author: ARNOLD:

text:
    Estate of Lee R. Farrell, Deceased, Mrs. Lee R. Farrell, Executrix, Discharged January 30, 1931, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 77345.
    Promulgated January 15, 1937.

      W. R. Lansford, Esq., for the respondent.
   OPINION.

ARNOLD:

This proceeding arises on respondent’s determination of a deficiency in income tax of Lee R. Farrell, deceased, for the period January 1 to November 18, 1929, in the amount of $1,454.97.

The facts are drawn from exhibits put in evidence by respondent and are as follows: Petitioner was executrix of the estate of her husband, who died November 18, 1929, until her discharge by the probate court on .January 80, 1981. She filed a personal income tax return for 1929, which sought to include the income of decedent with her own under a joint return. On July 15, 1931, the revenue agent at Cleveland, Ohio, reported that the decedent’s income had been eliminated from Mrs. Lee R. Farrell’s return, under authority of section 25 (e) of the Revenue Act of 1928 and Treasury Regulations 74, article 746; and stated that in accordance with the regulations “a separate delinquent return [without penalty] has been prepared to show the income of the decedent, and a report thereon is being submitted under even date hereof.” In this report the decedent’s income was increased by $27,000 in respect of a distribution to decedent by the Portage Silica Co. said to be taxable as a dividend. Petitioner’s counsel, Klooz, was informed of this action. The respondent on July 24,1931, under form letter 850, addressed to petitioner as “executrix”, enclosed a copy of the revenue agent’s report on decedent’s tax and the unsigned delinquent return prepared for her as executrix. In an undated letter to the revenue agent petitioner, signing herself as “executrix” of the decedent’s estate, acknowledged receipt of this report and requested that the estate’s case “be held in abeyance pending the outcome” in the courts of the Portage Silica Co.’s case, which involved the March 1,1913, value of the company’s sand deposits. Petitioner’s letter makes no reference to the delinquent return, and it does not appear that it was ever signed by her and filed with the revenue agent or the Commissioner. These papers were forwarded by the revenue agent to the Commissioner on August 25, 1931.

Nothing further occurred until February 12, 1932, when respondent wrote petitioner as executrix, informing her that the adjustments in tax recommended in the revenue agent’s report wrould be made and that the statute would run by March 14, 1932, but that her waiver would extend the period. Petitioner, signing herself as “executrix” in an undated letter which was, however, received by the respondent on February 17, 1932, enclosed a waiver and gave as her reason for so doing tire case still pending on the tax liability of the Portage Silica Co., already referred to. The waiver was executed on February 16, 1932, by petitioner as executrix and extended the period to December 31, 1932. Accompanying this waiver was petitioner’s statement, under oath, executed before a notary public on the same day, that she was “the duly qualified and acting executrix” and that she then possessed “the powers * * * resulting from such fiduciary relationship.” Respondent informed petitioner on February 20, 1932, that for her consent to be acceptable she must furnish letters testamentary or other evidence of her authority to act as executrix.

A “certificate of appointment” of the Probate Court of Mahoning County, Ohio, executed by its judge on March 15, 1930, and certifying that petitioner had been appointed executrix of the decedent on December 10, 1929, and was at the time of the certificate’s execution the legal and acting executrix, was received by respondent on February 26, 1932. The receipt of this certificate was acknowledged by respondent on March 4, 1932, and in the same letter petitioner was informed that her consent had been accepted.

On November 10,1932, one Oscar I. Koke, accountant, of Cleveland, purporting to act for the petitioner, wrote to respondent, requesting a further extension of time to December 31, 1933, and the necessary agreement forms. Respondent on November 18, 1932, wrote directly to petitioner, referring to Koke’s letter, and to the absence of any evidence of a power of attorney given to him, and sending the consent forms. It was further pointed out by respondent that petitioner must submit documentary evidence of her authority to act as executrix “as of the date of the execution of the consent.” Petitioner, as executrix, on November 29,1932, duly executed before a notary public a consent extending the period to June 30, 1934, which was sent to respondent. On December 3, 1932, respondent acknowledged this consent but informed petitioner that she must execute the consent on form 56-M. No consent around this date was put in evidence, but it would appear to have been received, for on December 27, 1932, the respondent informed the petitioner that he had accepted “the consent.” No further evidence of petitioner’s status as a fiduciary as of this date appears to have been submitted.

On May 9,1934, Koke & Co., referring to a letter of April 24, 1934, from respondent, informed him that a power of attorney could not be obtained from executrix since she had been discharged by the court as such, and inquiring whether a power of attorney executed in her personal capacity would suffice.

Thereupon, on June 5, 1934, acting under authority of section, 3176 of the Revised Statutes, as amended, respondent prepared and, filed a delinquent return for “Lee R. Farrell, deceased, Mrs, Lee R,. Farrell, Executrix”, for the period January 1 to November 18, 1929. On J une 20, 1934, respondent sent to petitioner as executrix a notice of deficiency in the amount of $1,454.97, allowing appeal to this Foard in 90 days. From this notice of deficiency petitioner brought this appeal on September 17, 1934.

In these circumstances, petitioner has pleaded to the jurisdiction •of this Board, first, on the ground that the decedent’s tax liability may not be asserted against his estate after the bona fide discharge of his executrix without prior notice of the claim; and, second, that the statute of limitations has run against the assessment and collection of the deficiency. On the merits, petitioner contends that the distribution by the Portage Silica Co. to decedent in 1929 was out of the March 1, 1913, value of its property and not taxable as a dividend. Petitioner made no appearance, filed no brief, and offered no evidence. Eespondent contends that the petitioner is estopped to deny the Board’s jurisdiction, and, while moving for judgment on the merits for petitioner’s failure to prosecute, suggests that that issue is res judicata under prior decisions of this Board. Portage Silica Co., 11 B. T. A. 700; affd., 49 Fed. (2d) 985; 284 U. S. 667; certiorari denied, 29 B. T. A. 881 (appealed to C. C. A., 6th Cir., July 5, 1934).

Petitioner’s first contention is answered in our decision in Elnora C. Haag, 19 B. T. A. 982, where we said:

The discharge of an executrix does not bar collection of taxes on income received by a decedent in Ms lifetime, provided assessment is made witMn the statutory period. Elna S. Evans, Administratrix, 12 B. T. A. 334; Karl J. Kaufmann, Administrator, 15 B. T. A. 141. See also Joseph Simon, Executor, 9 B. T. A. 84. It is not important that the petitioner had no notice or knowledge of any taxes due from the decedent. Elna S. Evans, supra.

In affirming, the Circuit Court of Appeals for the Seventh Circuit said (59 Fed. (2d) 516, 518):

The notice of the deficiency tax, which the Commissioner mailed February 19, 1927, was addressed to the executrix of the estate of Louis E. Haag. Inasmuch as there was no such executrix in existence at this date and inasmuch as there was no deficiency tax assessed against Elnora C. Haag, individually, the recipient of the estate upon its being fully administered, it is argued that there was no valid deficiency tax assessed. Associated with this contention is the fact that petitioner sought relief from the Board of Tax Appeals through a petition signed by her as “former executrix of the estate of Louis E. Haag, deceased.” Thereafter, petitioner sought to avoid the consequences of such petition and adjudication of her petition by asserting that she, as the former executrix of the estate, could not take an appeal from the assessment of a tax against the executrix of the estate. Complete answer to this position is to be found in the decisions of this court and of other courts. [Citing authorities.] These cases hold that although the notice was not directed to the proper party, nevertheless if it axjpeared that the proper party had received the notice or that the party who succeeded to the title of the party filing the return had received the notice, it was sufficient.

We turn now to the question whether the deficiency notice was timely. Respondent contends that it was, on the ground, first, that petitioner is estopped to deny the effectiveness of the waivers which she executed, by reason of her holding herself out to the respondent as having the capacity to execute them as executrix, and, second, that since petitioner never filed a return as executrix of the decedent, the respondent might file such a return on her behalf as executrix under authority of section 3176 of the Revised Statutes, as amended, and, having done so, the statute would run two years from the date of this return, or until June 5, 1936, and consequently that respondent’s deficiency notice of June 20, 1934, was timely. As the second contention, if sound, will dispose of the case without necessity of our considering at length the facts and legal effect of the several waivers executed by petitioner, we shall proceed now to consideration of the second point.

