author: Arundell :

text:
    Crawford H. Ellis, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95133.
    Promulgated October 18, 1939.

      Robert Ash, Esq., for the petitioner.

      Joe D. Hughes, Esq., for the respondent.
   OPINION.

Arundell :

The petitioner insists that he is entitled to be classified as the head of a family within the meaning of section 25 (b) (1) of the Eevenue Act of 1934. His argument is that under the facts in his case he meets every element of article 25-4 of Kegulations 86, which defines the statutory term of “head of a family” as follows:

A head of a family is an individual who actually supports and maintains in one household one or more individuals who are closely connected with him by blood relationship, by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based on some moral or legal obligation.

This definition given in the respondent’s regulations has been approved as a fair interpretation of the statute. Alfred E. Fuhlage, 32 B. T. A. 222.

Granting, for the purpose of discussion, that the facts bring the petitioner within the words of the quoted definition, it does not follow that he is the head of a family. The definition is framed for the purpose of ascertaining which individual of a family group is to be considered the head of that group and shall receive the larger credit. The statutory phrase is “the head of a family.” Obviously, this means but one person may be the head of a family and the definition must be read in the light of that premise. Otherwise, it might be that more than one person would be entitled to the family head credit. For example, a father and mother might each contribute equal sums in payment of the food, lodging, etc., for themselves and their children, and each would thus literally come within the definition. Under petitioner’s view, carried to the extreme, a family could have as many “heads” as there are adults living in the household and contributing materially to the support of the minor children. It is too clear for argument that this is not the intent of either the statute or the regulations.

In this case the Hindermanns — husband and wife and two sons— constituted a family. Although one son was supported entirely by his grandfather, he was not thereby removed from the Hindermann family fold. He was not adopted by the grandfather and he at all times lived in the same household with his parents and his brother. Franz Hindermann was the head of his family under the generally recognized principle of law that the husband is the head of the family, and, in the absence of unusual circumstances, he should be so regarded here. In Annette Loughran, 40 B. T. A. 252, the very unusual facts resulted in the allowance of the family head credit to a woman taxpayer who was obliged to support her mother in consequence of the willful omission of the mother’s husband to support her. While the husband was gainfully employed, other dependents apparently consumed his income. The mother had no income of her own, and upon her husband’s failure to support her, she was dependent on the taxpayer, her only child, for support. We said in part:

It is true tliat under local law a husband is a head of a family and has a primary legal duty to support his wife; nevertheless, where he has neglected his legal duty and failed to exercise his legal rights as a head of a family, then, in applying a provision of a revenue act, we believe that it is in accord with the intendment of Congress to hold that another person who acts as head of the family under exercise of a moral obligation was the head of the family for purposes of taxation.

In the present case we have none of the unusual facts that we had in the Loughran case. Here Franz Hindermann had substantial income and there is no evidence of any inability or unwillingness on his part to support his sons. There are no facts in this case that deprived Franz Hindermann of his status as the head of his family. This being so, the petitioner’s support of one member of that family does not make him its head.

Reviewed by the Board.

Decision will be entered for the respondent,


source: Caselaw Access Project

author: Black:

license: Public Domain

text:
    G. B. R. Oil Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92604.
    Promulgated October 18, 1939.

      Robert Ash, Esq., and J. D. Anderson, G. P. A., for the petitioner.

      James H. Teatman, Esq., and M. L. R. Wade, Esq., for the respondent.
   OPINION.

Black:

There is no dispute in this proceeding as to petitioner’s net income for the taxable year. Petitioner’s net income as shown on its income tax return was $36,109.32 and petitioner paid the normal tax thereon of $4,334.21, which did not include any surtax because of undistributed profits. By certain adjustments made in petitioner’s income for the taxable year, the Commissioner has determined petitioner’s corrected net income to be $38,430.31. This results in an increase of $301.73 in petitioner’s normal tax over that shown on its return. This part of the deficiency petitioner does not contest.

Petitioner does contest the surtax of $6,603.73 which the Commissioner has computed under the provisions of section 14 of the Bevenue Act of 1936. Petitioner contends that it is entitled to a credit under section 26 (c) (2) of the Bevenue Act of 1936 of the entire amount which the Commissioner has held to be undistributed net income within the meaning of the statute and subject to the surtax provided in section 14. Section 26 (c) (2) is printed in the margin.

The Commissioner, in his deficiency notice, determined that the credit claimed by petitioner does not meet the requirements of “section (c) (1) and (2) of the Revenue Act of 1936.” Petitioner, in its brief, does not claim that section 26 (c) (1) is applicable and it appears that it is not. Therefore, we have not printed (c) (1) in the margin.

The Board cases which have dealt with the surtax on undistributed profits under the 1936 Act have dealt with the application of section 26 (c) (1) and are, therefore, not applicable to this proceeding. See Crane Johnson Co., 38 B. T. A. 1356; affd. (C. C. A., 8th Cir.), 105 Fed. (2d) 740; Cooperative. Publishing Co., 40 B. T. A. 466. We are cited to no Board or court case, either by petitioner or respondent, which construes section 26 (c) (2), supra. Section 26 (c) (2) was not contained in the 1936 Revenue Bill, either as it passed the House or the Senate, but was added in conference between the two Houses. Therefore, nothing with reference to this particular provision is contained either in the Report from the Committee on Ways and Means of the House or in the Report of the Finance Committee of the Senate, and no comment is made upon it in the Conference Report. That portion of article 26-2 of Regulations 94 which relates to section 26 (c) (2) of the Revenue Act of 1936 is printed in the margin.

In determining whether the claimed credit of a corporate taxpayer falls within section 26 (c) (2) and the regulations promulgated thereunder, three things seem to be necessary:

(1) There must be a written contract executed prior to May 1, 1936, which expressly deals with the disposition of earnings and profits of the taxable year.

(2) The credit relates to that portion of the earnings or profits which are required to be paid or irrevocably set aside in the discharge of a debt.

(3) The credit is allowable to the extent that the money has been so paid or set aside.

We shall give consideration to these three necessary conditions as disclosed by the facts of the instant case.

(1) We find that all the written contracts of assignment were executed prior to May 1, 1936. As to this, there is no dispute between the parties. Did these contracts “expressly” deal with the disposition of earnings and profits of the taxable year? The word “express” is defined by Webster’s New International Dictionary, Second Edition, Unabridged, as follows:

Directly and distinctly stated; expressed, not merely implied or left to inference; as an express commitment; hence definite, clear, explicit, unmistakable; not dubious or ambiguous; as express consent; express command.

