author: Murdock. : Opper,

text:
    Estate of Paul F. Donnelly, Deceased, Mercantile-Commerce Bank & Trust Co., a Corporation, and Virginia G. Donnelly, Co-Administrator de Bonis Non, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 87103.
    Promulgated November 23, 1938.
   OPINION.

Murdock. :

This trust was not a revocable trust within the meaning of section 802 (d) of the Revenue Act of 1926, as amended by section 401 of the Revenue Act of 1934. That section, as amended, provides for the inclusion in the gross estate of property transferred in trust by the decedent, “where the enjoyment thereof is 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.” The decedent reserved no power to alter or amend. He purported to reserve the power to revoke the trust with the consent of his wife. Those two, being the only interested parties, could have revoked the trust at any time in the absence of that reservation. Stephens v. Moore, 298 Mo. 215; 249 S. W. 601. It has been held that a reservation of that kind is not a power to revoke within the meaning of the words above quoted. Helvering v. Helmholz, 296 U. S. 93; White v. Poor, 75 Fed. (2d) 35; affd., 296 U. S. 98.

Section 803 of the Revenue Act of 1932, entitled “Future Interests,” provides in part as follows:

(a) Section 302(c) of the Revenue Act of 1926, as amended by the .Toini, 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 * ⅜ ⅜ intended to take effect in iDossession 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 * ⅜ ⅜.”

The property in question is the $100,000 which the wife was to receive and did receive under the trust instrument upon the death of her husband. Possession of that property from the time of the creation of the trust until the death of the decedent was in the trustees. The enjoyment of the property likewise took effect immediately when the trust was created. Thus, the transfer which the decedent made took effect in possession or enjoyment immediately, rather than at or after his death, and the decedent did not retain the possession of the property for himself during any period. May v. Heiner, 281 U. S. 238; Burnet v. Northern Trust Co., 283 U. S. 782; McCormick v. Burnet, 283 U. S. 784; Morsman v. Burnet, 283 U. S. 783; Helvering v. St. Louis Tr. Co., 296 U. S. 39; Becker v. St. Louis Union Trust Co., 296 U. S. 48; Frederick Davis Van Sicklin et al., Executors, 35 B. T. A. 306. Klein v. United States, 283 U. S. 231, is not in point because here the decedent divested himself of the entire estate and the remainder could vest in him only upon the happening of a condition precedent.

The remaining question is, Did the decedent retain for his life or for a period which in fact did not end before his death, the enjoyment of the property or the right to the income from the property, within the meaning of section 302(c), as amended? The respondent argues that the rights which the decedent retained in regard to the use of the income, that is, the right to have it used for their family and joint living expenses and for the support and maintenance of the wife, were such that the income of the trust would be taxable to the grantor under a line of cases beginning with Douglas v. Willcuts, 296 U. S. 1. See also Helvering v. Schweitzer, 296 U. S. 551; Helvering v. Stokes, 296 U. S. 551; Hill v. Commissioner, 88 Fed. (2d) 941: Commissioner v. Grosvenor, 85 Fed. (2d) 2. Cf. Helvering v. Blumenthal, 296 U. S. 552. The courts in those cases held that income from trusts set up by a husband and father for the support and maintenance of his wife, or for the payment of family living expenses, is income to him under the general definition of income, since it is used to discharge his obligations, and in that way he has the enjoyment and benefit of it. This is an estate tax case, not an income tax case, and it must be decided under the specific provisions of section 302 (c), as amended, rather than upon any analogy from income tax cases. The language of the statute does not clearly indicate that it was intended to apply to a situation like this. This decedent did not retain the enjoyment of the property nor the right to the income from the property, as those phrases are ordinarily understood. He retained no right to receive the income, and any enjoyment of the property or right to the income from the property came to him in a very indirect manner, if at all. The use of the income was not limited to the discharge of his legal obligations. The legislative history of the amendments to section 302 (c) of the Revenue Act of 1926 indicates that Congress was trying to prevent the evasion of estate tax in cases where the decedent retained a life interest in trust property for himself and conveyed the remainder to others.

The following language appears in the report of the Ways and Means Committee of the 72d Congress, Report No. 708, p. 46:

The purpose of this amendment to section 302(c) of the revenue act of 1926 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. * * *
(2) The insertion of the words “or for any period which does not in fact end before his death,” which is to reach, for example, a transfer where decedent, 70 years old, reserves the income for an extended term of years and dies during the term, or where he is to have the income from and after the death of another person until his own death, and such other person predeceases him. This is a clarifying change and does not represent new matter.
(3) The insertion of the words, “the right to the income” in place of the words “the income” is designed to reach a case where decedent had the right to the income, though he did not actually receive it. This is also a clarifying change.

Similar statements are contained in the Finance Committee Report, Report 665, p. 49. The discussion of the Joint Resolution of March 3, 1931, contained in the Congressional Record of that date, volume 74, pp. 7078, 7079, indicates that the purpose of the Joint Resolution was to preclude the possibility of estate tax avoidance through trusts where the grantor reserved the income to himself for life, or the right to the disposition of the income, with remainder to others, which, under decisions of the Supreme Court handed down on the previous day in the cases of Burnet v. Northern Trust Co., 283 U. S. 782; McCormick v. Burnet, 283 U. S. 784; Morsman v. Burnet, 283 U. S. 783, following May v. Heiner, 281 U. S. 238, were held not a part of the decedent’s gross estate under section 302 (c) of the Revenue Act of 1926.

This was not the kind of a trust that the amendments to section 302 (c) were intended to catch. It is obvious that the present trust was designed neither to evade estate tax nor as a substitute for a testamentary disposition of the decedent’s property. The decedent did not reserve the income to himself for life and convey the remainder to others. He knew that he was given to the intemperate use of alcohol and that there would probably be times when he would not have sense enough to take care of his wife or himself. He wanted his wife to have income with which to take care of herself and also himself at such times, and he wanted her at other times to have a small independent income. The fact that the decedent retained the right to receive all income in excess of $417 a month seems unimportant. The property in question is not the entire corpus of the trust which, was placed there to produce income of $417, but is only $100,000 thereof. It is unlikely that a fund of $100,000 would produce more than $417 a month and expenses, and, furthermore, the evidence does not indicate that there ever was any excess from the entire trust fund. The application of section 302 (c), as amended, to this trust is doubtful, to say the least, and doubts under such circumstances must be resolved in favor of the taxpayer. The $100,000 was not properly included in the decedent’s estate under section 302 (c), as amended.

Reviewed by the Board.

Decision will be entered under Bule 50.

Opper,

dissenting: In the majority opinion the underlying questions of fact are treated as though found in favor of respondent. The opinion assumes that the trust instrument carried out the grantor’s desire for “his wife to have income with which to take care of herself and also himself at such times [as he was unable to care for himself] and he wanted her at other times to have a small independent income.” Although the wife did not in fact use the income for the family living expenses, she did use it “to buy her own clothes” and “for spending money.” Whether or not the terms of the trust instrument itself and their requirement that the income be “used and applied upon their family and joint living expenses, and provide in full for her [the wife’s] own bills and expenses and for her own care, maintenance and support” would be reformed in an action brought by the wife is at least doubtful. Robinson v. Korns, 250 Mo. 663; 157 S. W. 790; Parker v. Vanhoozer, 142 Mo. 621; 44 S. W. 728; Southern Surety Co. v. United States Cast Iron Pipe & Foundry Co., 13 Fed. (2d) 833. In any event payment for the wife’s necessary personal expenses and for her clothes were obligations of the husband and when incurred were debts of his which he could be required to pay. See Johnson v. Briscoe, 104 Mo. App. 493; 79 S. W. 498. The use of the proceeds of a fund of this size by the wife, under her admitted obligation, for the discharge of her personal expenses and for the purchase of her clothing in a case like this where the income of the husband was approximately $25,000 a year can not, it seems to me, be said to be unreasonable as a matter of law. At least the burden must have been upon the petitioner to show that the decedent’s obligation to provide funds for his wife’s use in those respects was less than the income provided by the trust. See Commissioner v. Grosvenor, 85 Fed. (2d) 2. No such burden has been sustained. For all the foregoing reasons and because the majority opinion proceeds upon that assumption, it seems to me this case must be regarded as presenting the same question as to estate tax that was passed upon under the income tax provisions in Douglas v. Willcuts, 296 U. S. 1, and similar cases.