The statute provides that income taxes shall be assessed (or a proceeding in court begun) within two years after the return is filed (sec. 275 (a), Revenue Act of 1928), but if income is “received during the lifetime of a decedent, or by his estate during the period of administration”, the tax shall be assessed “within one year after written request therefor * * * by the executor, administrator, or other fiduciary representing the estate of such decedent * * *.”■ (Sec. 275 (b).) In respect of the fiduciary of a taxpayer the statute-pro vides (sec. 312 (a)) :

* * * Upon notice to the Commissioner that any person is acting in a fiduciary capacity such fiduciary shall assume the powers, rights, duties, and' privileges of the taxpayer in respect of a tax imposed by this title (except as otherwise specifically provided and except that the tax shall be collected from the estate of the taxpayer), until notice is given that the fiduciary capacity has terminated.

No question is here involved of a request by the petitioner as-executrix to have the assessment made. On the contrary, petitioner,, holding herself out to be still lawfully acting as executrix, requested, about July 1931, postponement of further action by respondent pending the adjudication of the Portage Silica case, and as executrix executed waivers on February 16, 1932, and November 29, 1932, which would, if valid, have extended the period to June 30, 1934, under section 506 of the statute.

Section 276 (a) and (b) of the Revenue Act 1928 provides as follows:

(a) False return or no return. — In the case of a false or fraudulent return with intent to evade tax or of a failure to file a return the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time.
(b) Waivers. — Where before the expiration of the time prescribed in section 275 for the assessment of the tax, both the Commissioner and the taxpayer have consented in writing to its assessment after such time, the tax may be assessed at any time prior to the expiration of the period agreed upon. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.

Section 3176 of the Revised Statutes, as amended (sec. 1103, Revenue Act of 1926), provides as follows:

Seo. 3176. If any person, corporation, company, or association fails to make and file a return or list at the time prescribed by law or by regulation made under authority of law, or makes, wilfully or otherwise, a false or fraudulent return or list, the collector or deputy collector shall make the return or list from his own knowledge and from such information as he can obtain through testimony or otherwise. In any such case the Commissioner of Internal Revenue may, from his own knowledge and from such information as he can obtain through testimony or otherwise, make a return or amend any return made by a collector or deputy collector. Any return or list so made and subscribed by the Commissioner, or by a collector or deputy collector and approved by the Commissioner, shall be prima facie good and sufficient for all legal purposes.
ijs # * ❖ % *
The Commissioner of Internal Revenue shall determine and assess all taxes, other than stamp taxes, as to which returns or lists are so made under the provisions of this section.

Respondent bad prepared and sent to petitioner on July 24, 1931, a delinquent return covering the income of the decedent fpr that period of 1929 properly returnable by petitioner as executrix. It does not appear, however, that petitioner ever signed and filed this return. Respondent’s counsel catagorically states that the only return filed for the estate for the year 1929 was that filed by the Commissioner in 1934, and in the circumstances we must accept this as conclusive. Respondent, acting under the authority of section 3176 of the Revised Statutes, filed a return for the decedent’s estate on June 5, 1934. On June 20, 1934, he sent to petitioner, as executrix of decedent’s estate, a deficiency notice based on this return. From this deficiency notice petitioner brings the instant appeal.

That the deficiency notice was timely can not be doubted, for under section 276 (a) the statute of limitations does not begin to run until a return has been filed. The Commissioner’s return filed on behalf of the petitioner constituted the only return made and the deficiency notice followed promptly upon the return so made by the respondent. Petitioner as executrix never filed a return of decedent’s income for 1929, and the joint return originally filed by her covering her own and decedent’s income for that year can not be construed as a return by her in her fiduciary capacity. This point has been settled adversely to petitioner. The Court of Appeals for the Third Circuit held, in Bliss v. Commissioner, 76 Fed. (2d) 101, that a wife whose husband died prior to the end of the taxable year was precluded from filing a joint income tax return with her deceased husband, saying (p. 102) :

* * * Thus the petitioner is left to the statute alone for a right to file a joint return. We find nothing in the statute thar gives her such a right. On the contrary, it is clear from section 225 (Revenue Act of 1924) that the duty of filing a return of income of a deceased spouse, in this case the husband, devolves upon his personal representative, leaving the inescapable inference that no such duty devolves upon the surviving spouse and no such right is accorded her.

To the same effect is Gertrude H. Thompson, 30 B. T. A. 30. We are of the opinion that no bar exists to the collection from the estate of the asserted tax.

On the question raised on the merits, in so far as the merits may be grasped from the brief references in the petition, from the correspondence between petitioner and respondent, and from respondent’s counsel’s statements at bar, it appears to depend upon the March 1, 1913, value of certain mineral deposits, which wras considered by us in the Portage Silica Co., cases, supra, and resolved adversely to the taxpayer’s contention. In any event, since petitioner has not prosecuted her appeal on its merits, we must consider ourselves bound by respondent’s determination. Respondent’s determination is prima facie correct, and petitioner’s failure to rebut it in any way by testimony or other evidence leaves it undisturbed.

Judgment %oiTl be entered for the respondent.

       (a) General rule. — The amount of income taxes imposed by this title shall be assessed1 -within two years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period.


source: Caselaw Access Project

author: Tuener : ARUNdell,

license: Public Domain

text:
    Louise C. Slack and W. B. Merwin, Executors of the Estate of A. B. Slack, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 72404, 78525.
    Promulgated January 19, 1937.

      Claude I. Parker, Esq., Bayley Kohl/meier, Esq., and L. A. Luee, Esq., for tlie petitioners.

      John H. Pigg, Esq., and Arthur Clark, Esq., for the respondent.
   OPINION.

Tuener :

Our first question is whether or not the respondent erred in disallowing the net loss deduction claimed by the decedent on his returns for 1930 and 1931 as the result of the loss sustained by him in 1929 from the sale of real estate to Sears, Roebuck & Co. The deduction was disallowed by the respondent, first, on the ground that the loss was not sustained in a trade or business regularly carried on by the decedent and, second, on the ground that it represented a capital loss; which, under the terms of the statute, is deductible in computing a net loss only to the extent of capital gains. It is the contention of the petitioners that the decedent, during the year 1929, was regularly engaged in the business of buying, selling, and leasing real estate, and the loss, having been sustained in the sale of real estate, was attributable to the operation of that trade or business and was a net loss within the meaning of section 117 of the Revenue Act of 1928.

A capital loss, by the terms of the statute, is a loss resulting from the sale or exchange of capital assets, and a capital asset is defined by section 101 (c) (8) of the Revenue Act of 1928 as “property held by the taxpayer for more than two years (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale in the course of his trade or business.”

In our opinion the record definitely and clearly shows that the property sold to Sears, Roebuck & Co. was a capital asset within the meaning of section 101 (c) (8) mentioned above. There is no •question that the property had been held for more than two years. It was not stock in trade; neither was it property held by the taxpayer primarily for sale in the course of his trade or business. The taxpayer was a man of considerable means. His money was invested largely in rent-producing real estate and substantially all his income was derived from the rents. We have found as a fact that he held the said real estate primarily for rental purposes and not for sale. It is apparent from the testimony that the sales of real ■estate were prompted by the fact that the parcels sold were no longer profitable from a rental standpoint, rather than by the thought of making a profit from such sales. As a matter of fact, the decedent sustained losses on all of his real estate sales, excepting possibly two sales where in each instance a portion of a parcel was sold. Some argument is made to the effect that by the terms of the lease agreement with the Pasadena Furniture Co., which gave the lessee the right to purchase the property under certain circumstances, the lessor thereafter held the property primarily for sale. The terms of the lease and the activities of the decedent negative this contention. There is nothing in the lease or in the record which indicates that the decedent desired to sell the property so long as it was profitable from a rental standpoint. On the other hand, the record does indicate that the property was bought for rental purposes and the whole scheme and plan of the transaction with the Pasadena Furniture Co. was to arrange for rentals to the decedent over a long period of years.

It is also contended that the decedent placed the property in the hands of a real estate agent for sale as early as 1927, and that this act on his part changed the situation so that the property was thereafter held by him primarily for sale. As a matter of fact the real estate agent was unable to say, when questioned on cross-examination, that the property had been listed for a period of more than eight or nine months prior to the sale to Sears, Roebuck & Co., which occurred in October 1929, and, furthermore, the property was listed with him for lease or sale. It is not enough, however, under the statute, that property be held primarily for sale. It must be held for sale in the course of the taxpayer’s trade or business. Phipps v. Commissioner, 54 Fed. (2d) 469. In the instant case-it may be said that the decedent was engaged in the business of owning and renting real estate, and when a piece of property was no longer valuable for that purpose it was disposed of, but the facts do not show that the decedent was engaged in buying and selling real estate as a business and we have found as a fact that he was not so engaged. The property sold to Sears, Roebuck & Co. was a capital asset and the loss sustained therefrom was a capital loss, and, since the decedent realized no capital gains in the year of the sale, the loss in question may not be included in computing his net loss for 1929.

