under the laws of the State of Texas, the estate of Mary McAdoo King had a valid claim to one-half of the fee in question, such amount would not be the “ income of ” petitioner and would not be taxable to him. Poe v. Seaborn, supra. We, therefore, turn to the statutes and court decisions of the State of Texas relating to the ownership of property under conditions such as are present in the instant proceeding.

Article 4619 of Yernon’s Annotated Revised Civil Statutes of the State of' Texas defines community property as follows:

All property acquired by either husband or wife during marriage, except that which is the separate property of either, shall be deemed the common property of the husband and wife-, and during coverture may be disposed of by the husband only.

Article 2578 of the same statutes provides that, upon the dissolution of the marriage relation by death, the community estate, if there be a child or children of the deceased, shall pass one-half to the survivor and the other half to such child or children.

Petitioner and his deceased wife had one son, Leon, who was the only child and who survived his mother. Since the contract between petitioner and Baker which resulted in petitioner receiving the $52,000 fee was entered into prior to the death of petitioner’s wife, it would appear that the contract itself was at least a part of the community estate, and a one-half interest therein would, under article 2578, supra, pass to the surviving child. But what did this one-half interest represent ? The respondent contends that since the contract was for an indefinite amount of compensation conditioned upon the successful outcome of the suit then contemplated, and, further, since this condition had not been performed prior to the death of petitioner’s wife, the fruits of the contract can not be said to have been “ acquired * * * during marriage,” within the meaning of article 4619, supra, and, not being a part of the common property, no part thereof would constitute a part of decedent’s estate.

The word “ acquired ” as used in article 4619, supra, “ is not to be construed in any restricted sense, but must necessarily have that broad significance as will include all effects or gains or propert};' of every kind coming to the husband or wife during coverture in any manner other than by 4 gift, devise, or descent.’ ” Lee v. Lee, 112 Texas, 392; 247 S. W. 828. The court in the Lee case also quoted with approval from the Supreme Court of Arizona in La Tourette v. La Tourette, 15 Ariz. 200; 137 Pac. 426, as follows:

The law makes no distinction between the husband and wife in respect to the right each has in the community property. It gives the husband no higher or better title than it gives the wife. It recognizes a marital community wherein both are equal. Its policy plainly expressed is to give the wife in this marital community an equal dignity, and make her an equal factor in the matrimonial gains. It recognizes that property acquired during marriage by community funds or the labor and industry of either spouse * * * is the common property of the husband and wife. All that either the husband or wife or both may acquire during the existence of the marriage, other than is specifically excepted, is an acquest of the community, and the presumption m all doubtful oases is strongly in favor of treating that which either spouse may oten as community property. It recognizes that the wife in her station is as much an agency in the acquisition as the husband, and is entitled to just as great an interest. [Italics supplied.]

In view of the liberal construction to be placed upon the word acquired,” can it be said that, since the right to the fee had its inception in the contract made with the receiver in 1920, the character of the fee is determined by the character of the right which produced it? Petitioner contends that in cases of inchoate rights it is the time of the inception of the initial rights that determines the status of property as between community and separate. In this connection, McKay, a recognized authority, in his book on Community Property, 2d ed., par. 520, says:

An inchoate title or pecuniary right is property in the sense of the law of separate and common property, just as truly as the most unimpeachable or perfect title. It takes its rank as separate or common property, for the same reason, and in response to the same tests, as the perfect or complete title or right, and it retains its character as separate or common so long as it can be traced; its development from an inehoate to the absolute or complete form does not shift it fro-m one fund to another; it may he relieved of conditions and burdens but this does not change its character; it may pass from a conditional to an unconditional form, without change or legal character; it may be exchanged for other things or rights, and its character as separate or common passes to whatever was acquired by the exchange. If the property, consists of an obligation, either contractual or delictual, it may be performed or enforced; and whatever is so acquired takes the same character as the obligation. [Italics supplied.]

At paragraph 533, the same author, in referring to property acquired in discharge of an obligation, says:

* * * but the case is not so clear when the contract contains conditions which must be performed to preserve the contract right. In some of the cases it seems at first blush as though the final fruits of the contract are acquired by the performance of the conditions, but clearly this is not in accord with legal principle and is against the great weight of authority.

And, again, at paragraphs 535 and 536, the same author continues as follows:

Pab. 535. When a contract containing conditions is closed before marriage, and the conditions are performed during marriage by the community, some confusion has arisen in the authorities, due to the mistaken view taken by some coui'ts that in such cases the property is acquired not through the separate ante-nuptial contract, but through the performance of the conditions during marriage. If the contract is largely executory and the conditions and stipulations of the contract are burdensome, and are performed by the community, it may seem to some like a legal nicety devoid of substantial justice to refer the origin of the property to- the date of closing the contract through which it was acquired; but generally justice is better subserved by the rule now firmly established that property acquired by contract is deemed to have its origin as of the date of the contract.
And it is not difficult to find a justification for the rule: The contract itself is property, and having been acquired before marriage it is separate by force of the plain terms of the statute. If it should be sold without performance of the conditions clearly the proceeds of the sale would be separate, and if the conditions are performed after marriage through the expenditure of separate funds no one would insist that the property is common. The community may be reimbursed for its funds used to perform the conditions and when this is done even and exact justice is done to all; the separate estate obtains the advantages of its separate contract, or suffers the disadvantages of any, and the community is reimbursed for its outlay. If the circumstances impose no obligation to make reimbursement, this should not change the rule just stated.
Pab. 536. A condition precedent must be performed before title passes. A right to have property on performance of a condition precedent is not ownership of the property but a right to have ownership on performance of the condition. On the other hand, the holder of property under a title subject to a condition subsequent is the owner, though his ownership may be lost by breach of the condition. In the first case ownership is in the future; in the second in the present, but conditional. In either case the right is vested and protected by law, and is properts in the sense of the law of separate and common property ; in the first case it is the same as the right of one under a covenant to have property delivered to* him in full ownership on performance of his contract; in the second case he is owner, but his ownership may be lost. In neither case is the character of the right changed! from separate to common or vice versa, by a performance of the condition. If the initial right is separate it remains so even though the condition he performed by the community and if the initial right he common, a, performance of the condition at the expense of the separate estate does not divert the property to it; the property remains common. [Italics supplied.]

In Jackson 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 incipiency of the right by virtue of which title is finally vested, and when title is so vested it relates back 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.

In Welder v. Lambert, supra, one James Power and another, as empresarios, obtained a certain colonization contract with the State of Coahuila and Texas, by the terms of which, upon their compliance with certain conditions contained in the contract, they acquired the right to a grant of lands. Their right to the lands was contingent upon compliance by them with the conditions of their contract, they being not entitled, however, to any specific tract or tracts of land. The contract was.entered into while Power was a single man. The conditions were complied with after his marriage. The question involved was ivhether the lands, which were acquired by him after his marriage as a result of his contract, were a part of the community or his separate estate. The point was raised and argued in the Supreme Court of the State of Texas that since the contract vested Power only with the potentiality of earning the land, and since this right was not fixed or earned prior to his marriage, that the property was community and not separate. The court held the land to be Power’s separate property and at page 286 it said:

* * * In this cause tbe title originated in the contract of Power and Hewitson with the state of Coahuila and Texas. That contract, in the language of the Louisiana Court, was the “ cause ” of the title. Power was single when it was entered into, and the right to earn the lands acquired by it was his separate property. The title relates to its origin, and must take the impress of its character from it.

In Creamer v. Briscoe, supra, one Josiah Creamer and his first wife settled upon certain land to acquire it as a homestead under the laws then in force, and did everything necessary to that end, except to complete the three years of occupancy. After they had occupied the land for more than a year, Mrs. Creamer died, and Creamer, thereafter and during the three years, married a second time, and with his second wife completed the occupancy and obtained a patent. Creamer’s second wife predeceased him and a contest arose as to whether the homestead was community property of Creamer and his first wife or Creamer and his second wife. The Supreme Court of Texas, in reversing the lower court, held that the heirs of the second wife had no interest whatever in the property. We quote from the opinion as follows:

* * * The original property riglit, Raving been “ acquired ” during the marriage, is community, and the title which completes that right relates back to its origin and takes character from it.
# * * * * * *
It follows, from what we have said, that the character of the property in controversy had been fixed as belonging to the community estate of the first marriage, when Creamer last married, and that such character could not be affected by that marriage. The last wife merely came into the family and resided on the homestead in use, the title to which was no more changed thereby than if it had been Creamer’s separate property.

