author: Black :

text:
    Fanny M. Dravo and Fidelity Trust Company, Surviving Executors of the Will of Francis R. Dravo, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent. Jane M. Dravo, J. D. Berg, and L. A. Mertz, Executors of the Will of Ralph M. Dravo, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 88094, 89366.
    Promulgated July 27, 1939.

      Wm. 3. Moorhead, Esq., and Wm. F. Knox, Esq., for the petitioners.

      Ha/róld Allen, Esq., and Lewis T. Matlaeh, Esq., for the respondent.
   OPINION.

Black :

In Docket No. 88094 the respondent, under subdivision (c) of section 302 of the Eevenue Act of 1926, as amended, included $395,-000 in the decedent’s gross estate as a result of the transfer in trust made by Francis E. Dravo on January 17, 1931. In Docket No. 89366 the respondent, under subdivisions (c) and (d) of the same act, included $415,000 as a result of the transfer made by Ealph M. Dravo on January 15, 1931. In neither case has the respondent allowed any deduction under section 303 (a) (3) from the amounts thus included under section 302. Petitioners contend that no amount should have been so included under section 302 except the value of certain remainder interests of the Ealph M. Dravo trust and that, should any part payable to such charities as the respective settlors shall designate be held to be includable under section 302, then petitioners are entitled to a deduction in the same amount under section 303 (a) (3). First, we shall consider to what extent, if at all, the respective transfers are includable in the gross estates of the respective decedents.

At the time the two trusts were created in January 1931, the material provisions of section 302 of the Eevenue Act of 1926 were as follows:

Seo. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
(c) To the estent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * *
(d) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke, or where the decedent relinquished any such power in contemplation of his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * *

In applying subdivision (c) in his respective determinations, the respondent applied it not as it was originally enacted, but as it was later amended by Joint Resolution of March 3, 1931, Public 131, Seventy-first Congress, and by section 803 (a) of the Revenue Act of 1932. At the hearing the parties stipulated that neither of the transfers in question was made in contemplation of death. In so stipulating, the respondent, in each proceeding, reserved the right to contend for the application of subdivision (c), not as it was originally enacted in section 302, supra, but as it was later amended. It is now settled that these amendments to subdivision (c) apply only to transfers made after the dates of their respective adoption. Hassett v. Welch, 303 U. S. 303. They do not apply here. Subdivision (d) has been amended by section 401 of the Revenue Act of 1934 and by section 805 of the Revenue Act of 1936. The latter amendment is not applicable here, and the former amendment to the estent that it might be applicable is not material. The material provisions of the applicable statute are therefore subdivisions (c) and (d) of section 302 of the Revenue Act of 1926, supra, as they existed at the time the trusts in question were created.

In the statements attached to the deficiency notices the respondent gives two principal reasons for including the corpora of the two trusts of Francis and Ralph in their respective gross estates. The first is that the trusts were made in contemplation of death. Since it has been stipulated that such was not the fact, the respondent’s first reason requires no further discussion. The second principal reason is that, due to the simultaneous trusts created by Fanny and Jane, each decedent in effect retained during his lifetime the income from the property he transferred, and that such a retention of income brings his transfer within section 302 (c) of the Revenue Act of 1926, as amended by section 803 (a) of the Revenue Act of 1932. As pointed out in the previous paragraph, the amendments to subdivision (c) are not applicable here because of the fact that the trusts were created prior to March 3, 1931. Hassett v. Welch, supra. The retention or nonretention of income by the decedents in these proceedings is not a deciding factor. May v. Heiner, 281 U. S. 238. Therefore, assuming without deciding that the fact that Francis was made the life beneficiary of the trust created by his wife, Fanny, was equivalent under the circumstances to a reservation by Francis in his own trust of the income for life and that the same situation existed as to Ealph M. Dravo, such facts would not enable the Commissioner to prevail. Hassett v. Welch, supra. In the statement attached to the deficiency notice in Docket No. 89366 the respondent gives an additional reason for including a part of the corpus of Ealph’s trust in his gross estate. He says:

On the death of decedent and wife one-half of the common stock of the Dravo Corporation, however, not to exceed 20 percent of the total trust estate, is to be distributed to employees of the Dravo Corporation, 75 per cent of which is to go to the officers and employees certified to the trustees. Frank R. Dravo, decedent’s brother, predeceased decedent, therefore, from the date of the brother’s death up until the time of decedent’s death the decedent alone possessed the power to shift the economic benefit of the remainder interest amongst the employees due to the power the decedent had to certify who should share in the remainder interest. The cessation of this power brings this portion of the trust principal under Section 302 (d) of the Revenue Act of 1920.

If the remaining part of the corpus of Ealph’s trust and all or any part of the corpus of Francis’ trust are to be included in their respective gross estates, it must be for reasons other than those contained in the deficiency notices. Cf. Helvering v. Gowram, 302 U. S. 238. Petitioners contend that, with the possible exception of that part of the corpus of Ealph’s trust which went to those officers and employees of the Dravo Corporation as might be certified by Ealph alone after the death of his brother Francis and prior to the death of his wife, Jane, no part of the corpus of either trust is includable under either subdivision (c) or (d) of section 302, supra. Probably due to the death of respondent’s counsel, Harold Allen, no brief has been filed on behalf of the respondent.

Is any part of the corpora of the Francis E. Dravo trust and the Ealph M. Dravo trust includable in the respective gross estates of the decedents by reason of the provision contained in article second, section 1, of all four trusts, whereby the trustees could in their discretion advance portions of the principal of the wife’s trust to her husband and vice versa ? In Allan S. Lehman et al., Executors, 39 B. T. A. 17, we said:

It can not be questioned tbat the decedent gave to bis brother, Allan S. Lehman, the right to receive the income for life of the two trust estates created by him and a right to withdraw $150,000 from the principal of the trust estate during his life or until December 31,1935, in exchange for similar rights of the decedent in the trust estates created by Allan. Up to the date of his death the decedent had the power to bring into his own estate $150,000 of the corpora of the trusts created by Allan The right to make this withdrawal out of the reciprocal trusts created by Allan was the equivalent of a right in the decedent to withdraw that amount from the trust estates which he had created. This right had a value at the time of decedent’s death of $150,000. It was an interest in property “which ceased by reason of the death.” Edwards v. Slocum, supra. We are of the opinion that the respondent did not err in including the $150,000 in the gross estate of the decedent.

We do not think we have tbe same situation here as we had in the Lehman case. There the decedent gave his brother Allan the absolute and unconditional right to withdraw the $150,000 in exchange for similar rights of the decedent in the trust created by Allan. No such absolute and unconditional rights are present in the instant proceedings. Neither of the decedents here could withdraw any of the principal of his wife’s trust at his pleasure, nor could either wife withdraw any of the principal of her husband’s trust at her pleasure. Neither Francis nor Kalph ever received any part of the principal deposited under the deeds of their respective wives. Any payment of principal under article second, section 1, of any of the four trusts could be made only in discretion of the trustees, and if they abused this discretion they would render themselves liable to any remainderman whose interest would thereby be adversely affected. Cf. Higgins v. White, 93 Fed. (2d) 357. We hold that no part of the corpora of the four trusts is includable in the respective gross estates of the decedents by reason of the provision contained in article second, section 1, of all four trusts whereby the trustees could in their discretion advance portions of the principal of the wife’s trust to her husband and vice versa.

