text:
    Ambassador Petroleum Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 40039.
    Promulgated August 8, 1933.

      George Bouchard, Esq., and J oseph D. Brady, Esq., for the petitioner.

      J. M. Leinenkugel, Esq., R. W. Wilson, Esq., and Charles R. Voróle, Esq., for the respondent.
   OPINION.

Black :

We are asked to determine the amount of petitioner’s net loss, if any, for the taxable year 1924 which petitioner seeks to deduct from its net income for the year 1925, and the amount of depletion deductible from petitioner’s gross income for the year 1925, These are the only two issues in this proceeding.

The parties have stipulated that if petitioner sustained a loss on the abandonment of its leasehold interest in parcel A in excess of $23,817.11, then and in that event it sustained a net loss within the meaning of section 206 of tbe Revenue Act of 1924, in the amount of such excess.

In his deficiency notice the respondent determined that petitioner sustained a loss on the abandonment of its leasehold interest in parcel A in the amount of $15,000, and stated in part:

Lease was acquired * * * for $15,000.00 cash and an issuance of 105,000 of its own capital stock. Tbe stock, having no market value and not having been issued until August 14, 1923, the only amount allowable as a deduction from gross income on the abandonment of the lease is the cash paid for same * * *.

Petitioner contends that the 105,000 shares of its capital stock given in part payment for the leasehold interest had a fair market value of at least $166,666.66 and that its loss due to the abandonment of the lease was $181,666.66 instead of $15,000 determined by the respondent.

Under section 204 (a) of the Revenue Act of 1924, the basis for determining the loss here claimed is the cost of the property abandoned. In Seymour Mfg. Co., 19 B.T.A. 1280, we said: “ The cost of property acquired for stock is the ‘ fair market value ’ of the stock.”

What was the fair market value in 1920, at the time parcel A was acquired, of the 105,000 shares which petitioner obligated itself to issue to the Wilshire Oil Co.? Respondent makes the point that the stock was not actually issued until August 14, 1923, but we see nothing important about that. In this connection see Anita Owens Hoffer, 24 B.T.A. 22, 27.

As far as the record shows, the only assets acquired by petitioner at the time of organization were the three leasehold interests in parcels A, B and C. There were no sales of petitioner’s stock at or about the basic date, other than petitioner’s agreement to issue 315,000 shares for the three leases, and the 700 shares originally subscribed and sold for $1 per share. Under such circumstances it is proper to consider evidence tending to prove the fair market value, if any, of the leases on the date acquired by petitioner. Commissioner v. Swenson, 56 Fed. (2d) 544; Melville Hanscom et al., Executors, 24 B.T.A. 173; Herman Adaskin, 8 B.T.A. 460. Cf. also Walls v. Commissioner, 60 Fed. (2d) 347; Mount v. Commissioner, 48 Fed. (2d) 550; Patterson v. Commissioner, 42 Fed. (2d) 148; O'Meara a v. Commissioner, 34 Fed. (2d) 390; and Mead Realty Co., 21 B.T.A. 1062.

We have examined the evidence carefully and, on the basis of the fair market value of the lease (parcel A) on the date acquired, we find the fair market value of the stock contracted to be issued for the lease was $1 per share, which was its par value. This makes the cost of the lease in question $105,000 paid in stock plus $15,000 which was paid the seller in cash.

This corresponds with the way petitioner returned the transaction for taxation purposes in 1924 and we think is well supported by the facts.

At the hearing petitioner introduced the testimony of two witnesses to show that the lease on all three tracts, A, B and C, 165 acres in all, had a fair market value of $500,000 at the time they were transferred to petitioner and that one third of this amount, or $166,666.67, was properly allocable to tract A, abandoned in 1924. We are not convinced by this testimony. We are convinced that, considering the location of tract A with reference to the original discovery well in the Santa Fe Springs Oil Field and the other wells which were being drilled at that time in nearby outlying territory, the demand for oil leases and all other relevant circumstances, the lease in question was worth what was paid for it; viz., $15,000 in cash and 105,000 shares of stock of petitioner, of a par value of $1 per share, which we hold had an actual value of $1 per share.

The Corporation Commission of the State of California authorized petitioner to issue 105,000 shares of its stock of the par value of $1 per share for the lease in question plus the $15,000 which was to be paid in cash, and we are satisfied that this estimate by the Corporation Commission of the valuation was reasonably correct at the time. Subsequent events proved that the three leases taken together had a value greatly in excess of the $500,000 claimed by petitioner as of the basic date, but it is not subsequent events from which we are to determine value at the basic date. If that were true, then we should find that tract A had no value because it ultimately proved to be worthless and was entirely abandoned in 1924, whereas tract C, on which the producing wells were subsequently brought in, proved to be of great value.

It is by the conditions and known facts which existed in 1920 that we must judge to find our valuation in 1920, and, applying that test, we are of the opinion that petitioner treated the cost of parcel A correctly in its income tax return for 1924, viz.;, a cost of $120,000. Petitioner’s net loss for 1924 should be determined accordingly.

The second issue is whether the respondent erred in determining that petitioner’s deduction for percentage depletion was limited under section 204 (c) (2) of the Revenue Act of 1926 (quoted in the margin ) to the amount of $73,745.41. The respondent’s computation is set out in our findings.

Petitioner does not contend that the depletion allowance determined by the respondent is “ less than it would be if computed without reference to ” section 204 (c) (2), supra, and that it should, therefore, be determined under section 234 (a) (8) of the same act. Both parties agree that petitioner’s depletion allowance should be determined under section 204 (c) (2), supra, but it is petitioner’s contention that in determining the “ net income of the taxpayer (computed without allowance for depletion) from the property,” the respondent erred in deducting development expenses in the amount of $91,883.28.

The Bevenue Act of 1926 eliminated so called discovery depletion entirely as far as oil and gas wells were concerned and substituted in its place the percentage depletion of 27% percent subject to the limitation already stated. The regulations promulgated under the 1926 Act continued the provisions granting an election to either capitalize or deduct as a development expense all expenditures in connection with the exploration and development of properties, and defined the phrase “net income” as used in section 204 (c)(2), as follows:

* * * The phrase “ net income of the taxpayer (computed without allowance for depletion)” means the gross income from the sale of all mineral products from the mining property and any other income incidental to the operation of the property for the production of mineral products, less the deductions-in respect to the property upon which the discovery is made, including operating expenses, depreciation, taxes, losses sustained, etc., but excluding any allowance for depletion. * * * [Italics supplied.]

On September 26, 1927, the respondent published an opinion by the General Counsel of the Bureau of Internal Revenue, known as G.C.M. 2315 (VI-2 C.B. 21), the material portion of which is set out in the margin.

Section 114 (b) (3) of the Revenue Acts of 1928 and 1932 is identically the same as section 204 (c) (2) of the Revenue Act of 1926 (see footnote No. 1), except that the Revenue Act of 1932 added at the close of the first sentence the phrase “ excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property.”

It has been the consistent practice of petitioner since its organization to elect to deduct from its statutory gross income in determining its statutory net income all “ development expenses ” as ordinary and necessary business expenses.

It is petitioner’s contention that the administrative practice of the respondent in construing the provisos limiting discovery depletion in the Revenue Acts of 1921 and 1924 to mean that the “net income from the property ” should be computed without regard to development expenditures regardless of whether the taxpayer elected to treat such expenditures as ordinary and necessary business expenses or to charge them to capital, must be deemed as having received legislative ajiproval by Congress in the reenactment by Congress of a similar proviso limiting percentage depletion in the Revenue Act of 1926; and that, therefore, the ruling in G.C.M. 2315, supra, is in error in so far as it holds that in determining the “ net income of the taxpayer (computed without allowance for depletion) from the property ” under section 204 (c) (2) of the 1926 Act, development expenditures must be deducted in those cases where the taxpayer has elected to treat such development expenditures as ordinary and necessary business expenses deductible from statutory gross income in determining statutory net income under other sections of the act. See Brewster v. Gage, 280 U.S. 327; Murphy Oil Co. v. Burnet, 287 U.S. 299; and United States v. Dakota-Montana Oil Co., 288 U.S. 459. Petitioner further contends that in any event the respondent’s construction of the earlier acts is the correct construction for the reason that Congress could never have intended the “ net income * * * from the property ” to have one meaning for taxpayers who elect to capitalize development expenditures and an entirely different meaning for taxpayers who elected to deduct from statutory gross income such expenditures as ordinary and necessary business expenses.