It is our opinion that the statutes and court decisions of the State of Texas uphold petitioner’s contention that since the right to the fee had its inception in the 1920 contract, which was entered into during the marriage of petitioner and his deceased wife, the fee when received was impressed with the character of community property and belonged one-half to petitioner and one-half to the estate of his deceased wife. The fact that the marital relationship was dissolved by death before the condition in the contract was fully performed does not affect the property interest in the fee when it was received, because, as we have pointed out above, it is the time of the inception of the initial right which determined the status of the property, and its development from an inchoate to an absolute right did not shift the fee from one fund to another. This is also in accord with the settlement which petitioner made with his son about the year 1921.

The deficiency for the year 1925 should be redetermined by excluding the amount of $26,000 from the net income determined by the respondent.

Reviewed by the Board.

Judgment will be entered under Rule 50.

Smith, Sternhagen, Arundell, Murdock, and McMahon dissent.


source: Caselaw Access Project

author: Smith :

license: Public Domain

text:
    David K. Cochrane, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 60428.
    Promulgated October 11, 1932.

      E. Barrett Prettyrmn, Esq., for the petitioner.

      G. A. Bay, Esq., for the respondent.
   OPINION.

Smith :

The only question for our determination in this proceeding is whether the fees received by the petitioner in 1930 as master in chancery of the Superior Court of Cook County, Illinois, are in-.eludable in his gross income and subject to the Federal income tax. The material facts are stipulated.

The petitioner was first appointed a master in chancery of the Superior Court of Cook County, Illinois, in 1916, to fill a vacancy and was reappointed by the court for succeeding statutory terms of two years, the first of which commenced on December 1, 1917, and the last on December 1,1929. He served in such capacity during the entire year 1930, for which services he received fees paid by litigants before the court in a total amount of $953.21.

In 1930 the petitioner was also engaged in the practice of law and was a member of the law partnership of Cochrane & George, 35 North Dearborn Street, Chicago, Illinois. In connection with his private practice, the petitioner incurred the usual office expenses. He reported as income from the partnership in 1930 a net amount of $7,192.98.

The appointment of masters in chancery is authorized by the statutes of Illinois (see chapter 90, Smith-Hurd Illinois Revised Statutes, 1929). The statutory term of office is two years. The duties of the office are prescribed by the statute, which also provides for compensation in the form of fees, some of which are statutory and some fixed by the court. The masters are required to take an oath of office and to give bond.

Since there is no governing statutory provision in the income tax laws relating to the exemption or exclusion of the income of a state officer or employee for the year 1930 or for any year subsequent to 1924 (see section 1211, Revenue Act of 1926), any exclusion or exemption of the income in question must rest upon constitutional grounds. The income is taxable unless the imposition of the tax by the Federal Government would result in “ a charge upon the means and instrumentalities employed by the State, in the discharge of its ordinary functions as a Government.” South Carolina v. United States, 199 U. S. 437. See also Collector v. Day, 11 Wall. 113; United States v. Railroad Co., 17 Wall. 322; Pollock v. Farmers’ Loan & Trust Co., 157 U. S. 429; Flint v. Slone Tracy Co., 220 U. S. 107; Frey v. Woodworth, 2 Fed. (2d) 725; Hugh W. Ogden, 24 B. T. A. 1239; G. Ridgely Sappington, 25 B. T. A. 1385.

It must be conceded, we think, that the petitioner, as a master in chancery of the Superior Court of Cook County, Illinois, was an officer of that state.

An office is a public station conferred by the appointment of government. The term embraces the idea of tenure, duration, emolument and duties fixed by law. Where an office is created, the law usually fixes its incidents, including its term, its duties and its compensation. United States v. Hartwell, 6 Wall. 385, 18 L. Ed. 830; Hall v. Wisconsin, 103 U. S. 5, 26 E. Ed. 302. * * * [Metcalf & Eddy v. Mitchell, 269 U. S. 514.]

All of these requirements were met substantially in the petitioner’s case. The appointment, tenure, duration and duties were all authorized by the state statutes. The petitioner’s compensation consisted of fees, which were in part fixed by statute and in part by the court in the manner of other court costs. We held in Hugh W. Ogden, supra, that an auditor appointed by a judge of the Superior Court of Massachusetts, acting on authority of the state statutes, was an officer or employee of that state within the meaning of section 1211 of the Revenue Act of 1926, and that such-office was analogous to the office of master in chancery.

We think it can not be questioned that the petitioner was an instrumentality of the State of Illinois engaged in an essential governmental function. As a master in chancery of the Superior Court of Cook County, Illinois, he was an integral part of the judicial system of the state.

The respondent takes the position that since the compensation sought to be taxed was not paid to the petitioner by the state, the imposition of the tax thereon by the Federal Government does not constitute a burden upon the state and does not come within the constitutional exemption.

A study of the leading cases with a view to ascertaining the reason for the rule establishing the exemption does not lead us to this conclusion. We do not perceive that the constitutional objections to the imposition of a tax by either the Federal Government or the States upon the governmental instrumentalities of the other obtain only where the financial burden of the tax ultimately falls upon the State or the Federal Government. One of the earliest Supreme Court cases in which this question was discussed in McCulloch v. State of Maryland, 4 Wheat. 315, in which a tax imposed on a Federal bank by the State of Maryland was held unconstitutional. “ The power of taxation,” said Chief Justice Marshall, speaking for the court, “ is an incident of sovereignty, and is coextensive with that to which it is an incident.” He further stated:

That the power to tax involves the power to destroy; that the power to destroy may defeat and render useless the power to create; that there is a plain repugnance, in conferring on one government a power to control the constitutional measures of another, which other, with respect to those very measures, is declared to be supreme over that which exerts the control, are propositions not to be denied. * * *

In Collector v. Day, supra, there arose a question of the right of the Federal Government to tax the salary of a judicial officer of the State of Massachusetts. The court there said:

These views, we think, abundantly establish the soundness of the decision of the case of Dobbins v. The Commissioners of Eric, which determined that the States were prohibited, upon a proper construction of the Constitution, from taxing the salary or emoluments of an officer of the government of the United States. And we shall now proceed to show that, upon the same construction of that instrument, and for like reasons, that government is prohibited from taxing the salary of the judicial officer of a State.
* ***** *
* * * Such being the separate and independent condition of the States in our complex system, as recognized by the Constitution, * * * it would seem to follow, as a reasonable, if not a necessary consequence, that the means and instrumentalities employed for carrying on the operations of their governments, for preserving their existence, and fulfilling the high and responsible duties assigned to them in the Constitution, should be left free and unimpaired, should not be liable to be crippled, much less defeated by the taxing power of another government, which power acknowledges no limits but the will of the legislative body imposing the tax. And, more especially, those means and instrumentalities which are the creation of their sovereign and reserved rights, one of which is the establishment of the judicial department, and the appointment of officers to administer their laws. * * *

Also, in Flint v. Stone Tracy Co., supra, it was said:

The cases unite iga exempting from Federal taxation the means and instru-mentalities employed in carrying on the governmental operations of the state. The exercise of such rights'as the establishment of a judiciary, the employment of officers to administer and execute the laws, and similar governmental functions, cannot be taxed by the Federal government. The Collector v. Day, 11 Wall. 113, 20 L. ed. 122; United States v. Baltimore & O. R. Co., 17 Wall. 322, 21 L. ed. 597; Ambrosini v. United States, 187 U. S. 1. * * *

As we have pointed out above, it seems undeniable that the petitioner, as a master in chancery of the court of Illinois, was an officer of that state who rendered services in aid of the administration of justice.