The problem under the language of section 803 (a) of the Revenue Act of 1932 is therefore to determine whose income it was that the trust fund provided. This is the same question as was before the Supreme Court in Douglas v. Willcuts, supra. The Court said there (pp. 9, 10):

* ⅜ * We have held that income was received by a taxpayer, when, pursuant to a contract, a debt or other obligation was discharged by another for his benefit. The transaction was regarded as being the same in substance as if the money had been paid to the taxpayer and he had transmitted it to his creditor. * * * The erteation of a trust by the taxpayer as the channel for the application of the income to the discharge of his obligation leaves the nature of the transaction unaltered. ⅜ ⅜ ⅜ In the present case, the net income of the trust fund, which was paid to the wife under the decree [providing for the wife’s maintenance], stands substantially on the same footing as though he had received the income personally and had been required by the decree to make the payment directly.
* * * we ⅛⅛ no warrant for a construction which would preclude the laying of the tax against the one who through the discharge of his obligation enjoys the benefit of the income as though he had personally received it.
* * * in contemplation of law the income remains in substance that of the grantor. * * * [Emphasis added.]

It can not, I tbink, be doubted that if the settlor of a trust were to provide that his trustees should use the income to pay his bills instead of distributing the cash to him he would be held to have “retained * * * the * * * enjoyment of or the right to the income from, the property”, within the meaning of section 302. Hero the only difference is that the wife was constituted an intervening agency for attaining the same result. This does not require a different conclusion. See Commissioner v. Crosvenor, supra. In fact upon her omission, the trust instrument provided for the direct payment by the trustees of those obligations of the settlor which it was contemplated it would in the first instance be the duty of the wife to discharge. The precise language is:

If at any time the said Virginia George Donnelly shall not use said monthly income of $417.00 to pay her own bills and expenses and to care for her own support, maintenance and care and in and about their joint living expenses, then the trustees may pay out and apply and use said monthly income of $417.00 to pay and discharge and take care of her maintenance, care and support and apply any excess to their joint living expenses * * *.

To bold in the face of that language that the settlor did not retain the enjoyment of and the right to the income from the property seems to me to deprive the provisions of the statute of all meaning and practical effect.

It is said in the majority opinion that the legislative history of the section shows that it was designed “to preclude the possibility of estate tax avoidance through trusts where the grantor reserved the income to himself for life” and that “the instant proceeding does not present the kind of a trust that the amendments to section 302 (c) were intended to catch.” But the very situation thus described appears to be present here. True, there is no evidence of any intention on the part of the decedent to avoid estate taxes. But it has been repeatedly stated that the mere desire to escape taxation is not material in determining whether or not a. particular transaction is subject to tax. See Gregory v. Helvering, 293 U. S. 465, and cases there cited. And certainly the effect, if not the intent, will have been accomplished. The $100,000 which the Avife received from the trust fund at decedent’s death would have been a part of decedent’s estate and taxable as such had it not been for the creation of the trust. It seems clear that the land of trust now before us could be used as a vehicle of avoiding estate taxes. Prevention of this is the very motivation recognized in the majority opinion, for the passage of the amendments to section 302.

The language quoted in the majority opinion from the report of the Ways and Means Committee seems to me to indicate that the provisions of section 302 should apply to such a situation as this, rather than otherwise. For the purpose is said to be “to render taxable a transfer under which the decedent reserved the income for his life.” What the decedent did here was tantamount to such a reservation. The income was reserved to him as much as though he himself had received it. Douglas v. Willcuts, supra. The report says further: “the insertion of the words ‘the right to the income’ in place of the words ‘the income’ is designed to reach a case where decedent had the right to the income though he did not actually receive it.” This language is peculiarly apt to describe the provisions of the present instrument under which, even though decedent may have failed to insist upon it, he could have compelled the trustees to use the income for his own living expenses and to discharge the obligations placed upon him by law to pay those of his wife. I think the principle of Douglas v. Willcuts, supra, is applicable to this proceeding and am obliged to note my dissent from the conclusion reached by the majority.

Tyson and Disney agree with this dissent.

       SEC. 803. EUTURE INTERESTS.
      (a) Section 302 (c) 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, 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. * * *”


source: Caselaw Access Project

author: Hill:

license: Public Domain

text:
    First National Bank of Braddock, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89268.
    Promulgated November 25, 1938.

      Sanvuel Kaufman, Esq., for tlie petitioner.

      Loren P. O alees, Esq., for the respondent.
   OPINION.

Hill:

Respondent determined a deficiency in petitioner’s income tax liability for the year 1934 in the amount of $1,887.56, and a deficiency in excess profits tax liability for the same year in the amount of $681.46. These deficiencies result from three adjustments made by respondent to the net income reported on petitioner’s return, only two of which are called in question here. Petitioner assigns as error the action of respondent in disallowing (1) a deduction of Federal deposit insurance premiums in the amount of $2,066.52, and (2) a deduction of accrued interest on savings deposits in the amount of $11,661.25.

Petitioner is a national bank corporation, with its principal office at Braddock, Pennsylvania. It was incorporated December 8, 1933, and commenced business on the same date. On December 22, 1933, petitioner remitted to the Federal Deposit Insurance Corporation, to be subsequently paid into the temporary deposit insurance fund, the sum of $2,066.52. The amount was recorded on petitioner’s books in a separate account and treated as an asset until December 22,1934. The Federal deposit insurance did not become operative until January 1,1934. Prior to that date, petitioner had no deposit insurance protection. Petitioner’s total payments to the fund established by the Federal Deposit Insurance Corporation were not finally determined and made until November 1934, and thereafter all of such payments were charged to expense on December 22, 1934. Tlie amount of the remittance made on December 22, 1983, was claimed by petitioner as a deduction from its gross income for 1934, and was disallowed by respondent.

On January 2, 1935, petitioner credited to the savings accounts of depositors interest earned for the period July 1 to December 31, 1934, in the amount of $11,661.25. Such interest was at intervals in 1934 computed and recorded by petitioner in an account called “accrued interest” and charged against 1934 operations. It was not available for credit to or withdrawal by the depositors prior to January 2, 1935. The amount so credited to the depositors was claimed as a deduction from gross income for 1934. The deduction was disallowed by respondent.

During the taxable year 1934 petitioner kept its books of account on the basis of cash receipts and disbursements, and for such year made its Federal income and profits tax return on the same basis.

Kespondent contends that, since petitioner was on a cash basis and neither of the claimed deductions represents payment made in the taxable year 1934, both must be disallowed. Bespondent argues in his brief that petitioner made its return on a cash basis; and that, since the deficiencies were determined by respondent on a cash basis, pursuant to the discretion vested in him by section 41 of the Bevenue Act of 1934, and petitioner has not shown abuse of discretion, such determination is final. This argument in large part, we think, is not directed to the point in controversy. Petitioner readily concedes, and we so find as a fact, that it kept its books and made its tax return on the basis of cash receipts and disbursements. Petitioner contends, nevertheless, that it is entitled to the deductions claimed; that the allowance of such deductions is not inconsistent with the cash basis of reporting taxable income.

Bespondent disallowed the deduction ^of the deposit insurance premium in the amount of $2,066.52 because, he asserts, it was paid on December 22, 1933, prior to the beginning of the taxable year. There is no disagreement over the amount, or that it is an allowable deduction. In the deficiency letter respondent held that such amount was an allowable deduction for 1933.

The Federal Deposit Insurance Corporation was created by section 8 of the Banking Act of 1933, enacted June 16,1933, 48 Stat. 162,168, amending the Federal Beserve Act as amended, by inserting therein sections 12A and 12B. Subdivision (y) of section 12B provided that the Federal Deposit Insurance Corporation should open on its books a “Temporary Federal Deposit Insurance Fund” which should become operative on January 1, 1934. Each member of the fund was required, on or before the date of its admission, to file with the corporation a certified statement of deposits and to pay into such fund a certain percentage of the deposits certified. Thus, it was necessary for petitioner to comply with the statutory provisions not later than January 1, 1934, if it was to become a member and have the benefits of the temporary insurance fund when it became operative. The making of such payment alone, however, did not constitute petitioner a member. There were other requirements, and, if its application for membership had been rejected by the Federal Deposit Insurance Corporation, the advance payment would have been refunded. Petitioner set up the amount remitted in December 1933 in an asset account on its books and thereafter, when the payment became final in 1934, charged such amount to expense.

This procedure, we think, was proper. Disregarding the contingency whereby the amount originally remitted, or a part thereof, might have been returned to petitioner subsequent to January 1, 1934, it seems plain that prior to that date it could not be said that such amount had been “paid” by petitioner either into the temporary fund or to the Federal Deposit Insurance Corporation. The temporary fund, by specific statutory provision, did not go into operation until January 1, 1934. Prior thereto, the amount remitted by petitioner to the insurance corporation was still its property; the insurance corporation merely held the money for petitioner until paid into the temporary fund when it came into operation on January 1, 1934. Undoubtedly petitioner had the right to demand the return of its money at any time before that date if it had so desired; and before such date the Federal Deposit Insurance Corporation had no property right in the money and could not have used it for any purpose. The money ceased to be petitioner’s property only when it was paid into the temporary insurance fund, the purpose for which it was specifically remitted by petitioner, on or after January 1, 1934. It follows, therefore, that “payment” of the amount was made by petitioner within the taxable year 1934, and is an allowable deduction from gross income for that year.