We do not feel that we are called upon in this proceeding to decide whether or not the Commissioner’s regulations dealing with discovery depletion under the 1921 and 1924 Acts and his consistent practice with reference thereto, were correctly interpretative of the law as written in these acts. The act we have here for interpretation is the 1926 Act, which abandoned discovery depletion so far as oil and gas wells are concerned and substituted a flat percentage basis of depletion, subject to a limitation. This limitation was that the percentage allowance for depletion should in no case exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, etc. This section 204 (c) (2), although it contained some of the same language used in prior acts in defining discovery depletion, was an entirely new provision and naturally called for new interpretative regulations on the part of the Commissioner of Internal Eevenue.

The Commissioner has construed the words “ The net income of the taxpayer from the property ” contained in section 204 (c) (2), Revenue Act of 1926, to mean that if a taxpayer elects to treat development expenditures as ordinary and necessary business expenses deductible under section 214 (a) (1) or section 234 (a) (1) of the same act in computing taxable income from the property, such expenditures must be deducted in determining the net income from the property, which amount is used as a limitation in the computation of the depletion allowance based on income. As we have already pointed out, the provisions as to percentage depletion deductions granted in the case of income from oil and gas wells are substantially the same in the 1928 and 1932 Acts as in the 1926 Act, and the Commissioner in his regulations applicable to the 1928 and 1932 Acts gives the same construction to the words “net income of the taxpayer from the property ” as he has given in applying the provisions of the 1926 Act to the instant case.

For example, article 221 (i), Regulations 74, 1928 Act, reads in part:

Tlie phrase “ net income of the taxpayer (computed without allowance for depletion)” means the gross income from the sale of oil and gas less the deductions in respect to the property upon which depletion is claimed, including overhead and operating expenses, development expenses {if the taxpayer has elected to deduct development expenses), depreciation, taxes, losses sustained, etc., but excluding any allowance for depletion. [Italics supplied.]

To the same effect is article 221 (h) of Regulations 77, Revenue Act of 1932.

We think this construction by the Commissioner of the meaning of “ net income ” of the taxpayer from the property is correctly interpretative of the meaning of the words as used in the revenue act now under consideration, section 204 (c) (2), Revenue Act of 1926. We therefore hold that respondent committed no error when he reduced petitioner’s gross income from the property in question by the sum of $91,883.28 for the taxable year 1925, in which year petitioner incurred that amount in the development of the property from which the income was received and claimed such amounts as allowable deductions in determining its net income for 1925, which deductions were allowed by respondent.

Reviewed by the Board.

Decision will be entered under Rude 50.

       Sec. 204 (c) (2). In the case of oil and gas wells the allowance for depletion shall be 27% per centum of ;the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph.

       See art. 223, Regulations 69, and I.T. 2338, VI-1 C.B. 74.

       Art. 201 (h), Regulations 69. See also art. 1602, Regulations 69.

       Shortly after the enactment of the Revenue Act of 1921, the construction of the proviso inserted in section 234 (a) 9 of the Act that the “ depletion allowance based on discovery value shall not exceed the net income, computed without allowance for depletion, from the property upon which the discovery is made” was given consideration by the Bureau, and the decision was reached that the “ net income from the property ” referred to in the proviso should he computed without regard to development expenditures ; that is, that development expenditures should not be treated as a deduction i'n computing the “ net income from the property ” regardless of whether the taxpayer corporation under article 223 of Regulations 62 elected to treat such expenditures as operating expenses deductible in computing taxable income or to charge them to capital returnable through depletion. In view of the decision made at that time, the fact that it has been uniformly followed in closing a great number of cases, and the desirability of a consistent administration of the provision in question, the conclusion is reached that in applying the limitation on discovery depletion in the case of oil and gas wells provided for in section 234 (a) 9 of the Revenue Act of 1921, the gross income from a discovery property should not be reduced by development expenditures in the computation of the “ net income from the property,” which amount measures the maximum depletion allowance based on discovery which can be allowed in respect to such property. A like construction should be followed in applying the provisions of section 214 (a) 10 of the Revenue Act of 1921 and the provisions of section 204 (c) of the Revenue Act of 1924. The latter section restricts a depletion allowance based on discovery value to “ 50 per centum of the net income (computed without allowance for depletion) from the property upon which the discovery is made.”
      The construction herein adopted relative to discovery depletion in the case of oil and gas wells under the 1921 and 1924 Acts should be confined to those Acts, under section 204 (c) 2 of the Revenue Act of 1926, provision is made that in the case of oil and: gas wells the allowance for depletion based upon the gross income from the property “ shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property.” The term “ net income ” as used in that section should he taken to mean the net income defined in sections 212 and 232 of the Act. Accordingly, if a taxpayer elects to treat development expenditures as ordinary and necessary business expenses deductible under section 214 (a) 1 or 234 (a) 1 in computing taxable net income, such expenditures must be deductible in determining the net income from the property, which amount is used as a limitation in the computation of the depletion allowance based on income.


source: Caselaw Access Project

author: Matthews :

license: Public Domain

text:
    J. F. Wilcox & Sons, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 40619.
    Promulgated August 8, 1933.

      John LeRoy Peterson, Esq., for the petitioner.

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

Matthews :

This proceeding is for the redetermination of a deficiency in income tax asserted against the petitioner for the fiscal year ended October 31, 1926, in the sum of $545.83. The respondent disallowed a deduction claimed by the petitioner on account of an alleged net loss for 1925 in the sum of $4,263.08, and determined that the petitioner should have reported a net income for 1925 in the amount of $633.54. It is conceded by the petitioner that unless a net loss was sustained in 1925 which may be applied against income for 1926 the respondent’s determination is correct.

The petitioner’s contention that it suffered a net loss in 1925 is based upon the theory that it is entitled to deduct from gross income for 1923 and for 1925 expenditures made in connection with the purchase and installation of new glass to replace the glass in the petitioner’s greenhouses which had been broken by hail. The respondent has taken the position that the items relating to hail losses sustained in 1923 and in 1925 are not deductible in those years and denies that there was any net loss for 1925. Although no deficiencies have been asserted against' the petitioner for the fiscal years 1923, 1924, and 1925, and the taxable period involved herein is the fiscal year 1926, it wiil be necessary to make reference to the petitioner’s income tax returns for the years 1923 to 1926, inclusive, and to the adjustments made by the respondent in his determination of the petitioner’s tax liability for each of these periods, before it can be determined whether the respondent erred in disallowing the net loss claimed for 1925, which disallowance resulted in the determination of a deficiency for 1926.

Petitioner is a corporation, organized and existing under the laws of the State of Iowa, with, its principal office and place of business at Council Bluffs, Iowa. It is engaged in the wholesale florist business and operates and maintains greenhouses. Petitioner had under glass in 1923 and in 1925, 454,872 square feet. The glass was 16 inches by 24 inches, double strength, and the petitioner carried hail insurance thereon in the Florists’ Hail Association, which is a mutual association.

In the years 1928 and 1925 considerable damage was done to the petitioner’s greenhouses by reason of the breaking of glass by hail. After each hailstorm it was necessary to remove the broken glass from the flower beds in the greenhouses. The broken glass left on the roof was then carefully removed; scaffolds were erected and as one group of workmen removed glass another group followed to remove the old putty from the bars supporting the panes of glass. Gas torches were used to-burn out the old putty and this so damaged the paint on the bars that they had to be wire-brushed. These bars were gone over before putting in new putty and new glass. The same kind of glass was put in to replace the glass broken by hail. No additions or substitutions were made to the .rafters or the bars and no new material was used in the greenhouses except the new glass and the putty. About forty men were employed to replace the glass damaged by the hail in 1925. As a result of burning out the old putty and scraping them, the bars supporting the panes of glass became narrower and the new glass could not be put in as tightly as had been the glass broken by the hail. Thereafter, as the bars would expand and contract, the glass would sometimes fall through and the damage to the bars also permitted leakage from the rains.

In 1923 petitioner expended the sum of $9,218.87 to cover the cost of glass, paint, putty, freight and labor used in restoring the property damaged by hail and received as hail insurance the sum of $6,035.29. In its income tax return for the fiscal year 1923 petitioner deducted from gross income the amount of $3,183.58, representing the difference between the insurance received and the cost of buying and installing new glass to replace the glass broken by hail, and reported a net loss of $4,007.09. The respondent entirely disallowed this deduction of $3,183.58 and increased by $162.32 the allowance for depreciation, which adjustment by the respondent resulted in the reduction of the petitioner’s net loss in 1923 to $985.83.

The petitioner reported a net loss for 1924 in the sum of $5,368.14, which was increased by the respondent to $5,530.46 by allowing additional depreciation.

For 1925 the petitioner reported a net loss of $4,263.08. Petitioner’s books show expenditures to restore the property damaged by hail in 1925 in the total sum of $19,766.51 and hail insurance collected in the sum of $17,534.56, the difference of $2,231.95 being claimed as a deduction by petitioner in its income tax return for the fiscal year 1925. The respondent entirely disallowed this deduction of $2,231.95 and added to income for 1925 the sum of $3,021.26, representing the reduction by the respondent in the net loss for 1923. The respondent determined a net income for 1925 in the amount of $633.54, which is less than the exemption to which petitioner is entitled, so that no deficiency in tax was determined to be due for that period. As has been stated above, the net loss for 1925 claimed by the petitioner in the sum of $4,263.08 was entirely disallowed by the respondent in computing the petitioner’s tax liability for 1926.