The contracts in question directed, authorized, and empowered the Eepublic National Bank & Trust Co. to “receive and collect and hold all sums of money of every character whatsoever” from the oil leases in question. Thus it seems to us that the contracts in question not only assigned to the bank that portion of petitioner’s “earnings and profits” which resulted from the operation of these properties, but the entire gross receipts therefrom as well. It is true that these written assignments did not refer specifically to the taxable year 1936, but the language of the assignments was certainly broad enough to include the taxable year 1936 and the parties have so construed the contract in their dealings with each other.

(2) As we have already stated, by these written contracts of assignment, not only a portion of petitioner’s earnings and profits were required to be paid to the Eepublic National Bank & Trust Co. in discharge of its debt, but all of the receipts from the property were required to be so paid. All of petitioner’s income for 1936 came from these oil properties except $154. The evidence shows that all of the gross receipts from these oil properties were in fact paid to the bank and that it then permitted petitioner to use sufficient of the funds for its necessary operating expenses and certain development costs incurred in bringing in new oil wells on the property. We do not see where this concession made by the bank to the petitioner affects in any way the validity of its assignments of all the earnings from these oil properties to the bank or in any way voids the application of section 26 (c) (2).

(3) The record shows that $52,703.81 was actually paid to the bank from these oil receipts during the taxable year on its indebtedness. The fact that the amount of these payments exceeds petitioner’s net taxable income as determined by the Commissioner in the notice of deficiency is probably due to statutory depletion allowances and other items which, although affecting taxable net income, do not affect gross receipts. But be that as it may, the $52,703.81 which petitioner has paid to the bank on its indebtedness out of these oil receipts in 1936 is considerably greater than petitioner’s net income as determined by the Commissioner. It had to be paid under the terms of the written assignments which were executed prior to May 1,1936, and we think petitioner is entitled to the credit which it claims under the provisions of section 26 (c) (2). Petitioner had no right to disburse any of these oil receipts to its stockholders until its indebtedness to the bank was paid, and in the taxable year before us it made no such distribution.

The general purpose of section 26 (c) (2), it seems to us, is to give a credit where a dividend paid credit can not be secured. In other words, the basic intent of Congress seems to have been to include in the provision only contracts which inevitably require in their performance a drawing on current earnings, thus removing current earnings as a source of dividend payments. See Paul and Mertens, par. 32 A. 46, 1938 cumulative supplement.

Eespondent in his brief cites no authority in support of his contention, but, after quoting the language of the assignments from petitioner to the bank, says:

We are unable to find in these contracts or assignments any provision which expressly deals with the disposition of petitioner’s earnings and profits of the taxable year.

It is true, as we have already said, that the assignments in question do not expressly refer to “earnings and profits” as such, but they certainly do require that all of petitioner’s gross receipts from these properties be paid to the bank and that would certainly include all “earnings and profits” from them.

Eespondent says in his brief that petitioner “could have declared a dividend out of its earnings and profits of the taxable year and paid same with borrowed money, notes, credits, or in stock.” Perhaps it could have done so. We do not consider that is a matter which we have to decide. Even assuming that it is so, we do not see where that fact affects the application of the credit provided by section 26 (c) (2). We sustain petitioner in this assignment of error.

Eeviewed by the Board.

Decision will be entered u/nder Bule 50.

       SEC. 26. CREDITS OP CORPORATIONS.
      In the case of a corporation the following credits shall be allowed to the extent provided in the various sections Imposing tax—

      (c) Contracts Restricting Payment of Dividends. — .

      (2) Disposition of profits of taxable year. — An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by tbe corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside, ffor the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word “debt” does not include a debt incurred after April 30, 1936.

         (c) Disposition of profits of taxable year. — TJnder the provisions of section 26 (c) (2) a corporation is allowed a credit in an amount equal to that portion -of the earnings and profits of the taxable year which, by the terms of a written contract executed by the corporation prior to May 1, 1936, and expressly dealing with the disposition of the earnings and profits of the taxable year, it is required within the taxable year to pay in, or irrevocably to set aside for, the discharge of a debt incurred on or before April 30, 1936. The credit is limited to that amount which is actually so paid or irrevocably set aside during the taxable year pursuant to the requirements of such a contract.
      Only a contractual provision which expressly deals with the disposition of the earnings and profits of the taxable year shall be recognized as a basis for the credit provided in section 26 (c) (2). A corporation having outstanding bonds is not entitled to a credit under a provision merely requiring it, for example, (1) to retire annually a certain percentage or amount of such bonds, (2) to maintain a sinking fund sufficient to retire all or a certain percentage of such bonds by maturity, (3) to pay into a sinkingl fund for the retirement of such bonds a specified amount per thousand feet of timber cut or per ton of coal mined, or (4) to pay into a sinking fund for the retirement of such bonds an amount equal to a certain percentage of gross sales or gross income. Such provisions do not expressly deal with the disposition of earnings and profits of the taxable year. A contractual provision, however, shall not be considered as not expressly dealing with the disposition of earnings and profits of the taxable year merely because it deals with such earnings and profits in terms of “not income,.” “net earnings,” or “net profits.”


author: ARNOLD:

text:
    Jamie A. Bennett, Petitioner, v. Commissioner of Internal Revenue, Respondent. J. M. Bennett, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 94439, 94440.
    Promulgated October 18, 1939.

      Muolüeroy HcDonnold, Esq., for the petitioners.

      E. L. Oorbin, Esq., for the respondent.
   OPINION.

ARNOLD:

Petitioners assign as errors (a) the disallowance to each by the Commissioner of a deduction of $238.29 representing one-half of the payment made to the Standard Trust Co., trustee, for interest accrued on the Lane Taylor note, (b) the disallowance to each of a bad debt deduction of $16,748.67 representing one-half of the worthless notes of Casey and Taylor, (c) failure to allow an additional deduction of $9,867.33 each for loss on the Casey and Taylor notes, or, in the alternative, (d) failure to allow to each an additional deduction of $6,149.38 representing loss from the sale of capital assets. Petitioners in their reply brief expressly abandon (d).