The petitioner relies on S. Rose Lloyd, 32 B. T. A. 887. In that case, however, the Board found as a fact that the petitioner was regularly engaged in the business of buying and selling real estate and that the property on which the loss was sustained was held primarily for sale in the course of that trade or business. The record in this case, as we have pointed out, definitely shows that the property in question was not held primarily for sale. On the first issue, the respondent is sustained.

The second issue requires a determination of the question as to whether or not the decedent realized taxable gain in 1931 upon default and forfeiture of the lease by J. W. Dickinson. As the result of the forfeiture the decedent came into possession of a building, erected on the premises by Dickinson, which at the time of forfeiture had a depreciated value of $36,000. .That amount was reported in income on the decedent’s return for 1931. It is alleged, in the petition that the inclusion of that sum in income for 1931 was error. Among the cases cited by the petitioners in support of that allegation is Miller v. Gearin, 258 Fed. 225; certiorari denied, 250 U. S. 667. In that case, as in this, the lessee erected a building on leased premises. Upon default the lessor repossessed the property and the respondent included in the lessor’s income in the year of repossession an amount equal to the fair market value of the building at the time it was repossessed. The court held that the lessor in that year acquired nothing except possession of that which for many years had been her own property. It was suggested that, if the building might be termed income from the use of the property, it must have been income in the year in which it was completed and enhanced the value of the real estate of which it became a part.

The respondent does not take issue with the rule laid down in Miller v. Gearin, supra, but, to the contrary, claims that that case and article 63 of Regulations 74, as amended by T. D. 4282, O. B. VTII-2, p. 82, are controlling. He argues that under the provisions of T. D. 4282 the petitioners are estopped from denying that the decedent realized gain in the amount of $36,000 in 1931 by reason of the cancellation of the lease. T. D. 4282, which includes the rule laid down in Miller v. Gearin, supra, as an alternative method of reporting income in such cases, reads in part as follows:

Article 63 of Eegulations 74 is hereby amended to read as follows:

Art. 63. Improvements 'by lessees. — When buildings are erected or improvements made by a lessee in pursuance of an agreement with the lessor, and such buildings or improvements are not subject to removal by the lessee, the lessor may at his option report the income therefrom upon either of the following bases:
(а) The lessor may report as income at the time when such buildings or improvements are completed the fair market value of such buildings or improvements subject to the lease.
(б) The lessor may spread over the life of the lease the estimated depreciated value of such buildings or improvements at the expiration of the lease and report as income for each year of the lease an aliquot part thereof.
Except in cases where the lessor has exercised the option to report income upon basis (&)■, if the lease is terminated so that the lessor comes into possession or control of the property prior to the time originally fixed for the expiration of the lease, the lessor derives no income by reason thereof, and, just as when the lessor comes into possession or control of the property upon the expiration of the lease, the basis for determining gain or loss to the lessor from the subsequent sale or other disposition of the buildings or improvements and for depreciation in respect of such property is the amount previously reported as income by the lessor because of the erection of the buildings or improvements * * *.
*******
In all eases where the lessor has exercised the option to report income upon basis (5), if the lease is terminated so that the lessor comes into possession or control of the property prior to the time originally fixed for the expiration of the lease, the lessor derives additional income for the year in which the lease is so terminated to the extent that the value of such buildings or improvements when he becomes entitled to such possession exceeds the amount already reported as income on account of the erection of such buildings or improvements. * * *

Iii applying article 63 above, the respondent contends that the decedent, under paragraph (a), had the option of reporting income in respect of the building in the year in which it was completed, or under paragraph (5) of prorating the income in respect thereto over the life of the lease, and, since he did neither, it must be deemed that he exercised the option to prorate the income over the life of the lease and, further, since the decedent did not report income in accordance with that election, the petitioners are now estopped from claiming that he realized no income in the year the lease was terminated. The fallacy in this contention is at once apparent on examination of the facts. The lease was for a 99-year period and the building obviously had a probable life of not more than 40, or at the most, 50 years. According to the terms of the above regulation the decedent should have reported as income, in the year in which the building was completed, an amount equal to the fair market value of the building, subject to the lease, or should have reported in each year during the time the lease was in force an aliquot part of the estimated depreciated value at the expiration of the lease. Certainly in the absence of proof to the contrary no one would be justified in holding that a building such as we have here would, subject to a 99-year lease, have any fair market value, and it would be equally startling to say that it would have any depreciated value at the expiration of the lease. It is at once apparent from these facts that there is as much ground for saying that the decedent exercised the option under paragraph (a) of the above regulation as there is for saying that he exercised the option under paragraph (b), and if the decedent lessor did elect the option under paragraph (a), the regulation itself states that he derived no income by reason of the termination of the lease prior to the time originally fixed for its expiration. There is nothing whatever in the record to show that the decedent failed in any year prior to the taxable year to report any and all income in respect of the building in question, as provided by the regulation the respondent relies on. There is no showing of misrepresentation on the part of the decedent and, on the facts before us, the respondent could not possibly have been misled by any affirm-itive act of the decedent. Since the doctrine of estoppel was invoked by the respondent, the burden was on him to present proof of facts sufficient to justify its application. Helvering v. Brooklyn City Railroad Co., 72 Fed. (2d) 275. He has presented no such proof and the claim of estoppel is denied.

The claim of the petitioners that the decedent realized no taxable gain in 1931 by reason of the forfeiture of the Dickinson lease is supported by Miller v. Gearin, supra, the soundness of which has been accepted in numerous cases. Shelby D. Scott, 9 B. T. A. 1219; Joseph L. B. Alexander, 13 B. T. A. 1169; W. H. Martin, 24 B. T. A. 813; United States v. Boston Providence R. R. Corporation, 37 Fed. (2d) 670; Organ v. Wardell, 263 Fed. 248; Hewitt Realty Co. v. Commissioner (majority and concurring opinions), 76 Fed. (2d) 880. Ownership of the building vested in the decedent when it was erected on his property and, in the taxable year, he merely came into possession of that which he already owned. “Possession so acquired was not income.” Miller v. Gearin, supra. Although not cited by the respondent, Gilbert Butler, 4 B. T. A. 756, gives some support to the proposition that the decedent realized gain in 1931 to the extent of the fair market value of the building at the time the lease was forfeited. That case involved the treatment for income tax purposes of improvements consisting of shafts, tunnels, and the like, made by a lessee on mineral properties. The Board said: “Commonly, permanent improvements placed upon leased property by the lessee result immediately in income to the lessor. See Miller v. Gearin (C. C. A.), 258 Fed. 225; Cryan v. Wardell, supra. However, if the life of the improvement is less or only equal to the term of the lease, the Bureau of Internal Revenue has always conceded that no income resulted until the lessor acquired possession and beneficial use thereof. This we believe to be the correct rule.” No effort was made in that case to show how the acquisition of possession of property already owned constituted the realization of gain in the one case and not in the other. It is true that in Miller v. Gearin, the lease was for a term of 23 years, while in Gilbert Butler the term was for the life of the mine, but in neither case did the lessor come into possession of the property by the running of the term fixed in the lease instrument. In each case possession of the property with the improvements thereon was obtained by forfeiture of the lease prior to the running of the term. It was the acquiring of possession of improvements by forfeiture that the-court held was not income. We are now of the opinion that Gilbert Butler, supra, can not be reconciled with the decision of the court in Miller v. Gearin, supra, and on that point our opinion therein will not be followed. The second issue is determined for the petitioners.

The question involved in the third issue is whether or not the decedent properly deducted as an ordinary and necessary expense the item of $1,800 paid during the year 1931 to his attorneys for legal services rendered in connection with an appeal to this Board from the determination of a deficiency in income tax against him for the year 1923. As we have pointed out, the decedent derived substantially all of his income from real estate rentals. In our opinion his activities in connection with the management of his rental properties constituted the carrying on of a trade or business and the income involved in the proceeding before the Board was derived from the sale of a portion of a parcel of real estate bought for use in connection with that trade or business. Under authority of the decision of the Supreme Court of the United States in Kornhauser v. United States, 276 U. S. 145, it is our opinion that the fee in question was an ordinary and necessary expense, incurred and paid by the decedent m carrying on a trade or business. The petitioners are sustained on this issue. See also Caroline T. Kissell, 15 B. T. A. 1270. Cf. Alice G. Kales, 34 B. T. A. 1046.