Is any part of the corpus of the Francis E. Dravo deed includable in the gross estate of Francis upon any ground ? That part representing the life estate in his wife, Fanny, took effect in possession and enjoyment at the time of the creation of the trust and no power was reserved to alter, amend, or revoke this life estate. It is not includable in the decedent’s gross estate. Reinecke v. Northern Trust Co., 278 U. S. 339. The trust deed provided that upon the death of Fanny the remainder was to be divided into three equal parts, designated as parts “A”, “B”, and “C”. All of the remainder interests designated as part “A” vested completely at the time of the creation of the trust, with no power reserved to alter, amend, or revoke, and should not be included in the gross estate. Reineehe v. Northern Trust Go., sufra. In Fawny M. Dravo et al., Executors, 34 B. T. A. 190, we had this identical trust deed before us in connection with the Commissioner’s determination that certain income of the trust was taxable to Francis for the year 1931 under section 167 of the Eevenue Act of 1928 rather than to the Francis E. Dravo trust. In the course of our opinion we said:

* * * Tbe disposition to be made of parts “A” and “B” shows clearly that none of the corpus of those parts, and consequently, no portion of the accumulated income included thereon, was distributable to Francis R. Dravo, nor could any action of bis change tbe conditions of the trust so as to make such corpus distributable to him.

Although it may well be that no action of Francis could change the conditions of the trust so as to make part “B” distributable to him, yet upon the death of both Fanny and Francis, the trustees were to divide the principal of part “B” among such charities as designated in the latest designation certified to the trustees by Francis before his death. We think that the enjoyment of all of part “B” was subject at the date of Francis’ death to a change through the exercise of a power by Francis alone to alter or amend, and that all of this remainder interest should be included in decedent’s gross estate under section 302 (d), supra. Cf. Porter v. Commissioner, 288 U. S. 436, the leading case with respect to section 302 (d). The parties have stipulated that the value of this remainder interest at the date of death of Francis was “not in excess of $86,922.” This remainder interest is a part of the entire fee which the respondent included at a value of $395,000. Petitioners do not claim nor have they shown that the value of this remainder interest was any less than the amount of $86,922. In view of these circumstances, we hold that the amount of $86,922 should be included in the decedent’s gross estate in Docket No. 88094. Whether the entire amount thus included or any part thereof is deductible under section 303 (a) (3) of the Bevenue Act of 1926 is an issue to be considered later in this opinion.

As to the 75 percent of part “C” which went to those officers and employees of the Dravo companies “as shall be certified to the Trustees by Balph M. Dravo and/or Francis R. Dravo * * * At any time during the lifetime of Fanny M. Dravo”, we do not think anything should be included in decedent’s gross estate. It has been stipulated that the value of the remainder interest of the employees designated to receive 75 percent of part “C” was not in excess of $65,191.

While it is true that Francis had the right to file with the trustees up to the very moment of his death a list of the employees who were to participate under part “C” of his trust and alter, amend, or revoke the proportion which each was to receive, any designation which he might make under this reserved power was by no means final and conclusive as it was in the designation of charities under part “B” discussed above. If the power of designation to be made by Francis had been final and conclusive as to the 75 percent of part “C”, then undoubtedly Porter v. Commissioner, supra, would govern. In that case, the Supreme Court, among other things, said:

But tbe reservation bere may not be ignored for, while subject to the specified limitation, it made tbe settlor dominant in respect of other dispositions of both corpus and income. His death terminated that control, ended the possibility of any change by him, and was, in respect of title to the property in question, the source of valuable assurance passing from the dead to the living. That is the event on which Congress based the inclusion of property so transferred in the gross estate as a step in the calculation to ascertain the amount of what in Sect. 301 is called the net estate. Thus was reached what it reasonably might deem a substitute for testamentary disposition.

But in the instant case, the right of Francis to file with the trustees at any time before his death an altered, amended, or revised list of the employees who were to participate in 75 percent of part “C”, was not final and conclusive. He was not “dominant in respect of other dispositions of both corpus and income”, as said in the Porter case. Any alterations or amendments or revisions which Francis might make in the employees’ list might be completely changed after his death by his brother Ralph, who survived him. In view of these circumstances, it seems plain that the death of decedent, Francis, was not the source of valuable assurance of title passing from the dead to the living, for the reason that what he had done was subject to revision and was actually revised by Ralph M. Dravo after Francis’ death. Cf. Helvering v. St. Louis Union Trust Co., 296 U. S. 39. In the instant case, the power of Francis to control the ultimate disposition of the interest in question was entirely dependent upon whether he survived his brother, Ralph, an occurrence, as in the St. Louis Union Trust Co. case, which was entirely fortuitous so far as any control, design, or volition on his part was concerned. As in the St. Louis Union Trust Go. case, the death of Francis passed no interest to any of the beneficiaries of the remainder interest of 75 percent of part “C.” Cf. Frederick Davis Van Sicklen, 35 B. T. A. 306. On this issue involved in Docket No. 88094, we hold for the petitioner.

The case of Fanny M. Dravo et al., Executors, supra, in which we held that the income from part “C” was taxable to the settlor in 1931, while involving the same trust as here considered, is distinguishable because the section of the statute there involved was section 167 of the Revenue Act of 1928, involving “income for benefit of grantor”; whereas the section of the statute here involved is section 302 (d), involving estate tax.

As to the 25 percent of part “C” which went to the Dravo Management Co., if in existence, and, if not, to the Dravo Corporation, to be apportioned among the employees of either company, respectively, in such proportions and upon such terms as the respective board of directors should determine, we held in Fanny M. Dravo et al., Executors, supra, that, since “control by decedent of either or both of these corporations” was not contradicted, the income from this remaining 25 percent of part “C” should be taxed to the decedent for the same reason as was given for taxing the income from the 75 percent to the decedent. It has been stipulated in these proceedings that the Dravo Management Co. never came into existence and that at no time during tbeir respective lives did Francis or Ralph control the Dravo corporation. In view of this stipulation we are of the opinion and hold accordingly that the remainder interest represented by this 25 percent of part “C” took effect in possession and enjoyment at the time of the creation of the trust, with no power reserved to alter, amend, or revoke by either Francis R. Dravo or Ralph M. Dravo, and that it should not, therefore, be included in Francis’ gross estate. Reinecke v. Northern Trust Co., supra.

Is any part of the corpus of the Ralph M. Dravo deed includable in Ralph’s gross estate upon any ground ?

For the same reasons as given in the case of Francis above, we hold that the life estate in Ralph’s wife, Jane, the $5,000 remainder interest payable to Frank Pettit, 25 percent of the remainder interest specified in article second, section 4, of the trust deed, and all of the remainder interests specified in article second, sections 5, 6 and 7, of the trust deed should not be included in Ralph’s gross estate. On the other hand, we hold that the value at date of death of Ralph of the remainder interest mentioned in article second, section 2, of the trust deed which was distributable to officers and employees of the Dravo Corporation and the value at date of death of Ralph of 75 percent of the remainder interest specified in article second, section 4, of the trust deed, should be included in the decedent’s gross estate. It has been stipulated that the total value of the remainder interests referred to in the preceding sentence at the date of death of Ralph was “not in excess of $19,949.” These remainder interests are a part of the entire fee which the respondent included at a value of $415,000. Petitioners do not claim nor have they shown that the value of these remainder interests was any less than the amount of $19,949. In view of these circumstances, we hold that the amount of $19,949 should be included in the decedent’s gross estate in Docket No. 89366.

This is a different holding from that which we made as to the remainder interest of the employees in 75 percent of part “C” in the Francis R. Dravo trust. The reason for this different holding is that the situations are fundamentally different. At the time of the death of Ralph, Francis was dead and therefore, there was no one but Ralph himself who had the power to alter, amend, or revise the list of employees who were to participate in the remainder interest of this part of the Ralph M. Dravo trust. This right to alter, amend, or revise was absolute and “dominant” in Ralph as to 29,167 shares of Dravo Corporation stock at the túne of his death and ceased by reason of his death. This, we think, makes the case of Porter v. Commissioner, supra, clearly applicable. We understand petitioners’ brief to concede as much- But petitioners do not make the same concession with reference to the remainder interest covered by section 8 of article 2 of the Ralph M. Dravo trust. Petitioners contend that nothing is to be included in decedent’s gross estate as to this contingent remainder interest. On this point, we agree with petitioners.