In the more recent case of Metcalf & Eddy v. Mitchell, supra, the court in a careful review of this question strictly applied the- rule established in the earlier cases. After finding that the recipients of the income sought to be taxed under the War Revenue Act of October 13, 1917, were not officers or employees of the state, the court went on to say:

We pass to the more difficult question whether Congress had the constitutional power to impose the tax in question, and this must he answered by ascertaining whether its effect is such as to bring it within the purview of those decisions holding that the very nature of our constitutional system of dual sovereign governments is such as impliedly to prohibit the federal government from taxing the instrumentalities of a state government, and in a similar manner to limit the power of the states to tax the instrumentalities of the federal government. See, as to federal taxation on state instrumentalities, [citing The Collector v. Day, supra; United States v. Railroad Co., supra; McCulloch v. State of Maryland, supra, and others].
Just what instrumentalities of either a state or the federal government are exempt from taxation by the other cannot be stated in terms of universal application. But this court has repeatedly held that those agencies through which either government immediately and directly exercises its sovereign powers are immune from the taxing power of the other. * * *
*******
As cases arise, lying between the two extremes, it becomes necessary to draw the line which separates those activities having some relation to government, which are nevertheless subject to taxation, from those which are immune. Experience has shown that there is no formula by which that line may be plotted with precision in advance. But recourse may be had to the reason upon which the rule rests, and which must be the guiding principle to control its operation. Its origin was due to the essential requirement of our constitutional system that the federal government must exercise its authority within the territorial limits of the states; and it rests on the conviction that each government in order that it may administer its affairs within its own sphere, must be left free from undue interference by the other. McCulloch v. Maryland, supra; Collector v. Day, supra; Dobbins v. Commissioners of Erie County, supra.
* * sfc * * * ' *
While it is evident that in one aspect the extent of the exemption must finally depend upon the effect of the tax upon the functions of the government alleged to be affected by it, still the nature of the governmental agencies or the mode of their constitution may not be disregarded in passing on the question of tax exemption; for it is obvious that an agency may be of such a character or so intimately connected with the^exereise of a power or the performance of a duty by the one government, that any taxation of it by the other would be such a direct interference with the functions of government itself as to be plainly beyond the tasiing power.

The last paragraph quoted above emphasizes the unsoundness of the respondent’s position in the instant case that the sole test to be applied is whether the imposition of the tax constitutes a burden in the material sense, that is, a financial burden upon the state. The immunity relates to all governmental agencies “ of such a character or so intimately connected with the exercise of a power or the performance of a duty ” that their taxation in any manner whatever would constitute a direct interference with the functions of government.” The petitioner, serving in his capacity of master of chancery, was such an agency of the State of Illinois.

The still more recent case of Fox Film Corp. v. Doyal, 286 U. S. 123, cited by the respondent, does not limit the application of this rule. The question there involved was whether the state had a right to tax copyright royalties, which question the court answered in the affirmative. In its opinion in that case the court restated the rule, as established by the earlier cases, governing the immunity from taxation of all governmental agencies.

The respondent also cites Miller v. McCaughn, 22 Fed. (2d) 165; aff'd., 27 Fed. (2d) 140. In that case the court held taxable the income received by an attorney appointed by judges of the orphans’ court in Philadelphia, Pennsylvania, as auditor to investigate the financial responsibility of surety companies applying to the court to furnish surety bonds. The compensation for such services was paid from funds contributed by the applying surety companies. The court there found that the taxpaj^er was not an officer or an employee of the State of Pennsylvania; that his employment was not authorized by any state statute; that he did not receive any pay from the state; that no power of the state was crippled or lessened by the imposition of the tax; and that the income in question was therefore taxable. The facts are different in the instant case. The office held by the petitioner was created by state statutes which also prescribe the incidents of such office. The petitioner was an officer of the state.

We think that Miller v. McCaughn, supra, is not authority for the proposition that the source of the income of a state officer alone determines its taxability by the Federal Government. In Warwick v. Bettman, 102 Fed. 127; aff'd., 108 Fed. 46, the court in holding that the bond required of a notary public appointed by the state was not subject to the stamp tax imposed by the War Revenue Act of June 13, 1898, said:

* * * They are officers of the state, charged with the performance of important duties, and invested with the powers necessary for such performance. They are officers and agents of the state who render services in aid of the administration of justice, and are employed by the state in the exercise of the functions belonging to it in its ordinary governmental capacity. The tax collected from the plaintiff was a tax on his right to qualify, in conformity with the law of Ohio, for the office to which he had been appointed, and was a restraint upon his duty to qualify, which might be made practically prohibitive, and was a restraint upon the state in the exercise of its function in the appointment and qualification of its officers and agents for ordinary governmental purposes, and was therefore illegal. * * *

In many of the states the so-called fee system is widely employed as a means of providing compensation for state, county, and municipal officers employed in the performance of duties clearly of a strictly governmental nature. The alternative of the fee system would necessarily require the payment of the compensation of these officers out of public funds.

We are of the opinion that the compensation earned by the petitioner serving in the capacity as a master in chancery of the Superior Court of Cook County, Illinois, is exempt from taxation by the Federal Government.

Reviewed by the Board.

Judgment will be entered for the petitioner.


author: Van Fossan:

text:
    Cyrus H. McCormick, Harold F. McCormick, Stanley McCormick, Trustees Sometimes Known as Chicago Stock Exchange Building Trustees, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 44139.
    Promulgated October 11, 1932.

      Edward Clifford, Esq., and A. E. James, Esq., for the petitioners.

      H. D. Thomas, Esq., for the respondent.
   OPINION.

Van Fossan:

The question here presented is whether or not petitioning taxpayers constituted an association, taxable as a corporation. In considering this question we must look to the form and purpose of the organization structure and the actual functioning of the organization during the taxable years.

An association is an unchartered organization employing the characteristics, form and procedure of a corporation in the prosecution of a business enterprise.

Here we find a trust charged with the management of a commercial office building. The creating deed denominated three trustees and gave them almost unlimited powers.

In actual fact, however, the three trustees had nothing more to 'do with the management of the building than had they been strangers to the matter. They never met as trustees. No minutes were kept by them or on their behalf. They had no separate books and records as trustees; no communications were ever sent or exchanged officially among themselves; they had no employees as trustees and to all practical ends completely ignored the trust relationship.

The property involved was one of some thirty similar properties owned by or on behalf of the several heirs of Cyrus H. McCormick, Sr., collectively known as the McCormick Estates. These properties were all managed by one office, directed by one Judson F. Stone. Stone held an unlimited power of attorney from the various heirs and dealt with the properties as fully as though individually owned by him. The heirs were seldom consulted and then only on matters of important policies. As funds became available for distribution they were placed to the credit of the respective heirs.

The property covered by the trust here involved was managed by Stone precisely as all other properties constituting the McCormick Estates — no distinction whatever being made in any respect because of the trust. No salary was paid to Stone or any of his office force by the trust, as such.

In this state of facts we see no resemblance to corporate operation. The trust was merely a shadow without substance and vitality. Respondent erred in holding the trust to be an association, taxable as a corporation.

Reviewed by the Board.

Decision will, be entered for the 'petitioners.


author: Black :

text:
    Mrs. Grant Smith, Petitioner, v. Commissioner of Internal Revenue, Respondent. W. E. Hauser, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 43300-43302, 43305, 43306.
    Promulgated October 12, 1932.

      Russell D. Morrill, Esq., and Josiah, 'Willard, Esq., for tbe petitioners.

      J. G. Gibbs, Esq., for the respondent.
   OPINION.

Black :

In Docket No. 43301 it has been stipulated that the liability of petitioner W. E. Plauser as the transferee of the assets of the Smith Securities Company for the year 1924 is $3,567.91. In Docket No. 43305 it has been stipulated that the liability of petitioner Mrs. Grant Smith as the transferee of the assets of the Smith Securities Company for the year 1924 is $3,567.91. Determination will be made accordingly.

The remaining issues are:

1. Whether or not W. E. Hauser and the estate of Grant Smith received all of the assets of the Smith Securities Company in 1925; and

2. Whether or not the Smith Securities Company had a taxable period from January 1 to January 12, 1925, for which it was obliged to file an income-tax return.

We will discuss issue No. 1 first. Petitioners contend that when' the corporation, Smith Securities Company, wa^ dissolved January 12,1925, only the liquid assets were paid over to them and that the remainder of the assets, consisting of stocks in certain closely held corporations, real estate, certain bills receivable, etc., were retained by the trustees for orderly liquidation and that inasmuch as the value of the liquid assets which petitioners received in 1925 was less than the cost of their stock, there was no gain or loss for petitioners to report for 1925. Respondent contends that the ’entire assets of the corporation were distributed to petitioners January 12, 1925, and that the value of these assets received in liquidation was greater than the cost of the stock and that hence each petitioner is chargeable with the profit on his stock which respondent has found resulted from the liquidation.