The second deduction claimed by petitioner and disallowed by respondent involves interest earned on the savings accounts of its depositors during the period July 1 to December 31, 1934, in the amount of $11,681.25. The amount was computed at intervals during 1934 and recorded on petitioner’s books during 1934 in an account designated “accrued interest.” The amounts due the respective depositors, however, were not entered in their accounts until January 2, 1935, or if the entries -were made prior thereto, they were made as of that date. Respondent makes no contention that the aggregate amount so credited is not an allowable deduction, but asserts that it is deductible from 1935 income because petitioner was on the cash basis and credited the amount to its depositors in the latter year.

There is some conflict in the evidence respecting the actual date on which the entries were made crediting the interest in controversy on the accounts of the respective depositors. Both petitioner and respondent have requested that we find as a fact that the entries were made on January 2, 1935, or not until that date. Thomas M. Watt, a witness for petitioner and its cashier, testified that the interest was actually credited on the depositors’ accounts on January 2, 1935. Tet this same witness also stated that the interest was computed about ten days to two weeks prior to January 2,1935; that each account was “figured” individually and the various amounts added together, after which the amounts were posted to the individual accounts; that “in this case” this was probably done around the 29th or 30th of December 1934, but in any event prior to December 31, 1934, as of January £, 1935.

Whatever may be the fact as to the date on which the credit entries were actually made on the depositors’ accounts, it seems clear that the entries were made as of January %, 1935, and that the interest so credited was not as a matter of right subject to withdrawal by the depositors, or, if not withdrawn, did not become a part of the principal of the depositors’ accounts and begin to draw interest prior to January 2, 1935. We conclude that this fact is established by the record, notwithstanding the witness Watt testified that if a depositor wanted his interest on December 30 or 31, he could withdraw it. This was optional with the bank, and was merely permitted by the officers.

The rules and regulations governing savings accounts with the petitioner bank provided that interest would be allowed at a rate fixed by the board of directors, subject to change at their discretion, and would be credited on the regular half-yearly interest crediting dates as fixed by the board of directors. On January 2, 1934, the board of directors adopted a resolution providing “that tire time of paying interest on the savings accounts be fixed as January 1 and July 1.” The interest hi question was not credited on or as of January 1, 1935, because the bank was not open for business on that date, which is a legal holiday in Pennsylvania.

Since the interest in controversy was neither paid by petitioner, nor made available to the depositors for credit or withdrawal, during the taxable year 1934, petitioner on the cash basis is not entitled to deduct the amount from its gross income for that year. Eespondent’s determination on this point is approved.

Judgment will he entered wader Rule 50.


author: Black:

text:
    A. and J., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 80815.
    Promulgated November 29, 1938.

      8. L. Herold, Esq., for the petitioner.

      R. P. Hertzog, Esq., for the respondent.
   OPINION.

Black:

The principal question involved in this proceeding is whether the respondent erred in determining that petitioner should be taxed under the provisions of section 104 of the Revenue Act of 1928, subsections (a), (b), and (c) of which are set out in the margin. Subsection (d) of section 104 is not involved in this proceeding.

Whether petitioner is subject to the application of section 104 depends upon whether it was “formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed.” The determination of this question is one of fact. Rands, Inc., 34 B. T. A. 1094, 1102; Reynard Corporation, 37 B. T. A. 552, 560; Commissioner v. Cecil B. De Mille Productions, Inc., 90 Fed. (2d) 12. Cf. Helvering v. National Grocery Co., 304 U. S. 282; Nipoch Corporation, 36 B. T. A. 662; R. L. Blaffer & Co., 37 B. T. A. 851.

The respondent in his deficiency notice has not indicated whether his determination is based upon a finding by respondent that petitioner was “formed” for the purpose mentioned in the statute or whether it was “availed of” for that purpose, or whether it was both formed and availed of for the condemned purpose. He has simply determined that section 104 applies and that determination “is presumed to be correct until the contrary appears from the evidence.” Nipoch Corporation, supra.

Section 104 (b) mentions certain facts, which, if any one is present, shall be prima facie evidence of a purpose to escape the surtax. The presumption thus arising under subsection (b) is in addition to the presumption of correctness attaching to the respondent’s determination. Almours Securities, Inc. v. Commissioner, 91 Fed. (2d) 427.

The respondent in his brief contends that petitioner was a “mere holding or investment company” and that the “record in this case falls far short of overcoming the presumption existing in regard thereto.”

Counsel for petitioner did not file any brief. The petition, however, alleges that the respondent erred as follows:

(a) In holding that petitioner had a net income for the year 1981 of Three Hundred Twenty-Two Thousand Six Hundred Ninety-Two and 33/100 ($322,-692.33) Dollars;
(b) In holding that petitioner was formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being distributed;
(e)In refusing to consider the financial condition of the corporation at the close of the taxable year, and the manner in which its funds were invested at that date;
(d) In refusing to recognize the effect of the law of the state of the creation of the petitioner which forbade the payment or distribution of any dividends because of petitioner’s condition in 1931;
(e) In holding that the profits of the corporation were permitted to accumulate beyond the reasonable needs of its business;
(f) In refusing to recognize the rights of the corporation to keep its capital intact;
(g) In refusing to recognize that the penalty under Section 104 is applicable only to consummated evasion of the tax through the accumulation of gains and profits in order to prevent the imposition of the surtax upon its stockholders;
(h) In refusing to recognize that, in the determination of whether the penalty should be imposed, the inquiry should be into the substance of the corporation’s affairs, and not to mere technical matters of accounting or to the form of its book entries;
(i) In imposing the penalty upon the petitioner for failure to distribute its apparent or nominal profits as dividends when such action would have been in violation of the laws of the State of its creation.

In the prayers for relief assignment of error (a) is to be regarded as in tlie alternative only.

In his opening statement counsel for petitioner, after referring to the several assignments of error (a) to (i), supra, stated that there were certain differences between the instant proceeding and the case of A. D. Saenger, Inc., 33 B. T. A. 135; affd., 84 Fed. (2d) 23; certiorari denied, 299 U. S. 577. In this connection counsel for petitioner said:

A. & J. Incorporated, we contend, was formed1 as a business corporation and not as a mere holding or investment company. It was conceded on the trial before [that] A. D. Saenger, Incorporated, was a mere holding or investment company whose sole assets were 50 per cent of the stock of A. & J. Incorporated. We are also contending and expect to adduce evidence to prove that the corporation did not receive during 1931 the income which the Commissioner finds in the decision. In other words, there is a question of fact here different from the A. D. Saenger case and a question of law based upon the different corporate purposes of the present petitioner in that case.

For the purposes of this opinion we shall assume that petitioner was not formed as a mere holding or investment company for the purpose of preventing the imposition of the surtax on A. D. Saenger and J. H. Saenger, who for many years had conducted their business operations as a universal partnership. We shall assume that there was a real business purpose for organizing the petitioner and that business purpose was to carry on under corporate form instead of partnership form the widespread business activities of the two brothers.

We have accepted the explanation given in that respect as a valid one and we have not found in our findings of fact that petitioner was formed for the purpose of preventing the imposition of the surtax upon A. D. Saenger and J. H. Saenger. We have, however, found that petitioner, after its organization, was availed of for that purpose. This finding is based upon the fact that in 1929, two years after petitioner corporation was organized, the two brothers, A. D. Saenger and J. H. Saenger, entered into negotiations with the Paramount Famous Lasky Corporation to sell to the latter the stock which the brothers owned in Saenger Theatres, Inc. The deal was consummated in 1929 and the manner of its consummation is detailed in our findings of fact and those details need not be here repeated. Suffice it to say that when the two brothers received the Saranac Investment Corporation stock as a result of the deal they transferred it to petitioner and immediately organized personal holding companies to hold the stock which each petitioner then owned in petitioner, A. & J., Inc. That organized for A. D. Saenger ivas known as A. D. Saenger, Inc., and we have already held, in A. D. Saenger, Inc., 33 B. T. A. 135; affd., 84 Fed. (2d) 23, that this latter corporation was formed and availed of for the purpose of preventing the imposition of the surtax upon the sole stockholder, A. D. Saenger.

The evidence in the instant case does not reveal any reasonable and valid business purpose for the transfer in 1929 by the brothers to petitioner of the stock which they received in the Saranac Investment Corporation as a result of their disposal to the Paramount Famous Lasky Corporation of their stock in Saenger Theatres, Inc. This stock bad at that time a fair market value of more than $3,000,000 and paid good dividends and it was apparently transferred to petitioner as paid-in surplus, although the record does not make that entirely clear.