The provisions of article second, section 8, of the Ralph M. Dravo deed, without repeating them in detail, are provisions which relate to a mere contingent remainder where decedent at the time of his death retained the right to designate the employees and the charities who were to receive the remainder interest in the event that Elizabeth Dravo Harlow died without issue. Whether Elizabeth would die without issue could not be foreseen at the time of decedent’s death. Nothing, we think, is required to be included in the decedent’s gross estate by reason of these provisions. Helvering v. St. Louis Union Trust Co., supra; Becker v. St. Louis Union Trust Co., 296 U. S. 48; Frederick Davis Van Sicklen et al., Executors, supra; Rothensies v. Cassell, 103 Fed. (2d) 834.

The only matter left for decision is whether the respondent erred in refusing to allow any deduction in Docket No. 88094, under section 303 (a) (3) of the Revenue Act of 1926, as amended by section 807 of the Revenue Act of 1932, by reason of article second, section 2 (b), of the Francis R. Dravo deed. The material provisions of the applicable statute, as amended, are:

Seo. 303. For the purpose of the tax the value of the net estate shall be determined—
(a) In the case of a resident, by deducting from the value of the gross estate—
(3) The amount of all bequests, legacies, devises, or transfers * * * to or for the use of any corporation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes * * *. If the taco imposed, by section SO t, or any estate, succession, legacy, or inheritance taxes, are, either by the terms of the will, l)y the law of the jurisdiction under which the estate is administered, or l)y the law of the jurisdiction imposing the particular tax, payable in whole or in part out of the bequests, legacies, or devices otherwise deductible under this paragraph, then the amount deductible under this paragraph shall be the amount of such bequests, legacies, or devises reduced by the amount of such taxes. The amount of the deduction under this paragraph for any transfer shall not exceed the value of the transferred property required to be included in the gross estate; and * * *. [Matter in italics was added by section 807 of the Revenue Act of 1932.]

On the same day that Francis created his trust and again on September 30, 1931, he, by virtue of article second, section 2 (b), designated Lehigh University, Valley Hospital, and St. Barnabas’ Free Home as the charities entitled to receive part “B” of the remainder after the death of himself and his wife. The parties have stipulated that these organizations were at the date of death of Francis and continue to be such charitable organizations as are referred to in section 303 (a) (3), supra. The reason for the respondent’s refusal to allow any deduction for charities on account of the remainder designated as part “B” was due to that part of article second, section 1, of the trust deed which provided:

The Trustees may advance portions of the principal hereof to or for the use or benefit of the Creator’s said wife, at such times, in such amounts and for such purposes as the said Trustees in their opinion may deem advisable.

The respondent contends that by reason of the above quoted provision it is impossible to determine what amount, if any, will pass to charity under the trust deed. The parties, however, have stipulated that at the date of death of Francis the value of the remainder interest, if any, of the charities entitled to receive part “B” in the Francis R. Dravo deed was not in excess of $86,922. We have held that this amount should be included in the decedent’s gross estate under section 302 (d) on account of the power reserved by Francis to change the list of charities, which power was “dominant” in him at the time of his death. In their brief petitioners argue in part as follows:

Tbe Commissioner, as we have said, refuses to allow tbe deduction to charities on account of the possibility that the remainder interest may be depleted by payments of principal out of the trust fund. If that position is correct, it is manifest that the remainder interest, over which Francis It. Dravo had the right to designate to charities, was subject to diminution by the possibility of payments out of principal. It is said by the Commissioner that the value of the charitable deduction is uncertain on account of the possibility of payments out of principal. We say the same argument applies to the value of the remainder interest to be included in the gross estate. The question, however, is of no importance because whatever is included in the gross estate, as the value of the interest over which Francis R. Dravo had the power to appoint to charities, must of necessity be the value of the interest which goes to charities; that is to say, the amount of the charitable deduction.

We think tbis argument is sound and we bold that petitioners in Docket No. 88094 are entitled to a deduction for tbe charities designated by Francis prior to bis death in tbe amount of $86,922, reduced by the amount of such taxes referred to in section 807 of tbe Revenue Act of 1932 as may be payable in whole or in part out of tbe bequests so designated. Cf. Humphrey v. Millard, 79 Fed. (2d) 107; and Ithaca Trust Co. v. United States, 279 U. S. 151. There is a line of cases — W. O. Knoernschild et al., Executors, 35 B. T. A. 886, as an example — which hold that, where a trustee under a will has power to distribute corpus to a life beneficiary of the will with remainder to charity, a deduction for charity will not be allowed. These cases are distinguishable, we think, from the instant case in that in such cases there is no question as to the value of the property to be included in the gross estate, to wit, the entire value of the property of the decedent at the date of his death, whereas, in the instant case only the value of the remainder interest can in any event be included and whatever that remainder is (in this instance $86,922) goes to charity. And whatever definitely goes to charity is deductible under section 803 (a) (3). The parties have stipulated that “If the Board should be of the opinion that any deduction for charities, allowable to the Francis R. Dravo Estate, is subject to deduction for a proportionate part of Federal estate tax the amount of said deduction will be agreed upon between counsel at the time of settlement under Rule 50.” Since petitioners have not made any contention that the deduction for charities should not be so reduced, we assume that the parties are in agreement as to this point.

Reviewed by the Board.

Decisions will he entered under Buie 50.


source: Caselaw Access Project

author: Black. :

license: Public Domain

text:
    Percy Wade, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95138.
    Promulgated July 27, 1939.

      Percy Wade pro se.

      E. M. Woolf, Esq., for the respondent.
   opinion.

Black. :

The Commissioner has determined a deficiency against petitioner for the year 1936 of $38.32. This deficiency arises because the Commissioner has determined that petitioner is not entitled to the $2,500 personal exemption granted by section 25 (b) (1) of the Revenue Act of 1936, but is entitled only to the $1,000 personal exemption accorded a single man, plus credit of $400 for one dependent under section 25 (b) (2) of the act. The petition assigns this action of the Commissioner as error.

The facts are brief and we find them as follows:

The petitioner, Percy Wade, is an unmarried man, with his residence at 2109 24th Street, N*. E., Washington, D. C. For the calendar year 1936 he filed his income tax return with the collector of internal revenue at Baltimore, Maryland, and on such return took credit for a personal exemption of $2,500 as the head of a family.

Something like forty years ago, petitioner began to live with a second cousin and his wife in a rented house in Washington, D. C. He was then a young man. He continued to live in their home for a period of about ten years. One day his cousin disappeared and has never returned, nor has he been heard of since. Being deserted by her husband, the wife of petitioner’s second cousin was left without any means of support. Because of his gratitude to her for furnishing him a home while he was a young man and for her many kindnesses to him, petitioner assumed the burden of supporting her. He has maintained a home for her ever since the day of her husband’s desertion, she keeping house for him. The lady, whose name was not disclosed at the hearing, is now 75 years of age and is still living with petitioner and is entirely dependent upon him for her support. She has no other relatives.

Section 25 (b) (1) of the Bevenue Act of 1936, which grants a $2,500 personal exemption to the head of a family, does not define “head of a family.” But article 25-4 of Regulations 94, Revenue Act of 1936, defines “head of a family” as follows:

* * * A Read of a family is an individual who actually supports and maintains in one RouseRold one or more individuals wRo are closely connected witR Rim by blood relationsRip, relationsRip by marriage, or adoption, and wRose rigRt to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation. * * *

A similar regulation has been approved by the Board, Alfred E. Fuhlage, 32 B. T. A. 222; Mary E. Walton, 37 B. T. A. 620.

Three essentials are established by the above quoted regulation to entitle the taxpayer to the personal exemption granted to the head of a family:

1. Dependence, accompanied by actual support.
2. Maintenance of tRe Rome.
3. Glose relationsRip by blood, marriage, or adoption in order that tRe right of the taxpayer to exercise family-control and provide for such dependents shall be based upon some moral or legal obligation.