Section 3833 of Remington’s Compiled Statutes of Washington provides:

Power of Trustees upon Dissolution of Corporation. Upon the dissolution of any corporation formed under the provisions of this chapter, the trustees at the time of the dissolution shall be trustees of the creditors and stockholders of the corporation dissolved, and shall have full power and authority to sue for and recover the debts and property of the corporation by the name of the trustees of such corporation, collect and pay the outstanding debts, settle all its affairs and divide among the stockholders the money and other property that shall remain after the payment of the debts and necessary expenses.

The decree of the Superior Court of Washington dissolving the Smith Securities Company recited :

It is therefore now Okdhkbd, Adjudged and Decbehd that the said corporation be and the same is hereby dissolved and the assets of said corporation shall be held by said three trustees above named to be divided among the stockholders above named according to their said respective interests.

It is well established that the mere dissolution of a corporation does not" effect a distribution of its assets among its stockholders, and furthermore that such a distribution is not effected by the turning over of the assets of the corporation to trustees in liquidation who may also be stockholders of the corporation.

The ease of Wells Fargo Bank & Union Trust Co. v. Blair, 26 Fed. (2d) 532, involved the question of whether or not the assets of a California corporation were received by its stockholders in 1919 or 1920. A decree of dissolution of the corporation was entered on December 30, 1919, and filed with the Secretary of State of California on the following day. The decree directed the board of directors “to settle all of the affairs of the said corporation and to distribute and convey all the property and assets of said corporation to its stockholders in proportion to their respective interests.” In January, 1920, the directors, acting as liquidating trustees, sold the assets of the corporation. Under decisions of the California courts, title to the assets of a dissolved corporation vests not in the trustees, but in the stockholders. The court held that, in spite of such decisions, there was no liquidation until the property was actually transferred to the stockholders and that, accordingly, the stockholders had not received these assets until 1920.

Respondent in his brief admits the force of Wells Fargo Bank & Union Trust Co. v. Blair, supra, and concedes that when the liquidating trustees, Hauser, Colman and Mrs. Grant Smith, took charge of the property of the corporation after the order of dissolution, it did not amount to a distribution of the property to the stockholders of the corporation, but respondent contends that, when the liquidating trustees entered into a trust agreement with the Metropolitan National Bank of Seattle, by which it was agreed that the bank should complete the liquidation, which arrangement was concurred in by the administrators of the estate of Grant Smith, deceased, and by the two beneficial owners of the assets of said corporation, this was a turning over of the assets of the corporation to the two stockholders,, Hauser and Mrs. Grant Smith, and that although they did not actually receive these assets in 1925, they constructively received them in that year. Hence the transaction was taxable to petitioners. We do not agree with respondent’s contention. We view the trust instrument entered into by the liquidating trustees with the bank as largely one of convenience by which the bank, because of its superior facilities, was to complete the liquidation, turning over to the stockholders of the corporation the proceeds resulting from sales as fast as it was expedient to do so. Until the stockholders actually received the assets or the proceeds resulting from the sale thereof, there was no receipt by them.

Article 548 of Regulations 69 (Revenue Act of 1926), reads as follows:

Abt. 548. Gross income of corporations in liquidation.- — When a corporation is dissolved, its affairs are usually wound up by a receiver or trustees in dissolution. The corporate existence is continued for the purpose of liquidating the assets and paying the debts, and such receiver or trustees stand in the stead of the corporation for such purposes. (See Section 282 and Articles 1293 and 1294). Any sales of property by them are to be treated as if made by the corporation for the purpose of ascertaining the gain or loss. * * *

Article 547 of Regulations 45 (Revenue Act of 1918) is identical with the above quoted regulation and was approved by the court, as a reasonable regulation and one which should be given effect, in Taylor Oil & Gas Co. v. Commissioner, 47 Fed. (2d) 108 (certiorari denied, 283 U. S. 818, affirming the Board’s decision in 15 B. T. A. 609. In that case, upon dissolution of the corporation, the stockholders authorized the president and directors to act as liquidating trustees. After a sale of the assets under that authorization, the question arose whether it was a sale by the corporation, or by the stockholders, on the theory that the assets had been distributed to them. The court said in part:

It is contended by petitioners that the legal title to the property vested in the president and directors as trustees by operation of law immediately upon the consummation of the necessary steps to effect the dissolution, and that the sale of the property made thereafter was for the benefit of the creditors and stockholders and not for the company. Conceding for the purpose of argument that the legal title to the property vested in the trustees by the dissolution, no part of the title passed to the stockholders thereby. The real owner was still the company until such time as its affairs were liquidated, the debts paid and the residue distributed to the stockholders.

We followed Taylor Oil & Gas Co. v. Commissioner, supra, in Hellebush, et oil., Trustees, 24 B. T. A. 660, and again approved the Commissioner’s regulations above referred to. If said regulations were applicable in Taylor Oil & Gas Co. v. Commissioner, supra, and in Hellebush, et al., Trustees, supra, we see no reason why they should not be applicable and controlling in the present proceeding. On authority of the cases above cited, we hold in favor of petitioner and against respondent on Issue No. 1.

We will next discuss Issue No. 2. Section 239 of the Revenue Act of 1926, relating to the filing of income-tax returns by corporations, is printed in the margin.

Article 622 of Regulations 69 (Revenue Act of 1926), relating to returns filed by receivers or trustees in dissolution, etc., reads as follows:

Abt. 622. Return ty receivers. — Receivers, trustees in dissolution, trustees in bankruptcy, and assignees, operating the property or business of corporations, must make returns of income for suck corporations on Form 1120, covering each year or part of a year during which they are in control. Notwithstanding that the powers and functions of a corporation are suspended and that the property and business are for the time being in the custody of the receiver, trustee, or assignee, subject to the order of the court, such receiver, trustee, or assignee stands in the place of the corporate officers and is required to perform all the duties and assume all the liabilities which would devolve upon the officers of the corporation were they in control. * * *

Under section 239(a), Bevenue Act of 1926, printed in the margin, and article 622, above quoted, 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 1925. 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 and the second period covering from the time when trustees in liquidation took charge to the end of the calendar year.

In O. D. 821, C. B. 4, p. 279, 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.
* * * * * * >fs
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 saíne 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. II-2, p. 210.

The above citations are in conformity with the applicable statutes, we think, and hence we hold in favor of petitioners on Issue No. 2.

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.

In Docket No. 43306 it was stipulated:

If it is determined by the Board of Tax Appeals that the Smith Securities Company was liquidated and all of its assets distributed to its stockholders in 1925, then the deficiency determined by the respondent in Docket No. 43306 is correct.
If it is determined by the Board of Tax Appeals that the Smith Securities Company was not liquidated nor all of its assets distributed to its stockholders in 1925, then there is no deficiency due in said appeal filed under Docket No. 43306.

Since we have held that the Smith Securities Company was not completely liquidated in 1925, we hold, in conformity with the foregoing stipulation, that there is no deficiency in Docket No. 43306.

Reviewed by the Board.

In Docket No. 43306 decision will be entered for the petitioner. In Docket Nos. ¿¡3300, 43301, 43302, wnd 43305 decision will be entered under Rule 50.

       Sec. 239. (a) Every corporation subject to taxation under this title shall make a return, stating specifically the items of its gross income and the deductions and credits allowed by this title. * * * In cases where receivers, trustees in bankruptcy, or assignees are operating the property or business of corporations, such receivers, trustees, or assignees shall make returns for such corporations in the same manner and form as corporations are required to make returns. Any tax due on the basis of such returns mad.e by receivers, trustees, or assignees shall be. collected in the-same manner as if collected from the corporation of whose business Or property they have custody and control.


text:
    Mabel A. Ashforth, H. Adams Ashforth, Albert B. Ashforth, Jr., and George T. Ashforth, Executors, Estate of Albert B. Ashforth, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 47190, 48009, 49354.
    Promulgated October 12, 1932.

      Paul L. Peyton, Esq., for the petitioners.

      O. G. Holmes, Esq., for the respondent.
   OPINION.

Smith :

The respondent has taxed the income of the trust property to the decedent under section 219 (g) of the 1926 Act, which is as follows:

Where the grantor of a trust has, at any time during the taxable year, either alone or in conjunction with any person not a beneficiary of the trust, the power to revest in himself title to any part of the corpus of the trust, then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor.