The fourth and final issue raised the question as to whether or not the respondent erred in failing to allocate one-half of the decedent’s total taxable income for the year 1930 to the decedent’s wife. In support of the allegation of error, it is alleged that the property from which the income in question was derived was community property, such property having been purchased with community funds realized by the petitioner and his wife while residents of the State of Texas. No proof was presented in support of this allegation and no argument has been made by the petitioners to sustain the position taken in the petition. The issue has apparently been abandoned and is decided for the respondent by reason of failure on the part of petitioners to make any showing to sustain it.

Reviewed by the Board.

Decision will be entered under Rule 50.

Hill dissents.

ARUNdell,

concurring: I concur in the result reached on the second point but not in the reasoning by which it is reached. The substance of the holding on this point is that the petitioner is not to be taxed in the year 1931 by reason of his acquiring possession in that year of premises on which his lessee had erected a building. This is the same conclusion arrived at in the Hewitt Realty case, in which the reasoning of the court was that improvements to leased premises which become a part of the realty do not result in income to the lessor until he sells the realty. At the time of sale, and not before, the enhancement in value, if any, resulting from the improvements is realized by the lessor. That seems to me to be the sound rule, and, applying it here, the conclusion must be that the surrender of the premises by the lessee in 1931 did not produce income to the lessor in that year.

Sternhagen, Tyson, and Harron agree with the above.

       SEC. 117. NET LOSSES.
      (a) Definition of “net loss." — As used in this section the term “net loss” means the excess of the deductions allowed by this title over the gross income, with the following exceptions and limitations:
      (1) Non-business deductions. — Deductions otherwise allowed by law not attributable to the operation of a trade or business regularly carried on by the taxpayer shall be allowed only to the extent of the 'amount of the gross income not derived from such trade or business;
      (2) Capital losses. — In the case of a taxpayer other than a corporation, deductions for capital losses otherwise allowed by law shall be allowed only to the extent of the capital gains;

        ****** *

      (b) Net loss as a deduction. — If, for any taxable year, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year (hereinafter in this section called “second year”), and if such net loss is in excess of such net income (computed without such deduction), the amount of such excess shall be allowed as a deduction in computing the net income for the next succeeding taxable year (hereinafter in this section called “third year”) ; the deduction in all cases to be made under regulations prescribed by the Commissioner with the approval of the Secretary.


author: Smith :

text:
    Pearl W. Dahl, Executrix of the Estate of Chester T. Dahl, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81962.
    Promulgated January 19, 1937.

      Ezra W. Deeoto, Esq., and J. Meredith Wortz, Esq., for the petitioner.

      Dean P. Kimball, Esq., for the respondent.
   OPINION.

Smith :

In this proceeding the petitioner contends that the corpus of the trust created by Chester T. Dahl on December 16, 1929, was erroneously included by the respondent in the gross estate in the determination of the deficiency. She contends that at the time the trust was created the estate tax law in force did not require the inclusion in the gross estate of the value of the corpus of an irrevocable trust of the character created by the decedent on December 16, 1929; that the amendment to section 302 (c) of the Revenue Act of 1926 effected by Joint Resolution 529 of March 3, 1931, and by section 803 (a) of the Revenue Act of 1932, was not intended to be retroactive; and that if such amendment is to be retroactively construed to include a transfer of the character above described, the amendment is unconstitutional.

Section 302 (c) of the Revenue Act of 1926, which was in effect in 1929, required the inclusion in the gross estate of the value of any interest in property at date of death:

* * * 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. * * *

Section 302 (h) of the same act provided that subdivision (c) of the act should:

* * * apply to the transfers, trusts, estates, interests, rights, powers, and relinquishment of powers, as severally enumerated and described therein, whether made, created, arising, existing, exercised, or relinquished before or after the enactment of this Act.

The respondent argues that the interests created under the trust deed of December 16, 1929, were intended to take effect in possession or enjoyment at or after death and that they are therefore includable in the gross estate. He argues that the interests of the beneficiaries of the trust were not vested prior to the date of death of the decedent; that upon the death of the decedent they became vested; and that therefore the value of the corpus of the estate at death of decedent is includable in the gross estate.

The argument of the respondent overlooks the incidence of the estate tax. The estate tax is an excise tax upon the transfer of the net estate. It does not tax the interest to which some person succeeds on a death, but the interest which ceases by reason of death. Y. M. C. A. v. Davis, 264 U. S. 47; Edwards v. Slocum, 264 U. S. 61. If no property or interest in property passed at the date of death (except in case of property transferred in contemplation of death), there is no value in any property right upon which the estate tax falls.

The parties have stipulated that the trust created by the decedent was not created in contemplation of death. At the time of the transfer in 1929 the decedent parted with all right, title, and interest in and control of the corpus of the trust fund. He retained only a right to receive the income for life. Upon his death that right ceased and became valueless. The facts in this case are in all respects similar to those which obtained in May v. Heiner, 281 U. S. 238. It was there held:

The transfer of October 1, 1917, was not made in contemplation of death within the legal significance of those words. It was not testamentary in character and was beyond recall by the decedent. At the death of Mrs. May no interest in the property held under the trust deed passed from her to the living; title thereto had been definitely fixed by the trust deed. The interest therein which she possessed immediately prior to her death was obliterated by that event.

The opinion of the Court in the above cited case was immediately followed by and relied upon in Burnet v. Northern Trust Co., 283 U. S. 182; Morsman v. Burnet, 283 U. S. 783; and McCormick v. Burnet, 283 U. S. 184.

Upon the authority of the above cited cases it must be held that the property conveyed by the decedent to the trustee on December 16,1929, passed as of that date; that the value of the decedent’s interest in the property reached the vanishing point at the date of the death of the decedent; and accordingly that no interest in property passed at his death.

It further must be held that the transfer completed on December 16, 1929, was not one “intended to take effect in possession or enjoyment at or after his death.” The transfer from the decedent took effect on December 16, 1929, and not at the date of the death of the decedent on May 24, 1933. See Tait v. Safe Deposit & Trust Co. of Baltimore, 74 Fed. (2d) 851; Helvering v. St. Louis Union Trust Co., 75 Fed. (2d) 416; affd., 296 U. S. 39. In the last named case the Supreme Court said:

If, therefore, uo interest in the property involved in a given case pass “from the possession, enjoyment, or control of the donor at his death,” there is no interest with respect to which the decedent has created a trust intended to take effect in possession or enjoyment at or after his death. * * *

The respondent argues that, since the enjoyment of the income of the estate was in the decedent up to the date of his death, when it vested in another, there was such a shifting of economic benefits in the property (cf. Chase National Bank v. United States, 278 U. S. 327; Tyler v. United States, 281 U. S. 497) as warrants the inclusion of the value of the transferred property in the gross estate of the decedent. This argument is contrary to the reasoning of the above cited cases and is sufficiently answered by them — unless by reason of amendments made to section 302 (c) between the date of the creation of the trust and the date of death a different legal principle should be applied.

As the law stood on December 16, 1929, the transferred property was not required by the provisions of the estate tax act to be included in the gross estate. The first sentence of section 302 (c) of the 1926 Act was amended by Joint Resolution 529, approved March 3, 1931, to read as follows:

(c) To the extent 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, including a transfer under which the transferor has retained for his life or any period not ending before his death (1) the possession or enjoyment of, or the income from the property or (2) the right to designate the persons who shall possess or enjoy the property or the income therefrom; except in ease of a bona fide sale for an adequate and full consideration in money or money’s worth. [Italics supplied.]

The respondent, by Treasury Decision 4314, ruled that in view of numerous decisions of the Supreme Court the amendment made by Joint Resolution 529 would be “applied prospectively only, i. e., to such transfers coming within the amendment as were made after 10:30 P. M., Washington, D. C., time, March 3, 1931.” See Elizabeth B. Wallace, Executrix, 27 B. T. A. 902.

Section 803 of the Revenue Act of 1932, approved June 6, 1932, provides in part:

SEO. SO3. FUTURE INTERESTS.
(a) Section 302 (e) of the Revenue Act of 1926, as amended by the Joint Resolution of March 3, 1931, is amended to read as follows:
“(c) To the extent 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, or of which he has at any time made a transfer, by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom; except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * * ”

In the Ways and Means Committee Report (Rept. 708, p. 46) and the Senate Finance Committee Report (Rept. 665, p. 49), on the bill which later became the Revenue Act of 1932, each has the following to say with regard to the reasons for the enactment of section 803 of the Revenue Act of 1932:

The purpose of this amendment to section 302 (c) of the revenue act of 1026 is to clarify in certain respects the amendments made to that section by the joint resolution of March 3, 1931, which were adopted to render taxable a transfer under which the decedent reserved the income for his life. The joint resolution was designed to avoid the effect of decisions of the Supreme Court holding such a transfer not taxable if irrevocable and not made in contemplation of death. Certain new matter has also been added, which is without retroactive effect. [Emphasis supplied.]