An analysis of (a), (b), and (c), supra, shows that each turns upon the legal effect of J. M. Bennett’s endorsement and delivery of the Casey and Taylor notes to the trustee. The deficiency letter shows that respondent denied the deductions for interest and bad debts upon the theory that the notes had been transferred without consideration and that no liability resulted from the endorsement. Petitioners contend that liability resulted and that, the liability having been satisfied during the taxable year, the right to the deductions arose.

It has been held that the endorsement of a promissory note “is substantially the drawing of a new note in the terms of the old”, DeHass v. Dibert, 70 Fed. 227, 230, and Chief Justice Marshall said in Slocum v. Pomery, 6 Cranch, 221, 224, “the endorsement of a bill is understood to be not simply a transfer of the paper but a new substantive contract.” Like any other contract an endorsement requires consideration, and where there is a lack of consideration no personal liability is incurred by the endorser to one not a holder in due course, Farmers’ Savings Bank v. Hansmann, 114 Iowa, 49; 86 N. W. 31; Monroe v. State Bank (Wis.), 193 N. W. 991, and authorities cited; Texas Baptist University v. Patton, 145 S. W. 1063; Cline v. Receiver of Commercial National Bank, 90 Fed. (2d) 968.

Under petitioners’ theory the trustee must be a holder in due course to render J. M. Bennett liable upon his endorsement. A holder in due course under the Texas Negotiable Instruments Act, Title 98, Vernon’s Annotated Texas Statutes, is one who has taken the note in good faith and for value, art. 5935. J. M. Bennett testified in this proceeding, and the trust instrument recites, that his purpose in creating the trust and in transferring the property to it was to provide a competence for each of his children, without reference to the success or failure of his business ventures. He further testified that nothing whatever was paid for the transfer of these notes to the trust. His children were the natural objects of his bounty and, in the absence of any consideration for the transfer, the transfer was a gift in trust, and no liability resulted from Bennett’s endorsement of the Casey and Taylor notes.

Bennett’s transfer of certain securities to the trust in 1935 in exchange for the worthless notes maintained the trust corpus at the level originally deemed necessary to provide a competence for his children. That this was his motive is further demonstrated by the exchange in 1934 of certain properties for the other four Casey notes in the total principal amount of $15,602.26. His original intention was to make a gift to his children and he incurred no liability by his endorsement of notes constituting a part of the corpus of the gift. Cf. Simon Benson, 9 B. T. A. 279; Sand Springs Railway Co., 21 B. T. A. 1291, 1310.

If he was not liable by reason of his endorsement, then the amount paid as interest on the Taylor note would not be deductible. Wm. H. Simon, 36 B. T. A. 184; William Ainslie Colston, 21 B. T. A. 396; affd., 59 Fed. (2d) 867; certiorari denied, 287 U. S. 640. Neither would petitioners be entitled to a deduction by reason of J. M. Bennett’s having taken up the Casey and Taylor notes if he was not legally bound to pay them, as the voluntary assumption of obligations does not justify a loss deduction. Robinson v. Commissioner, 53 Fed. (2d) 810.

Petitioners contend that the duties and the obligations imposed upon the trustee by the trust instrument supplied the necessary element of consideration to constitute the trust a holder for value and make J. M. Bennett liable on his endorsement. With this contention we do not agree. Section 5 of the trust instrument provided that the trustee was to receive as “full compensation for services” in connection with the management and control of the trust corpus, “two per cent of the income paid by it”, and as a further benefit it was permitted to charge the borrower a reasonable commission for .its services on loans made. The parties having agreed that the amount so stipulated was to be full compensation for the services imposed on the trustee by the trust instrument, we do not think such duties and obligations constituted a consideration for the transfer.

We do not think there was any consideration, either by way of benefit to the promisor or detriment to the promisee, as contended by the petitioners, which made J. M. Bennett liable for the payment of the notes by reason of his endorsement.

The United States District Court for the Western District of Texas handed down a decision on May 26, 1939, in the case of Bennett v. United States, - Fed. Supp. -, involving a suit for the refund of taxes paid by these petitioners in the prior year. One of the Casey notes which J. M. Bennett had endorsed was taken up from the trust by the transfer of other assets on the assumption that by his endorsement he was legally liable to pay the amount due on the note. The court held that the assumption of the duties and liabilities imposed on the trustee was a detriment to the trustee and, therefore, a valuable consideration for the endorsement of the note. The loss was allowed as a bad debt deduction. We are unable to concur in this conclusion and do not feel bound by that decision.

In our opinion the trustee was to be fully compensated for such duties and liabilities as were imposed upon it by the trust instrument and the trustee recognized that it would receive “full compensation” for its services when it noted the acceptance of the trust. Such services so to be performed and paid for could not be construed as a detriment to the trustee constituting a consideration for the transfer of the notes to the trust.

The Commissioner’s determination will be approved.

Keviewed by the Board.

Decision will be entered for the respondent.


author: Leech :

text:
    Wesley V. E. Terhune, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 93894, 93914-93920, 94088.
    Promulgated October 19, 1939.

      Ward Loveless, Esq., Drnid W. Richmond, Esq., Lacy 1. Rice, Esq., Frank J. ATbus, Esq., Arthur R. Nelson, O. P. A., and O. 8. Goldston, C. P. A., for the petitioners.

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

       Proceedings of the following petitioners are consolidated herewith: Charles G. Smith; Prank C. Foreman; Thomas W. Martin; Shirley Carter Estate, by Shenandoah Valley National Bank of Winchester, Virginia; T. B. Patton; Clifford D. Grim; Gertrude A. McCormae, Trustee for H. B. McCormac, Jr.; Estate of Lewis B\ Cooper, by Eugene B. Cooper, Administrator.

   OPINION.

Leech :

Nine deficiencies in income tax for the calendar year 1934 are here in dispute. The proceedings were consolidated. The deficiencies, determined by the respondent, are as follows:

The proceedings were submitted on separate stipulations of fact. The facts are found as stipulated. The first issue, common to all of the petitioners, is whether gains accruing to the petitioners upon the exchange of their preferred stock in the Berkeley Woolen Co., a West Virginia corporation, for cash and debenture bonds, pursuant to apian of recapitalization, are taxable as distributions in partial liquidation or as gains from the sale or exchange of capital assets. The second, third, and fourth issue each concerns a different petitioner. The second issue presents the question as to whether stock of the McKown Orchard Co. became worthless in 1933 or 1934. The third issue raises the problem of whether respondent properly applied the “first in, first out” rule in computing the gain realized by one of the petitioners upon the recapitalization exchange. The last issue requires a determination of whether a note received by one of the petitioners in connection with the recapitalization exchange was a “security” within the meaning of section 112 (b) (3) of the Revenue Act of 1934 or the equivalent of cash.