It will be seen that the amounts which the petitioner claims to be deductible for 1923 and 1925 on account of necessary repairs to its greenhouses are arrived at by taking the amounts expended in reconditioning the greenhouses and subtracting therefrom the amounts received as hail insurance. The petitioner urges that the respondent erred in failing to take into consideration the real nature of the losses suffered by the petitioner during 1923 and 1925, such losses being almost entirely glass broken by hail.

In denying the deduction claimed by the petitioner the respondent asserts that the petitioner’s loss must be measured not by the difference between the cost of restoration and the amount of insurance received, but upon the basis of cost or March 1, 1913, value of the property properly depreciated. The respondent places reliance upon the case of Josefh E. Hubinger, 13 B.T.A. 960; affd., 36 Fed. (2d) 724, in which it was held that the amount expended, in excess of insurance received, in restoring a building partially destroyed by fire was not deductible either as a loss or as the cost of repairs. To the same effect is the case of Fred Frazer, 10 B.T.A. 409, which also involved a loss on account of the partial destruction of a building by fire.

Without questioning the correctness of the above cited decisions upon the particular facts of those cases, we are of the opinion that the instant case presents a different situation. In the Hubinger case the expenditures in question were made to restore the major part of a building damaged by fire. It was pointed out that there was a distinction between such a restoration and the maintenance of property through repairs necessitated as the result of a casualty, as in the case of Illinois Merchants Trust Co., Executor, 4 B.T.A. 103. In this latter case expenditures were made to shore up the wall and repair the foundation of the taxpayer’s building which had threatened to collapse because of the sudden lowering of the water level in the Chicago River and the resultant rotting of the exposed foundation piles under the building. We held that these expenditures were deductible from gross income, saying:

* * * A repair is an expenditure for the purpose of keeping the property in an ordinarily efficient operating condition. It does not add to the value of the property, nor does it appreciably prolong its life. It merely keeps the property in an operating condition over its probable useful life for the uses for which it was acquired. Expenditures for that purpose are distinguishable from those for replacements, alterations, improvements or additions which prolong the life of the property, increase its value, or make it adaptable to a different use. * * *

Applying these principles to the facts in the instant case, we find that the expenditures made herein did not add to the value or prolong the expected life of the greenhouses beyond what it was before the event which made the repairs necessary occurred. It was necessary for the petitioner to put in the new glass as early as practicable in order to keep the greenhouses in a serviceable condition. The placing of new glass in the frames where glass had been broken did not make the property adaptable to any different use. On the contrary, it was testified that the new glass when installed in the same frames is less efficient than the old glass in prolonging the life of the structure, because in burning out the old putty the frames are also damaged and the water is permitted to seep through and the new glass sometimes falls through and breaks. It is recognized that the glass itself is not subject to depreciation as is a building.

Under these circumstances, we hold that the respondent erred in disallowing the deductions claimed on account of necessary repairs to petitioner’s greenhouses.

The petitioner’s net loss for 1923, which was determined by the respondent to be $985.83, will be increased by $3,183.58, which amount we have found to be the cost of the repairs to the petitioner’s greenhouses in that year. As a net loss was also sustained for 1924 in an amount determined by the respondent to be $5,530.46, the net loss for 1923 should be carried forward and allowed as a deduction in computing net income for 1925. An examination of the petitioner’s income tax return for 1925 indicates that its net income for that year is sufficient to absorb entirely the net loss for 1923 and a portion of the net loss for 1924. The unabsorbed balance of the loss sustained for 1924 is allowable as a deduction in computing the petitioner’s tax liability for 1926.

Judgment will be entered under Bule 50.


author: Smith:

text:
    Woodlawn Cemetery Association, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 65207.
    Promulgated August 8, 1933.

      J. Robert Sherrod, Esq., for the petitioner.

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

Smith:

The petitioner’s principal contention is that it is entitled to deduct either as an ordinary and necessary business expense or as a loss in the years 1928 and 1929, the amounts paid over in those years to the Union Trust Co. as trustee for the perpetual care fund. The argument is made that the petitioner was under a binding obligation to the purchasers of lots already sold to provide an adequate fund for perpetual care and also that the establishment of the fund Avas necessary as a means of meeting competition in the sale of other lots.

Prior to 1928, the petitioner’s sale contract contained no specific provision for a fund for perpetual care. All sales of lots were made subject to the petitioner’s rules and regulations, which guaranteed the present and future general care of all lots and stated that a portion (no specific portion) of the sale price would be set aside for that purpose. In 1928, after the trust fund had been created, a new sale contract Avas adopted which provided that approximately 25 cents per square foot of the purchase price of each lot sold would be paid into a perpetual care fund. As to the sales made under the new contract the specified amount of 25 cents per square foot on the lots sold Avas impressed Avith a trust upon its receipt and was therefore not income to the petitioner. Portland Cremation Assn. v. Commissioner, 31 Fed. (2d) 843; Los Angeles Cemetery Assn., 2 B.T.A. 495; Troost Ave. Cemetery Assn., 4 B.T.A. 1169; affd., 21 Fed. (2d) 194; New York & New Jersey Mausoleum Co., 26 B.T.A. 128,

HoAvever, as to the prior sales made under the old contract the petitioner Avas not obligated, either contractually or by law, to set aside any specific portion of the sales price for perpetual care and no part of such income was impressed with the trust. Cf. Portland Cremation Assn. v. Commissioner, supra.

The amount of $384,000 transferred to the perpetual care fund in 1928 included the $133,500 which the petitioner had in a reserve for perpetual care at the beginning of 1928. We do not know from Avhat source these funds were derived or what percentage of sales, if any, they represented. Presumably the amounts, except the $133,500 already held in reserve, were taken out of general surplus. The question here raised, however, is not whether the amount of $384,000 is includable in gross income as in the years of its receipt by the petitioner, but Avhether it is deductible from gross income in 1928 because of its transfer irrevocably to the trustee for the perpetual care fund in that year. This question was raised in Evergreen Cemetery Assn., 25 B.T.A. 544, but was not there decided, the facts proved in that case having been found insufficient to support a conclusion upon the question of law. A similar question was considered in New York & New Jersey Mausoleum Co., supra, where we said:

* * * Tlie cost of the mausoleum up to the years here involved was something over $200,000, and under the requirements of the law there should have been a trust fund in existence in excess of $20,000. How could this in any way reduce income in subsequent years? The statement in the sales agreement to the effect that the purchase price would provide a perpetual care fund did not obligate petitioner to set aside any ascertainable sum which a purchaser could require to be administered as a trust. As a matter of fact ' the petitioner never treated any part of the receipts from sales as having been received by it as a trustee. The record is entirely bare of evidence that petitioner created a trust fund with the $15,000 it borrowed in 1921 and left on deposit with the bank as a “ special interest fund.” Even conceding that the borrowed money could somehow be regarded as a trust fund, it does not appear that there was any relation between that sum and petitioner’s income for the year 1921. It is obvious, we think, that the existence of a trust fund does not necessarily affect income one way or another. Such a fund may be created out of donations, surplus, or capital, with no effect whatever on current income. It is only in cases where sums that would otherwise be reflected in income are diverted from the use of the taxpayer, as in the cases above cited, that income is affected. When in 1921 the taxpayer paid off $10,000 of the loan it was merely liquidating a liability, which plainly could not serve to reduce income.
Inasmuch as the State law applicable to petitioner’s operations required the maintenance of a trust fund based on cost, and no connection whatever is shown between cost and sales, we are of the opinion that petitioner is not entitled to reduce income from sales by reason of its so-called trust fund. * * *

We are of the opinion tbat the amounts transferred to the perpetual care fund in 1928 and 1929 in excess of 25 cents per square foot on the lots sold during those years are not deductible either as ordinary and necessary business expenses of those years or as losses. The petitioner is entitled to deduct in each year as a business expense the amount actually paid out by it during such year for the care of the lots, but to the extent that the amounts paid into the trust fund in 1928 and 1929 represented a capital reserve or trust fund for future care of the lots they were in no sense an expense of the taxable years before us. There is no authorization at law for the deduction of the amounts set aside out of its earnings of prior years, or out of its current earnings, in excess of its contractual obligation, for the care of lots in future years. Income must be computed upon an annual basis and the tax liability of each year must be determined with reference to the receipts and expenditures of that year. Burnet v. Sanford & Brooks Co., 282 U.S. 359.