Then follows an explanation of the changes made. Article 18 of Regulations 80, promulgated November 7,1934, provides that a transfer of the character of that made by the decedent on December 16, 1929, if made subsequent to September 8, 1916, is taxable, unless the transfer was made prior to 10:30 p. m., eastern standard time, March 31, 1931, and the decedent died prior to 5 p. m., eastern standard time, June 6, 1932.

It is under the authority of the law as construed by the above entitled regulations that the respondent has included in the gross estate of the decedent the value of the principal and accrued income of the transferred property at the date of the death of the decedent.

In the light of the legislative history of the amendments made to section 302 (c) of the Revenue Act of 1926 by Joint Resolution 529 of March 3, 1931 (see Elizabeth B. Wallace, Executrix, supra), and by section 803 of the Revenue Act of 1932, we are of the opinion that it was not the intention of Congress that the amendments made were to be effective prior to the dates when they were made. Cf. Jacob Schneider et al., Executors, 35 B. T. A. 183. If the transfer involved in this proceeding had been made after the effective date of Joint Resolution 529, March 3, 1931, 10:30 p. m., there could be no question but that the value of the transferred property should be included in the gross estate of the decedent; for there appears to be no doubt that a transfer of the character of that here involved made after the effective date of the joint resolution should be included in the gross estate. In Burnet v. Northern Trust Co., supra, the Supreme Court said, per curiam:

The question in this case is that of the construction of section 402 (c) of the Revenue Act of 1921, c. 136, 42 Stat. 227, 278, a provision similar to that of section 402 (c) of the Revenue Act of 1918, c. 18, 40 Stat. 1057, 1097, which has already been construed by this Court, and, in this view, there being no question of the constitutional authority of the Congress to impose prospectively a tax with respect to transfers or trusts of the sort here involved, the judgment of the United States Circuit Court of Appeals for the Seventh Circuit (43 F. (2d) 277) is reversed upon the authority of May v. Heiner, 281 U. S. 238, 50 S. Ct. 286, 74 L. Ed. 826, 67 A. L. R. 1244.

The transfer made by the decedent on December 16, 1929, was of the same character as that involved in the case of May v. Heiner, supra.

We are also of the opinion that a grave constitutional question would be involved if the amendments made to section 302 (c) were to be applied retrospectively. In Frew v. Bowers, 12 Fed. (2d) 625, it was held that, if the statute there under consideration were to be construed as applicable retrospectively to trusts in which the interests of the remainderman had vested absolutely, although deferred in enjoyment until the settlor’s death, the statute was unconstitutional and arbitrary; that, if the statute were so applied, the property of the remainderman would be used as a measure for the tax to be laid upon the decedent; and that where a tax laid on the estate was measured by property not belonging to the estate it was a direct tax and invalid if not apportioned. Certiorari was granted in this case, 273 U. S. 682, but was dismissed in the Supreme Court, 275 U. S. 578.

The reasoning of the Court in Frick v. Pennsylvania, 268 U. S. 473, was also along the same line and the reasoning of that opinion was applied in the case of Frew v. Bowers, supra. In Nichols v. Coolidge, 274 U. S. 531, the Supreme Court used the following-language :

The statute requires the executors to pay an excise ostensibly laid upon transfer of property by death from Mrs. Coolidge to them but reckoned upon its value plus the value of other property conveyed before the enactment in entire good faith and without contemplation of death. Is the statute, thus construed, within the power of Congress?
Undoubtedly, Congress may require that property subsequently transferred in contemplation of death be treated as part of the estate for purposes of taxation. This is necessary to prevent evasion and give practical effect to the exercise of admitted power, but the right is limited by the necessity.
Under the theory advanced for the United States, the arbitrary, whimsical and burdensome character of the challenged tax is plain enough. An excise is prescribed, but the amount of it is made to depend upon past lawful transactions, not testamentary in character and beyond recall. Property of small value transferred before death may have become immensely valuable, and the estate tax, swollen by this, may leave nothing for distribution. Beal estate transferred years ago, when of small value, may be worth an enormous sum at the death. If the deceased leaves no estate there can be no tax; if, on the other hand, he leaves ten dollars both that and the real estate become liable. Different estates must bear disproportionate burdens determined by what 1he deceased did one or twenty years before he died. See Frew v. Bowers, Collector (C. C. A.) 12 F. (2d) 625.
$ >}: sfc He * * *
* * * And we must conclude that section 402 (c) of the statute here under consideration, in so far as it requires that there shall be included in the gross estate the value of property transferred by a decedent prior to its passage merely because the conveyance was intended to take effect in possession or enjoyment at or after his death, is arbitrary, capricious and amounts to confiscation. * * *

In view of the language used by the Committees of Congress in their reports setting forth the reasons for the enactment of section 803 of the Revenue Act of 1932, it must be assumed that they were fully aware of the decisions of the Supreme Court bearing upon the retrospective operation of the estate tax laws, and that the amendments made to section 302 (c) of the Revenue Act of 1926 were to be applied prospectively only.

The action of the respondent, in including in the gross estate of the decedent $54,937.50 representing the value of the corpus of the trust fund at the date of death of the decedent, is reversed.

In none of the briefs filed in this case is any reference made to the action of the respondent in including in the gross estate $949.87 representing the accrued income upon the trust fund at the date of death of the decedent. The deficiency notice attached to the petition clearly shows that this amount was included in the $55,587.37 which was stipulated to be the corpus of the above mentioned trust fund. This clearly was in error. The accrued income belonged to the estate of the decedent and was properly included by the respondent in the gross estate in the determination of the deficiency.

Judgment will be entered under Rule 50.


author: Leech : Arundell,

text:
    Emma C. Morphy, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 76711.
    Promulgated January 19, 1937.

      Prewitt Semmes, Esq., for the petitioner.

      E. G. Algire, Esq., for the respondent.
   OPINION.

Leech :

The broad question here is when is income realized to the lessor from the erection of a building on his land by the lessee, which is not subject to removal on termination of the lease. The Treasury regulations provide that the income must be reported either in the year of completion of the building or prorated over the life of the lease. The respondent has determined a deficiency on the latter basis. The petitioner claims that the regulation is invalid and that income is not realized until the property is sold or the lease is forfeited or expires.

These regulations under attack are grounded upon the view, expressed if not held, in Miller v. Gearin, 258 Fed. 225, and Cryan v. Wardell, 263 Fed. 248.

These regulations have, in effect, been sustained. Shelby D. Scott, 9 B. T. A. 1219; Joseph L. B. Alexander, 13 B. T. A. 1169; Cataract Ice Co., 23 B. T. A. 654; W. H. Martin, 24 B. T. A. 813. Cf. Louise C. Slack et al., Executors, 35 B. T. A. 271.

It is true the Circuit Court of Appeals for the Second Circuit in Hewitt Realty Co. v. Commissioner, 76 Fed. (2d) 880 (1935), is contra. That opinion has had the respectful consideration of this Board. It offers what may seem to be a persuasively practical answer to a difficult problem. However, no other similar authority has come to our attention. And, the court, even in its decision of that case, was not unanimous. See dissenting opinion of Chase, Judge.

Therefore, we adhere to our position and sustain the validity of the contested regulations.

It is suggested in petitioner’s brief, as an alternative reason why no income was realized in the year involved that, under the lease, title to the building did not pass to the lessor until expiration or forfeiture of the lease. This argument has no merit, since that was not the effect of the present lease. Cf. Joseph L. B. Alexander, supra.

Reviewed by the Board.

Decision will be entered for the respondent.

Murdock dissents.

Arundell,

dissenting: It seems to me that the decision of the Second Circuit in the Hewitt Realty case, 76 Fed. (2d) 880, gives a sound solution to the question here involved. The substance of the lidding in that case is that the erection of a building by a lessee does not result in realization of income to the lessor; the realization of income, if any, occurs when the lessor sells. This view, as stated by Judge Learned Hand, author of the majority opinion, “answers every fiscal necessity far more directly and simply than any other formula.”