For convenience, the facts and opinions on each question have been found and expressed separately.

First Issue.

The first question is whether the gains realized by all the petitioners upon the exchange of their preferred stock in the Berkeley Woolen Co. for cash and debentures are to be taxed in full or only to the extent of 30 percent, under section 117 (a) .of the Revenue Act of 1934. All of the preferred stock here involved had been held for over 10 years, with the exception of 50 shares that the petitioner Frank C. Foreman had owned for V/2 years.

The corporate resolutions, covering the transactions at issue, recommended that the 7 percent cumulative preferred stock of the company, constituting 5,000 shares of $100 par value, be retired. It was resolved that $250,000 of the stock should be retired in cash, payable November 1, 1934, and $250,000 of the stock should .be exchanged for 5 percent debentures, to be issued November 1, 1934. The preferred stock was to be called for redemption according to the holdings of each preferred stockholder and was then to be canceled and retired. The concluding paragraph of the resolution recited that it was understood that the payment of $250,000, in cash, for the preferred stock, and $250,000, in debentures, was to be carried out only in the event that all of the holders of the stock should agree to accept cash and debentures. This statement was made necessary by the fact that the “certificate of reorganization”, under which the preferred stock had been issued in 1924, had provided that the company might redeem the stock from time to time by “paying” the holder the par value thereof and a $5 per share premium.

At a subsequent directors’ meeting, held November 20, 1934, the previous resolutions were amended to provide that $283,500 of the stock be redeemed in cash and $216,500 thereof be exchanged for debentures. The form of these debentures is not in evidence. They were debenture bonds carrying 5 percent interest and were issued on the basis of $105 for each share of preferred stock. The fair market value of these bonds at the time of the exchange was their face value.

The resolutions were carried out and each stockholder exchanged part of his stock for debentures and received cash for the balance, The Berkeley Woolen Co. continued in business following the exchange and the cancellation and retirement of its preferred stock

The Revenue Act of 1934 is controlling.

The respondent has treated the transaction as separable into two independent units for tax purposes, i. e., a corporate acquisition of part of its preferred stock for cash and the exchange of its debentures for the remainder of the preferred stock. He proposes no tax on the second unit but determined that the first was a partial liquidation under section 115 (i), and taxed the entire gain therefrom, under the sentence of section 115 (c) which provides that “Despite the provisions of section 117 (a), 100 per centum of the gain so recognized shall be taken into account in computing net income.”

Petitioners contend that the reduction in the capitalization of the Berkeley Woolen Co. constituted a “recapitalization” and therefore a statutory reorganization under section 112 (g) (1) (D); that there was a “plan of reorganization” within the meaning of section 112 (b) (3), as an essential part of which plan and reorganization the company exchanged its debentures and cash for its preferred stock, because of which, section 112 (c) (1) applies; that the realized gain on the'entire transaction is thus limited to the cash received, as “other property or money”, and is taxable at capital gain rates under the provisions of section 117 (a).

Undoubtedly there was a “recapitalization” and thus a statutory reorganization under section 112 (g) (1) (D). Kistler v. Burnet, 58 Fed. (2d) 687; L. & E. Stirn, Inc., 39 B. T. A. 143; R. D. Walker, 34 B. T. A. 983. With equal clarity, we think, the record demonstrates that there was a “plan of reorganization” and that the exchanges of debentures and cash for the preferred stock were both essential and component parts of that plan and reorganization. Miller v. Commissioner, 103 Fed. (2d) 58; Starr v. Commissioner, 82 Fed. (2d) 964; First Seattle Dexter Horton National Bank v. Commissioner, 77 Fed. (2d) 45; R. D. Walker, supra. This conclusion seems inescapable in view of the resolution of the board of directors that the plan could not be consummated except “in the event only that all of the holders of the preferred stock of this Company shall agree to accept cash and debentures * * *.” See Edwin L. Dana, 36 B. T. A. 231.

Moreover, as respondent contends and petitioners deny, the acquisition of some of the preferred stock for cash and its then cancellation, was a partial liquidation within the meaning of section 115 (i). Commissioner v. Cordingley, 78 Fed. (2d) 118; Commissioner v. Quackenbos, 78 Fed. (2d) 156; Palmetto Quarries Co., 30 B. T. A. 544; Salt Lake Hardware Co., 27 B. T. A. 482; Dill Manufacturing Co., 39 B. T. A. 1023. Cf. William A. Smith, 38 B. T. A. 317. Although it was an essential part of the reorganization and its plan, it did not thereby lose its tax significance as a partial liquidation. For the purpose of computing gam to petitioners, this partial liquidation is construed together with the exchange of debentures for the remainder of the preferred stock, as one transaction (Millicent Turle Roelker, 39 B. T. A. 967), but the total gain therefrom is taken into account under section 115, instead of being limited by section 117 (a).

The language of section 117 (a) which limits recognized gain on a capital transaction is not restricted in its purview. It seems clear, therefore, that it applies to exchanges included under section 112. See also Report of the Ways and Means Committee, 73d Cong., 2d sess., H. Rept. 704, pages 31 and 32. It is equally plain that when Congress, in the 1934 Act, added the sentence to section 115 (c) to the effect that, despite the provisions of section 117 (a), 100 per centum of the gain on a liquidating distribution should be recognized, its aim was to prevent the avoidance, by the stockholder, of surtax through the receipt of a liquidating, rather than an ordinary dividend. Report of Ways and Means Committee, 73d Cong., 2d sess., (H. Rept. 704, pp. 37, 38). Thus, the statutory scheme is that section 117 (a) shall limit the gain from reorganization sales and exchanges, unless one of those sales or exchanges is a distribution of surplus in partial liquidation, in which event the amount of gain, realized under section 111 and recognized under section 112, is to be taxed in its full amount under section 115 (c). See Helvering v. Chester N. Weaver Co., 305 U. S. 293; White v. United States, 305 U. S. 281.

The decision on the first issue will be for the respondent.

Second Issue.

The second issue, relating to the petitioner Thomas W. Martin alone, is whether the stock of the McKown Orchard Co. became worthless in 1934, as contended by petitioner, or in 1933, as determined by respondent.