The relationship of petitioner to the dependent in question was that of second cousin by marriage. We do not think this is the close connection by blood or marriage prescribed by the quoted regulation. Respondent in his determination of the deficiency has allowed petitioner the $400 credit permitted by section 25 (b) (2) for one dependent. We think that, under the facts disclosed by the evidence, this is all the credit petitioner is entitled to receive under the applicable statute and we sustain the Commissioner in his disallowance of $2,500 personal exemption as the head of a family.

Reviewed by the Board.

Decision will he entered for the respondent.


author: Stisenhagen :

text:
    Estate of Sidney F. Tyler, Deceased, Fidelity-Philadelphia Trust Company and Robert L. Montgomery, Executors, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95672.
    Promulgated July 27, 1939.

      W. W. Montgomery, Jr., Esq., for the petitioner.

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

Stisenhagen :

The Commissioner determined a deficiency of $121,936 in estate tax, by including in gross estate the value of the corpus of a trust.

Tyler died June 3, 1935. On April 22, 1885, he transferred personal property in trust, the trustee to hold, sell and invest, collect the income, and, after payment of taxes and expenses, to pay over the remaining income in equal shares to or for the benefit of Tyler’s children for life, and upon the death of one of the children, to the deceased child’s issue. Upon the death of the survivor of the children the trustee was to make distribution of the trust property among their issue in equal shares per stirpes, or, if either left no issue, in a specified manner not here material. It was further provided that:

* * * Sidney F. Tyler may at any time or times before said period of distribution of said trust property shall arrive, by any deed or deeds or other instruments in writing either alter or absolutely revoke and annul all or any of the uses, trusts and estates, hereinbefore limited and declared, and by the same or any other deed or instrument limit and declare such other uses, trusts and estates, of or concerning all or any part of the said trust property herein-before transferred and conveyed and the investments representing the same as he shall think fit, anything hereinbefore to the contrary notwithstanding.

On February 25, 1888, Tyler executed an instrument whereby he:

* * * releases and annuls the right of revocation so in the said Indenture of the twenty-second day of April A. D. 1885 was reserved and provided. [Sic.]
Provided, nevertheless, that nothing herein contained shall be deemed to affect or limit any other of the terms and conditions of said Indenture, or divest, affect or disturb any estate, right, title or interest of the said Sidney F. Tyler in the said estate, other than the said right of revocation.

In an estate tax return filed with the collector at Philadelphia, the gross estate did not include the value of the trust property. In determining the deficiency the Commissioner included $277,708.41, and the petitioner does not assail the figure of valuation if, contrary to its contention, the property is held to be within the statutory gross estate.

The essence of petitioner’s contention is that the instrument of 1888 ended the settlor’s power to alter, and that therefore the Eevenue Act of 1934, section 401, does not touch the estate. If this is so, it must be by virtue of a necessary construction of the 1888 instrument, for it would be plainly at variance with the decedent’s express language. An unsophisticated reading of the 1885 instrument shows a retention by the settlor of two separately conceived powers described disjunctively. He might either (1) alter or (2) absolutely revoke and annul; might also limit and declare such other uses, etc., of all or part of the trust property. In the 1888 document with equal care and precision he annulled but one of these, the right of revocation. Without more, this would leave unaffected the other retained rights, and any alteration or any declaration of new uses would be unassailable. But the settlor was not content that such retained rights should be left in any doubt; the expressio wrdus maxim was not enough. By the proviso he assured himself that the annulment of the right of revocation should not affect or limit any other terms or affect or disturb any right other than the right of revocation. Thus the settlor did about all that a forthright person could to show an intention to keep the right to alter and to forego the right to revoke. He used discriminating language, with a fine sense of draftsmanship, to express that intention.

The petitioner now urges, however, that such an understanding of the two instruments is indeed unsophisticated and that the juristic conception is otherwise. This is a refined argument (no less respected on that account) which must be supported not alone by logic, but by compelling authority. Petitioner’s logic is that any alteration, especially to change benefits, would be pro tanto a revocation and hence inhibited by the 1888 instrument. This is so inconsistent with the unmistakable intention to retain the rights described in the proviso that it would stultify the instrument in one of its important objects. Clearly it was no more designed to annul the power of revocation than it was to leave unimpaired the described power of alteration. It might have been possible to read the renunciation of the power to revoke as preventing an alteration if there were ambiguity of language or if there had been an emergence of unforeseen circumstances. But there is no such ambiguity and no unforeseeable situation arose. Petitioner suggests that the settlor clearly had no right after the renunciation of 1888 to vary the quantities by assigning to one beneficiary a part of what had theretofore been assigned to another, because as to the latter t.hi.g would be to some extent a revocation. But it would be more aptly described as a declaration of another use, trust, or estate “of any part of the said trust property hereinbefore transferred”, and this was separately retained in the 1885 instrument, covered by the proviso of 1888, and hence not relinquished under the cancellation of the power of revocation.

The petitioner cites Restatement of the Law of Trusts, ch. 10, sec. 381 comment h. This, we think, gives petitioner no support. The black letter states that the power to modify exists if reserved, and the comment and the cases cited in the explanatory notes of tentative draft ISTo. 5 (sec. 321) indicate that a reserved power to modify may be interpreted in the light of all the circumstances as subject to restriction, and that if not restricted it includes the power to revoke. This is far from saying that the relinquishment of a reserved power to revoke destroys a separately expressed power to alter, despite an express proviso containing the reservation of the latter. Faulkner v. Irving Trust Co., 231 App. Div. 87; 246 N. Y. Supp. 313, indicates that the power to amend may dominate an express restriction on the power to revoke so thoroughly as to support a complete termination of the interest of a cobeneficiary. Even the doubt as to the Faulkner decision which Judge Hand expressed in Porter v. Commissioner, 60 Fed. (2d) 673, would not affect the present case, for it relates only to an alteration which defeats the original beneficiaries to the profit of the settlor. Apparently a modification to redistribute the original interests would be free from doubt even though the power of revocation were restricted.

The petitioner cites an unreported decision of the Orphans’ Court of Philadelphia County in Grossman's Estate (May 25, 1938), confirming a trustee’s account. The terms of that trust and the later documents are materially different, and the circumstances much more complex. It can not be regarded as analogous. Chance's Estate, 29 D. & C. (Penna.) 586, is more like our case (although still not close enough to be controlling), and there the reserved power to amend by will was held not to include the power to revoke by will when there was expressly reserved a power to revoke by deed. From this it may be inferred that the restriction on the power of revocation did not reach the reserved power of amendment. But perhaps as to both these Orphans’ Court cases, Judge Van Dusen’s language could be aptly quoted: “This case is not at all helpful because the language used in the instant case is not at all similar to that used in the case cited.” There is really nothing we can find and nothing cited by petitioner which demonstrates that Pennsylvania would say that the decedent at the time of his death had no power to alter the trust, even though we are not so sure that any or every alteration which he might have attempted would have been successful. Conceivably some attempts would have been held to impinge upon the relinquishment of the power to revoke. But if there were any alterations which conceivably the decedent might validly have made, the revenue act imposes a tax upon the property thus under his control. Porter v. Commissioner, 288 U. S. 436. It is not for us to say that a power to alter so deliberately reserved and later so carefully preserved in the proviso was after all without force and substance because it was inadvertently destroyed with the annulment of the right of revocation.

The revenue act includes in the gross estate the trust property which was subject at the time of decedent’s death to a power to alter or a power to revoke the trust. Petitioner would say that although in terms the decedent retained a power to alter, in fact such power to alter was absorbed in the relinquishment of the power to revoke. Since the two were separate, we conclude for the foregoing reasons that petitioner retained the power to alter and that the corpus of the trust was squarely within the statutory language including it within the gross estate.

The determination is sustained.

Decision will be entered wider Rule SO.

       SEC. 401. REVOCABLE TRUSTS.
      Section 302 (d) of the Revenue Act of 1926 is amended to read as follows:
      “(O) (1) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revote, * *


author: Leech :

text:
    Edward H. Clark, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94259.
    Promulgated July 27, 1939.