The lease in the instant case was for a period of over thirty years. Under the view expressed in the Commissioner’s regulations and approved in the majority opinion, it is necessary to look into the future to the time when the lease terminates and determine the value of the building after taking into account the ravages of time. In many cases of long-term leases the original term extends beyond the useful life of the improvements. Some of them involve definite provisions for renewal. There are always the possibilities of termination prior to the expiration of the agreed term, and accelerated depreciation and obsolescence resulting from causes unforseeable when the lease is executed. These are factors that complicate any attempted application of the Commissioner’s regulations. But what is more serious, they show the impossibility of determining with any fair certainty the amount to be treated under the regulations as realized income. A promise to turn over possession of a building many years hence, and subject to the many contingencies necessarily in-wolved .in any transaction extending over a period of years, does not seem to be in any proper sense the present equivalent of cash. Cf. Burnet v. Logan, 283 U. S. 404. The difficulty of determining as a matter of fact the value of improvements is recognized in both opinions filed in the Hewitt case. The majority opinion obviates the •difficulty and offers a sound solution. It treats as income the full amount eventually realized when it is actually realized. Anything short of this does not meet the test of realized income with which the taxing act is concerned. For these reasons, I think we should adopt the principle of the Hewitt Realty case and decline to follow the earlier cases that hold otherwise.

Sternhagen and Tyson agree with this dissent.

       Article 63 of Regulations 74, as amended, reads in part as follows:

        “Improvements by lessees. — When buildings are erected or improvements made by a lessee in pursuance of an agreement with the lessor, and such buildings Or improvements are not subject to removal by the lessee, the lessor may at his option report the income therefrom upon either of the following bases:
      “(a) The lessor may report as income at the time when such buildings or improvements are completed the fair market value of such buildings or improvements subject to the lease.
      “ (b) The lessor may spread over the life of the lease the estimated depreciated value of such buildings or improvements at the expiration of the lease and report as income for each year of the lease an aliquot part thereof.”


author: Smith:

text:
    P. J. Hiatt, Petitioner, v. Commissioner of Internal Revenue, Respondent. Anna Belle Hiatt, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 82568, 82569.
    Promulgated January 19, 1937.

      Arthur 0. Huston, Jr., Esq., Stephen W. Downey, Esq., and Harry B. Seymour, Esq., for the petitioners.

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

Smith:

The question presented by these proceedings is whether the petitioners realized taxable income by having assessments against their lands in the amount, including interest, of $82,094.05 satisfied by a charge against them on the books of the mortgagee of the lands of $15,258.63, the latter amount representing the cost to the mortgagee of purchasing bonds to satisfy' the assessment. In his deficiency notices the respondent states: “These transactions are held to be equivalent to sales and the difference between the purchase price of the bonds and the amount of credit received against the assessments represents property subject to tax just the same as if the bonds had been purchased and sold outright, even though the credit may have applied against an item that had been capitalized.” The authorities relied upon by the respondent in his determination are United States v. Kirby Lumber Co., 284 U. S. 1; Helvering v. American Chicle Co., 291 U. S. 426; Commissioner v. Coastwise Transportation Corporation, 71 Fed. (2d) 104; certiorari denied, Coastwise Transportation Corporation v. Commissioner, 293 U. S. 595.

The facts in the above cited cases were entirely different from those which obtain in the proceedings at bar. In United States v. Kirby Lumber Co., supra, the Kirby Lumber Co. was held liable to income’ tax upon profit realized by it in the redemption of some of its bonds at a price less than the issuing price. The facts clearly showed that the company had a cash profit from the redemption of the bonds at prices less than the issuing price. In Helvering v. American Chicle Co., supra, the facts were that the American Chicle Co. had purchased the assets of another corporation and as a part of the purchase price had assumed the payment of the bonds at par. The American Chicle Co. redeemed some of these bonds at less than par. The case involved, as the Court pointed out, a “narrow point.” Upon the facts before it the Court held the company liable to income tax in respect of the difference between the par value of the bonds and the redemption price. Substantially the same facts obtained in Commissioner v. Coastwise Transportation Corporation, supra, and Twin Ports Bridge Co., 27 B. T. A. 346. In all of these cases a reduction in the amount of a personal obligation of a taxpayer was involved. No such situation is presented by these proceedings.

In Fulton Gold Corporation, 31 B. T. A. 519, it was held that the’ doctrine of United States v. Kirby Lumber Co., supra, and Helvering v. American Chicle Co., supra, has no application in any case where, as here, the indebtedness reduced is not the personal obligation of the taxpayer although it may be a lien upon its landsj The facts in the Fulton case were that the taxpayer purchased certain real property upon which there stood a prior mortgage which was not assumed by the taxpayer. Thereafter the taxpayer was able to secure the release of the mortgage lien by the payment of less than its full face amount. Later the taxpayer sold the property and in its income tax return for that year set forth its adjusted cost basis as being the purchase price of the land, including the full face amount which it compromised for a smaller sum. It based its position upon the doctrine of United States v. Kirby Lumber Co., supra. The Board held, however, that the adjusted cost basis could only include the amount actually paid to settle the mortgage rather than its face amount. It said that the Kirby Lumber Co. and the American Chicle Co. cases had no application to the case because the mortgage lien discharged by the taxpayer was not its own personal obligation even though it was a lien on its lands. In American Seating Co., 14 B. T. A. 328, the facts were that the taxpayer acquired assets subject to an outstanding mortgage securing bonds issued by the seller. The American Seating Co. did not assume liability on the bonds. Subsequently, the buyer purchased the bonds then outstanding in the hands of the public for less, than par and the mortgage was satisfied. We held that the payment represented part of the cost of the assets and did not result in taxable income in the year in which it was made. Cf. Leichner & Jordan Co., 4 B. T. A. 133; and James Sweinhart, 29 B. T. A. 1179.

In A. M. Lawrence, 13 B. T. A. 463, the facts were that the taxpayer owned practically all of the stock of a- California corporation. By an agreement between the taxpayer and a third party such third party canceled the amount of the corporation’s indebtedness. It was claimed by the Government that such cancellation of indebtedness amounted to a taxable gain by the taxpayer in view of the fact that he was practically the sole stockholder of the corporation. The Board held, however, that Lawrence realized no income in the transaction, but at most realized an increase in the value of his stock as a capital investment.

Likewise, in Union Pacific Railroad Co., 32 B. T. A. 383, the Board held that United States v. Kirby Lumber Co., supra, has no application in a case where the taxpayer secures a reduction in the cost of a capital investment but there is no reduction for personal obligation in connection therewith.

Special assessment benefits such as those levied upon the lands of the petitioners, when paid, are not legal deductions from gross income. Under the income tax law they are treated as additional cost of the land benefited. F. M. Hubbell Son & Co., 19 B. T. A. 612; affd., 51 Fed. (2d) 644. Where, as here, the land owner does not pay the assessment in full the only additional cost to the land owner is the amount that he pays on the assessment. If he obtains a reduction of the assessment, such reduction merely serves to reduce the amount of the additional cost of the land. It does not result in taxable income. The cost of the petitioners’ lands in 1932 was not enhanced by $82,094.05 by the satisfaction of the special assessment upon it, but only by the amount of $15,258.63, which was the amount of cash advanced for their benefit by the California Trust & Savings Bank in satisfaction of the assessment. |

The respondent in his deficiency notices also relies upon the decision of the Board in Dallas Transfer & Terminal Warehouse Co., 27 B. T. A. 651. It was there held that since in 1928 the petitioner transferred to its principal creditor certain real estate in consideration of the cancellation of its indebtedness, which indebtedness was in excess of the petitioner’s equity in the property, 'the transfer constir tuted a sale upon which the petitioner realized taxable pro^t. The Board’s decision in that case was reversed by the Circuit Court of Appeals for the Fifth Circuit, 70 Fed. (2d) 95. The court stated:

* * * In effect the transaction was similar to what occurs in an insolvency or bankruptcy proceeding when, upon a debtor surrendering, for the benefit of his creditors, property insufficient in value to pay his debts, he is discharged from liability for his debts. This does not result in the debtor acquiring something of exchangeable value in addition to what he had before. There is a reduction or extinguishment of liabilities without any increase of assets. There is an absence of such a gain or profit as is required to come within the accepted definition of income. * * *

It is true that the total debt against the petitioners’ lands in 1932 was reduced to the extent of $66,835.42 by the purchase of the bonds and their application against the assessment. But the remaining indebtedness was far in excess of the market value of the lands then, or at any subsequent date. No gain, profit, or income can be spelled out of such a transaction. At most it served only to increase the mortgagee’s equity in the lands. Even after the transaction the petitioners’ equity in the lands was valueless.

The petitioners have offered no evidence with respect to the transaction by which the respondent added to the gross income of P. J. Hiatt $2,604.87, as shown in our findings of fact, although the transaction appears from the deficiency notice to have been of the same nature as that considered herein. For lack of proof upon the point, the action of the respondent in adding $2,604.87 to the reported net income is sustained.

Reviewed by the Board.

Judgment will he entered under Rule 50.

Murdock, Leech, and Tóense concur only in the result.


author: Disney :

text:
    Wilputte Coke Oven Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74775.
    Promulgated January 21, 1937.