There was no element of a loss in the transaction by which the amounts in dispute were transferred to the trust fund. The entire net income from the fund was to be used in the care of the lots. This was an annual expense which the petitioner was obligated to meet in some manner. If there had been no trust fund established for that purpose, then the petitioner would have been required to pay the cost each year out of its own funds.

The petitioner in his brief refers to section 11166, Michigan Compiled Laws, 1915, which reads as follows:

Sec. 7. It shall be the duty of such board of directors to preserve good order in the grounds of such cemetery; to provide for the laying out and embellishing of the same, and to see that they are well kept and in good condition. When the payments for lands purchased shall have been fully made, to reserve at least two-thirds of all the receipts of such corporation which shall be derived from the sale of burial rights after the payment of the current expenses for interest, improvements, and embellishing, until the aggregate amount thereof shall, in the opinion of said board, be sufficient to constitute a permanent fund which, when invested, shall produce an income large enough to meet the expense of keeping the grounds of such cemeteries perpetually in good condition after the same shall have once been properly laid out, improved, and embellished according to the plan thereof; to invest the receipts to be reserved as aforesaid in the bonds of the United States, or of the state of Michigan, or of municipal corporations of this state, and to use the income thereof only for the purposes aforesaid; to cause to be issued scrip or certificates to each subscriber to the articles of the association, which certificates shall specify the amount paid into the capital stock by such subscriber. Such script shall be personal property and transferable by the holder thereof, under such regulations as the board of directors may adopt; to make a report to the annual meeting of the condition of the association, and its receipts and disbursements for the previous year.

The evidence does not indicate, however, that the petitioner set aside the amounts in question in compliance with this provision of the Michigan law. The same law was in effect in prior years. Its effect, if any, on the petitioner’s taxable income was to impress a trust upon a portion of the receipts from the sale of lots in those years, removing such amounts from petitioner’s taxable income. See cases cited above.

Since the disallowance of the deduction of the $284,000 item in 1928 offsets the claimed net loss of that year of $92,864.18, there is no net loss which may be carried forward in 1929.

The petitioner claimed the deduction in its 1929 return of $71,000 represented the total of additional amounts transferred to the perpetual care fund in that year. The respondent allowed the deduction of $13,959.37 representing 25 cents per square foot on the lots sold during the year, which amount the petitioner was obligated under the sales contracts to pay into the perpetual care fund. The balance, $57,040.63, was disallowed as a deduction. This adjustment was correctly made. Of course, as shown by the deficiency notice, the amount of $13,959.37 was not deductible as a business expense but was excluded from gross income because received by the petitioner in trust for the benefit of the lot owners.

The petitioner also alleges error on the part of the respondent “ in including in taxable income interest from tax-exempt municipal bonds in the amount of $19,700.22.” During 1929, the petitioner expended in caring for the lots $25,110.91 which it claimed as a deduction in its return for that year, but it did not report in its return the above amount of $19,700.22 received from the perpetual care fund. What the respondent actually did, as shown by the deficiency notice, was to charge back to income, or disallow as a deduction, $19,700.22 of the amount of $25,110.91 claimed in the return. The deficiency notice states:

5. Since the income received by the trustee from the perpetual care fund was turned over to the Cemetery Company to take care of expenses of maintenance and upkeep of the cemetery and does not constitute income to the corporation such portion of the expenses is thereby offset and does not constitute an allowable deduction from income.

It is not material whether the income received by the petitioner from the perpetual care fund is exempt as income from tax-free securities or not. The petitioner is entitled to deduct from gross income for perpetual care only the expense borne by it. To the extent that the cost of perpetual care was reimbursed to it by an amount received from the perpetual care fund the expense was not borne by it. And if the amount thus received is not reflected in petitioner’s gross income, the cost of perpetual care must be reduced pro tanto. See Glendinning, McLeish & Co. v. Commissioner, 61 Fed. (2d) 950, in which the Circuit Court of Appeals for the Second Circuit held that deductions claimed in 1922 to 1926 as ordinary and necessary expenses should be disallowed because the contract under which the payments represented by the deductions were made provided for repayment to the plaintiff of such amounts. The respondent’s action on this point is sustained.

Judgment wiU, Toe entered for the respondent.


author:
Van Fossan:
      Sea well,

text:
    Edgar A. Igleheart, Executor, Cora B. Igleheart, Executrix, Estate of Addison W. Igleheart, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 52042.
    Promulgated August 8, 1933.

      JohnE. M cOlure, Esq., for the petitioner's.

      Frank T. Horner, Esq., for the respondent.
   OPINION.

Van Fossan:

For the purposes of our discussion the questions to be determined herein may be grouped as follows:

I. Were certain transfers made by the decedent prior to his death made in contemplation of or intended to take effect in possession or enjoyment at or after the decedent’s death?

II. Is section 302 (c) of the Revenue Act of 1926, in so far as concerns the so-called “conclusive presumption” thereof, constitutional ?

III. Should there be included in the gross estate the value, at the date of decedent’s death, of certain transfers made by him, where the value at the date of death is in excess of the value at the date of the transfer, and is such inclusion constitutional?

IY. Are the petitioners entitled to the deduction of the amount of an obligation incurred by them for the perpetual care of a cemetery lot and mausoleum?

V. To the extent of their excess over $40,000, should the proceeds of certain insurance policies be included in the gross estate ?

YI. Should any part of the value of certain Federal Farm Loan bonds be included in the gross estate for Federal tax purposes?

I. and II. The respondent contends that the value of the assets of the trust of which decedent’s wife, Cora B. Igleheart, was trustee was included lawfully in the gross estate for the reason that the creation of the trust was a transfer in contemplation of or intended to take effect in possession or enjoyment at or after the death of the decedent, within the provisions of section 302 (c) of the Revenue Act of 1926. He also contends that a transfer in contemplation of death within the intent of the statute occurred in each of the following transactions: The purchase by the decedent of an endowment insurance policy of $100,000 on his wife’s life; the making of a cash payment by the decedent as part consideration for a house in Florida, title to which was taken in his wife’s name; and the payment of income taxes due from the Cora B. Igleheart trust.

Section 302 of the Revenue Act of 1926 reads, in part, as follows:

Sec. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
(a) To the extent of the interest therein of the decedent at the time of his death;
*******
(c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, except in ease of a bona fide sale for an adequate and full consideration in money or money’s worth. Where within two years prior to his death but after the enactment of this Act and without such a consideration the decedent has made a transfer or transfers, by trust or otherwise, of any of Ms property, or an interest therein, not admitted or shown to have been made in contemplation of or intended to taire effect in possession or enjoyment at or after his death, and the value or aggregate value, at the time of such death, of the property or interest so transferred to any one person is in excess of $5,000, then, to the extent of such excess, such transfer or transfers shall be deemed and held to have been made in contemplation of death within the meaning of this title. Any transfer of a material part of his property in the nature of a final disposition or distribution thereof, made by the decedent within two years prior to his death but prior to the enactment of this Act, without such consideration, shall, unless shown to the contrary, be deemed to have been made in contemplation of death within the meaning of this title.

The so-called “ conclusive presumption ” contained in the second sentence of section 302 (c) has been pronounced unconstitutional. Heiner v. Donman, 285 U.S. 312. To this extent petitioners’ contention is sustained. This, however, is not an end of the matter.

Under the valid provisions of the section, the petitioners must establish by a preponderance of evidence that the transfers in question were not, in fact, made in contemplation of death or intended to take effect in possession or enjoyment at or after the decedent’s death. J. Bertram Lippincott et al., Executors, 27 B.T.A. 735. The petitioners contend that the transfers here in question were induced by motives different from contemplation of death and that none of the transfers were intended to take effect in possession or enjoyment at or after the death of the decedent.

In United States v. Wells, 283 U.S. 102, the Supreme Court has definitely established the tests to be applied in determining whether any particular transfer was made “ in contemplation of death.” In that case the court interpreted the phrase “ contemplation of death ” as used in section 402 (c) of the Revenue Act of 1918. The phrase is used similarly in section 302 (c) of the Revenue Act of 1926. In the Wells case the Supreme Court said, inter alia:

* * * Transfers in contemplation of death are included within the same category, for the purpose of taxation, with transfers intended to take effect at or after the death of the transferor. The dominant purpose is to reach substitutes for testamentary dispositions and thus to prevent the evasion of the estate tax. Nichols v. Coolidge, 274 U. S. 531, 542; Milliken v. United States, ante p. 15. As the transfer may otherwise have all the indicia of a valid gift inter vivos, the differentiating factor must be found in the trans-feror’s motive. Death must be “ contemplated ”, that is, the motive which induces the transfer must be of the sort which leads to testamentary disposition. * * * The question, necessarily, is as to the state of mind of the donor.