      J. Marvin Haynes, Esq., and Chester J. McGwire, Esq., for the petitioner.

      Charles E. Lowery, Esq., for the respondent.
   OPINION.

Leech :

This is a proceeding to redetermine a deficiency in income tax for the calendar year 1934 in the amount of $10,618.87. The question presented is whether petitioner derived income by the payment to him of an amount of $19,941.10, by Ms tax counsel, to compensate Mm for a loss suffered on account of erroneous advice given Mm by the latter. The facts were stipulated and are so found. The stipulation, so far as material, follows:

3. The petitioner during the calendar year 1932, and for a considerable period prior thereto, was married and living with his wife. He was required by the Revenue Act of 1932 to file a Federal Income Tax Return of his income for the year 1932. For such year petitioner and his wife could have filed a joint return or separate returns.
4. Prior to the time that the 1932 Federal Income Tax return or returns of petitioner and/or his wife were due to be filed, petitioner retained experienced tax counsel to prepare the necessary return or returns for him and/or his wife. Such tax counsel prepared a joint return for petitioner and his wife and advised petitioner to file it instead of two separate returns. In due course it was filed with the Collector of Internal Revenue for the First District of California. * * *
5. Thereafter on or about the third day of February, 1934, a duly appointed revenue agent of the United States audited the aforesaid 1932 return and recommended an additional assessment against petitioner in the sum of $34,590.27, which was subsequently reduced to $32,820.14. This last mentioned sum was thereafter assessed against and was paid by petitioner to the Collector of Internal Revenue for the First District of California.
6. The deficiency of $32,820.14 arose from an error on the part of tax counsel who prepared petitioner’s 1932 return. The error was that he improperly deducted from income the total amount of losses sustained on the sale of capital assets held for a period of more than two years instead of applying the statutory limitation required by Section 101 (b) of the Revenue Act of 1932.
7. The error referred to in paragraph six above was called to the attention of the tax counsel who prepared the joint return of petitioner and his wife for the year 1932. Recomputations were then made which disclosed that if petitioner and his wife had filed separate returns for the year 1932 their combined tax liability would have been $19,941.10 less than that which was finally assessed against and paid by petitioner.
8. Thereafter, tax counsel admitted that if he had not erred in computing the tax liability shown on the joint return filed by the petitioner, he would have advised petitioner to file separate returns for himself and his wife, and accordingly tax counsel tendered to petitioner the sum of $19,941.10, which was the difference between what petitioner and his wife would have paid on their 1932 returns if separate returns had been filed and the amount which petitioner was actually required to pay on the joint return as filed. Petitioner accepted the $19,941.10.
9. In his final determination of petitioner’s 1934 tax liability, the respondent included the aforesaid $19,941.10 in income.
10. Petitioner’s books of account are kept on the cash receipts and disbursements basis and his tax returns are made on such basis under the community property laws of the State of California.

The theory on which the respondent included the above sum of $19,941.10 in petitioner’s gross income for 1934, is that this amount constituted taxes paid for petitioner by a third party and that, consequently, petitioner was in receipt of income to that extent. The cases of Old Colony Trust Co. v. Commissioner, 279 U. S. 716; United States v. Boston & Maine Railroad, 279 U. S. 732, are cited as authority for his position. Petitioner, on the contrary, contends that this payment constituted compensation for damages or loss caused by the error of tax counsel, and that he therefore realized no income from its receipt in 1934.

We agree with petitioner. The cases cited by the respondent are not applicable here. Petitioner’s taxes were not paid for him by any person — as rental, compensation for services rendered, or otherwise. He paid his own taxes.

When the joint return was filed, petitioner became obligated to and did pay the taxes computed on that basis. John D. Biggers, 39 B. T. A. 480. In paying that obligation, he sustained a loss which was caused by the negligence of his tax counsel. The $19,941.10 was paid to petitioner, not qua taxes (cf. T. G. Nioholson, 38 B. T. A. 190), but as compensation to petitioner for his loss. The measure of that loss, and the compensation therefor, was the sum of money which petitioner became legally obligated to and did pay because of that negligence. The fact that such obligation was for taxes is of no moment here.

It has been held that payments in settlement of an action for breach of promise to marry are not income. Lyde McDonald, 9 B. T. A. 1340. Compromise payments in settlement of an action for damages against a bank on account of conduct impairing the taxpayer’s good will by injuring its reputation are also not taxable. Farmers & Merchants Bank of Catlettsburg, Ky. v. Commissioner, 59 Fed. (2d) 912. The same result follows in the case of payments in settlement for injuries caused by libel and slander. C. A. Hawkins, 6 B. T. A. 1023. Damages for personal injury are likewise not income. Theodate Pope Riddle, 27 B. T. A. 1339.

The theory of those cases is that recoupment on account of such losses is not income since it is not “derived from capital, from labor or from both combined.” See Merchants Loan & Trust Co. v. Smietanka, 255 U. S. 509; United States v. Safety Car Heating & Lighting Co., 297 U. S. 88. And the fact that the payment of the compensation for such loss was voluntary, as here, does not change its exempt status. Rice, Barton & Fates Inc. v. Commissioner, 41 Fed. (2d) 339. It was, in fact, compensation for a loss which impaired petitioner’s capital.

Moreover, so long as petitioner neither could nor did take a deduction in a prior year of this loss in such a way as to offset income for the prior year, the amount received by him in the taxable year, by way of recompense, is not then includable in his gross income. Central Loan & Investment Co., 39 B. T. A. 981.

Decision will be entered for the petitioner.


author: Smith :

text:
    Bertha K. Bynum, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 94378-94381, 94389, 94390.
    Promulgated July 27, 1939.

      Boss M. Lambdin, E'sq., and Walter Q. Bussell, G. P. A., for the petitioners. ■

      Leonard O. Mitchell, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: B. C. D. Bynum; Nora C. Early; Allen Early; Willie Elliott Kirk; and R. D. Kirk.

   OPINION.

Smith :

The only question to be determined in these proceedings is whether the dividends received by the petitioners in 1935 from the Badger Oil Co. were liquidating dividends, as the petitioners contend, or ordinary dividends, as the respondent contends. The pertinent provisions of the statute are found in section 115 of the Revenue Act of 1934, which provides in part as follows:

SEO. US. DISTRIBUTIONS BT CORPORATIONS.
(a) Definition of Dividend. — The term “dividend” when used in this title * * * means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.
(b) Source of Distributions. — For the purposes of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. * * *
(c) Distributions in Liquidation. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, * * *
(i) Definition of Partial Liquidation. — As used in this section the term “amounts distributed in partial liquidation” means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.

Dividends paid by the Badger Oil Co. in 1935 were designated as liquidating dividends in the resolutions of the stockholders and directors by which they were authorized. But the name by which they are called does not determine their character. That is a question of fact to be determined from all of the circumstances. Gossett v. Commissioner, 59 Fed. (2d) 365, affirming 22 B. T. A. 1279; Edward S. Bacharach, 29 B. T. A. 282; Rollestone Corporation, 38 B. T. A. 1093. In Fred T. Wood, 27 B. T. A. 162, we said:

* * * Liquidation has been defined as the operation of winding up the affairs of a corporation by realizing upon its assets, paying its debts and appropriating the amount of its profit or loss. W. E. Guild., 19 B. T. A. 1186, and eases there cited. It differs from the normal operation of the corporation for current profit in that it ordinarily results in the winding up of the corporation’s affairs. There must be a manifest intention to liquidate, a continuing purpose to terminate its affairs and dissolve the corporation, and its activities must be directed and confined thereto. It contemplates an impairment of capital or a retirement of outstanding stock, though a distribution, if one of a series of distributions in liquidation may be a liquidating dividend even if it, of itself, does not impair capital. Liquidation can not be brought about by mere declaration, and tbe question of whether a corporation is in liquidation is therefore one of fact. See W. E. Guild, supra; James P. Gossett, 22 B. T. A. 1279; affd., 60 Fed. (2d) 484; Martha Briggs Phelps, 20 B. T. A. 866; affd., 54 Fed. (2d) 289; E. G. Perry, 9 B. T. A. 796; Milton Tootle, Jr., 20 B. T. A. 892.