There is no showing that petitioner was in need of any such capital contribution from its stockholders. So far as the record shows, petitioner had ample capital at that time to carry on all of its business transactions.

We must conclude from the evidence that the transfer of this Saranac Investment Corporation to petitioner was a part of the plan of preventing the imposition of the surtax upon the two brothers, A. D. Saenger and J. H. Saenger. Therefore for reasons which we shall state more at length later on, we hold that petitioner was availed of in the taxable year for the purpose of preventing the imposition of the surtax upon A. D. Saenger and J. H. Saenger.

We shall next consider assignment of error (e). If the respondent held, as alleged by petitioner, that petitioner’s profits were permitted to accumulate beyond the reasonable needs of its business, such a holding is embodied in his general determination that petitioner was “subject to taxation under the provisions of section 104,” as the respondent did not mention this point in his brief. The only evidence on the point, however, is the fact that petitioner’s balance sheets show surplus and undivided profits at the beginning and end of the taxable year of $1,917,653.82 and $2,238,714.20, respectively. Petitioner’s only business during the year, aside from collecting dividends on stocks of domestic corporations, was collecting gross rentals of $38,946.38 from 17 different pieces of property and loaning $5,600 to the E. & D. Shoe Corporation. Petitioner has offered no explanation for this large amount of surplus and undivided profits. As will be noted later in this opinion when we consider assignment of error (f), it could be that a part or all of this large surplus and undivided profits was actually a paid-in surplus, paid in at the time petitioner acquired the 2,500 shares of Saranac Investment Corporation from the two Saenger brothers in 1929. But there is no evidence in the record that it was so paid in. Therefore, upon the evidence which is before us, we are compelled to find as a fact that petitioner permitted its gains or profits to accumulate beyond the reasonable needs of its business. This fact is, under subsection (b), prima facie evidence of a purpose to escape the surtax upon petitioner’s shareholders.

Our next inquiry is whether petitioner has succeeded in overcoming with evidence the presumption of correctness attaching to the respondent’s determination and the additional presumption arising under subsection (b) by reason of our finding that during the taxable year petitioner had permitted its gains or profits to accumulate beyond the reasonable needs of its business. In addition to the evidence mentioned above, petitioner offered some proof to the effect that the market value of its assets both at the beginning and end of the taxable year was substantially less than the cost of such assets. We are unable to find from the evidence ivhat this market value was, but, even if we assume the situation most favorable to tire petitioner, namely, that petitioner’s liabilities both at the beginning and end of the year were in excess of petitioner’s total assets valued at market, we should still have to hold that such a finding would be of no ultimate assistance to petitioner and that its assignments of error (c), (d), and (i) are without merit. Rands, Inc.; Nipoch Corporation; R. L. Blaffer & Co., all supra.

The evidence relative to assignment of error (f) is also wholly insufficient to sustain petitioner’s position. As a matter of law it is not disputed that a corporation may keep its “capital” intact without incurring the liability imposed by section 104. United Business Corporation of America, 19 B. T. A. 809, 828; affd., 62 Fed. (2d) 754; certiorari denied, 290 U. S. 635. But the evidence in the instant proceeding does not show that the declaration of a dividend equal to petitioner’s gains or profits for the taxable year 1931 would have impaired petitioner’s capital. In other words, petitioner could have declared a dividend of $322,692.33 during the taxable year and still have had surplus and undivided profits of $1,916,021.87, as shown by its books at the close of the year 1931. Of course, as suggested in this opinion under our discussion of assignment of error (e), it might be that a part of the large surplus and undivided profits appearing on petitioner’s balance sheets at the beginning and end of the taxable year, if not all, represented a paid-in surplus, in which event the principles enumerated in W. S. Parish & Co., 38 B. T. A. 150, might be applicable. We say this for the reason that the record is not clear as to the manner in which petitioner acquired the 2,500 shares of stock of the Saranac Investment Corporation, which stock had a value of over $3,000,000 at the time it was acquired by petitioner. But if any part of this large surplus and undivided profits represented a paid-in surplus and had been impaired by prior losses so that at the end of the year there were capital deficits instead of earned surplus, the burden was upon petitioner to prove that fact. Welch v. Helvering, 290 U. S. 111. Without such proof we are unable to find that the respondent erred as alleged in assignment (f).

Begarding assignments (g) and (h), suffice it to say that they are identically the same as were assigned by the petitioner and considered by the Board in the case of A. D. Saenger, Inc., supra.

We need not prolong this opinion further with the discussion of every point that is necessarily inherent in a case of this kind. It would serve no useful purpose here for the reason that, after a careful consideration of all the evidence contained in the record, we are of the opinion that it falls far short of overcoming the presumption of correctness attaching to the respondent’s determination, and the prima facie evidence of a purpose to escape the surtax upon petitioner’s shareholders which is present by reason of the existence of some of the facts mentioned in subsection (b) of the statute. We have therefore found as a fact that petitioner was during the taxable year 1931 availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed. The fact that the sole stockholders of petitioner were A. D. Saenger, Inc., and J. H. Saenger, Inc., and that we hold that these two latter corporations were formed and availed of for the purpose of preventing the imposition of the surtax upon A. D. Saenger and J. H. Saenger, respectively, brings the instant case, we think, within the rule of Mead Corporation, 38 B. T. A. 687.

Regarding petitioner’s alternative position, little need be said. On petitioner’s income tax return it reported as a part of its gross income under section 22 (a) dividends on stocks of domestic corporations in the amount of $371,175. It also deducted the same amount under section 23 (p). Section 104 (c) provides that such deductions must be restored to income. Petitioner apparently contends that it was in error in reporting the $370,000 dividend declared by the Saranac Investment Corporation as a part of its gross income, for the reason that it was declared for the purpose of absorbing the liability which petitioner then owed Saranac. This is not a valid reason for excluding the dividend from petitioner’s gross income. The petitioner correctly reported the item, and, under section 104 (c), the respondent was correct in including it in his computation of net income subject to the 50 percent additional tax under section 104 (a) of the Revenue Act of 1928. The respondent’s determination is approved.

Decision will be entered for the respondent.

       SEC. 104. accumulation Off SURPLUS TO EVADE SÜRTAXES.
      (a) If any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 50 per centum of the amount thereof, which shall be in addition to the tax imposed by section 13 and shall be computed, collected, and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax.
      (b) The fact that any corporation is a mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax.
      (c) As used in this section the term “net income’’ means the net income as defined in section 21, increased by the sum of the amount of the dividend deduction allowed under section 23 (p) and the amount of the interest on obligations of the united States issued after September 1, 1917, which would be subject to tax in whole or in part in the hands of an individual owner


author: Hill :

text:
    Jennie King Mellon, Richard King Mellon, Sarah Mellon Scaife and the Union Trust Company of Pittsburgh, Executors of the Estate of R. B. Mellon, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74241.
    Promulgated November 29, 1938.

      W. A. Seifert, Esq., D. D. Shepard, Esq., Floyd F. Toomey, Esq., and William, H. Quealy, Esq., for the petitioners.

      Arthur Carnduff, Esq., and Chester Guy, Esq., for the respondent.
   OPINION.

Hill :

The single issue submitted for decision in this case involves an interpretation of section 104 of the Revenue Act of 1928, which provides in subdivision (a) that, if any corporation is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 50 per centum of the amount thereof. In such case net income is increased by (1) the dividend deduction allowed under section 23 (p), and (2) the amount of interest on certain obligations of the United States which would be subject to tax in the hands of an individual owner. Subdivision (d) provides that the tax imposed by this section shall not apply if all the shareholders of the corporation include (at the time of filing their returns) in their gross income their entire distributive shares, whether distributed or not, of the net income of the corporation for such year.

Throughout the taxable year 1930, R. B. Mellon, petitioners’ decedent, owned all the capital stock of the Mellbank Corporation, a domestic corporation. In his original tax return for 1930 decedent included in the amount of dividends reported the sum of $37,705.09, which represented the undistributed net income of the Mellbank Corporation for the year 1930, as then shown by the books and records of the corporation. Thereafter, respondent determined, and it is now agreed, that the undistributed net income of the corporation, including dividends, for 1930 was $142,964.70, or $105,259.61 more than the amount reported by decedent in his return. In determining the deficiency in controversy, respondent included such additional amount in the taxable income of the decedent.

Petitioners allege that the determination of respondent is erroneous for the reason that the sole stockholder of a corporation is not taxable on any of the undistributed net income of the corporation which the shareholder does not voluntarily include in his gross income at the time of filing his original return. Petitioners further assert (a) that a shareholder including less than his entire distributive share of the net income of a corporation at the time of filing his return may recover the tax paid on the amount so included, and (b) that no part of the undistributed earnings of the Mellbank Corporation may be taxed to its sole shareholder because the corporation was not subject to the tax imposed by section 104 (a), supra.