The petitioners contend that the terms of the trust agreement prevented the decedent from revesting in himself title to any part of the corpus of the trust at any time within the taxable year, since in order to do so he must give formal notice of such intention to the trustees prior to the beginning of the taxable year, or within the “ first fifteen days in December in the calendar year next preceding such contemplated revocation.” The respondent argues that this requirement of the trust agreement did not render the trust irrevocable within the taxable year.

The above provision of the statute was new in the Revenue Act of 1924, the legislative history of which indicates that the grantor’s “ power to revest in himself title to any part of the corpus of the trust ” was limited to the existence of that power “ at any time during the taxable year,” and further that the limitation was a material consideration in determining the taxability of the income from the trust.

As originally written, section 219 (g) made the income taxable to the grantor where he “reserved a power of revocation which, if exercised, would revest in him title to the corpus of the trust.” Committee Prints Nos. 1 and 2, H. R. 6715. The Senate rewrote this provision, except for the descriptive phrase “ not a beneficiary of the trust ” following the word “ person,” which was added by the Conference Committee on this bill. See Committee Print No. 3, Senate Amendment No. 62, and Committee Print Agreed in Conference. In the Senate Finance Committee Report No. 398, 68th Cong., 1st sess., is the explanation of this new provision of the statute and the Senate’s change in the House proposal, as follows:

(2) Paragraph (g) of this section provides that where the grantor of a trust reserves the right to change the trust in favor of himself the income is taxed to the grantor. The subdivision of the House bill has been rewritten in order that there shall not be taxed to the grantor the income of a trust as to which the grantor has a power of revocation subject, however, to a condition which has not happened.
The creation of a revocable trust constitutes nothing but an assignment of the right to receive future income. Since such an assignment does not operate to increase [sic — decrease] the taxable income of the assignor, the creation of a revocable trust should not so operate, but the income of such a trust should be included in the income of the grantor. The bill so provides.

In construing this provision, of the statute, the District Court for the District of Massachusetts, in Lewis v. White, 56 Fed. (2d) 390, reviewed its legislative history and said:

These proceedings indicate that the words “ at any time during the taxable year” were inserted for a definite purpose. They limited the application of the statute to those cases where the grantor had reserved in the trust agreement an unconditional power by the exercise of which during any taxable year he could control or appropriate the income derived from the trust during that year and which was payable to another. According to the section, as originally proposed, the mere reservation of the power of revocation was sufficient to render the income from the trust taxable to the grantor, and it was deemed wise to add provisions excepting from the operation of the law income of a trust as to which the grantor’s power of revocation was subject to a condition that had not happened. It is this power to reach and apply the income at the grantor’s option that renders it subject to the tax, regardless of whether or not he exercised the power. It was the reservation of this power, control, or “ command over the property taxed ” that was advanced in Corliss v. Bowers, supra, as adequate grounds upon which to base the constitutionality of section 219 (g).
The scope of the statute, as the Commissioner construed it, would be as wide as the scope of the section originally proposed by the House. Under such a construction it would make no difference when the power of revocation could be exercised, whether during the taxable year or prior to the taxable year; if the power of revocation is there, it is sufficient. To accept this interpretation of the act is to impart no significance whatever to the words of limitation introduced into the law by the Senate amendment.

The provision was held constitutional in Corliss v. Bowers, 281 U. S. 376, and the income of the trust involved in that case and the one in Clapp v. Heiner, 34 Fed. (2d) 506; aff'd., 51 Fed. (2d) 224, taxed to the grantors because the revocation in each case was capable of consummation during the taxable year. Those cases are thus distinguishable from the instant proceedings, in which the power of revocation was conditioned upon notification in the preceding taxable year. In Lewis v. White, supra, the trust instrument could be revoked on or after January 1 in any year “ only upon condition that and provided the Trustor shall in the preceding calendar year have notified in writing the trustees of his intention so to revoke, alter and/or amend this instrument.” The court there held that the grantor could not during the taxable year “ by any amendment or revocation, revest in himself title to any part of the corpus of the trust ” and the income thereof was not taxable to him.

The petitioners’ contention is sustained. The income of the trust here involved should not be taxed to the grantor, who, although reserving the power of revocation, subjected that power to a condition, to wit, notification to the trustees “ during the first 15 days of December in the calendar year next preceding such contemplated revocation,” which has not happened. After the beginning of each of the taxable years under consideration, the decedent having failed to notify the trustees of an intention to revoke or change the trust within either taxable year, the income was not subject to his “ unfettered command” and he was not free to enjoy it during the taxable year. This holding is consistent with the decisions in Corliss v. Bowers, supra; Claff v. Heiner, supra; and fully supported by Lewis v. White, supra. Elida B. Langley, 24 B. T. A. 1156, holds to the contrary, although the facts are not distinguishable. That case erroneously disregarded the condition of notice, which if not given we believe is the “ condition which has not happened ” and the kind that makes the income not taxable to the grantor. That case is therefore overruled.

Reviewed by the Board.

Judgment will be entered under Rule 50.


author: Murdock:

text:
    W. P. Brown & Sons Lumber Company, and Brown Realty Company, Petitioners, v. Commissioner of Internal Revenue, Respondent. Brown Brothers Land & Lumber Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 39970, 39971.
    Promulgated October 12, 1932.

      W. W. Spalding, Esq., for the petitioners.

      J. A. Lyons, Esq,, for the respondent.
   OPINION.

Murdock:

No evidence was offered in explanation of the incorporation expenses, amounting to $507, or the title examination and recording, amounting to $341. Apparently the Brown Realty Company was incorporated in the fall of 1922. Expenses incident to incorporation are not deductible as ordinary and necessary expenses of carrying on a business in any one year, but are capital expenditures relating to the entire period of corporate life. The cost of title examination and recording of a deed to the hotel property, if that is what the other item represents, is a part of the cost of the property and is not deductible as an ordinary expense of the year paid.

In 1922, the year for which the attorney was paid $1,500 by the Brown Realty Company, the company was carrying on no business that we know of in which it used the services of this attorney. Instead, it was building a hotel so that later it could carry on a business. All of the services of the attorney related to the construction of this building and perhaps to the organization of the corporation. He may also have had something to do with the loan secured by a bond issue maturing over 20 years, although the testimony is not clear on this point. The cost of legal services incident to the erection of the building is properly a part of the cost of the building. Those incident to organization should likewise be capitalized. Expenses of a loan should be spread over the life of the loan. So under no circumstances appearing in the record would this fee be deductible in its entirety in 1922. In fact, we can not say that any part of it should be deducted for that year. The Commissioner did not err in this respect.

The insurance premium mentioned in the second assignment of error, of course, added nothing to the value of the building, but such insurance is certainly not unusual in the construction of a building of the size of this hotel. If the petitioner were claiming it as part of the cost of the hotel, what defense would there be to the claim? It had no relation to any business carried on by the petitioner during the year 1922. It was properly treated by the Commissioner as a part of the cost. Cf. Columbia Theatre Co., 3 B. T. A. 622.

The $10,000 expense of the bond issue was a part of the cost of securing the loan, a continuing benefit, and not an ordinary and necessary expense attributable to carrying on the business in any one year. The Commissioner spread this expense ratably over the life of the loan. No greater amount was deductible in the year before us than the Commissioner has allowed. Julia Stow Lovejoy, 18 B. T. A. 1179; Sigmund Spitzer, 23 B. T. A. 776.

In our findings of fact we have listed the various items totaling $59,479.18 which the petitioner claims were incident to speeding the completion of the building. We have also explained the nature of each item as fully as the evidence permitted. For some items the record contains no explanation. In many instances the explanation fails to identify the item with the speeding-up process. While in others the expenditure is shown to have had no connection with this process. On any theory of the case such items may not be deducted from income of one year but must be left where the Commissioner placed them, as part of the cost of the building.

Decision of the question of whether or not an expenditure should be classified as capital or expense depends upon the exercise of judgment in the light of circumstances and good accounting principles. Cf. Rankin v. Commissioner, 60 Fed. (2d) 76. There are in the list before us a number of relatively small items which under other circumstances might form the basis of a deduction as ordinary expenses or losses. But where, as here, they were incurred in the ordinary course of erecting a building which was to become the principal business asset of the corporation, they should be included in the cost of the building. Liability insurance, loss of small tools, wages of watchmen necessary during the construction period, and telephone and telegram expense incident to construction, are some of the items we have in mind.