By section 22 (a) of the Revenue Act of 1934 “gross income” is defined as including gains, profits and income derived from “dividends” or “from any source whatever.” By section 115 (a) the term “dividend” is defined as “any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.” We can not doubt from the evidence of record in these proceedings that the dividends paid by the Badger Oil Co. in 1935 were out of earnings or profits. The evidence is to the effect that after the payment of these dividends the Badger Oil Co. had assets for which it had refused offers of more than the par value of the shares of stock outstanding; and there is no evidence that the fair market value of the assets paid in for the shares of stock at the time of the organization of the corporation was in excess of the par value of its shares. Therefore, the denomination of the dividends paid in 1935 as liquidating dividends is immaterial. The corporation was not in liquidation in 1935. The recipients of the dividends are taxable upon the amounts received as upon the receipt of ordinary dividends.

Decisions will be entered for the respondent.


author: Mellott :

text:
    Dresser Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 84795, 88294.
    Promulgated July 27, 1939.

      George E. H. Goodmer, Esq., and Percy R. Everett, O. P. A,, for the petitioner.

      F. S. Gettle, Esq., for the respondent.
   OPINION.

Mellott :

The Commissioner determined deficiencies in petitioner’s income tax for the years 1933 and 1934 in the respective amounts of $3,990.57 and $9,702.32. Petitioner claims an overpayment of tax for the year 1933 in the amount of $8,215.67 and alleges that the Commissioner erred in determining $8,805 of the $9,702.32 as a deficiency in the year 1934. The proceedings were consolidated for hearing.

Certain affirmative allegations made by the respondent in his answer to the amended petition were abandoned. The questions to be decided may be succinctly stated as follows: (1) Are expenditures in the amount of $96,509.10, or any part thereof, made by petitioner in an unsuccessful attempt to develop a gas compressor engine, deductible from its gross income in 1933? and (2) Is the amount of $62,856.34 expended by petitioner in 1934 in a further unsuccessful attempt to develop a gas compressor engine deductible from its gross income for that year ?

Petitioner, successor to the S. E. Dresser Manufacturing Co., is a corporation with its principal office at Bradford, Pennsylvania. It is engaged in the manufacturing business and for many years its principal products have been pipe line couplings and fittings.

The cost of compressor or “booster” plants used in keeping up the pressure in gas lines has always been considerable. In 1931 petitioner’s officers conceived the idea of developing, and perhaps ultimately manufacturing and selling, a gas compressor engine which would cost much less than a booster plant and yet perform the same work. Petitioner was primarily interested in stimulating transportation of gas through pipe lines and thereby increasing its own business of manufacturing and selling pipe line couplings and fittings. Incidentally, it was also interested in, and anticipated the possibility of realizing, profit from the sale and manufacture of compressor engines.

In 1931 petitioner designed and began development work on what was characterized by the witnesses as “Engine No. 1,” which it hoped and expected would suit the existing need. It employed an expert combustion engineer for consultation purposes and continued its experimental and development work throughout the years 1931 and 1932 and the major portion of 1933. Late in 1933 it was definitely determined that the experiment was a failure; that the engine would not accomplish what was expected of it; that no asset of any value had been created; and that petitioner had nothing for its expenditures. Accordingly the engine Avas scrapped, the blue prints were destroyed, and the project was abandoned.

During the three years of experimental work on Engine No. 1 petitioner expended the following amounts in its attempt to perfect the engine:

1931_ $28,051.01
1932_■_ 36,387.30
1933_ 32,070. 79
Total_ 96,509.10

The amounts expended in 1981 and 1932 respectively were charged against surplus in 1933. At the end of 1933 petitioner’s officers became concerned over the entries which had been made upon its books capitalizing the expenditures for 1931 and 1932, since no asset of corresponding value had been developed. After consulting with its accountants petitioner concluded that such expenditures constituted ordinary and necessary expenses of carrying on its trade or business and should be deducted from gross income in the year incurred.

The Commissioner determined a deficiency in income tax against petitioner for the year 1932 upon a theory not presently material. Petitioner sought a redetermination by this Board. Although it had claimed no deduction from gross income in its return for the year 1932 in connection with the expenditures made in an attempt to perfect Engine No. 1, it claimed the right to reduce income as reported in the original return by $36,387.30, alleging that this amount represented “expenses in connection with the development of a gas engine and compressor unit.” This issue was decided against petitioner, the following language being used in the opinion:

* * * It was the thought and intention of the petitioner and its officers at the time the experimental work was started on the gas compressor, in 1931, that a capital asset would be created. It was their intention to develop a machine which could be manufactured and sold at a profit. The distinction between the work to tb;at end and the experimental work directly applicable to the manufacture of pipe couplings and fittings was carefully drawn and maintained. Throughout the years 1931 and 1932, the petitioner thought that the machine being developed would be workable, practicable, economical and salable, and if these views had proved to be true, there would never have been any doubt that the expenditures were properly capitalized. It was not until after the end of the taxable year, and in 1933, that doubts arose and it was decided that the machine which had been thought workable in 1931 and 1932 was of no practical value and that the amounts expended in connection therewith should be written off the taxpayer’s books by allocation as business expenses to the years in which they were actually made. We express no opinion as to the year in which the expenditures so capitalized would become deductible, but do hold that they were properly capitalized during the taxable year and were clearly different from expenditures for experimentation and research directly connected with the manufacturing activities being carried on during the current year. The deduction claimed is not allowable for 1932. American Seating Co., 4 B. T. A. 649; Forest Products Chemical Co., '27 B. T. A. 638; John F. Canning, 29 B. T. A., 99; Acme Products Co., Inc., 24 B. T. A. 194. Cf. Homer L. Strong, 14 B. T. A. 902, wherein it was found as a fact that the machine in respect of which the expenditures sought to be deducted were made “was an absolute failure” in the taxable year. IS. R. Dresser Mfg. Co., Docket No. 80177.]

The amounts expended in the years 1931 and 1932 were not claimed as deductions from gross income for those years (except as to the amount claimed in the proceeding above) and neither of said amounts has ever been allowed as a deduction. The amount expended in 1933 ($32,070.79) was deducted from gross income in petitioner’s return for 1933, but was disallowed by the respondent.

Petitioner filed a claim for refund of taxes paid for the year 1931, claiming that the expenditures made in that year in connection with the development of Engine No. 1 should be allowed as ordinary and necessary business expenses. The claim for refund was rejected by the Commissioner on October 12, 1938.

For the year 1933 petitioner paid income tax as follows:

March 15, 1934_$2, 053.92
June 14, 1934_ 2,053.92
September 15, 1934_ 2,053.92
December 13, 1934_ 2,053.91
Total_ 8,215.67

The petition for 1933 (Docket No. 84795) was filed May 27, 1936.

At the end of 1933 the consulting engineer advised that there was no practical value in Engine No. 1 and no further effort was ever made to develop it. The need for an engine which would perform the work still existed and petitioner, hopeful that it could develop one which would be practical and efficient, designed, and in 1934 began work upon, Engine No. 2. There was little similarity between Engine No. 1 and Engine No. 2, but petitioner and its engineers, in working upon Engine No. 2, utilized the knowledge which had been acquired through the experiments made on Engine No. 1. It expended, during 1934, in experimental work on Engine No. 2 $62,856.34 (erroneously set up on its books and claimed in its return as $64,035.69), charged the said amount to expense, deducted it in its return, and now claims that it should be allowed as a deduction from gross income. The Commissioner disallowed the entire amount. Engine No. 2 proved to be a failure, was found to be impractical, and was abandoned during the year 1934.