Respondent contends (1) that the decedent taxpayer made a voluntary election to be taxed under section 104 (d), supra, and that he, respondent, was without power to compel or deny the exercise of the election; (2) that decedent, having made a binding election, waived all other methods of taxation; and (3) that the failure to return all of the distributive share did not nullify the election, and respondent had the right to audit, adjust, or correct the amount reported by the taxpayer.

We think it is plain that subdivision (d) of section 104 is applicable only in a case involving a corporation subject to the tax imposed by subdivision (a) of that section. To hold otherwise would be to permit the shareholders of any corporation to choose the year in which they desire to be taxed upon their distributive shares of the corporate earnings, whether distributed or not. Such a rule would accord to taxpayers a right of election which is not authorized under the provisions of the income tax statutes. Hence, in the instant case, if the Mellbank Corporation was not subject to tax for the year 1930 under section 104 (a), supra, its sole shareholder was not entitled to include in gross income reported in his individual return any portion of his distributive share of the undistributed net income of that corporation, and respondent was without authority to include the balance of the undistributed net income not so reported.

In Mellbank Corporation, 38 B. T. A. 1108, we held that this corporation was not formed, nor availed of in the taxable year 1932, for the purpose prohibited in section 104 of the Revenue Act of 1932, which contains the same material provisions as section 104 of the 1928 Act. Respondent does not contend here that the Mell-bank-Corporation was availed of in 1930 for the purpose of preventing the imposition of the surtax upon its sole shareholder through accumulation of profits, and the evidence submitted in the instant proceeding is even more persuasive that such was not the case than was the evidence we considered in respect of the year 1932. We hold, therefore, that the Mellbank Corporation was neither formed nor availed of in 1930 for the purpose stated, and was not subject to tax under section 104 (a), supra, for that year. The deficiency will be redetermined by eliminating from the decedent’s gross income the amount of the undistributed net income of the Mellbank Corporation as computed and included therein by respondent.

The conclusion reached disposes of the only issue submitted for decision, and renders it unnecessary to consider here other contentions of the respective parties referred to above.

Reviewed by the Board.

Judgment will be entered under Rule 50.


author: Disney:

text:
    Angier B. Duke, Petitioner, v. Commissioner of Internal Revenue, Respondent. Cordelia Biddle Robertson, as General Guardian of the Property of Anthony N. Duke, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 79942, 79943.
    Promulgated November 30, 1938.

      John G. Jackson, Esq., for the petitioners.

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

Disney:

In his determination of the deficiencies the respondent included in gross income of the petitioners amounts accumulated by the trustees for the account of the Duke children on the ground that they constituted taxable income under the provisions of article 862 of Regulations 77.

Article 862 of Regulations 77 relates to section 162 of the Revenue Act of 1932, which provides in subsection (c) that:

In the case of income received by estates of deceased persons during tbe period of administration or settlement of tbe estate, and in the case of income which, in the discretion of the fiduciary, may be cither distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.

The respondent filed no brief and his position respecting the Angier B. Duke, Sr., trusts is not clear. The amount of $10,000 paid by the trustee of the Angier B. Duke, Sr., trusts to the general guardian of each beneficiary was reported as income in returns filed by the general guardian, and no contention is being made that additional income of the Angier B. Duke, Sr., trusts was paid to the Duke children or to their general guardian, or that undistributed income was paid or credited to subsidiary trusts. The respondent treats the accumulated income as part of the trusts created for each child by the will of the decedent. Was the income not paid over properly credited during 1932 to the petitioners within the meaning of the act? If so, it is includable in their taxable income.

In Commissioner v. Stearns, 65 Fed. (2d) 371, the court said:

* * ⅜ Such distributions [of income received during the course of administration], and distributions at the discretion of the fiduciary, must be actually made, or irrevocably fixed, before they become the beneficiary’s as of right. They should appear in the fiduciary’s return, if they are still his; in the beneficiary’s, only in ease he has become presently entitled to them, or received them.
This serves to determine what is meant by the word, “credited,” the alternative to “paid,” though we can find no authority on the point. The income must be so definitively allocated to the legatee as to be beyond recall; “credit” for practical purposes is the equivalent of “payment.” Therefore, a mere entry on the books of the fiduciary will not serve unless made in such circumstances that it cannot be recalled. ⅜ * *

This interpretation was concurred in by the court in Lynchburg Trust & Savings Bank v. Commissioner, 68 Fed. (2d) 356; certiorari denied, 292 U. S. 640, in which it was said that:

* * * The parage “paid or credited” is used in opposition to the term “accumulated”; so that, the amount which is set aside for and made available to the beneficiary, either by actual payment or by credit, may be deducted, but the amount retained or accumulated forms part of the taxable income of the trust.

“The test of taxability to the beneficiary is not receipt of income, but the present right to receive it.” Freuler v. Helvering, 291 U. S. 35.

In the case of each of the Angier B. Duke, Sr., trusts the trustee at all times important had discretionary power to distribute or accumulate income allocable to the interests of the Duke children. Acting under this discretionary power it withheld all of the income of each trust except $10,000, which was paid to the general guardian. The crediting of the accumulated amounts to accounts kept for the beneficiaries was not equivalent to payment, for it did not make the income available or in any sense subject to the demand of the Duke children or their general guardian prior to the time the Duke children reached 21 years of age, and that event did not occur in or prior to the taxable year. It is clear that under the prevailing rule the petitioners did not receive distributions of income from the Angier B. Duke, Sr., trusts other than the amounts paid and reported as income. We therefore hold that respondent erred in including more than said amounts in income of these petitioners.

The trustees of the Doris Duke trust regarded the income which was withheld from the Duke children but credited to their income accounts as payment to trusts separate from the general trust or, in other words, they treated the amounts as distributions of income to subsidiary trusts as beneficiaries of the general trust. Checks were issued in connection with the distributions. The Commissioner has taxed the income, together with amounts withheld in like manner from other beneficiaries, to the general trust on the ground that the decedent’s will did not create more than one trust. It does not appear whether the trustee, as trustee of the subsidiary trusts, returned the amounts as income received from the general trust, or whether the respondent has determined deficiencies against the so-called subsidiary trusts on the ground that they received income as beneficiaries of the general trust. The respondent’s theory, as announced at the hearing, is that the accumulated income was credited to the petitioners, no contention being made that amounts were paid to them or for their account.

The intention of the statute is to tax the entire net income of the trust. Freuler v. Helvering, supra. None of the income of the Doris B. Duke trust during the taxable year was paid directly to the Duke children or to their general guardian. It is unnecessary to decide in these proceedings whether the will of James B. Duke created one trust or, in addition to a general trust, subsidiary trusts for accumulated income of the main trust. If but one trust was created the amount accumulated for each of the Duke children would fall within the same classification as the accumulated income of the Angier B. Duke, Sr., trusts, on which we have already hereinabove reached a conclusion. If the will of the decedent created subsidiary trusts to receive by way of payment or credit, as in Lynchburg Trust & Savings Bank v. Commissioner, supra, income of the general trust not distributed directly to the Duke children, the amount paid or credited would be deductible by the general trust and constitute income taxable to the separate trusts as beneficiaries of the general trust. As beneficiaries of trusts receiving income of the general trust there would be no crediting of income to them in the absence of a right of election on their part or that of their guardian to receive it from the trustees of the subsidiary trusts. Such a right did not exist. Neither of the Duke children nor their guardian was entitled to receive any part of the accumulated income of the general trust until the Duke children reached their majority, and in the meantime the fund was to be kept under the exclusive control of the trustees, whether as the fiduciary of a single trust or of subsidiary trusts. We hold that the income was not paid or credited to petitioners.

It was error for the respondent to include the amounts in question in the taxable income of the petitioners.

Decision will be entered under Bule 50.


author: Kern: Black,

text:
    Sterling Morton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86517.
    Promulgated December 2, 1938.

      Robert V. Jones, Esq., for the petitioner.

      Carroll Walker, Esq., for the respondent.
   OPINION.

Kern:

This proceeding involves that part of a deficiency of $2,159.05 determined by respondent in petitioner’s income tax liability for the year 1932 which arises by reason of (1) respondent’s disallowance of a deduction claimed by petitioner in the sum of $848.32, representing interest paid by him on an obligation of the Twelve-Sixty Astor Street Building Syndicate, (2) respondent’s disallowance of a deduction taken by petitioner in the sum of $3,625, representing an investment in common stock of the First Investors Co. of Illinois and claimed by him to have become worthless in that year, and (3) the disallowance by respondent of a deduction claimed by petitioner in the sum of $65,000, representing an investment by him in the 1242 Lake Shore Drive Syndicate and alleged to have become worthless in 1932.