There are some items in the list, however, which were definitely and solely related to expedition in the completion of the building. This group would include the first three items representing the “ overtime ” paid by the Brown Realty Company. The company had contracted for the performance of certain work at a’ certain price based upon an 8-liour working day. In order to hasten this work the Brown Realty Company agreed to pay the contractor the difference between the amount charged by the workmen for working overtime and the amount they would have charged had the same hours been spent during a normal working day. Obviously, the amounts thus paid benefited the owner in only one way, i. e., they permitted the building to be occupied and used at an earlier date than otherwise. Likewise, items 4 and 5 fall within this group. The contracts there fixed certain times for the completion of certain work, with penalties for delay and bonuses for days saved. In both instances bonuses were earned, so that the owner paid something for speed over what it would have paid had the work progressed only as rapidly as the parties had agreed was a normal rate. The only difference is that here the normal depends upon the agreement of the parties, whereas the union wage scale fixed the normal and overtime wages from which the first three items were determined. The furniture storage charge and at least a part of the drayage would also come within this group.

The cost of electric light (poles, current, and bulbs) incident to overtime work would be a similar expenditure. But the amount thus spent can not be determined from this record. The poles were for excavation, not for wrecking. We do not know that the excavating was rushed on an overtime basis, nor that it cost in all more than a normal amount. The items for light and bulbs included light for the temporary sidewalk and canopy, light for the advertising signs, and perhaps some normal charges for light in the building. These items can not be charged entirely to overtime work. Nor is there any basis in the record for a segregation. We can not see that the excess of union over nonunion wages for hodcarriers bears any relation to the speeding-up process. Originally, the cheaper nonunion labor was employed and the owner and contractor thought they could continue to use it. The other workmen insisted later upon the employment of union labor to perform these functions. This entailed additional cost which the owner had to pay, but it did not hasten completion of the work. The building cost just that much more than it would have cost had they been able to use nonunion labor. Suppose all wages had increased, would the increase be other than cost of the building or have any relation to time of completion? Item 37, the cost of erecting temporary signs leased for profit, is no part of the cost of the building, but an expense incident to earning some income in 1923. It was a proper deduction in that year. The other items are so clearly unrelated to the time element or are so inadequately explained as to require no particular discussion.

The petitioner contends that the overtime, bonus and storage items, which were expended solely for the purpose of advancing the day when the hotel could be used to produce income, should be offset as deductions against the earnings from the hotel for the initial period of use made possible by those expenditures, i. e., the last three months of 1923 and the first two months of 1924. The latter months are not before us and our question is whether any portion of- these expenditures should be offset against the earnings of the last three months of 1923 as ordinary and necessary expenses of carrying on the business during these months or as a measure of extraordinary depreciation during this period. It does not appear, however, that any extraordinary depreciation or exhaustion of the property took place during this period and there is no basis for a deduction under section 234 (a) (7), unless a rule should be applied such as is used to justify spreading the cost of a loan over the period that the borrower has the use of the money.

In O. D. 664, 3 C. B. 131, a bonus paid for early delivery of a steamship was held to be an ordinary and necessary expense deductible from income received between the date of delivery and the date it would have been delivered had no bonus been paid. The Commissioner has taken a different view, however, in the present case, which involves a new building instead of a vessel. Cf. Tonningsen v. Commissioner, 60 Fed. (2d) 199. The petitioner also cites two decisions of the Circuit Court of Appeals for the Third Circuit. Atwater Kent Mfg. Co. v. Commissioner, 43 Fed. (2d) 331, and Frank & Seder Co. v. Commissioner, 44 Fed. (2d) 147. These two cases reversed Board decisions reported at 15 B.T.A. 881, and 13 B.T.A. 1, respectively.

Arguments advanced in support of the petitioner’s contention are not without persuasive force. But we must interpret the law as we find it and can not make exceptions, no matter how reasonable they may appear to be. The general rule is that the cost of capital assets is to be recovered through depreciation during use. Section 215 (a) (2) of the Revenue Act of 1921 provides that no deduction shall be allowed in any case in respect of “ any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate.” Section 235 makes this provision applicable in computing the net income of corporations. The amounts in question were paid out for new buildings. It is immaterial that they did not increase the value of the property in the sense of making the building a better building than it would have been otherwise. The phrase “ made to increase the value of any property or estate” modifies “permanent improvements or better-ments ” and can not modify “ new buildings ” without violence to grammatical construction and without giving to the' words other than their ordinary meaning. It would be both unusual and awkward to speak of “ new buildings made to increase the value of any property or estate,” but quite proper to speak of “ permanent improvements or betterments made to increase the value of any property or estate.” The words “ or for ” after “ new buildings ” indicate clearly that the latter only was intended. Thus the statute specifically and clearly provides that the income may not be reduced by the amount in question. Cf. Robert Buedingen, 6 B. T. A. 335.

Judgment will be entered under Riile 60.


author: TRAmmell :

text:
    The Hub, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 46298, 46991, 64276.
    Promulgated October 12, 1932.

      11. A. Mihills, C. P. A., for the petitioner.

      Owen W. Swecker, Esq., for the respondent.
   OPINION.

TRAmmell :

These proceedings, duly consolidated for hearing, are for the redetermination of deficiencies in income tax for the fiscal years ended January 31, 1927, 1928, and 1929, in the amounts of $37.12, $601.87, and $1,004.69, respectively. The sole error alleged in each case is the disallowance by the respondent, as a deduction from gross income, of a payment made by the petitioner on its subscription to the capital stock of the Ohio Valley Industrial Corporation.

The petitioner is a West Virginia corporation, with its principal office at Wheeling, and for 25 years has been engaged in the ready-to-wear clothing business for men, women and children.

Wheeling is located in an iron and coal district, and some |ten years prior to the taxable years there began a continued decline in the sales of all classes of business in that district, due primarily to the fact that several large steel plants'were moved from the Wheeling district to Gary, Indiana. As an accompanying result the bituminous coal industry was adversely affected and a large number of men thrown out of employment, which materially reduced the pay rolls of the Eastern Ohio District contiguous to Wheeling and from which it drew business amounting to about fifty million dollars annually. Also, the'steel industries remaining in the district reduced production and employment. The decline in pay-roll volume after 1921 amounted to about 50 per cent. All merchants in the district suffered approximately the same decline.

This situation brought about cooperative action by the larger retail dealers of Wheeling, including the petitioner. Meetings were held with a view to devising the most suitable plan for bringing new and varied industry into the Wheeling District. Finally it was decided to form for that purpose a nonprofit corporation, to be known as the Ohio Valley Industrial Corporation, with a subscribed capital of $1,000,000, payable in annual installments over a period of 10 years. The capital was oversubscribed to the extent of about $180,000 and the corporation was organized, its charter being granted by the State of West Virginia on April 1, 1926. It is exempt from state, county, and city taxes, and paid on charter fee.

The principal purposes for which said industrial corporation was formed are stated in its charter as follows: “To rehabilitate and otherwise assist manufacturing plants that deserve financial and other assistance” within the Wheeling District; to assist in locating additional manufacturing plants in said territory and to assist in increasing and bettering of manufacturing plants already operating therein; and generally to authorize and conduct “ such traveling, research, comparative statistics and other study as may be deemed proper to carry the foregoing objects into effect.” The charter further declares that, “ This corporation is not organized for personal gain, but only as a civic undertaking, and there shall never be any dividends declared from profits, and all profits accruing shall be placed in a surplus fund for the objects and purposes of the Corporation.”

The purposes of the corporation have been accomplished to a considerable extent. Conditions in Wheeling have been improved, due to the fact that opportunities for employment have been increased. Some six or seven hundred men have been employed through the operations of the industrial corporation, and the effect of such enlarged pay rolls has been reflected in the increased sales of the petitioner.

The petitioner subscribed for $50,000 of the stock of the corporation, and has paid in something in excess of $22,000 to date, the balance of the subscription being subject to call of the corporation. During the fiscal years ended January 31, 1921, 1928, and 1929, the petitioner paid on its stock subscription the amounts of $1,500, $4,500, and $5,500, respectively, which amounts were charged off as expense and deducted in reporting taxable income. The deductions were disallowed by the respondent in computing the deficiencies in controversy.

The question of the allowance of expense deductions in computing taxable income of corporations has been considered by us in numerous cases arising under widely varying facts. In Eitingon-Behild Co. et al., 21 B. T. A. 1163 (p. 1116 et seq.), we reviewed briefly some of our prior decisions on this subject, as well as decisions of the courts, and stated the rule to be that an expenditure “ is deductible as a business expense when, and only when, it bears some reasonable relation to the conduct of the corporation’s business.”