In 1930, the McKown Orchard Co., needing funds to finance its apple orchard, issued bonds in the amount of $28,000, secured by a first mortgage on its property and bearing interest at 8 percent, payable semiannually. Ño interest was paid on the bonds after July 20, 1931. On November 14 of that year the company gave a promissory note for $4,770; subsequently it defaulted on the note; and on January 16,1932, receivers were appointed by the Federal District Court for the Northern District of West Virginia at the instance of the holder of the note. The receivers operated the orchard property thereafter. In 1932 the apple crop was small because of drought. In 1933 the crop was good but the market was depressed. Losses were sustained in both years.

By decree of the court having jurisdiction over the receivership, dated March 6,1934, a special master was appointed to offer the properties of the Orchard Co. for sale on April 14,1934, but no bids were received. Thereafter, at another public auction on June 20, 1934, the properties were sold for $9,000, of which $8,500 was for the real estate and $500 for the machinery and other personal property. The terms of the sale were $3,333.34 cash and the balance secured by deferred purchase money notes payable in one and two years. The court costs including expenses of the sale and the preferred claims exceeded the proceeds of the sale, leaving nothing for distribution to the stockholders.

Petitioner, who had purchased 50 shares of the stock of the Orchard Co. in 1920 at a cost of $5,000, claimed a loss of $5,000 on this stock in his 1934 return.

Respondent’s determination that the stock became worthless in 1933 rather than in 1934 rests upon two grounds — first, that the Orchard Co. operated at a loss in 1933, and second, that no unusual event transpired between January 1,1934, and June 20,1934, the date of the public auction sale. He urges that petitioner has not shown that the stock had any value at the beginning of 1934.

While the evidence on this point is somewhat cryptic, it is clear that the attempt to put the Orchard Co. on its feet had not been abandoned in 1933. There was no crucial event in that year that would justify a finding that the stock then became worthless. An abundant crop may well have tempered the prospects of ruin. There was corporate life and the stock still reasonably had at least potential value. But, in 1934, the actual worth of the company was tested by the market; and the proceeds of the sale were actually insufficient to leave anything even for the bondholders. We do not think the stock was valueless at the close of 1933. The objective fact of complete worthlessness was certainly not established before April 14, 1934, when the first auction sale demonstrated the absence of market value of the company’s assets.

The nonoccurrence of any significant event between January 1 and June 20 of the taxable year, advanced by the respondent in support of his position, seems to have no significance other than to show that no “identifiable event” fixing the loss took place until the latter date.

The identifiable event that evidences a loss in a manner sufficiently definitive for tax purposes is not necessarily the appointment of a receiver. John H. Watson, Jr., 38 B. T. A. 1026; George H. Horning, 35 B. T. A. 897; Lyon v. United States, 5 Fed. Supp. 138. Respondent, moreover, does not contend that the stock of the Orchard Co. became worthless in 1932, the year of the receivers’ appointment. The fact of losses in earnings alone is likewise not crucial, if there are possibilities of future recoupment. John W. Burdan et al., Executors, 37 B. T. A. 642 (on appeal C. C. A., 3d Cir.); Gowen v. Commissioner, 65 Fed. (2d) 923; certiorari denied, 290 U. S. 687.

A receivers’ sale, however, destroying as it does all possibilities of corporate recovery, is an event which sufficiently demonstrates the loss on or worthlessness of stock. Burnet v. Imperial Elevator Co., 66 Fed. (2d) 643; American Utilization Co., 38 B. T. A. 322; Olds & Whipple, Inc. v. Commissioner, 75 Fed. (2d) 272. We conclude that petitioner’s loss on his Orchard Co. stock was sustained in 1934 and on this issue decision will be for the petitioner.

Third Issue.

The third issue concerns only the petitioner Frank C. Foreman. We are asked to determine whether respondent correctly applied the “first in, first out” rule to the exchange of petitioner’s Berkeley Woolen Co. preferred stock for cash and debentures in the 1984 recapitalization. On November 1, 1934, the date of the exchange, this petitioner owned 550 shares of the preferred stock of the company. He had acquired 500 shares thereof on Jidy 1,1924, at a cost of $33% per share and had purchased 50 additional shares on May 22,1933, at a cost of $105 per share. In the exchange he surrendered simultaneously 330 shares for $34,650 in cash and 220 shares for debenture bonds haying a fair market value of $23,100. There was no designation, either by the petitioner or the company, of the particular stock which was surrendered for cash or of the particular stock which was surrendered for debentures.

Respondent, pursuant to his theory that the money received was a distribution in partial liquidation, applied a basis of $33% per share to the 330 shares surrendered for cash, considering the first 330 shares acquired to have been the 330 sold for cash. See Regulations 86, art. 22 (a)-8. Petitioner contends that it is unfair so to allocate the cost, assuming respondent’s theory on the first point to be correct, and that it is arbitrary and erroneous to treat the 50 high-cost shares as having been exchanged for debentures. Instead he seeks to divide the 50 shares between cash and debentures in the same proportion as the entire lot of 550 shares was divided, i. e., to consider that. 30 shares were exchanged for cash at a cost of $105 and 20 were exchanged for debentures.

There is no occasion here to apply the first in, first out rule or to separate the transactions for purposes of computing gain. R. D. Walker, supra.

In our opinion on the first issue, we have pointed out that all of the gain realized under section 111 and recognized under section 112 is taxable to each petitioner. The total cost of this petitioner’s stock was $21,916.67. In the exchange he received debenture bonds having a then fair market value of $23,100 and $34,650 in cash. The gain, thus realized, is the total of these amounts less the aggregate cost of the stock, or $35,933.33. Williams v. Commissioner, 44 Fed. (2d) 467. But this gain is recognized only to the extent of the cash received, or $34,650. Sec. 112 (c) (1), Revenue Act of 1934. This total recognized gain is taxable. Sec. 115 (c), Revenue Act of 1934.

Effect will be given to the decision on this issue under Rule 50.

Fourth Issue.

The last question also pertains to only one of the petitioners, namely, Gertrude A. McCormac, trustee for H. B. McCormac, Jr. Part of the consideration received by her upon the surrender of preferred stock of the Berkeley Woolen Co. consisted of a note. She takes the position that this note falls within the meaning of the term “securities” as used in section 112 (b) (3) of the Revenue Act of 1934. Respondent lias determined that such note was the equivalent of cash.