      Hugh /Satterlee, Esq., for the petitioner.

      John II. Pigg, Esq., for the respondent.
   OPINION.

Disney :

The respondent determined a deficiency in income tax for the year 1930 in the amount of $10,285.72, which is controverted by the petitioner.

The error assigned by petitioner is that the respondent refused to allow as a deduction an item of depreciation of certain patents assigned to the petitioner for a valuable consideration and not as a gift.

The petitioner is a Maine corporation, organized about 1923, with its principal office in New York, New York. It succeeded to all the assets, business, and liabilities of a Delaware corporation of the same name organized about 1917. At all times material to this proceeding, prior to the sale thereof by them in January 1928, Louis Wilputte and his wife, Alice A. Wilputte (the two hereinafter sometimes referred to as the Wilputtes), were the owners of all of the petitioner’s outstanding capital stock, consisting of 340 shares of no par value, of which one share each stood in the names of Alan Fox and Robert Metcalfe, directors of the petitioner, the only other director being Louis Wilputte, its president. The business of petitioner during 1930 and prior years was the building of byproduct coke ovens or supplying engineering services in designing coke ovens and supervising their construction. The type of byproduct coke oven here involved is well known in this country and in foreign countries as the “Wilputte Oven” and is completely covered by patents, which, prior to their assignment to the petitioner in January 1928 were owned jointly by Louis Wilputte and wife, Alice A. Wilputte. In consideration of license granted by them to the petitioner to operate under aforesaid patents, the petitioner paid license fees or royalties to the Wilputtes.

In the early part of December 1927, J. E. Lewis, who was engaged in the manufacture of brick and refractory materials used in the construction of coke ovens and from whom petitioner had theretofore bought quantities of those materials, began negotiations with Louis Wilputte with a view to securing the exclusive right to promote the sale of the “Wilputte Oven” and build that type of oven.

At the time negotiations were going on, the liquid assets of the petitioner had a value of approximately $515,000. Lewis' desired to acquire complete control of the “Wilputte Oven” and the name and good will of the petitioner, but not its liquid assets. About the 15th or 20th of December 1927, Lewis made Wilputte an offer which, as originally expressed in general terms, provided that Lewis should pay the Wilputtes $575,000 and they should assign, to Lewis or whomever he might designate, the numerous Wilputte patents, all of which stood in the Wilputtes’ individual names. It was agreed between Lewis and Louis Wilputte that all the outstanding stock of petitioner would be transferred by the Wilputtes to and become the property of Lewis, but that before the stock was “turned over” to Lewis, the Wilputtes would have the right to take out the liquid assets of approximately $515,000 value, which constituted practically the working capital of the petitioner. During negotiations there were also discussions of the best method and means of effecting the transaction so as to produce the least tax liability.

The plan considered and adopted for the purpose of divesting the petitioner of its liquid assets for the benefit of its stockholders was the organization of a subsidiary company to which the liquid assets would be transferred in consideration of the issuance to the petitioner of capital stock of the subsidiary; the petitioner, in turn, to distribute the subsidiary’s stock to its own stockholders. It was finally agreed that the Wilputtes would assign the patents to the petitioner and that the outstanding capital stock of the petitioner would then be sold by the Wilputtes to Lewis for a consideration of $575,000. The final written contract contained such provisions.

The negotiations and agreements above outlined were carried out and culminated in the acquisition by Lewis of the entire outstanding stock of the petitioner and the consequent control of the Wilputte patents.

On December 31, 1927, the petitioner’s only assets of any consequence other than good will (which Lewis acquired) consisted of its aforesaid liquid assets of the approximate value of $515,000 and some office furniture ■ and fixtures and some secondhand construction equipment scattered over the country, all of which had a value of approximately $25,000.

At a meeting of the board of directors of petitioner held on January 3, 1928, the following resolutions were unanimously adopted:

Whereas, Mr. Louis Wilputte and Mrs. Alice A. Wilputte have heretofore owned the so-called “Wilputte” patents on coke ovens and accessories upon which the business of the Company depends, and the company has been in the habit of paying to Mr. and Mrs. Wilputte large annual royalties for the use of such patents, and,
Whereas, Mr. and Mrs. Wilputte have now assigned all such patents to this Company,
Resolved, That the Treasurer of this Company be and is authorized and directed to assign to such patents on the books of the Company a value of $400,000.
Whereas, The Company lias certain cash, securities and receivables which the Company is of opinion may better be handled through a subsidiary of the Company,
Resolved, That the Company cause to be organized under the laws of Delaware a subsidiary company for the holding of certain of its assets, to be called the Willdell Corporation, and having an authorized capital of 500 shares of no par value.
Resolved, That this Company transfer to such Willdell Corporation in exchange for 840 shares of its authorized stock the cash, securities and receivables which the Company owned at the close of business on December 31, 1927, a list of which is hereto attached as Schedule A.
Resolved, That after this Company shall have received all such issued stock of the Willdell Corporation it distribute such stock to the stockholders of this corporation in the proportion in which the stockholders of our Company now hold our stock

The patents here involved were transferred to petitioner by the Wilputtes by written assignment, reciting “in consideration of one dollar and other good and valuable consideration”, on January 3 or 4, 1928, though not delivered until January 17 or 18, 1928. The organization of the subsidiary corporation, the Willdell Corporation* under the Delaware laws was not completed until on or about January 17, 1928. The Willdell Corporation is merely a holding corporation for the Wilputtes.

The final agreement between Wilputte and Lewis, under the terms of which the latter purchased the entire outstanding capital stock of the petitioner, was executed on January 18, 1928, and in part and in so far as material to the issues here is, literally or in substance* as follows:

Whereas, Wilputte Coke Oven Corporation, hereinafter called the Company, a corporation of the State of Maine, has an authorized capital stock of one thousand (1,000) shares of no par value, of which three hundred and forty (340) shares are outstanding, and Mr. Lewis desires to acquire all of the capital stock of the Company; and,
Whereas, the Company heretofore transferred to a Delaware corporation certain cash, securities and receivables which it had on December 31, 1927, in exchange for stock of such Delaware corporation and has since distributed such Delaware corporation stock to the stockholders of the Company;
Now, Therefore, in Consideration of the Mutual Covenants Herein Contained the Parties Hereto Covenant and Agree as Follows :
1. Wilputte will immediately sell and transfer or cause to be sold and transferred to Lewis all of the said 340 shares of the outstanding capital stock of the Company. Wilputte warrants that the said stock is full paid and non-assessable and is all of the capital stock issued and outstanding. * * *
2. Lewis will pay for such stock as follows:
(a) One Hundred and Seventy-five Thousand Dollars ($175,000.00) in cash upon the execution and delivery of this agreement.

Further conditions of the contract provided for payment of $400',000 additional, evidenced by promissory notes, pledge of the 340 shares of stock for payment thereof, payment of all indebtedness by Wilputte, delivery by Wilputte of resignations of all company officers and directors except himself, employment of Wilputte as president and general manager for five years, and that the company-should benefit by any inventions made by Wilputte.

Lewis paid the Wilputtes the $575,000 purchase price of the stock agreed on, the payments being made either before or when due. The patents, upon their assignment to the petitioner, were set up on its books at a valuation of $400,000 and the good will of the petitioner was considered to have a value of $175,000.

The petitioner’s income tax return for the year 1930 disclosed a gross income for that year of $224,940.07, and a net income of $57,423.51. In arriving at the said amount of net income, the petitioner claimed net loss deductions for the years 1928 and 1929 in the respective amounts of $134,820.06 and $32,696.50, which amounts were reported as net losses in its returns for those years. In each of its returns for 1928,1929, and 1930 the petitioner claimed a deduction of $28,571.43, as and for depreciation or amortization of the patents which it acquired by assignment, under the circumstances hereinabove set forth. These deductions are reflected in the amounts of the net losses as disclosed by the petitioner’s returns for the years 1928 and 1929, and the net income as disclosed by its return for the year 1930.

In his determination of the deficiency involved, the respondent disallowed the patent depreciation or amortization deductions so claimed by the petitioner for the years 1928, 1929, and 1930. The effect of that disallowance is to reduce by the amount of $28,571.43 the net losses as reported by the petitioner for each of the years 1928 and 1929, and to increase the taxable net income as reported by the petitioner for the year 1930 by an aggregate amount of $85,714.29.

In the individual tax returns of the Wilputtes for the year 1928, there is no report of any sale of the “Wilputte” patents. In schedule “D” of their respective individual returns for the year 1928, the Wilputtes reported sale of “stock” acquired in 1917 and sold in 1928 as follows: By Louis Wilputte, stock costing $32,980.31, sold for $133,823.55, gain $100,843.31; by Alice A. Wilputte, stock costing $6,383.70, sold for $41,176.45, gain $34,792.75.