In American Rolling Mill Co., 41 Fed. (2d) 314, the United States Circuit Court of Appeals for the Sixth Circuit held that a contribution by a taxpayer corporation to a civic improvement fund was properly deductible as a business expense, saying:

- The question always is whether balancing the outlay against the benefits to be reasonably expected, the business interest of the taxpayer will be advanced. * * * •
We cannot accept the contention that to permit the petitioner to' make this contribution would give to a corporation the right to make donations to charity which is given exclusively to individuals * * *. The contention overlooks the fact that the contribution was not a philanthropy, but was a business expenditure to be reflected in increased earnings.

In the present case the claimed deductions, in our opinion, quite clearly come within the two rules above set forth, which in essential substance are the same. The expenditures of this petitioner, while they represented installment payments made on its subscription for the capital stock of the industrial corporation, did not in any proper sense constitute an investment in a capital asset, since they were made without hope of any return in the form of dividends either from profits or in liquidation. The petitioner plainly was actuated by the motive of business gain, a reasonable expectation that the plan of operation when put into effect would result in an increase of its own sales and thus an increase of profits. That expectation was justified by subsequent events. Certainly these expenditures can not fairly be said to be donations to charity, and that they bore a reasonable relation to the conduct of the petitioner’s business, we think is too obvious to require argument.

In Emery, Bird, Thayer Dry Goods Co., 20 B. T. A. 796, we held that the amounts paid by the petitioner to the Kansas City Chamber of Commerce on account of subscriptions and membership dues were deductible from gross income as ordinary and necessary expenses. The purpose of the contributions to the chamber of commerce in that case was identical with the purpose of the petitioner herein in subscribing to the stock of the industrial corporation. There we said: “ The evidence is pursuasive and convincing that such memberships and the subscriptions and dues paid on account .thereof were intended to and did materially increase the volume of the petitioner’s business.” The only substantial difference between the facts of that case and those of the instant case lies in the form of the instrumentality selected to effect the result desired, and such difference, we think, has no material bearing on the question of the-allowance of the expenditures as expense deductions.

Again, in Matson Navigation Co., 24 B. T. A. 14, we considered substantially the same problem as is here involved, and held that a payment of $2,500 made by the petitioner to Californians, Inc., a nonprofit cooperative advertising agency, was deductible as a business expense. In that case, as here, the instrumentality was in corporate form, but to that fact we attributed, no significance. In our opinion we said:

We are convinced that petitioner’s contribution was motivated primarily by business consideration; that it received definite tangible advantages therefrom; and that it was by every test a proper business expense. Hirsch-Weis Manufacturing Co., 14 B. T. A. 796.

The action of the respondent herein is reversed. The deficiencies will be redetermined accordingly.

Judgment will be entered wider Rule 50.


author: Smith:

text:
    Estate of Richard B. Turner, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 53554.
    Promulgated October 14, 1932.

      James G. Peaeoch, Esq., for the petitioner.

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

Smith:

It is the contention of'the petitioner in this proceeding that, since it was the intention of the decedent to retain 1,200 shares of the United Gas Improvement Company stock as an investment, and that intention was understood by his associates who gave the orders to purchase and sell the stock and by an employee of the brokerage concern, it must be assumed that the 1,300 shares that were sold by the broker in 1928 represented the 300 shares received as a stock dividend and in addition the 1,000 shares purchased by the decedent on June 8, 1928. The respondent rejected such contention, in accordance with article 58 of Regulations 74, which provides, so far as material, as follows:

Sale of stoolc and rights. — When shares of stock in a corporation are sold from lots purchased at- different dates and at different prices and the identity of the- lots can not be determined, the stock sold shall be charged against the earliest purchases of such stock. The excess of the amount realized on the sale from the cost or other basis of the stock will constitute gain. In the case of stock in respect of which any stock dividend was paid, -the basis for determining gain or loss from a sale of a share of such stock shall be ascertained in accordance with the principles laid down in article 600. * * *

The evidence indicates that the decedent in the case at. bar assumed that when he purchased shares of stock on margin a certificate for a given number of shares was acquired by him and retained by the broker. When the respondent first claimed that the decedent owed an additional tax for 1928, he, through his attorney, went to the broker’s office to ascertain what certificates of stock were carried to the credit of the decedent and what certificates were actually sold for him in 1928. He learned that no certificates were earmarked for the decedent on the broker’s books of account and that the broker could not advise him as to any specific certificate for the shares of stock that were purchased for him in the years 1926 and 1928. The character of the transaction is stated by the Circuit Court of Appeals for the Third Circuit in Snyder v. Commissioner, 54 Fed. (2d) 57, in the following language:

* * * The evidence of the transaction and of the customer’s ownership is merely a hook entry of a debit of the shares purchased against a credit of the margin paid. The shares are commingled with perhaps many thousand held by the broker for other customers, subject always to be hypothecated by him in raising the difference in money between the customer’s margin and the purchase price of the shares, which of course the broker must pay in order to get a certificate. The shares are not delivered or earmarked or allocated to the customer even on the books.

The facts in the case referred to above are substantially the same as those which obtain in the proceeding at bar. In that opinion the court affirmed the decision of the Board in John A. Snyder, 20 B. T. A. 778. See also Skinner v. Eaton, 34 Fed. (2d) 575; aff'd. 45 Fed. (2d) 568; certiorari denied, 283 U. S. 814.

The contention of the petitioner, that article 58 of Regulations 74 does not apply to the facts in this case and that if it does to that extent it is unreasonable and invalid, is sufficiently answered by the decisions above referred to.

The petitioner makes the further contention that if the shares sold can not be identified, then under the general principles of law there was no profit on sales of these shares until the entire capital investment therein had been recovered. Petitioner relies upon Burnet v. Logan, 283 U. S. 404. In our opinion there is no merit for such a contention. Manifestly, shares of stock represent divisible interests in a corporation, and where a person sells one or more of a lot of shares owned he may sustain a gain or loss in respect of that transaction.

Judgment will he entered for the respondent.


author: Goodrich :

text:
    Gustave Anderson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 36224.
    Promulgated October 18, 1932.
    . Marvin Farrington, Esq., for the petitioner.

      L. W. Greason, Esq., for the respondent.
   OPINION.

Goodrich :

In this proceeding petitioner assails respondent’s determination of a deficiency of $205.53 in income tax for the year 1924. The sole question at issue is whether the Commissioner erred in determining the basis he used in computing the gain realized by petitioner upon the maturity of a life insurance contract entered into prior to and maturing subsequent to March 1, 1913.

Petitioner is an individual, residing at 2309 Clermont Street, Denver, Colorado.

On May 24, 1904, the petitioner, who was then 32 years of age, took out a life insurance policy, which is in evidence and incorporated herein by reference. Under the terms of this policy the petitioner agreed to pay an annual premium of $206.88 for 20 years, and the company agreed to pay to his estate or beneficiary the sum of $4,000 if he died during that period and the policy was still in force, or to pay to him, if living, at the end of the 20-year period, the sum of $4,000. The policy also provided that if the petitioner was living, and the policy still in force on May 18, 1924, when it matured the company would pay to the petitioner a cash dividend, consisting of the policy’s full share of surplus profits, and that “ until said date no dividend shall be apportioned to this policy.”

On this policy the petitioner paid 20 annual premiums of $206.88, or a total of $4,13T.60. The premiums paid to March 1, 1913, amounted to $1,861.92, and the premiums paid from March 1,1913, to the maturity of the policy amounted to $2,275.68.

The reserve value of the policy during the policy year which included March 1,1913, was $1,439. The cash surrender value of the policy as of March 1,1913, was $1,139.68.

At maturity of the policy petitioner was living, and received from the company $5,369, or $1,231.40 in excess of the total premiums paid. In his income-tax return for the year 1924 the petitioner included this amount as a dividend subject only to surtax.

Respondent determined that the value of the policy as at March 1, 1913, was $1,152; that the cost of insurance protection, subsequent to March 1, 1913, was $1,142.68; and that there was a total gain to the petitioner on maturity of $3,084, of which $1,369 was subject to surtax only, and of which $1,715 was subject to both normal tax and surtax. From this determination arises the deficiency herein.