At the time of the recapitalization exchange on November 1, 1934, this petitioner owned, apparently as trustee, 550 shares of the pref erred stock of the Berkeley Woolen Co. Pursuant to the plan, she exchanged 220 shares for debenture bonds in the face amount of $23,100 and surrendered 380 shares for $17,350 in cash and a note for $17,300. Respondent has included the face amount of the note in his computation of her cash gain.

The record is barren of any details concerning this note. We are not informed as to its form or terms nor even as to whether it was secured by company assets. There is therefore no basis for determining whether it gave petitioner enough of a continuing interest in the company to raise the note to the dignity of a “security” as that word is used in section 112 (b) (3). On the authority of Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462; Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937; certiorari denied, 288 U. S. 599; and Marjorie Fleming Lloyd-Smith, 40 B. T. A. 214, decision on this issue will be for respondent.

Reviewed by the Board.

Decision will he entered under Rule 50.


author: SteRniiagen :

text:
    Allison L. S. Stern, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93134.
    Promulgated October 19, 1939.

      Hugh Satterlee, Esq., and I. Herman Sher, Esq., for the petitioner.

      Francis S. Cettle, Esq., and Paul J. Ashe, Esq., for the respondent.
   OPINION.

SteRniiagen :

In determining petitioner’s income tax for 1935, the Commissioner included in his gross income the $14,048.20 representing income of the trust. His determination was based upon the postulate that the petitioner was the grantor of the trust, and upon that hypothesis it cited Helvering v. Brooks, 82 Fed. (2d) 173; Commissioner v. Hyde, 82 Fed. (2d) 174; and Douglas v. Willouts, 296 U. S. 1. Since that time the Broohs decision has been overruled by the same court in Leonard v. Helvering, 105 Fed. (2d) 900, which followed Fitch v. Commissioner, 103 Fed. (2d) 702, and Commissioner v. Tuttle, 89 Fed. (2d) 112. In both the Fitch and the Leonard cases certiorari has been applied for.

But we think it unnecessary to consider the doctrines of those cases. The evidence shows that notwithstanding the language of the trust instrument the petitioner was not the “grantor” and that he transferred nothing in trust. He was but the nominal grantor of a fund which was actually transferred by another in settlement of litigation in which that other was the defendant. This fact appearing in evidence free from doubt, the ground for the Commissioner’s determination falls and the holding falls with it.

The nearest that petitioner is brought to participation in this trust is as a possible recipient of its property upon its termination. But the termination can only occur with the election of the attorneys for the two women who were adversaries in the suit. This clearly gave petitioner no use, control, or enjoyment of the corpus or income, and, even if he should be treated as the grantor, his election to revoke or revest would be subject to the control of substantial adverse interests.

The Commissioner’s determination was in error in including the $14,048.20 income of the trust in the petitioner’s taxable income. Another item of adjustment by the Commissioner is not in dispute.

Decision will he entered vmder Bule SO.


author: Steenhagen :

text:
    Freda R. Caspersen, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92765.
    Promulgated October 19, 1939.

      Jackson B. Collins, Esq., for the petitioner.

      B. M. Brodsky, Esq., for the respondent.
   OPINION.

Steenhagen :

The Commissioner held that the income of the trust of June 3, 1932, was properly taxable to the petitioner under the Revenue Act of 1934, section 167, and the controversy narrows down to the question whether the petitioner’s husband is by virtue of subdivision 3 of the instrument a “person not having a substantial adverse interest in the disposition of such part o’f the income.” The amounts actually distributed to the grantor are not in question, since she included them within her income.

The power of the husband with regard to the income remaining after the mandatory distribution to petitioner of $600 each quarter is entirely discretionary, first as to distributing it to blood relatives and then as to distributing it to petitioner. As to the distribution under these powers, the petitioner is without right or control. The power is exclusively in the husband. The income which in the husband’s discretion remains undistributed is added to corpus, and the grantor is likewise helpless as to its disposition. Thus the excess income over the grantor’s prescribed share is beyond her control and is subject to disposition solely by the husband. Whether under these circumstances alone it could be said that the husband had a substantial adverse interest is a question which we pass in view of the important sentence which follows in the instrument.

Bearing in mind that all of the excess income may in the husband’s sole discretion be withheld from blood relatives and from the grantor, it is clear that it may all be permitted by the husband to be added to the corpus. However, the trust then provides that the husband in his discretion may direct the disposition of such income “for the payment of educational, food, shelter, clothes, medical or other necessary expenses of” his child. This seems to us to give the husband a substantial adverse interest in the disposition of the income, for it enables him without hindrance or accountability to use the income /for the discharge of his own obligation. By New Jersey law it is /clear that the husband is under a duty to support his minor child, Alling v. Alling, 52 N. J. Eq. 92; 27 Atl. 655; In re Ganey, 93 N. J. Eq. 389; 116 Atl. 19; Sewage v. Commissioner, 82 Fed. (2d) 92. Although this duty rests apparently equally upon the child’s mother and father, as respondent suggests, that fact does not lessen the duty of the father or detract from the proposition that it exists. Thus the husband had an untrammeled power to use the excess trust income in his own behalf to discharge his personal parental obligation. This was not a remotely possible legal or contingent obligation, as in Mary A. Cushing, 38 B. T. A. 918. It was a presently existing obligation inherent in the fact that the child was a minor and, as shown by the evidence, was without sufficient means of support and maintenance. The power to use the income for his child’s support gave the husband such a substantial interest in it as to support a disregard of the financial position of his wife and a refusal of any demand or request which she might make for the income or in regard to its use. This we think was ani interest adverse to that of the grantor, irrespective of their common interest in the welfare of the child and their apparently harmonious relations, Savage v. Commissioner, supra; Clark v. Commissioner, 84 Fed. (2d) 725; Jeme B. Shiverick, 37 B. T. A. 454. We find no decision which is sufficiently close to this case to need reconciliation.

The Commissioner was in error in adding to the petitioner’s income any part of the trust income in excess of the amounts which in the taxable years were actually distributed to her.

Decision will be entered v/nder Bule 60.


author: Leech:

text:
    William T. Walker, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92600.
    Promulgated October 19, 1939.

      Raymond H. Berry, Esq., and Arthur L. Evely, Esq., for the petitioner.