The facts as to the first issue have been stipulated by the parties. With regard to the second, and third issues, part of the facts have been stipulated. A deposition has been introduced with reference to the second issue, and at the hearing of this proceeding evidence was offered with regard to the third issue which the parties agreed should also apply to a similar issue in Docket No. 91705.

The findings of fact and opinion as to each issue are set out separately.

Issue No. 1.

In the year 1930 the taxpayer became associated with a small group of persons ivho were interested in the erection of a cooperative apartment building at 1260 Astor Street, Chicago, Illinois. These persons formed a syndicate under the name of, and did business as, the 1260 Astor Street Building Syndicate. During the year 1930 this syndicate caused to be organized the 1260 Astor Street Building Corporation and caused to be conveyed thereto title to real estate at 1260 Astor Street, Chicago. Prior to its incorporation subscriptions were received for a part of the corporation’s stock by prospective tenants of the building. The organization of the company, and its leasing of apartments, was in the form commonly used in Chicago at that time in the erection of cooperative apartments. The financial plan of the enterprise, as originally formulated by the syndicate, called for a first mortgage of approximately one-half of the cost of the building, with the balance of the cost to be financed by the payments on the stock subscriptions.

Difficulty ivas encountered, however, in securing subscriptions to all of the company’s stock; and stock representing five apartments remained unsold. Thereupon, the National Bealty & Investment Co. (whose subsidiary, the Ouilmette Construction & Engineering Co., was given the contract for the construction of the building) offered to lend to the syndicate enough money to complete the financial program, upon condition that the stock of the building company to be formed be pledged as security for the loan and the proceeds of all apartments sold be used for repayment.

This offer was accepted, and a total of $170,000 was lent by National Eealty & Investment Co. Under the agreement put in evidence by which the syndicate was created, Louis C. Sudler was appointed syndicate manager, and executed, pursuant to the powers given him as such, promissory notes payable to the National Eealty & Investment Co. representing the amounts borrowed by the syndicate. Each of the notes was in the ordinary form of promissory notes and was signed “1260 Astor Street Building Syndicate, by Louis C. Sudler, By Syndicate Manager”; the second occurrence of “By” being evidently an error.

The cash received from the National Eealty & Investment Co. was employed in the purchase of stock in 1260 Astor Street Building Corporation. This stock was pledged as collateral security for the promissory notes given to the National Eealty & Investment Co. In 1931 the 1260 Astor Street Building Syndicate sold a portion of this stock (and the right to a lease to one of the apartments in the building, the right accompanying the stock under the cooperative plan) for $85,000.^ This amount was paid on the principal of the promissory notes, leaving an unpaid balance throughout the year 1932 of $85,000.

During the year 1932 the petitioner paid $848.32 on account of his proportionate share of the interest due from the syndicate on the unpaid balance of the promissory notes. This sum was paid by the petitioner to the 1260 Astor Street Building Corporation, which, in turn, transmitted the money to the National Eealty & Investment Co. All the members of the syndicate made their payments of interest on the loan in similar fashion through the 1260 Astor Street Building Corporation.

Petitioner claimed a deduction on account of interest paid in this amount pursuant to section 23 (b) of the Eevenue Act of 1932, set out in the margin. This deduction was disallowed by respondent on the ground that the interest was an expense chargeable to the syndicate, and, since this particular syndicate was held by respondent to be taxable as a corporation, the interest paid by petitioner might not be deducted by him. In his brief respondent further contends that this payment of interest by petitioner represented an additional cost of the unsold stock held by the syndicate, and therefore was not deductible.

We shall assume, as both parties seem to have assumed, that the syndicate involved in this case should be considered as being classified for the purposes of the Revenue Act of 1932 as a corporation.

Section 23 (b) of the act, which we have quoted, plainly and categorically grants a deduction from gross income as to “all interest paid or accrued within the taxable year on indebtedness”, with two specific exceptions not pertinent to this case. We have held that “indebtedness” means “something owed in money which one is unconditionally obligated or bound to pay, the payment of which is enforceable.” William Park, 38 B. T. A. 1118; W. S. Gilman, 18 B. T. A. 1277; affd., 53 Fed. (2d) 47. The question of whether there is an enforceable obligation to pay so as to constitute an indebtedness within the meaning of this section depends for its solution on the law of the state having jurisdiction. William Parle, sufra. Since the notes upon which interest was paid by the petitioner were executed in Illinois and were to be paid in Illinois, and the parties to the notes lived in Illinois, it is obvious that the law of Illinois must determine whether the interest due upon the notes was an indebtedness of petitioner. Under the laws of that state, if a note is executed on behalf of a syndicate by the syndicate manager pursuant to the authority granted to him by the syndicate agreement, each member of the syndicate is liable on the note as a primary obligation and if the note is unpaid as to principal or interest the payee may enforce payment against the individual members of the syndicate. Slater v. Clark, 68 Ill. App. 433. The Illinois law in this respect is in accord with the common law rule universally recognized. 33 C. J. 873.

Since the interest paid by petitioner and claimed by him as a deduction under section 23 (b) was interest paid by him on an indebtedness, for which he was primarily liable, it necessarily results that the disallowance of this deduction by respondent was erroneous, unless the granting of this deduction is so limited by other provisions of the act as to make it unavailable to the petitioner.

Respondent contends that, since the syndicate should be considered as an association taxable as a corporation, it must be considered as a corporation for all purposes in any case arising under the revenue act. For this broad proposition respondent cites Burk-Waggoner Oil Association v. Commissioner, 269 U. S. 110. That case held that Congress had the power to classify an association as a corporation with regard to the imposition of a tax upon the income of the association even though, according to the laws of the state in which it was organized, held property, and conducted its business, it was a partnership. In the opinion the following language wTas used: “It is true that Congress cannot convert into a corporation an organization which, by the law of its state, is deemed to be a partnership. But nothing in the Constitution precludes Congress from taxing as a corporation an association which, although unincorporated, transacts its business as if it were incorporated.”

In Pierce Oil Corporation, 32 B. T. A. 403, 429, we held that, where an association which was taxable as a corporation completely liquidated and its sole shareholder received its assets in lieu of its certificates, this gave rise to gain measured by the difference between the investment in the certificates and the actual value of the liquidated assets taxable to its shareholder. As to the gain arising from this transaction between the association and its shareholder, we held that the shareholder was taxable in the same way as he would have been had he been a shareholder of a corporation. That this was within the intent of Congress was indicated by section 201 (a) of the Act of 1921, cited by us, to the effect that the term dividend “means (1) any distribution made by a corporation ⅛ * * to its shareholders or membersThe holding in the Pierce Oil Corporation case may be authority for the proposition that in a transaction between an association and its members gain or loss should be computed in the same way as in a transaction between a corporation and its stockholders, but it is not authority for the proposition that in all cases arising under the revenue act an indebtedness incurred by an association to persons other than its members must be considered as an indebtedness of a corporation upon which its members are not personally liable, when the fact is that as to such indebtedness it is not a corporation, is not liable thereon, and can not even be sued for the indebtedness, the primary obligation, in truth the sole enforceable obligation as to the indebtedness, being on the members of the association. We are not disposed to extend the doctrine of Burk-Waggoner Oil Association v. Commissioner, supra, to this result.

To classify an association for income tax purposes as a corporation has been held properly within the powers of Congress, and this classification has been extended to cases involving the taxation of distributions made by the association to its members; but to carry this classification to the extent of denying that members of an association are personally liable on obligations of the association for the reason that they are to be considered as stockholders of a corporation protected by the cloak of a nonexistent corporate entity is to accomplish a legal metamorphosis which would be in direct conflict with the language of the Supreme Court in Burk- Waggoner Oil Association, supra, which we have quoted.

The argument that the indebtedness of the members of the association, although a primary obligation, was incurred for the benefit of the association, and therefore should be treated as a capital contribution by stockholders to a corporation, is predicated upon an assumption that the association will be regarded in the situation present in this case as a corporation. As we have indicated above, an association will be considered as a corporation for the purposes of computing the tax upon its income or upon income received by its members resulting from transactions between them and the association, cf. Pierce Oil Corporation, supra, but will not be considered as a corporation in a consideration of the facts of this case, and therefore, the argument fails.

It may further be argued that in the event the syndicate had received an income in the taxable year the interest upon the syndicate obligations might have been paid out of this income and the syndicate in its return might have claimed as a deduction the amount of the interest thus paid. While this may be a valid criticism of the symmetry of the act, it does not seem a valid or even a pertinent argument against the conclusion that, where the members of an association themselves pay interest on an indebtedness upon which they are individually and primarily liable, the payments thus made are properly deductible from their individual gross income pursuant to section 23 (b). Cf. dissenting opinion of Roberts, J., in Helvering v. New York Trust Co., 292 U. S. 455; McFeely v. Commissioner, 296 U. S. 102.