The Supreme Court also said':

As the test, despite varying circumstances, is always to be found in motive, it cannot be said that the determinative motive is lacking merely because of the absence of a consciousness that death is imminent. It is contemplation of death, not necessarily contemplation of imminent death, to which the statute refers. It is conceivable that the idea of death may possess the mind so as to furnish a controlling motive for the disposition of property, although death is not thought to be close at hand. Old age may give premonitions and promptings independent of mortal disease. Yet age in itself cannot be regarded as furnishing a decisive test, for sound health and purposes associated with life, rather than with death, may motivate the transfer. The words “in contemplation of death ” mean that the thought of death is the impelling cause of the transfer, and while the belief in the imminence of death may afford convincing evidence, the statute is not to be limited, and its purpose thwarted, by a rule of construction which in place of contemplation of death makes the final criterion to be an apprehension that death is “ near at hand.”

In. the search for the motive inducing the transfers in this proceeding, we do not find such a state of facts as appeared in the Wells case, in which the Court of Claims had held that the immediate moving cause of the transfers there in question “ was the carrying out of a policy, long followed by decedent in dealing with his children, of making liberal gifts to them during his lifetime.” In the present proceeding there is no evidence of any policy on the part of the decedent of making gifts prior to the transfers in question. The picture here is that of a man of 74 years or more of age whose physical activities had been greatly limited for about 11 years because of a hemiplegia resulting from a so-called stroke. In other respects he was apparently in good health. He was thoughtful, intelligent, cheerful and interested in the affairs of the business with which he had been connected for many years.

In April 1926, as a result of the redemption of the preferred stock of Igleheart Brothers of Indiana, and as a result of the sale of that corporation, the decedent found himself possessed of a large amount of free capital. He talked about its investment with his brothers, who were relatively in the same position as himself. He consulted his counsel. Shortly thereafter, on June 1, 1926, he executed three instruments prepared by his counsel at his request, namely, (a) the irrevocable trust for the benefit of his wife during her life with remainder over; (b) a revocable trust for his own benefit for life with the remainder to his children and grandchildren; and (c) his last will and testament.

Of the trusts created by the decedent June 1, 1926, when he also executed his will, only the transfer effected by the execution of the trust to Cora B. Igleheart is here in question. In respect to this transfer it is our opinion that the evidence discloses testamentary intent and therefore the motive inducing it was contemplation of death. United States v. Wells, supra; Heiner v. Donnan, supra; J. Bertram Lippincott et al., Executors, supra.

The evidence shows that the decedent and his brothers were con-cérned about the investment of their newly acquired free capital. They wanted to invest it in such a way that in the event of their “ absence ” their “ wives would not have the burden of it, in the care of it.” The natural conclusion is that the “ absence ” referred to is that permanent separation effected by death. While the decedent and his brothers did not discuss the possibility of the decedent’s death, the evidence further shows that they, including the decedent, considered that they ought to be “ prepared for any eventuality ” by getting “ their estates fixed up.” The decedent was then over 74 years of age and the hemiplegia, resulting from the stroke, which seriously limited his locomotion, undoubtedly furnished him a constant reminder of the uncertainty of life. What then was the “ eventuality ” in preparation for which the decedent wished to have “ his estate fixed up ? ” The answer is patent. What the decedent had in mind was so to dispose of his property that his estate “ would be fixed up ” finally in preparation for his death. The evidence shows that he wanted so to dispose of his property when there was “ no rush ” and he was “ clear-headed.”

Another significant bit of evidence is found in the statement of the lawyer to whom decedent entrusted his confidence and the drafting of the trusts and his will, all executed June 1, 1926. Asked if decedent made any statements indicating the reason for executing the will at the same time the trusts were executed, he replied: “ Yes, that inasmuch as the trust made a certain disposition as to that part of the property that was to go to his children he wished to indicate the way the remainder of his estate should go, outright, as to his wife and children.” To us this statement speaks with striking clarity. It enunciates the same testamentary intent in the making of the trusts as in making the will. Moreover, it is consonant with the recitals of other witnesses above referred to. Short of a deliberate declaratory statement of purpose, it would be difficult to conceive better proof of a testamentary intent than is found in these excerpts of testimony when coupled with the actual execution of the three documents — the trusts and the will — on the same day. The motive, therefore, which induced the decedent to execute, on June 1, 1926, the Cora B. Igleheart trust was the same motive which induces testamentary disposition of property and which in fact induced the decedent to execute his last will and testament on the same date. The inducing motive wa,s contemplation of death.

The petitioners contend that the main motive inducing the transfer to Cora B. Igleheart, as trustee, of a part of the decedent’s property was his desire to give her, for life, an independent income consistent with his means. In support of their contention in this respect the petitioners rely largely on the testimony of decedent’s counsel who prepared the three instruments referred to. The latter testified that during his consultations with decedent concerning the drafting of the instruments, the decedent informed him that since he, the decedent, for the first time in his life was possessed of ample free capital he wished to give his wife an independent income consistent with his means. This desire of decedent is not inconsistent with testamentary intent with respect to the trust in her favor. Every person executing a testamentary instrument thereby exhibits a desire to give something to the beneficiary named therein. The decedent’s counsel also testified that the decedent told him that he wanted his wife to get experience in handling investments and the petitioners contend that this statement is evidence that the motive inducing decedent to execute the trust to his wife was not, in fact, testamentary in character. There appears no special reason why the decedent’s wife should have managed investments while the decedent remained alive and the expression of his desire to have her learn to manage investments seem to us to be evidence that when he made such statement he was contemplating his death, as a result of which his wife would become one of the executors of the last will and testament, charged with the management of a large estate.

Petitioners’ counsel also stresses by questions to his witnesses that decedent was of a cheerful, optimistic disposition, concerned with living, never morose and never given to discussing the eventuality of death and argues therefrom that this state of mind was not consistent with the contemplation of death or a testamentary purpose. If any act can be said to be done in contemplation of death, it is the making of a will. It is the most usual testamentary disposition. Yet the prudent man makes his will while in the full vigor of life. The prefatory words to most wills refer to the sound and disposing mind of the testator. Though the making of a will is a testamentary act, provocative of solemnity, nothing could be further from truth than the impression that such acts are not performed by persons of cheerful, optimistic dispositions, uninfluenced by the shadows of approaching death. Yet, the Supreme Court has said, such acts are in contemplation of death.

The humor and disposition of the person is no necessary indication of a testamentary purpose or of its absence.

These contentions of the petitioners, together with their contention that one reason for the execution of the .Cora B. Igleheart trust was the decedent’s wish to reduce his income tax, are not, in our judgment, of sufficient weight to overcome the implications of the other evidence already referred to which points strongly to the fact that the execution of the Cora B. Igleheart trust was induced by the same motive which induced the decedent to execute his will, namely, the contemplation of death.

On all the evidence we hold that the petitioners have failed to prove that the transfer to Cora B. Igleheart, as trustee, was not in fact made in contemplation of death.

The petitioners have presented no evidence relating directly to the motive inducing the decedent’s purchase, in August 1927, of the $100,000 endowment policy on the life of his wife, the purchase price of which was included by the respondent in the gross estate. It would perhaps be fair to presume that this gift was induced by the same motive as the transfer to Cora B. Igleheart, as trustee, namely, contemplation of death. In any event, petitioners, who had the burden of proof, have not proved the contrary. Therefore, the cash surrender value of the policy at the date of decedent’s death, $94,500, should be included in the gross estate.

It appears that in addition to the fall corpus of the estate, the respondent included in the taxable gross estate the sum of $25,672.63, which amount had been paid by the decedent during 1927 for and on account of income taxes for the year 1926 assessed against the Cora B. Igleheart trust. It was stipulated that the payment was made “ in order to keep the capital of the trust intact.” This payment did not remain in the corpus of the trust. In effect it merely passed from decedent through his wife’s hands to the Government as income taxes. It was not in the estate at decedent’s death. Except for this payment the corpus of the estate would have been depleted by $25,000 and the taxable estate would have been correspondingly less. Respondent has included the full amount of the estate. Therefore, the inclusion in the taxable gross estate of this payment constitutes a duplication of the amount.

It is our opinion that the payment of $40,214.48 by the decedent as cash consideration for the house in Florida, title to which was taken in the name of his wife, was not a transfer in contemplation of death. The petitioner and his wife had lived in Newburgh, Indiana, in a house the title to which was in his wife’s name. The evidence shows that the decedent established residence at Fort Myers, Florida. As part payment for the house there the house at New-burgh belonging to decedent’s wife was transferred to the owner of the Fort Myers house. The normal inference in this transaction is that the decedent was merely substituting one house standing in his wife’s name for another house of like category and that any expenditure of cash connected with such substitution was not, in fact, made in contemplation of death.