      T. F. Callahan, Esq., for the respondent.
   OPINION.

Leech:

Petitioner seeks redetermination of deficiencies in gift taxes of $552.40 and $1,121.29, for the calendar years 1935 and 1936, respectively. He also asks a finding that he has overpaid gift taxes for those years in question, in the respective amounts of $145.85 and $203.83. The issue is whether petitioner’s transfers of securities and cash in 1935 and 1936, to a trust created by him in 1930, are subject to gift tax under section 501 of the Revenue Act of 1932, as amended. The facts have been stipulated.

Petitioner, a resident of Detroit, Michigan, established an irrevocable trust on April 14,1930, to provide his mother with a life annuity and to have the income in excess of the annuity requirements paid to himself. He conveyed to the Detroit & Security Trust Co. and himself, as trustees, certain named securities having a then market value of $155,222.50. The trust company was a Michigan corporation. These securities were to be held in trust during the life of the donor’s mother, Edith T. Bradley, and were to be invested and reinvested subject to the joint control of the petitioner as cotrustee. Petitioner, as donor, reserved the privileges of adding securities to and withdrawing securities from the trust corpus, provided that in the latter case he substituted others of equal value. Further material portions of the trust instrument follow:

Out of the net income arising from investments and reinvestments made or held under authority of this instrument, and as far as shall be necessary out of the trust principal, the Trustees, or in case said William T. Walker shall cease to act as Cotrustee for any reason, then the corporate Trustee alone, or its successor, if any, shall pay to the Donor’s mother, Edith T. Bradley, the sum of Five Hundred ($500.00) Dollars each month during her entire life, but all net income in excess of Furs Hundred ($500.00) Dollars each month shall be paid, in monthly installments, to the said William T. Walker.
Upon the death of the said Edith T. Bradley, this trust shall terminate and all money, property and securities then held under authority hereof shall be assigned, transferred and delivered to the said William T. Walker, if he be then living, and if not, then unto his issue, per stirpes; but if the said William T. Walker shall predecease his mother and leave no issue who survive the said Edith T. Bradley, then upon the termination of this trust all money, property and securities held hereunder shall be distributed among the then living heirs-at-law of said William T. Walker, as though he had then owned the trust property and died intestate, the persons to benefit hereunder to be selected and the distribution to be made in accord with the laws of Michigan which at that time govern the distribution of the personal property of those who leave no Last Will and Testament. The distribution shall be made in kind as far as practicable.

The trustees were to have powers to manage, to control, to purchase proper trust investments, to borrow and to pledge; and the corporate trustee was directed to retain all securities in the trust as long as petitioner should act as cotrustee unless he consented to a sale, exchange, or other disposition thereof.

A further provision was as follows:

No part of this trust property, while subject to the control of any person acting as Trustee hereunder, shall ever be subject to transfer, assignment, sale, pledge or anticipation in any other manner by the beneficiary or any remain-derman hereunder, nor shall the interests of the beneficiary or any remainder-man, prior to the final distribution of the last remaining portion of this trust property, be seized in any manner or held liable for his or her debts, contracts, obligations or engagements of any kind whatsoever.

On February 18, 1935, petitioner, without increasing the amount to be paid to his mother under the terms of the trust, added securities thereto having a market value of $45,925.

On March 8, 1935, the trust was amended to reserve to petitioner the power to direct investments and reinvestments, petitioner agreeing to save the corporate trustee harmless in case any of the directions should be to invest the trust funds in improper trust investments.

During the year 1936, petitioner, without increasing the amount to be paid to his mother under the terms of the trust, added a totail of $20,000, in cash, to the corpus of the trust.

Petitioner was born on February 22, 1904, and his mother, Edith T. Bradley, was born on July 3, 1884.

Petitioner filed a gift tax return on March 15, 1936, in which he reported the 1935 transfer of securities to the trust, together with another gift not here in question. In that return the value of the life interest of petitioner’s mother in the securities transferred to the trustees was stated to be $22,373.17, which amount, less the $5,000 exclusion, Was included in the return as a taxable gift. At the time of filing the return, he paid a gift tax of $145.85.

Petitioner also filed a gift tax return on March 15, 1937, in which he reported the 1936 transfers of cash to the trust. In that return the value of the life interest of petitioner’s mother in the cash transferred to the trustees was stated to be $9,507.26, which amount, less the $5,000 exclusion, was included in the return as a taxable gift. At the time of filing the return he paid a gift tax of $203.83.

Respondent determined deficiencies for both years on the theory that the full market value of the property transferred to the trust should have been returned as taxable gifts. The petition in this proceeding was filed with the Board on March 14, 1938.

Since the estate tax and the gift tax supplement each other and may be construed in conjunction (Hesslein v. Hoey, 91 Fed. (2d) 954; certiorari denied, 302 U. S. 756; Harriet W. Rosenau, 37 B. T. A. 468) it is proper to test the instant trust by considering whether petitioner as grantor retained an interest which will eventually be taxable as part of his gross estate. If he did, then and to that extent, the creation of the trust in 1930, and the subsequent transfers in 1935 and 1936, did not constitute completed gifts.

By the trust instrument, petitioner gave his mother an annuity of $6,000 for the rest of her life, payable out of income so long as the. income Was sufficient, and otherwise to be paid out of corpus. Her life interest in the trust was confined to that specific animal sum. See Burnet v. Whitehouse, 283 U. S. 148. All the excess income was to be paid to petitioner. The trust was to end upon the mother’s death and the corpus was to be returned to petitioner if he should then be alive, or if he were dead, to his issue per stirpes; if he should die before his mother and leave no issue, then upon the termination of the trust, the corpus was to be distributed among those living persons who should be petitioner’s heirs at law under the laws of Michigan.

Our initial question is whether the interest retained by petitioner is a possibility of reverter or a reversion. If it is the former, it will form no part of his gross estate and the 1935 and 1936 transfers to the trust, made after the enactment of the tax on gifts in the Revenue Act of 1932, are completed gifts. If it is a reversion, then either the gift of a life annuity was completed in 1980, and the subsequent transfers merely increased the value of the reversion, or the donor is taxable only to the extent of his mother’s life interest in the property transferred.