Respondent, in making his computation, has followed the method of determining the capital value of this policy as of March 1, 1913, as outlined in E. A. Armstrong, 1 B. T. A. 296. We there held that the capital value of a policy at March 1, 1913, was its realizable value at that time; that is, its then cash surrender value plus any accumulated dividends or excess premiums which had been credited to the insured in such a way that he could have realized them had he then disposed of the policy. However, the Supreme Court in Lucas v. Alexander, 279 U. S. 573, held that the fair value of a policy on the basic date is not necessarily what might then have been realized upon it by a forced liquidation, but that the amount of the reserve set aside by the insurance company to meet its liability during the policy year which included March 1, 1913, plus dividend accumulations provisionally apportioned to the policy as of that date, constitutes the capital value of the policy to the insured at that time where, as in the instant case, it exceeds the realizable value. The rule of the Armstrong case, therefore, must be modified to conform to the decision of the Supreme Court.

Based upon the American Experience Tables, which the parties agreed might be considered as evidence herein, we determine that the company’s reserve in the policy, year including March 1, 1913, for the policy here involved was $1,439, which is more than its cash surrender value on that date. That amount should be used in the computation rather than $1,152, as determined by respondent. Under the rule of Lucas v. Alexander, supra, to that amount might be added the dividends, if any, accumulated to March 1,1913, and provisionally apportioned to the policy. While respondent has not included in his determination of capital value any amount for dividends, petitioner has furnished no proof that there were such dividend accumulations to be apportioned under this policy, or, if there were, the amount thereof. Nor has petitioner proved to be erroneous respondent’s determination of the cost of insurance protection and of the amount of petitioner’s gain on the policy subject to surtax only. Perforce we must adopt respondent’s determinations except; as to the March 1, 1913, value of the policy, which we change by substituting the amount of the company’s reserve for the policy at that time, in accordance with Lucas v. Alexander, supra, Cf. Keystone Consolidated Publishing Co., 26 B. T. A. 1210.

Judgment will be entered wider Rule 50.


author: Goodeich :

text:
    Keystone Consolidated Publishing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 46311.
    Promulgated October 18, 1932.

      Frederick Schwertn&r, Esq., and J. K. Lasser, O. P. A., for the petitioner.

      W. R. Lamsford, Esq., for the respoondent.
   OPINION.

Goodeich :

Petitioner contests a deficiency in income taxes for the calendar year 1926 of $944.05. The sole issue involved is whether the excess of premiums paid on life insurance policies carried by a corporation on its officers (who were also stockholders) over the amount received from sale of the policies in 1926 is deductible from income as a loss sustained by the corporation.

Petitioner is a corporation, having its principal office at Tenth Avenue and 36th Street, New York City.

The parties, by counsel, have stipulated the facts as follows:

The petitioner took out insurance policies on the following officers in the following years and for the amounts stated:
The said officers were stockholders of the petitioner, and the said petitioner was named as the beneficiary under the policies to protect it against loss in the event of their death.
Premiums were paid by the petitioner during the years set forth below in the amounts stated:
1917. $280.00 1923_ $1, 831.40
1918. 280. 00 1924_ 1, 727.43
1919. 240. 00 1925_ 2, 301. 60
1920. 280. 00 1926_ 305. 59
1921. 1, 851.40
1922. 1, 851. 40 Total_$10, 948. 82
These premiums were charged to expense on the petitioner’s boohs, and were not deducted in its federal income tax returns for the years in which paid.
As of January 1, 1926, a sum of $3,650.55 was carried on petitioner’s books as “ cash value life insurance,” which represented the then cash surrender value of the above listed policies.
On June 30, 1926, the petitioner sold the life insurance policies carried on its several officers to these officers for an aggregate sum of $3,825.36, which was the cash surrender value of the policies at that time.

The excess of the premiums paid over the amount received upon sale of the policies, $7,128.56, petitioner claimed as a deduction from income for 1926. Respondent disallowed that deduction and from that action arises the deficiency herein.

It is petitioner’s contention that the item of $7,123.56 is deductible either as a loss incurred in trade or business under section 214 (a) (4) of the Revenue Act of 1926, or as a loss sustained upon sale of property under section 204 (a) of the same act. Without passing upon petitioner’s right to the deduction upon either ground, we sustain respondent for the reason that petitioner has failed to prove any loss. It is clear that its loss, if any, must be measured by the difference between the cost of the property sold and the selling price (section 204 (a), Revenue Act of 1926). Petitioner acquired the property which it later sold to the insured stockholders through the payment of premiums, but the total premiums paid did not represent the cost of the capital asset, as petitioner contends. To so hold would be to disregard the element of insurance protection in the period prior to the sale, the benefit of which accrued to petitioner.

In Stadard Brewing Co., 6 B. T. A. 980, we considered this identical issue arising upon similar facts (except that there the policies were surrendered while here they were sold at cash surrender value) and that decision is determinative of the case at bar. We there said:

To the extent that the premiums paid by the petitioner created in it a right to a surrender value, they constituted a capital investment. To the extent they exceeded the surrender value, they constituted payment for earned insurance and were current expenses. Appeal of E. A. Armstrong, 1 B. T. A. 296. The surrender value of the policy was the measure of the investment and upon the surrender there was no capital lost.

Petitioner urges that our conclusion in Standard Brewing Co. is inconsistent with the decision of the Supreme Court in Lucas v. Alexander, 279 U. S. 573. With that view we disagree. In the Lucas case it was necessary to determine the fair market value as of March 1, 1913, of certain endowment policies paid up prior to that date and maturing subsequent thereto, for the purpose of determining the profit derived by the insured upon his investment when, at maturity, the principal amounts of the policies, together with accumulated dividends, were paid to him. It was held that such profit was taxable as income. The trial court determined the basis by discounting to present value the amount which the insured might reasonably anticipate he would receive at maturity of the policy. The Supreme Court pointed out that, since the events had occurred, the basis should have been determined upon actual figures of values and annual accretions rather than upon approximations thereof and, further, that in determining the basis the policy owner was not limited to the realizable value, consisting of the cash surrender or loan value of the policy as of March 1, 1913, plus dividends then collectible, but that the amount of reserve established by the company for the policy year including that date, if greater, might be used for that purpose, adding thereto the dividend accumulations provisionally apportioned to the policy. Because of the provisions of the Revenue Act of 1918 (section 202 (a) (1)) the question of the cost of the capital asset was not before the court, but only the fair market value thereof as of March 1,1913, and therefore the principles pronounced are not applicable to a situation (obtaining in both the Standard case and the proceeding now before us) where the policies were issued subsequent to 1913 and were sold or surrendered in a period when the statute required that the basis for determining gain or loss upon disposal of a capital asset be the cost thereof.

For that reason we respectfully disagree with the decision in Forbes Lithograph Mfg. Co. v. White, 42 Fed. (2d) 287, cited by petitioner in support of his position, where, under facts similar to the case at bar (although there the policies were surrendered) plaintiff was allowed as a deductible loss the excess of the premiums paid over the amount received upon termination of its ownership of the policies. The learned judge deemed it unnecessary to consider the exact nature of premium payments on policies issued and held under the circumstances set out because, he says:

In Lucas v. Alexander, 279 U. S. 573, the principle is adopted of setting up such an account by taking the total amount paid in on one side, and the total amount received when the transaction is closed out on the other side.

In our opinion no such rule can be deduced from the Supreme Court’s decision in the Lucas case and certainly, for the reasons above stated, if deduced, it is not applicable to this case; nor do we agree that in cases such as this, where the policies are issued, after 1913 and their cost must be used as the basis for determining gain or loss upon their subsequent disposal, it is unnecessary to consider the nature of the premium payments. Only a part of those premiums went toward the purchase of a capital asset; the balance was expended for insurance protection, which entails a recurring, nondeductible expense. The division of such payments between these purposes is a matter of proof and upon it depends the ascertainment of the cost of the investment made by the insured and the loss resulting (leaving aside the issue of its deductibility) from the surrender or sale of the policies.

In this proceeding the only proof we have is that a part of the premiums paid purchased a capital asset represented by the surrender values of the policies, amounting to $3,815.36. At that amount the policies were sold, so no loss resulted from the sale. So far as this record discloses, the balance of the premiums went for insurance protection, of which petitioner had the benefit, which is not a capital asset, and can not constitute a loss. Cf. Gustave Anderson, 26 B. T. A. 1208.

Judgment will be entered for the respondent.