III. At the date of the decedent’s death the respective values of the assets of the two trusts described in the findings of fact were in excess of their values at the date of their creation. The respondent included in the gross estate the respective values at the date of death. The petitioners contend that the inclusion of the increase in value between the date of creation of the trusts and the date of decedent’s death is unconstitutional. They rely solely on the following quotation from Heiner v. Donnan, 285 U.S. 312:

Moreover, under the statute the value of the gift when made is to he ignored, and its value arbitrarily fixed as of the date of the donor’s death. The result is that upon those who succeed to the decedent’s estate there is imposed the burden of a tax, measured in part by property which comprises no portion of the estate, to which the estate is in no way related, and from which the estate derives no benefit of any description. Plainly, this is to measure the tax on A’s property by imputing to it in part the value of the property of B, a result which both the Schlesinger and Hoeper cases condemn as arbitrary and a denial of due process of law. Such an exaction is not taxation but spoliation. “ It is not taxation that government should take from one the profits and gains of another. That is taxation which compels one to pay for the support of the government from his own gains and of his own property.” United States v. Baltimore & O. R. Co., 17 Wall., 322, 326, 21 L. ed. 597, 599.

It is evident that the quoted statement is related solely to the question then before the Court, namely, whether the second sentence of section 302 (c) of the Eevenue Act of 1926 is constitutional. The Court was elaborating its argument with respect to the arbitrary character of the so-called “ conclusive presumption.” Earlier in its opinion the Court had held that the second sentence violates the due process clause of the Fifth Amendment to the Constitution. The Court had stated, however, that “ there is no doubt of the power of Congress to provide for including in the gross estate of a decedent, for purposes of the death tax, the value of gifts made in contemplation of death.” In Heiner v. Donnan, supra, the Court discussed the nature of the tax imposed by section 301 of the Revenue Act of 1926, saying that “ the thing taxed is the transmission of property from the dead to the living,” citing Knowlton v. Moore, 178 U.S. 41. Citing Milliken v. United States, 283 U.S. 15, the Court said that the value of property transferred without consideration and in contemplation of death is included in the value of the gross estate of a decedent for the purpose of a death tax “ because the transfer is considered testamentary in effect.” It is our opinion, therefore, that in the quotation from Heiner v. Donnan, relied on by the petitioners, the Court was not suggesting that there was anything arbitrary or unconstitutional in measuring the tax on transfers made in contemplation of death by the same measure applying to all testamentary transfers of property. Such a suggestion would be inconsistent with the stated reason for including, for the purposes of a death tax, the value of property transferred without consideration and in contemplation of death.

The inclusion of the value of the assets- of the two trusts at the time of the decedent’s death is in strict conformity with the provisions of section 302 of the Revenue Act of 1926. In Milliken v. United States, supra, a question quite similar to the one before us was involved. In that case, while the Revenue Act of 1916 was in force, the decedent gave certain shares of stock to his children. The decedent died after the effective date of the Revenue Act of 1918. The Commissioner included the shares of stock in the decedent’s estate and collected a tax computed on the value of the stock at the date of the decendent’s death. The Court said, in part:

Tbe objection to the tax, chiefly ni’ged in biflef and argument, is that the taxing statute, as applied, is a denial of due process of law because retroactive. It is said that the statute is invalid not alone because it reaches a gift made before its enactment, but because it measures the tax by rates not in force when the gift was made, applied to the value of the property not when given, hut at the uncertain later time of the death of the donor.
Hence, in challenging the present tax it does not suffice to say that the gift antedated the statute. It is necessary to consider the nature of the tax and of the decedent’s gift. When the gift was made it was subject to the provisions of the 1916 Revenue Act. By it, Congress had adopted the well understood system of taxation of transfers of property at death, already In force in forty-two states. * * *
* * * Not only was the decedent left in no uncertainty that the gift he was then making was subject to the provisions of the existing statute, but in view of its well understood purpose he should be regarded as taking his chances of any mofease m the taw harden which might result from carrying out the established policy of taxation under which substitutes for testamentary gifts were classed and taxed with them. [Italics supplied.]

It is our opinion that the above quotations from Milliken v. United States, are directly applicable to the question now under consideration. Here it is urged that the taxing statute as applied is invalid because it applies the rates in force to the value of the transfers not when made, but at the uncertain later time of the death of the trans-feror. It appears from the evidence that at the time he executed the two trusts the decedent was advised as to the application to them of the provisions of the Revenue Act of 1926. Therefore, as suggested in Milliken v. United States, supra, under similar circumstances, he should be regarded as taking his chances of any increase in the tax burden which might result from carrying out the established policy of taxation under which substitutes for testamentary gifts are classed and taxed with them. We therefore hold that the inclusion in the gross estate of the increase in value of the two trusts between the date of their creation and the date of the decedent’s death is both proper and constitutional.

IV". The respondent allowed as a deduction the cost of a cemetery lot and a mausoleum. He disallowed the deduction of the sum of $1,500 which represents an obligation incurred by the petitioners for the perpetual care of the lot and mausoleum. The petitioners contend that this disallowance was error. This obligation was not incurred by the decedent but by the executors and therefore the question for determination is whether the amount is deductible as a proper funeral expense.

Section 303 (a) (1) of the Revenue Act of 1926 provides, in part, for the deduction of “ such amounts for funeral expenses * * * as are allowed by the law of the jurisdiction, whether within or without the United States, under which the estate is being administered.”

Apparently the decedent’s estate was being administered under the laws of the State of Florida where the decedent had established his legal residence during his last years. Section 5541 of the laws of Florida provides, among other things, that executors and administrators shall be allowed all reasonable charges on account of funeral expenses. There is no evidence before us from which we can infer that the Florida court having jurisdiction allowed this item in the accounts of the petitioners.

It is the general rule that necessary amounts expended for the burial of a decedent are allowable out of the decedent’s estate and that where the estate is solvent the amount to be allowed must vary with local custom, the station in life of the decedent, the extent of his fortune, as well as other material circumstances. Schouler on Wills, Executors and Administrators, 6th ed., vol. III, p. 2293; Crothers v. Crothers, 123 Md. 603; 91 Atl. 691; Pierce v. Fulmer, 168 Ala. 344. The respondent allowed the deduction of the cost of the cemetery lot and mausoleum in accordance with this rule. It has been held that where there is objection the expenses of fencing, preserving and improving a cemetery lot are not allowable out of the estate. Tuttle v. Robinson, 33 N.H. 104. Expenditures for perpetual care are expenditures for preservation. In some states, however, a payment to a cemetery corporation for perpetual care of a burial lot is made allowable by statute. Hall v. Burgess, 40 R.I. 314; 100 Atl. 1013. It does not appear that such is the case in the State of Florida. The statute of that state appears to contemplate allowance only of expenses necessary to the burial. Such expenses manifestly do not include the perpetual care of a cemetery lot and mausoleum. It is, therefore, our opinion that the respondent correctly disallowed the amount in question.

V. The petitioners contend that no portion of the proceeds of the 13 life insurance policies set forth in the findings of fact, the issuance of which was originally procured by Igleheart Brothers of Indiana, should be included in the taxable estate.

Section 302 of the Revenue Act of 1926 provides for the inclusion in the gross estate of the value of a decedent’s property at the time of his death to the extent of the amount receivable by the executor as insurance under policies taken out by the decedent upon his own life; and to the extent of the excess over $40,000 of the amount receivable by all other beneficiaries as insurance under policies taken out by the decedent upon his own life.

The proceeds of the policies in question were receivable by beneficiaries other than the executors of the decedent’s estate, but it is contended by the petitioners that the policies were not taken out by the decedent on his own life and, therefore, the proceeds thereof are not within the provisions of the section.

• These policies were originally taken out on decedent’s life through the procurement of Igleheart Brothers of Indiana and for the benefit of that corporation. The decedent signed the respective applications for the policies. The corporation procuring the policies paid all the premiums up to about February 16, 1926. On the latter date the decedent purchased from Igleheart Brothers of Indiana all its right, title, and interest in and to the policies, paying therefor the cash surrender value of the policies, plus any premiums paid or to be paid after January 30, 1926. Thereupon, at the instance of the decedent, the beneficiaries of the policies were changed, the decedent reserving the right to change the beneficiaries further, and he paid all of the premiums falling due thereafter until the date of his death.