The case of Wood v. Rasquin, 21 Fed. Supp. 211, relied upon by respondent is not in point, since the interest payments were made by a stockholder on behalf of a de jure corporation.

Upon this issue our decision is for petitioner.

Issue No. 2.

The second issue is whether or not the petitioner is entitled to a deduction of $3,625 from his gross income because of the worthlessness of an investment of that amount in the common stock of First Investors Co. of Illinois, an Illinois corporation. The petitioner contends that this common stock became worthless in 1932. The respondent has determined that the stock became worthless in 1931.

On July 1, 1929, the petitioner purchased 325 shares of common stock of the First Investors Co. of Illinois for $3,625. The petitioner also purchased certain shares of preferred stock in the same company. As to these shares of preferred stock, no question is here presented, since respondent has allowed a deduction in 1932 by reason of their becoming worthless in that year. While the certificates of common and preferred stock are not in evidence, both parties have assumed in their arguments that the preferred stock was preferred over the common stock not only as to the payment of dividends but also as to any liquidation. The statement contained in the minutes of the investment advisory committee of the company dated March 27,1930, to the effect that the common stock of the company, as of that date, was about $14,000 minus in value is consistent with this assumption. We shall, therefore, make the same assumption in our discussion.

First Investors Co. of Illinois was an investment trust of the management type. In 1930 or 1931 it organized as a subsidiary an investment company of the fixed type, known as Distributors Unified Service, Inc. As such an investment trust, the First Investors Co. of Illinois held and dealt in securities. It operated to a substantia] extent upon borrowed money.

The decline in the market value of securities which began in 1929 affected the company, and on March 27, 1930, the value of the assets of the company was less than its current and preferred stock liability by $14,000. Oh November 14, 1930, its directors authorized the sale of sufficient securities to reduce the loan of the company with Sutro Bros. & Co. (one of the principal brokers of the company) to $210,000. The continued decline in the securities markets in 1931 made the sale of a substantial additional amount of the company’s assets either necessary or desirable, and the book value of the investment inventory of the company accordingly diminished from $1,068,264 on September 30, 1930, to $598,764.46 on September 30, 1931, and to $106,257.61 on December 31, 1931. The current liabilities of the company were correspondingly reduced from $460,752.23 on September 30, 1930, to $16,670.86 on December 31, 1931. The book value of the assets, including investment inventory and accounts receivable, on December 31,1931, was $144,896.66. On December 31, 1931, the investments of the corporation had a market value of $42,000. This valuation included a valuation of $25,000 for the investment of the First Investors Co. of Illinois in Distributors Unified Service, Inc. There is no evidence that the accounts receivable had any value. The liability of the company on its preferred stock outstanding on December 31, 1931, was the amount of $609,825.

The manager of the affairs of the First Investors Co. of Illinois was Kittredge Batchelder. First Investors Co. of Illinois had invested, prior to December 31, 1931, in excess of $25,000 in getting its subsidiary, Distributors Unified Service, Inc., under way, and “at the end of 1931 Batchelder informed the directors that he thought he was getting somewhere with his investment trust and that he felt that it had great possibilities.”

No formal corporate action, either by the board of directors or by the stockholders, was at any time taken with respect to the sales of securities which were made during the year 1931, except to the extent, if any, that the corporate action above related on November 14, 1930, may have applied to any sales made in 1931.

The securities markets suffered a further decline in the year 1932. On June 22, 1932, the board of directors of First Investors Co. of Illinois authorized liquidation of the company. On July 16, 1932, the stockholders of First Investors Co. of Illinois ratified the act of the directors of June 22,1932, and passed a resolution “that this corporation be and the same hereby is dissolved.” On January 7, 1933, the board of directors adopted a further resolution for the payment of any further assets pro rata among certain remaining creditors of the corporation.

The petitioner deducted his investment in the common stock of this company as ivorthless in his income tax return for 1932.

The common stock of the First Investors Co. of Illinois did not become worthless in 1932.

Petitioner, in his income tax return for the year 1932, made a deduction from his gross income on the ground that it represented a loss which arose by reason of worthlessness of common stock owned by him in the First Investors Co. of Illinois, and was deductible under section 23 (e) of the Revenue Act of 1932, and article 174, of Regulations 77, which are set out in the margin. This deduction was disallowed by respondent on the ground that the stock in question became worthless not in 1932, but in 1931.

The petitioner contends that the dissolution and liquidation of the corporation occurred in 1932 and, therefore, the loss was suffered in that year, since this action constituted an “identifiable event” fixing the loss. Eespondent contends that, since he has determined that the stock became worthless in 1931, the petitioner, in order to show that it became worthless in 1932, must present substantial evidence that the stock in question had some value in 1931, which he can not do, and further, that the “identifiable event * * * can not be looked upon as the inevitable ‘yardstick’ in the decision of all * * * cases” involving losses predicated on worthless stock.

Since the opinion of the Supreme Court in United States v. White Dental Manufacturing Co., 274 U. S. 398, there have been many opinions of the various Circuit Courts of Appeal, and of the Board, which have considered deductions claimed by reason of the worthlessness of stock which the taxpayer has not sold but continues to hold. Some of these cases decided by the Circuit Courts of Appeal are the following: Gowen v. Commissioner, 65 Fed. (2d) 923; Squier v. Commissioner, 68 Fed. (2d) 25; Deeds v. Commissioner, 47 Fed. (2d) 695; Olds & Whipple, Inc. v. Commissioner, 75 Fed. (2d) 272; Benjamin v. Commissioner, 70 Fed. (2d) 719; Jarvis v. Heiner, 39 Fed. (2d) 361; De Loss v. Commissioner, 28 Fed. (2d) 803; Royal Packing Co. v. Commissioner, 22 Fed. (2d) 536; Rosing v. Corwin, 88 Fed. (2d) 415.

From an examination of these cases it is apparent that a loss by reason of the worthlessness of stock must be deducted in the year in which the stock becomes worthless and the loss is sustained, that stock may not be considered as worthless even when having no liquidating value if there is a reasonable hope and expectation that it will become valuable at some future time, and that such hope and expectation may be foreclosed by the happening of certain events such as the bankruptcy, cessation from doing business, or liquidation of the corporation, or the appointment of a receiver for it. Such events are called “identifiable” in that they are likely to be immediately known by everyone having an interest by way of stockholdings or otherwise in the affairs of the corporation; but, regardless of the adjective used to describe them, they are important for tax purposes because they limit or destroy the potential value of stock.

The ultimate value of stock, and conversely its worthlessness, will depend not only on its current liquidating value, but also on what value it may acquire in the future through the foreseeable operations of the corporation. Both factors of value must be wiped out before we can definitely fix the loss. If the assets of the corporation exceed its liabilities, the stock has a liquidating value. If its assets are less than its liabilities but there is a reasonable hope and expectation that the assets will exceed the liabilities of the corporation in the future, its stock, while having no liquidating value, has a potential value and can not be said to be worthless. The loss of potential value, if it exists, can be established ordinarily with satisfaction only by some “identifiable event” in the corporation’s life which puts an end to such hope and expectation.

There are, however, exceptional cases where the liabilities of a corporation are so greatly in excess of its assets and the nature of its assets and business is such that there is no reasonable hope and expectation that a continuation of the business will result in any profit to its stockholders. In such cases the stock, obviously, has no liquidating value, and since the limits of the corporation’s future are fixed, the stock, likewise, can presently be said to have no potential value. Where both these factors are established, the occurrence in a later year of an “identifiable event” in the corporation’s life, such as liquidation or receivership, will not, therefore, determine the worthlessness of the stock, for already “its value had become finally extinct.” De Loss v. Commissioner, supra, at 803. Cf. Squier v. Commissioner, supra; Monmouth Plumbing Supply Co. v. United States, 4 Fed. Supp. 349. In cases where the stock has concededly lost any liquidating value in a certain year, but an event occurs in a subsequent year which the taxpayer claims is “identifiable,” and where the Commissioner of Internal Bevenue has determined that stock became worthless in the year in which it lost its liquidating value, then the taxpayer, in order to be entitled to the loss deduction in the latter year, has the burden of proving that, although the stock lost its liquidating value in the prior year, it continued to have a potential value until the occurrence of the event. This we consider to be implicit in the rule stated in Mark D. Eagleton, 35 B. T. A. 551; affd., 97 Fed. (2d) 62, and John J. Flynn, 35 B. T. A. 1064. Cf. William E. Steinback, 30 B. T. A. 1252.