The need for a gas compressor engine was still present in 1935 and sometime during that year petitioner began experimenting on Engine No. 3. This also proved worthless and in 1937 petitioner abandoned it and gave up entirely the thought of developing a successful gas compressor engine to accomplish the desired purpose.

Petitioner was more or less constantly engaged in experimental work, trying to improve the articles which it was producing and to develop new articles for sale at a profit. It kept separate records of its experimental expenditures and the records pertaining to the gas compressor engines were kept separate from its other experimental expenditures. In each year after 1932 petitioner charged to expense of doing business all expenditures made by it in carrying on experiments during the year, including the expenditures made on the various compressor engines.

Petitioner contends that the entire amount ($96,509.10) expended by it in connection with Engine No. 1 is deductible in 1933 when this particular engine was abandoned. The same contention is made with reference to the expenditures made upon Engine No. 2 during the year 1934. In the alternative petitioner contends that in any event the sum of $32,010.79 expended by it in 1933 upon Engine No. 1 is deductible in that year.

Respondent’s contention is thus stated upon brief:

Where experimentation is carried on, the entire plan, idea or project must be taken into consideration as well as the ultimate purposes to be reached. If those purposes are reached a capital asset results. If the experimentation results in a failure and the idea, scheme or project is definitely abandoned, the loss, if any, then becomes definitely sustained. Up to that point it is not known whether a successful machine would result. If the petitioner had not so thought, it would not have persisted in its experimentations through 1935, 1936 and into 1937. The failure of Engine No. 1, or Engine No. 2 does not determine the result of the project. The very nature of experimentation requires a determined persistency to attempt to reach the goal sought.

The parties appear to agree that if experimentation results in the development of a machine or contrivance which is reasonably practical and workable a capital asset is thereby acquired and the expenditures so made should be capitalized. John F. Canning, 29 B. T. A. 99; Claude Neon Lights, Inc., 35 B. T. A. 424, 442. This was petitioner’s view of the law during 1931 and 1932 and we declined to permit it to deduct the 1932 expenditures as ordinary and necessary expenses of carrying on its trade or business, holding that they had been properly capitalized. Neither party sought to overturn our decision and, as we understand the present contentions, neither now seeks to avoid its effect. The issue is the narow one whether petitioner may deduct as a loss in 1933 the capital expenditures which it had made in a futile effort to perfect Engine No. 1, and deduct as a loss in 1934 the capital expenditures which it had made in a futile effort to perfect Engine No. 2, or whether it nmst. as contended by respondent, wait until the whole “idea, scheme or project is definitely abandoned.”

In Homer L. Strong, 14 B. T. A. 902, it was held that expenditures made in an unsuccessful attempt to perfect a threshing machine, which did not “result in the acquisition, development or improvement of a capital asset having a useful life beyolnd the taxable year in which the outlay was made”, were deductible in the year expended. The rationale of that case would probably require that we uphold petitioner’s alternative contention and allow as a deduction at least the. amount expended during the year 1933 in a futile effort to perfect Engine No. 1. But we do not believe we should resolve the present controversy by merely alio wing the amount expended during that year. The evidence shows that at the end of 1933 the petitioner had no asset of any value, though it had expended $96,509.10 in an effort to develop Engine No. 1. The whole plan of construction of an engine which it was hoped would accomplish the desired result was abandoned, the design was changed, the patterns and blueprints were discarded, and, in the language of petitioner’s president, they “had nothing whatever to show for [their] * * * efforts at the end of 1933.” They had merely “learned a great many ways of not doing it and that was about all.” The consulting engineer testified that Engine No. 1 had no salable value at the end of 1933 and “was not a practical engineering proposition.” He had made such a report to petitioner’s officers and, under the circumstances, we think it was justified in charging off, in 1933, all of the expenditures theretofore made.

Nor is the situation materially different as to Engine No. 2 and the expenditures made during 1934. It also was found to be impracticable and unworkable and the amount expended upon it ($62,856.34) was charged off during that year.

Section 23 (f) of the Revenue Acts of 1932 and 1934 authorizes the deduction from gross income of “losses sustained during the taxable year and not compensated for by insurance or otherwise.” Petitioner sustained a loss of $96,509.10 in 1933 and a loss of $62,856.34 in 1934. They are proper deductions from gross income for those years. Of. Lucas v. American Code Co., 280 U. S. 445; H. B. Perine, 22 B. T. A. 201.

Judgment will Be entered under Rule BO.


author: Van Fossan:

text:
    The Commodore Mining Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91621.
    Promulgated July 27, 1939.

      George T. Evans, Esq., for the petitioner.

      Bernard D. Darnels, Esq., for the respondent.
   OPINION.

Van Fossan:

The petitioner contends that it is entitled to a depletion deduction computed on the discovery value or unit basis as established by the respondent on March 1, 1927.

The respondent’s position is that the petitioner is entitled to no such deduction, that it failed to state in its return for the year 1934, its first return under the prolusions of section 114 (b) (4) of the Revenue Act of 1934, whether it elected to have its depletion allowance computed with, or without regard to percentage depletion, and that therefore, under the statute, such computation must be made without reference to percentage depletion. He construes the phrase “without reference to percentage depletion” as used in the 1934 Act to mean that the base must be either cost or March 1,1913, fair market value.

The allowance for depletion of mines based on discovery value, a practice long established by the taxing statutes, was continued in the Revenue Act of 1934 but it was limited to mines other than metal, coal, or sulphur. (Sec. 114 (b) (2).) That act specifically grants to the owners of metal, coal, and sulphur mines a depletion allowance on a percentage basis, but conditions such allowance on the taxpayer’s statement of its election to take advantage of the grant. If it elects not to avail itself of the privilege, obviously, no depletion is allowed on that basis. If it fails to indicate its election, it likewise forfeits its right to a percentage allowance and the allowance is computed without regard to percentage depletion.

Where the taxpayer excludes itself from the provisions of section 114 (b) (4) either by its affirmative action or by its inaction, the general rule of section 114 (b) (1) applies. Section 113 (b) states that the basis for determining gain or loss shall be the basis determined in subsection (a) as adjusted in accordance with certain rules set forth hi section 113 (b). Section 113 (a) states that the basis of property shall be the cost of such property and sets forth certain exceptions, the only one material to the issue being (14) which relates to March 1,1913, fair market value.

The petitioner contends that, since it was allowed a discovery value in 1927, as of September 15, 1924, it is entitled to that advantage continuously thereafter. The deduction for depletion based on discovery value is a matter of legislative grace. By the limitation of the Revenue Act of 1932, the allowance was withdrawn as to certain types of mines. Section 114 (b) (2) (continued in the Revenue Act of 1934) emphasized that exclusion in so far as it related to metal, coal, and sulphur mines and section 114 (b) (4) established a new basis for such mines. Nowhere in the Revenue Acts of 1932 or 1934 is there any suggestion that the discovery value principle was retained for computing depletion under those acts on that type of mines.

The petitioner did not elect to obtain a depletion allowance on the percentage basis. The discovery value basis was no longer available to it. Therefore, its base must be either cost or March 1, 1913, fair market value. It is stipulated that the property had no fair market value on March 1, 1913, and that its cost has been fully recovered. Consequently, it is entitled to no depletion deduction whatsoever.

The petitioner argues that under the facts it has had no real right of election. This argument was considered by us in Dorothy Glenn Coal Mining Co., 38 B. T. A. 1154 and C. H. Mead Coal Co., 38 B. T. A. 1163. In those cases we held that the allowance of the claimed deduction from gross income was a matter of legislative grace and that the taxpayer must conform to the conditions imposed by Congress. New Colonial Ice Co. v. Helvering, 292 U. S. 435. Since the petitioner did not so conform, it can not be allowed a depletion deduction on the percentage basis, although it obtains no advantage from the other statutory methods.