It is our opinion that to the extent of their excess over $40,000 the proceeds of these policies as of the date of decedent’s death should be included in the taxable estate. To hold otherwise would be either to ignore the intent of the statute or to nullify it by mere technical construction. The applicable provisions of the statute should be construed as intending to include all the insurance on a decedent’s life in favor of beneficiaries other than his estate which was acquired by him through the expenditure of his own money, where he has the power to dispose of the proceeds of the insurance at will. Such a construction is in harmony with the views of the Supreme Court expressed in Chase Nat. Bank v. United States, 278 U.S. 327. The tax is imposed on the transfer by death of the decedent’s net estate and in the Chase Nat. Bank case, referring to the word “ transfer ” the Court said, “ it must, we think, at least include the transfer of property procured through expenditures by the decedent with the purpose, effected at his death, of having it pass to another.” When the decedent bought from Igleheart Brothers of Indiana all of that corporation’s right, title and interest in and to the insurance policies on his own life he acquired, by expenditure of his own money, property rights which he intended to pass to others at his death but which, so long as he lived, he could dispose of at will, Since he originally signed the respective applications for the insurance policies, paid the cash surrender value for the assignment to himself of the corporation’s rights and immediately named new beneficiaries of the policies, the effect of the transfer was that on the date of such purchase he procured insurance on his own life, the proceeds of which were payable to beneficiaries designated by him. By this transfer he became a party to the insurance contracts as actually as if he himself had taken out ” the policies originally. The policies were owned by him like any other chose in action and his rights therein could only be defeated by forfeiture because of failure to pay the stipulated premiums. New York Life Ins. Co. v. Statham, 93 U.S. 24; Mutual Life Ins. Co. v. Hurni Packing Co., 263 U.S. 167. Under these conditions we must hold that the acquisition of these policies by purchase was, in result, the taking out of the policies by the decedent on the date of purchase by him of all the rights thereunder. Therefore, the proceeds of the policies, to the extent of their excess over $40,000, should be included in the gross estate.

In reaching this conclusion we have not failed to consider Bessie M. Ballinger, Executrix, 23 B.T.A. 1312. The facts of that proceeding are distinguishable from the facts respecting the insurance here involved. That proceeding in part concerned group insurance taken out by a corporation to cover the lives of its employees. There was no evidence of any payment of money by the insured and no evidence that he had any rights under the group policy except to change the name of the beneficiary. Here, however, by the expenditure of $94,000 the decedent had had himself substituted for the corporation which originally procured the insurance, securing thereby all of the rights and privileges attendant upon ownership of the policies. Bessie M. Ballinger, supra, is, therefore, not applicable to the question under consideration.

VI. With respect to the Federal F arm Loan bonds referred to in the findings of fact, the petitioners contend that to include the value of the whole or any part thereof in the gross estate for purposes of estate tax is to subject to taxation instrumentalities of the Government which are exempted from such taxation by provisions of the statute authorizing their issue. This contention is based primarily on the provisions of section 26 of the Federal Farm Loan Act approved July 17, 1916, ch. 245 (39 Stat. 360) which reads in part as follows:

First mortgages executed to Federal land banks, or to joint stock land banks, and farm loan bonds issued under tbe provisions of this Act, shall be deemed and held to be instrumentalities of the Government of the United States, and as such they and the income derived therefrom shall be exempt from Federal, State, municipal and local taxation.

Section 302 (a) of the Revenue Act of 1926 provides in substance that to the extent of his interest therein at the time of his death, the value of all the decedent’s property, real and personal, tangible and intangible, wherever situated, shall be included in his gross estate. It is, of course, apparent that Farm Loan bonds are within the classification of property contained in the section. It is urged, however, that the phraseology of section 26 of the Farm Loan Act above quoted discloses that it was the intention of Congress to exempt the principal of the bonds issued in accordance with the provisions of the act, together with the income therefrom, from all forms of taxation, including taxation under the estate tax law. In this connection it should be observed that the Federal estate tax law was not approved until September 8, 1916, and therefore it can not be said to have been necessarily within the contemplation- of the Congress at the date of the enactment of the Federal Farm Loan Act on July 17, 1916. It is our opinion, however, that the inclusion of the value of such bonds in the gross estate of the decedent for the purpose of determining the amount of tax imposed on the transfer of the net estate is not interdicted by the quoted provisions of the Federal Farm Loan Act.

The nature of the estate tax imposed by the revenue acts, beginning with the Revenue Act approved September 8, 1916, is well settled. It is not a tax on property. It is an excise, the amount of which is measured by the value of the property transferred. Chase Nat. Bank v. United States, supra; Heiner v. Dorman, supra.

. Questions closely akin to the one here involved were discussed by the Supreme Court in Plummer v. doler, 178 U.S. 115, where the fundamental question was the constitutionality of the inheritance tax law of the State of New York when applied to a legacy which consisted of bonds of the United States containing a clause exempting them from state and Federal taxation. The Supreme Court upheld the validity of the state law, holding that “ a State may lawfully measure or fix the amount of the tax by referring to the value of the property passing and that the incidental fact that such property is composed, in whole or in part, of Federal securities does not invalidate the tax or the law under which it was imposed.” The language just quoted with reference to Plummer v. doler, supra, is an excerpt from Murdoch v. Ward, 178 U.S. 139; 44 L. ed. 1009. In the latter case the Court had under consideration the same statute considered in Knowlton v. Moore, sufra, namely, the War Revenue Act of June 1898, when applied to United States Government bonds issued under statutes providing that neither principal nor interest should be taxed. In Murdock v. Ward, the Court also said: “Without repeating the discussion in Plummer v. doler, and following the conclusion there reached, we are unable to distinguish that case from the present one.” Nor can we distinguish the Plummer case, on principle, from the issue now before us. If a state, by an inheritance tax law, can validly impose a tax measured by the amount or value of a legacy, even if the legacy includes tax-exempt United States bonds, the reasoning justifying such a conclusion must, in our opinion, when applied to the present issue lead to the similar conclusion that the United States may impose a death tax measured by the value of Farm Loan bonds although the principal and interest of such bonds are exempted by statute from Federal, state, and local taxation.

The petitioners urge, however, that the decision of the Supreme Court in First Nat. Bank of Boston v. State of Maine, 284 U.S. 312, recognizes that the estate tax, while not a direct tax, is in substance a tax on property and that, therefore, the value of no part of the Farm Loan bonds may be included in the decedent’s gross estate for estate tax purposes. The question in that case, as stated by Mr. Justice Sutherland, is “ whether the State of Maine has power under the Fourteenth Amendment to impose a tax upon the transfer by death of shares of stock in a Maine corporation, forming part of the estate of a decedent, who, at the time of his death, was domiciled in the Commonwealth of Massachusetts.” In its decision of the question the Supreme Court applied the rule mobilia sequunter personam and held that the situs of intangibles is at the domicile of a decedent for the pux’pose of state taxation of their transfer by death. We have heretofore considered the effect of this and similar decisions of the Supreme Court upon the power of Congress to tax. In Estate of John Joseph Garvan, 25 B.T.A. 612, we held that First Nat. Bank of Boston v. State of Maine and similar decisions “ are not controlling when the power of Congress to tax is considered.” Nor, in our opinion, is there anything in the decision in the First Nat. Bank of Boston case modifying the rule that in Federal taxation of transfers by death, “ the thing taxed is the transmission of property from the dead to the living.” Knowlton v. Moore, supra; Murdock v. Ward, supra; Chase Nat. Bank v. United States, supra; Heiner v. Donnan, supra.

The controlling statute has definitely set forth what property is to be included in a decedent’s gross estate for the determination of the amount of tax to be imposed on the transfer of the net estate and it is our opinion that the value of the Farm Loan bonds in question may not be excluded from the value of the gross estate.

Reviewed by the Board.

Decision umII be entered under Rule 50.

Sea well,

dissenting: Having reference to part III in the prevailing opinion, I do not agree, under the circumstances here present, that the property embraced in the trust should be valued for estate tax purposes, as of the date of decedent’s death; or, if it is required by the statute to be so valued, that the statute is not unconstitutional.

The statute in reference to estate taxes, here applicable, is section 302 of the Kevenue Act of 1926, which provides:

The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated * * *.

This obviously refers to property of the decedent owned by him at the time of his death, and is not sufficient to include property theretofore conveyed away and not then owned by him. This is shown further by subsection (a) of this section, 302, which provides immediately after the language above quoted:

(a) To the extent of the interest therein of the decedent at the time of his death.

It is significant that not only subsection (a) but also subsection (b) repeats the phrase theretofore used in the section, to wit: “ at the time of his death,” and that the next succeeding subsection, (c), does not use the phrase. It is subsection (c), in which the phrase “ at the time of his death ” is not used, that is controlling in this proceeding, and its pertinent language for the case at bar is as follows:

(c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in .contemplation of * * * death. * * *

The transfer being by trust in this case and having been determined to have been made in contemplation of death, we come to apply the cited portions of the statute to the following portions of the findings of fact:

On June 1, 1926, the date of the execution of the transfer to Oora B. Igleheart, as trustee, the total value of the property transferred to her was $498,599.88 and the value of the property held under the trust instrument at the date of the decedent’s death was $606,974.88, which latter amount was included by the respondent in the gross estate.