Applying these principles to the instant case, we find that petitioner’s common stock apparently had no present value as early as the spring of 1930. During that year and in 1931 the greater part of its assets were sold in order to obtain funds with which to pay its most pressing obligations. The corporation carried its investments on its books at $1,068,264 on September 30, 1930, at $598,764.46 on September 30, 1931, and at $106,257.61 on December 31, 1931. Its liabilities, exclusive of stock liability, appeared as $460,752.23 on September 30, 1930, and $16,760.86 on December 31, 1931. Its preferred stock outstanding on the latter date was in the amount of $609,825. The securities which made up the investment account of the corporation, carried on its books at $106,257.61 as of December 31, 1931, were estimated by an officer of the company to have a value of $42,000 on that date. There is no evideim that any of the other assets of the corporation had any value. The investment of the corporation in its subsidiary, Distributors Unified Service, Inc., was included in its investment account. The evidence, therefore, shows that the assets of the corporation on December 31, 1931, were worth $42,000, while its current liabilities were $16,610.86, and its outstanding preferred stock was carried as a liability, prior to any claim of petitioner’s common stock, at $609,825. During the year 1931 the corporation was trading in securities which it owned, but operated at a loss. Without question the common stock of the corporation had no liquidating value on December 31, 1931.

Did it have a potential value on that date? The assets of the corporation consisted of securities subject to fluctuation, and the ownership of a subsidiary corporation organized to carry on the business of an investment trust of the fixed type which one of the officers of the corporation felt had great possibilities. There is nothing in the record, however, to indicate that any officer or directer of the corporation had a hope or expectation that a continued operation of the corporation would result in creating an equity for the holders of its common stock, much less that such a hope and expectation was reasonable under the circumstances. Petitioner has failed to prove that the common stock of the First Investors Co. of Illinois had either liquidating or potential value on December 31, 1931. Therefore, we must conclude that this stock did not become worthless in 1932. Accordingly, our decision is against petitioner on this issue.

Issue No. 3.

In 1928 the petitioner with various other persons executed an agreement creating a syndicate known as the 1242 Lake Shore Drive Syndicate. Pursuant to the provisions of that agreement the petitioner paid $50,000 toward the capital of the syndicate during the year 1929. During the year 1930 the petitioner paid in an additional $15,000 to the capital of the syndicate.

The syndicate was formed for the purpose of promoting an apartment building upon property known as 1242 Lake Shore Drive, Chicago. The syndicate acquired the land and caused an apartment building to be erected thereon, all prior to the year 1932. The transaction was financed by a first mortgage of $850,000, and by money which was raised by the syndicate. Part of the syndicate money was in the form of the capital which the syndicate members contributed. Approximately $350,000 of additional money which was needed to complete the financing was raised by the syndicate through the medium of collateral notes which the syndicate managers issued, pursuant to authorization contained in the syndicate agreement.

The syndicate caused the property to be transferred to an Illinois corporation known as the 1242 Lake Shore Drive Building Corporation, and in return received 14,000 shares of the common stock of that company, being its entire authorized stock, and proprietary leases to all apartments in the building, the building being designed for operation on the so-called cooperative plan. Thus, the corporation owned the building subject to a first mortgage of $850,000, and had 14,000 shares of common stock outstanding. The syndicate initially owned all these shares and pledged them all for securing the payment of its outstanding collateral notes. The program of the syndicate was to sell these shares, and the proprietary leases accompanying the same, at a profit. Prior to the year 1982 the syndicate had sold and disposed of 5,883 shares of the stock and had transferred the proprietary leases relating thereto to the purchasers. The remaining 8,117 shares of stock remained with the syndicate, being pledged upon its collateral notes.

The syndicate has not been able to dispose of any of the remaining apartments or of any of the remaining shares of stock since 1931, when the last sale thereof occurred; and, in fact, certain of the shares of stock and certain apartments have had to be taken back by the syndicate, so that today its holdings of stock in the corporation are larger than they were in 1932.

In 1932 there was no market for the sale of this stock and the syndicate could not have been liquidated so as to leave any amount for the syndicate subscribers. At no time since 1932 has it been possible to sell this stock and, therefore, to liquidate the syndicate in such fashion as to produce anything for the syndicate subscribers. It was impossible in 1932, and has been impossible at all times since that date, to rent the apartments to which the syndicate holds proprietary leases at sufficient rental to pay the assessments made on the apartments by the 1242 Lake Shore Drive Building Corporation. The consequence is that the syndicate has lost money and is substantially indebted to the 1242 Lake Shore Drive Building Corporation, which indebtedness is over and above the indebtedness of the syndicate upon the outstanding collateral notes.

The balance sheet of the syndicate at the close of business on December 31, 1932, discloses that a deficit existed amounting to $211,978.01, which was charged against the investment of $543,750 originally made in the syndicate by the members participating therein. The value of the syndicate’s capital investment, as disclosed by the balance sheet, on December 31, 1932, was carried at $331,771.99.

The balance sheet of the syndicate at the close of business on December 31, 1933, shows a deficit of $224,093.68 and a net loss incurred for the year 1933 of $12,115.67. The value of the capital investment was reduced by the amount of the loss and carried on the balance sheet at $319,656.32.

The balance sheet at the close of business December 31, 1934, discloses a net loss for the year of $24,702.59, and the value of the capital investment was reduced to $294,953.73.

The petitioner’s investment in the 1242 Lake Shore Drive Syndicate did not become worthless in the year 1932.

This issue involves the right of petitioner to deduct, as a loss under section 23 (e) of the Revenue Act of 1932, the amount of his investment in the 1242 Lake Shore Drive Syndicate. It is petitioner’s contention that his investment became worthless in 1932. Respondent has determined, however, that the investment did not become worthless in that year, and has, accordingly, disallowed the deduction.

Attention is called to our discussion of the preceding issue.

The burden of proving that the Commissioner’s determination was wrong being on petitioner, he must prove that the investment became worthless in 1932. In order to do this, he must show that his investment represented by a proportionate part of the stock held by the syndicate in the 1242 Lake Shore Drive Building Corporation had neither liquidating nor potential value. The evidence tends to show that during the year 1932 the investment had no liquidating value, since there was no market for the sale of the stock of the investment corporation, and a liquidation at that time would have resulted in a complete loss. However, the corporation continued in business and the syndicate holding the greater part of its stock continued to operate. The balance sheets of the syndicate for the years 1932, 1933, and 1934 showed operating losses, but they also showed a substantial equity for the investment. It may be that petitioner has only proved an absence of market value of his investment, but certainly it is clear that petitioner has not proved that his investment was without potential value in 1932, and on this issue our decision is for- respondent.

Reviewed by the Board.

Decision will he entered under Rule 50.

Black,

dissenting: I dissent from the views expressed in the majority opinion as to issue No. 3. I think'the facts show that petitioner has proved his loss of investment in the 1242 Lake Shore. Drive Syndicate to all reasonable extent and purpose and should be allowed this loss in a computation of his net income for 1932. That he will ever recover anything from this investment seems to me so remote and improbable that it should not be the basis of disallowing the loss which petitioner claims.

       SEC. 23. DEDUCTIONS FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      * * * * * * *
      (b) Interest. — All interest paid or accrued within the taxable year on indebtedness except (1) on indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this title, or (2) on indebtedness incurred or continued in connection with the purchasing or carrying of an annuity.

       Sec. 23. (e) Losses by Individuals. — Subject to the limitations provided in subsection (r) of this section, in the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise—
      (1) if incurred in trade or business; or ■
      (2) if incurred in any transaction entered into for profit, though not connected with the trade or business; or
      (3) of property not connected with the trade or business, if the loss arises from fires, storms, shipwreck, or other casualty, or from theft. No loss shall be allowed as a deduction under this paragraph if at the time of the filing of the return such loss has been claimed as a deduction for estate tax purposes in the estate tax return.
      Art. 174. Shrinkage in value of stocks. — A person possessing stock of a corporation can not deduct from gross income any amount claimed as a loss merely on account of shrinkage in value of such stock through fluctuation of the market or otherwise. The loss allowable in such cases is that actually suffered when the stock is disposed of. If stock of a corporation becomes worthless, its cost or other basis as determined and adjusted under section 113 is deductible by the owner in the taxable .year in which the stock became worthless, provided a satisfactory showing is made of its worthlessness. Where banks or other corporations which are subject to supervision by Federal authorities (or by State authorities maintaining substantially equivalent standards) in obedience to the specific orders or general policy of such supervisory officers charge off stock as worthless, or write it down to a nominal value, such stock shall, in the absence of affirmative evidence clearly establishing the contrary, be presumed for income tax purposes to be worthless. For dealers in securities, see article 105. For limitations on deductions for losses from sales or exchanges of stocks and bonds generally, see article 272.