The petitioner further maintains that section 23 (m) of the Revenue Act of 1934 compels the allowance of some reasonable amount for depletion. Section 114 (b) (2) withdrew from metal, coal, and sulphur mines a depletion allowance based on discovery value. Section 114 (b) (4) gave the taxpayer the right to a percentage depletion or a depletion based on cost or March 1,1913, fair market value. The petitioner continued to make its returns by an obsolete method and ignored its right to the benefits of the percentage basis substituted therefor by Congress. The predicament in which the petitioner finds itself is not unique. See Dorothy Glenn Coal Mining Co., and C. H. Mead Coal Co., supra. The statute does not afford petitioner the relief which it claims.

Decision will he entered for the respondent.

       SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
      (a) Basis foe Depreciation. — The basis upon -which exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the adjusted basis provided in section 113 (b) for the purpose of determining the gain upon the sale or other disposition of such property.
      (b) Basis foe Depletion.—
      (1) Gbneeal rule. — The basis upon which depletion is to be allowed in respect of any property shall be the adjusted basis provided in section 113 (b) for the purpose of determining the gain upon the sale or other disposition of such property, except as provided in paragraphs (2), (3), and (4) of this subsection.
      (2) Discovery value in case of mines. — In the case of mines (other than metal, coal or sulphur mines) discovered by the taxpayer after February 28, 1913, the basis for depletion shall be the fair marlcet value of the property at the date of discovery or within thirty days thereafter, if such mines were not acquired as the result of purchase of a proven tract or lease, anil if the fair market value of the property is materially disproportionate to the eost. * * *

      (4) Percentage depletion foe coal and metal mines and sulphur. — The allowance for depletion under section 23 (m) shall be, in the case of coal mines, 5 per centum, in the case of metal mines, 15 per centum, and, in the case of sulphur mines or deposits, 23 per centum, of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property. A taxpayer making his first return under this title in respect of a property shall state whether he elects to have the depletion allowance for such property for the taxable year for which the return is made computed with or without regard to percentage depletion, and the depletion allowance in respect of such property for such year shall be computed according to the election thus made. If the taxpayer fails to make such statement in the return, the depletion allowance for such property for such year shall be computed without reference to percentage depletion. The method, determined as above, of computing the depletion allowance shall be applied in the case of the property for all taxable years in which it is in the hands of such taxpayer, or of any other person if the basis of the property (for determining gain) in his hands is, under section 113, determined by reference to the basis in the hands of such taxpayer, either directly or through one or more substituted bases, as defined in that section.

       SBC. 113. ADJUSTED BASIS BOR DETERMINING GAIN OR LOSS.

      (b) Adjusted Basis. — The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided.
      (1) Geneeal eule. — Proper adjustment in respect of the property shall in all cases be made—

      (B) in respect of any period since February 28, 1013, for exhaustion, wear and tear, obsolescence, amortization, and depletion, to the extent allowed (but not less than the amount allowable) under this Act or prior income tax laws. Where for any taxable year prior to the taxable year 1932 the depletion allowance was based on discovery value or a percentage of income, then the adjustment for depletion for such year shall be based on the depletion which would have been allowable for such year if computed without reference to discovery value or a percentage of income.

       SEC. 23. DEDUCTIONS FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:

      (m) Depletion. — In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. * * *


author: MuRdock :

text:
    George G. Allen, et al., Trustees of the Doris Duke Trust, a Trust Established by James B. Duke by Indenture Dated December 11, 1924, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 75945.
    Promulgated July 27, 1939.

      David B. Shelton, Esg., and Forrest Hyde, Esg., for the petitioners.

      B. H. Transue, Esg., for the respondent.
   OPINION.

MuRdock :

The Commissioner determined a deficiency of $110,287.26 in income tax for the year 1931. The issue for decision is whether there were separate trusts for infant beneficiaries, so that the main trust is entitled to deductions for the amounts set aside in 1931 as accumulations for the infant beneficiaries, or whether those amounts are taxable to the main trust as undistributed income. The facts have been stipulated and the stipulation is hereby adopted as the findings of fact in this proceeding.

James B. Duke, now deceased, executed a deed of trust in 1924 and conveyed certain property to the trustees, the petitioners herein. The preamble of the instrument recites, inter alia, that the property is conveyed to the trustees “in order to effectuate the trusts hereby created.” The main trust and the corpus thereof are consistently referred to in the instrument in the singular. The “Fourth” division of the instrument provides in general that the annual income, and eventually the corpus, of two-thirds of the trust property shall go to Doris Duke, daughter of the grantor, and her descendants during the continuation of the trust. It also provides for the use of such part in case of failure of the beneficiaries thus named. The “Fifth” division provides for the disposition of the income and corpus of the remaining one-third. The income of this part is to be distributed annually per capita,, in equal portions, among a number of persons named, and their descendants, during the continuation of the trust. It likewise provides for the use of such part in case of failure of the beneficiaries thus named.

The “Sixth” division empowers the trustees to withhold and accumulate in their discretion the income distributable to minors during the continuation of the trust. The amounts accumulated and the income therefrom were to “be separately kept and handled by said trustees as respects accounting, investment of funds, and otherwise, and the whole of such accumulations, incomes, revenues, and profits shall be fully and finally paid, applied and distributed by said trustees” to the beneficiary from whom withheld when he becomes twenty-one years of age or when the trust terminates. If the beneficiary died, his accumulations were to go to his heirs or, if none, to another trust. The trustees could use the accumulations, meanwhile, for the benefit of the beneficiary from whom withheld.

The trustees adopted the calendar year for the purpose of their accounting period. The income distributable to adult beneficiaries is not involved in the present controversy. The trustees, however, acting under authority of the “Sixth” division of the deed of trust, have accumulated the amounts to which infant beneficiaries have become entitled. They have construed the deed as creating a separate trust of the accumulations for each infant beneficiary, have set aside as separate trust funds all amounts accumulated for each infant beneficiary, have segregated those separate funds upon their books, have placed each separate accumulated fund in a separate bank account, have made separate investments for each fund, have kept the securities of each separate, and have filed separate returns for each fund as a separate trust, reporting its distributable share of the annual income of the main trust.

None of the original infant beneficiaries has died. Some have become of age and, as they did so, they received the funds accumulated for them. There were a number of infant beneficiaries during 1931. The petitioners, on their return for the main trust, showed the income distributable to infants as distributed and claimed deductions accordingly. The Commissioner, in determining the deficiency, has held that there was but one trust and there was no distribution of amounts added in that year to the accumulations for the infants. Thus he has taxed, as income of the main trust, that portion of its income which was withheld and accumulated for the infants. The petitioners contend that that income was deductible under section 162 of the Revenue Act of 1928.

The case of Lynchburg Trust & Savings Bank v. Commissioner, 68 Fed. (2d) 856; certiorari denied, 292 U. S. 640, reversing 27 B. T. A. 1182, involved a similar question under facts which are strikingly similar in all important respects. If that case is to be followed, there is no need to add to the full and able discussion contained in the opinion of Judge Soper. His reasoning applies with equal force here. Indeed this is a somewhat stronger case for the taxpayer than that was. The court there pointed out that the amounts annually set aside for the infants were deductible by the main trust under section 162 (c). The Commissioner recognizes the effect of that decision upon this case, but hopes that this one may result in a conflict with the other. The Board has already used the court’s opinion in the Lynchburg case as an authority on several occasions. See Charles S. Davis, Trustee, 37 B. T. A. 587; Leonard Marx, 39 B. T. A. 537; Gertrude McGinley, Trustee, 31 B. T. A. 81. There is no good reason to refuse to follow it here where it is so apposite. We think that this grantor intended to create trusts of the accumulations separate from the main trust. There were distributions in 1931 to those trusts and such amounts are deductible by the main trust under section 162 (c). Lynchburg Trust dt Savings Banh v. Commissioner, supra; Willcuts v. Ordway, 19 Fed. (2d) 917. Cf. United States Trust Co. v. Commissioner, 296 U. S. 481.

Decision will be entered wider Rule SO.