The question presented is how and by what yardstick of time should we measure and fix “ the extent ” of the “ interest ” in the property transferred on June 1,1926, to the trustee, for its inclusion in the gross estate of the decedent. The petitioner, answering the question, says by using the value of the property transferred at the date of the transfer; the respondent says by using the value of the property transferred at the time of the death of the transferor. The statute does not require that because the transfer is of a testamentary nature it should be measured as if under a testament.

On June 1, 1926, the extent of the interest of the transferor in the property was all of it, including the right to convey it even in contemplation of death. A conveyance made in contemplation of death is not void or voidable for that reason. The extent of the interest- of the transferor in the property after June 1, 1926, when he conveyed it to the trust, including the time of his death, was nothing. How the difference of $108,315 was added to the trust fund after the transfer made by decedent and before decedent’s death, whether by the efforts and management of the trust by the trustee, contributions by other friends of the beneficiaries, or by the general rise in the market values of the trust properties, or otherwise, is not shown in the evidence and the findings of fact. The only thing we know is that the $108,315 was not transferred by the decedent to the trust and his death was no generating source of any right therein. Coolidge v. Long, 282 U.S. 582. Shall it be included in the gross estate of the decedent % It seems to me that to measure the transferor’s estate at death, for estate tax purposes, by including property which was not then and never had been his property, is arbitrary and capricious beyond that permitted by the statute or the Constitution. Heiner v. Donnam, 285 U.S. 312. See also Frew v. Bowers, 12 Fed. (2d) 625.

In the case of Milliken v. United States, 283 U.S. 15, cited as the controlling authority in the prevailing opinion, decedent therein in contemplation of death, gave property to his children after the effective date of the 1916 Revenue Act and before the effective date of the 1918 Revenue Act, in which latter act the estate tax rate was increased. Decedent died in 1920. The tax was computed on the basis of the value of the gift at the time of the death of decedent and taxed at the rate in the 1918 Act; but there is nothing in the case in the Court of Claims or the Supreme Court to indicate that the value of the gift to the children was greater or less when decedent died than when the gift was made. In the Milliken case petitioner was contending that the 1918 Act, enacted after the gift to the children, was retroactive, and that he should be taxed at the lesser rate provided in the 1916 Act, if at all. There was no dispute as to the value of the property and no contention that its value at the time of the death of the decedent was different from its value at the time the gift was made. Whatever may have been said in the two opinions filed in the Court of Claims or in the opinion of Mr. Justice Stone in the Supreme Court, if anything, in reference to the time when the value of the gift should be computed, was obiter dictum, for that question, present here, was not present in the Milliken case. There are found in the books judicial expressions anticipatory of this question, but no case cited in the majority opinion or called to the attention of the Board presents this precise question for review.


author: Van Fossan :

text:
    E. V. Securities Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 49229.
    Promulgated August 8, 1933.

      Harry J. Budick, Esq., for the petitioner.

      Arth/m' Cflark, Esq., for the respondent.
   OPINION.

Van Fossan :

This proceeding was brought to redetermine a deficiency in the income tax of the petitioner for the year 1928 in the sum of $751. The petitioner also claims a refund of $1,158.17 with interest.

The petitioner alleges that the respondent erred in determining that the petitioner realized a taxable profit of $30,329.56 on the sale of 5,655 rights to subscribe to the common stock of the Commercial Investment Trust Corporation, instead of the taxable profit of $17,419.75, as claimed.

The petitioner was organized on October 26, 1923, with a capital stock of 1,500 shares of the par value of $100 per share, for the purpose of holding stock of the Commercial Investment Trust Incorporated (hereinafter called the Trust Incorporated) owned by Edwin C. Yogel, the petitioner’s president. During the taxable year there were issued and outstanding a total of 1,400 shares of petitioner’s stock. On October 30, 1923, Vogel owned 600 shares of class B stock of the Trust Incorporated which had cost him $39,686.34 and owned also rights to subscribe for 491 shares of the caxiital stock of that corporation at par. On that day he acquired 500 shares of the petitioner’s stock, paying therefor $50,000 in cash. He also agreed with the petitioner to transfer to it 600 shares of the common stock of the Trust Incorporated in exchange for 900 shares of the petitioner’s capital stock, and to transfer to it his rights to subscribe for 491 shares of the Trust Incorporated stock at its par value.

The exchange was completed and immediately thereafter Vogel owned all of the petitioner’s outstanding stock. On December 11, 1923, the petitioner exercised its option or right to purchase for cash the 491 shares of class B stock of the Trust Incorporated at par.

Shortly after October 30, 1923, the Trust Incorporated was reorganized by the formation of a new corporation called the Investment Trust Corporation (hereinafter called the Trust Corporation) for whose stock the stockholders of the Trust Incorporated exchanged their stock on the basis of five, to one for the old shares held. The petitioner, therefore, received 5,455 shares in the new corporation. On December 80, 1925, as the owner of such shares, the petitioner received 5,455 “ rights ” to subscribe to 1,091 shares of additional common stock of the Trust Corporation at $60 per share. In 1926 the petitioner sold 4,455 of such rights and exercised its option as to the remaining 1,000 rights by purchasing 200 shares of the Trust Corporation.

On November 12, 1928, the petitioner (then being the owner of 5,655 shares of the common stock of the Trust Corporation) received rights to subscribe to additional common stock thereof at the ratio of one to four at $95 per share. In 1928 the petitioner sold those rights for $35,639.98 and reported a profit thereon of $27,071.1!. The respondent determined the profit to be $30,329.56.

Upon the reorganization of the Trust Incorporated into the Trust Corporation a substantial portion of the new stock was held by the public. Prior thereto the stock was closely held. During the latter part of January 1924, the common stock of the Trust Corporation was traded in on the market at prices ranging from $33.75 to $36.50 per share.

In computing the cost of the stock rights sold by the petitioner in 1928, the values of stock and rights on December 20, 1925, and November 12, 1928, and the percentages of cost applicable to the said stock and rights on those dates, as shown by the deficiency letter, are stipulated to be correct.

The petitioner’s contention is twofold:

(1) As to the rights received by it with respect to the stock acquired by it in exchange for its own stock, the cost thereof is the cost to the petitioner and not the cost to the transferor.

(2) As to the rights derived from the exercise of rights transferred to the petitioner by Vogel, the proper cost basis is the subscription price of the stock plus the value of such rights.

The respondent contends that the correct basis for computing profit on the rights derived from both the stock and the rights is the cost thereof to the transferor, Vogel, and asserts that the transaction is governed by the provisions of section 113 (a) (8) of the Eevenue Act of 1928.

That section is as follows:

(a) Property acquired after February 28, 1913. — The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that—
(8) Same — cokpokation conteolled by tkanseekob.. — If the property was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) (including, also cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.

Section 112, subsections (a) and (b) (5), provides as follows:

(a) General rule. — Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
(b) Ecoohwnges solely in MnH.—
*******
(5) Tbanseeb to cokpokation contkoiajSd by tbanseekob.- — No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.

The case at bar patently comes within the exception of the above section 113 (a) (8). After the transaction of exchange above described in which Vogel acquired 900 shares of the petitioner’s capital stock he owned the entire outstanding issue of stock and was in absolute control of the petitioner corporation. Thereafter petitioner owned 600 shares of stock in the Trust Incorporated and 491 rights in the same corporation.

From a consideration of the entire record we are of the opinion that the transfer to petitioner of the stock and of the rights bjy Yogel constituted a single unified transaction and that the rights were part of the consideration involved. Such being our conclusion, it follows that the basis for determining gain on the sale of the rights by petitioner is the same as that of the transferor. Having cost Yogel nothing, the entire sum received from the sale of the rights is profit.

The petitioner asserts that the rights sold in 1928 were not acquired in the manner specified in the exceptions enumerated in the subsections of section 113 and that, therefore, those subsections are inapplicable. We see no merit in this contention. All rights sold were issued to the petitioner by virtue of its ownership of the Trust Incorporated or Trust Corporation stock. The reorganization of the Trust Incorporated under a new name or the increase of the capital stock did not alter or destroy the petitioner’s original proportionate interest in those corporations as represented by the common stock held by it. Only the form of the evidence of ownership was changed. Such transformation did not affect the character of the property exchanged by Vogel nor did it disturb the cost to him of his stock interest in the petitioner as measured by the cost of such property. The right to purchase additional stock of the Trust Corporation was inherent in the stock and remained so during the period above set forth. It is obvious that in computing a gain on the sale of the petitioner’s stock in the Trust Corporation issued in lieu of its original holdings in the Trust Incorporated, the proper basis is the cost of such original stock to Vogel. Likewise, in arriving at the profit accruing from the sale of the rights which were derived and emanated from the original stock, the cost of such stock must be the basis of computation.

Reviewed by the Board.

Decision will be entered for the respondent.