The total amount received by both the Wilputtes from the sale of stock in 1928 as reported by them in their returns for that year was $175,000, which is the same as the amount of the cash payment made by Lewis to them for stock upon the execution of the agreement of January 18, 1928. Neither of the returns for 1928 of the Wilputtes made any statement as to the number of shares of stock, the name of the corporation whose stock was sold, or how the cost of the stock sold was determined. These transactions must refer to the disposition by the Wilputtes- of their stock in the petitioner during the year 1928, since otherwise there would be no return filed by them for that year of the sale shown in this case to have been made.

The facts in the instant case with respect to the transfer of the patents by the Wilputtes to the petitioner are, in our opinion, similar to the facts in the Rosenbloom Finance Corporation case, 24 B. T. A. 763; reversed, 66 Fed. (2d) 556; certiorari, denied, 290 U. S. 692,, wherein the question or issue was whether whisky warehouse certificates owned by said corporation, the taxpayer, were acquired by gift from its majority stockholder, Sol Rosenbloom. “No stock; money or other property was paid by petitioner (said corporation) to said stockholders as the consideration” for the transfers of the warehouse receipts or certificates, and, notwithstanding other facts and circumstances presented and pressed to show the transfers were not gifts, the Circuit Court of Appeals for the Third Circuit held the transfers constituted a gift. See also King v. United States, 79 Fed. (2d) 453. The Rosenbloom case does not support the contention of the petitioner, though cited by it as authority, but in our opinion sustains the determination of the respondent that the transfer of the patents by the Wilputtes to the petitioner herein was a gift. The petitioner’s corporate resolution passed in January 1928, and set out herein, assigned a value of $400,000 to the patents, which valuation the petitioner in its 1928 tax return reported as “surplus.”

It has been held that capital contributions or surplus paid in by a stockholder is to be considered as additional consideration for the-stock issued to the person. Estate of L. W. Mallory, 27 B. T. A. 750; Kistler v. Commissioner, 58 Fed. (2d) 687; W. F. Bavinger, 22 B. T. A. 1239; Burns v. Commissioner, 31 Fed. (2d) 399; certiorari denied, 280 U. S. 564. If so, it is apparent that the patents transferred to the corporation herein should not be considered differently. The petitioner set them up as surplus at that time and under the above authority is in no position, at a later time when the present question arises, to contend that the patents were paid for. Indeed, upon brief petitioner admits and argues that the corporation paid nothing for the patents, but contends that Leivis paid for them and made a gift of them to the corporation, saying: “True, the company did not pay for the patents. The Government is correct in saying that they were ‘donated’ to the company. They were donated, however, by the man who had already bought or was in process of buying the company. Lewis, not Wilputte, was the donor.” But it is clear that Lewis did not purchase the patents and did purchase the stock in petitioner. The final written contract between Wilputte and Lewis is very particular in that regard, reciting as a preliminary that Lewis “desires to acquire all the capital stock of the company”; further reciting that Wilputte will sell to Lewis “all the said 340 shares of the outstanding capital stock”; further reciting that “Lewis will pay for such stock as follows”; further reciting that as collateral security Lewds will pledge “said 340 shares of stock of the company which this day is being transferred to him.” The contract contains no provision for purchase of the patents by Lewis. It was made as of January 18. The affidavit of the Wilputtes, dated September 20, 1983, which is in evidence, likewise says that Lewis was to buy the stock of the company after the exchange had been made, that is, the exchange of the patents for the liquid assets of the corporation. The patents had been transferred by the Wilputtes to the petitioner on or before January 3,1928, as indicated by the minutes of the meeting of the board of directors of that date, which recite that “Mr. and Mrs. Wilputte have now assigned all such patents to this company.” The record contains an amendment of said minutes under date of September 19, 1933, to the effect that the patents were to be assigned in consideration of the distribution of the Willdell stock. This amendment, however, was attempted more than eight months later, and after the present question arose, and we can not allow it to control over the original record.

Lewis purchased the stock in a corporation to which the patents had been transferred. The Wilputtes reported a sale of stock and no sale of patents. We conclude that Lewis was not the donor, and that the patents passed to the corporation, either as a gift, or for a contention by petitioner that the patents were consideration for the paid nothing for the patents, petitioner, in a way, precludes itself from any contention that there was consideration. between the Wilputtes and the corporation. Nevertheless, the record contains contention by petitioner that the patents were consideration for the liquid assets distributed to the Wilputtes, and we proceed to examine this situation and question further.

What was the consideration, if any, for the transfer of patents? If there was such, petitioner’s contention for a stepped-up base for depreciation purposes must be sustained. Any consideration came from the company, for we have held that Lewis did not buy the patents-. ■ What did the Wilputtes receive from the company which might constitute consideration for the transfer of their patents? They received nothing except a distribution of the stock of the company’s subsidiary, the Willdell Corporation, which was distributed “in the proportion in which the stockholders of our company (i. e., the parent company) now hold our stock.” The affidavit of the Wilputtes dated September 20, 1933, explains that “the corporation should declare a dividend.” The Wilputtes received a dividend. Is this a consideration for the patents transferred ? The Wilputtes reported nothing as income from such dividend, demonstrating that they (consistent with their affidavit above) regarded it as a nontaxable dividend and not a receipt of income from the sale or exchange of their patents. The statutory definition of dividend does not permit the inclusion of consideration for a transfer to a corporation, but is limited to earnings or profits accumulated after February 28, 1913. Sec. 115 (a), 1928 Act. Nor does logic approve an argument that a dividend may be the consideration for a transfer to a corporation, for a dividend is merely a proportionate distribution by virtue of the ownership of stock. The stockholder receives the distribution as such stockholder, and only by reason of such status. He can not be said to receive it in return for anything he has transferred to the company, or by virtue of contract or as creditor of the company, -except only his contractual status as stcokholder. A stockholder has no legal title to the profits of a corporate business until a dividend has been declared and therefore such profits are not the subject of barter or exchange between company and stockholder.

The situation in which the petitioner finds itself is brought on by the manner in which the transaction was handled in 1928, by the petitioner and the Wilputtes. At that time they saw fit to so transact the affair here involved that what the Wilputtes received (aside from the receipt of consideration for the stock in the Wilputte Coke Oven Corporation) should be and was received not directly from the corporation as a plain consideration upon an exchange of patents for the liquid assets of the corporation, but indirectly through the medium of the formation of a subsidiary company, transfer of the liquid assets to it, issuance of its stock to the parent corporation and distribution of said stock by the parent corporation as a dividend, to the Wilputtes. Whether designedly or otherwise, the result of this method of handling the matter was that it was a nontaxable receipt by the Wilputtes — of a dividend of stock in a corporation a party to a reorganization; for we hold that there was a reorganization under section 112 (i) (1) .(B), Act of 1928, for there was a transfer by a corporation of a part of its assets to another, and under the record in this case we consider it inescapable that immediately “after the transfer the transferor or its stockholders” (the Wilputtes) were “in control of the corporation to which the assets were transferred.” It is equally obvious that section 112 (g) applies to this situation, since stock in “another corporation a party to the reorganization” was distributed in pursuance of a plan of reorganization and “without the surrender by such shareholder of stock or securities in such corporation”, and there was therefore no gain to the distributees (the Wil-puttes) , who did not surrender their stock. It is true that they sold their stock in the parent corporation for a consideration in cash and notes, but under the theory of the whole transaction this was after the reorganization was completed and was a separate transaction.

The parties, having arranged that the Wilputtes should receive their quid pro quo through a subsidiary corporation as a nontaxable dividend in stock distributed, should not now be permitted to execute a volte-face and to say that such dividend was a consideration for an exchange. We conclude that the patents were a gift to the corporation, as contended, by the respondent. The entire record in this case convinces us that such was the intention and theory at that time and only upon such a theory can the tax returns made by the Wilputtes be explained, if they were made in good faith. The basis therefore remained the same as in the hands of the donors. Sec. 113 (a) (2), Act of 1928. It follows that the petitioner is not entitled, for purposes of depreciation or amortization, to the basis contended for; and, the cost of the acquisition of the patents to the donors or their predecessors in title, if any, not being shown, the petitioner is not entitled to the deductions claimed for depreciation on said patents for the years 1928, 1929, and 1930, and the action of the respondent in disallowing the same and in increasing in the amount thereof the taxable income of the petitioner for 1930 is accordingly approved.

Decision will be entered for the respondent.