According to the law of Michigan, under which the interests thus granted and retained by petitioner are to be determined (Kinney's Estate v. Commissioner, 80 Fed. (2d) 568; Estate of Waldo C. Bryant, 36 B. T. A. 669; affd., 104 Fed. (2d) 1011), “A reversion is the residue of an estate left in the grantor or his heirs, or in the heirs of a testator, commencing in possession on the determination of a particular estate granted or devised.” Compiled Laws of Michigan, 1929, sec. 12932; In re Coots, Estate, 253 Mich. 208; 234 N. W. 141. Petitioner’s transfer of property to a trustee does not, by itself, carry with it any interest he may have in such property by way of reversion. If he has a reversionary interest it will pass to others by reason of his death, and will pass from him as an individual, not from the trustees. Kinney’s Estate v. Commissioner, supra. See also Security-First National Bank of Los Angeles, Executor, 35 B. T. A. 815; Jay C. Hormel, 39 B. T. A. 244; Doctor v. Hughes, 225 N. Y. 305; 122 N. E. 221.

Here, the petitioner retained the right to the income from this estate, so far as it should exceed $6,000 per annum, powers of management, and the right to the return of the corpus upon the death of his mother should he then be alive. The latter right was the “residue” of the estate left in him. If he had died, the trust property Was to be returned to his issue per stirpes, or if there were none,, to his heirs at law. Thus, it is clear that, under Michigan law, and otherwise (Security-First National Bank of Los Angeles, Executor, supra; Jay G. Hormel, supra; Doctor v. Hughes, supra), petitioner retained a reversion in the trust corpus. The fact that petitioner, the holder of that reversion, might die before coming into its possession leaves it none the less vested at the creation of the particular estate. His death during the existence of that estate would merely divest it.

The facts in both Helvering v. St. Louis Union Trust Co., 296 U. S. 39, and Becker v. St. Louis Trust Co., 296 U. S. 48, are distinguishable. In those cases, the estate after the life estate was to go in the first instance to persons other than the grantor. His reacquisition of the corpus was conditioned upon his survival of each life beneficiary. Otherwise, the future interests continued their predestined course, and did not come back into his estate and to those who would be his heirs at law. But in the present situation, the corpus of the trust was to be returned to the grantor the moment his mother died, almost as if the trustees were tenants for years of the corpus and the grantor the landlord. If he were not alive at the termination of the trust, i. e., at the death of his mother, the corpus would not then go over to named remaindermen, as was true in Helvering v. St. Louis Trust Co., supra, or vest absolutely in the life tenant as in the Becker case, but would go to whoever might be his issue or his heirs at law. His death would divest his reversionary interest in their favor, and would vest their contingent remainders. It would be the “generating source of their rights” to the reversion he held during his life. It would remove the legal uncertainty of their interests and divest the prior vestiture of his. Doctor v. Hughes, supra.

This conclusion is supported by Estate of Waldo C. Bryant, supra, which illustrates the distinction just made. In that case there were two trusts, under one of which it was held that the grantor retained a reversion and, under the other, a possibility of reverter. The first trust, the material provisions of which were quite similar to those here, provided that the income from the trust should be paid to the grantor’s wife for life and then to the grantor for his life. Upon the death of the survivor, the corpus of the trust was to be paid over to the executors or administrators of the grantor’s estate. Decedent predeceased his wife and left a will which devised and bequeathed the corpus, after Ms wife’s death, in trust for his children and grandchildren. It was held that the decedent grantor had retained a vested reversionary interest. In the second trust, the income was to be paid to the decedent grantor’s daughter for life and upon her death the corpus was to be returned to the grantor, if living, but otherwise was to go to his wife, or if she were dead, to the issue of the daughter, etc. Here it was held the grantor retained a mere possibility of reverter.

Hughes v. Commissioner, 104 Fed. (2d) 144, upon which respondent relies as conclusive, involved different facts. Helvering v. St. Lords Union Trust Co., supra, and Becker v. St. Louis Trust Co., supra, were not cited. And, of great significance, the Court held the donor’s retained interest might have value, but, since no value was established, the value of the trust corpus was taxed as a gift.

To hold that a retained interest may have value is to hold that it is a reversionary interest, for a possibility of reverter can not be valued. Commissioner v. Hallock, 102 Fed. (2d) 1. The present trust is a spendthrift one. Consequently the Hughes decision is authority for the conclusion here reached, namely, that petitioner retained a valuable reversionary interest when he created the trust in 1930.

Having concluded that petitioner retained a reversion, did the 1935 and 1936 transfers merely increase the value of petitioner’s reversion, or should they be separated into a life interest in petitioner’s mother, which will be taxable to petitioner as a gift to his mother, and a reversionary interest in petitioner, as would have been done with the original transfer in trust had a gift tax been in force at that time? The securities transferred in 1930 exceeded the then value of the mother’s $6,000 annuity. Their value at the time of transfer was $155,222.50. The then value of the annuity would have been only $83,021.46. In 1935, it would have been $74,405.11 and in 1936, $72,602.22. [Regulations 79, art. 19 (7) and table A. Petitioner, however, has not shown the values of the securities in the trust in 1935 and 1936, on the dates of those respective transfers. For all that is in the record, the corpus may then have been less than the remaining value of the annuity.

Accordingly, we must hold that petitioner is not entitled to a finding of overpayment. He has returned and paid his gift tax on the theory, here deemed to be correct, that the taxable extent of the 1935 and 1936 transfers was the life interest of his mother in the property transferred. See Katherine S. Rheinstrom, 37 B. T. A. 308 (affirmed on this point, 105 Fed. (2d) 642). Therefore,

Judgment of no deficiency will be entered.


author: Smith:

text:
    Milton H. Friend, Bertha F. Levy and Ethel Pacyna, as Trustees of the Trust Estate Created Under the Last Will and Testament of Henry Friend, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 90672, 91415.
    Promulgated October 19, 1939.

      A. J. Pflawm, Esq., Harry N. Wyatt, Esq., and Richard H. Levin, Esq., for the petitioners.

      John D. Kiley, Esq., for the respondent.
   OPINION.

Smith:

These proceedings, consolidated for hearing, involve income tax deficiencies for the years 1934 and 1935 of $12,088.76 and $7,952.16, respectively. The petitioners allege that the respondent erred:

(1) In the determination of the net rentals from real property in the disallowance of:

a. Amortization of leaseholds upon property located at 6308-6314 South Halsted Street, Chicago;

b. Reasonable amounts for depreciation upon rental properties during each of the taxable years;

c. Legal expenses for 1934 in the amount of $1,290.35.

(2) In the disallowance of the deduction of taxes which had accrued prior to the death of the decedent.

(3) In the disallowance of the deduction from gross income for each year of $14,000 distributed out of income to the decedent’s widow.

The petitioners, residents of Chicago, Ill., are the duly qualified and acting trustees of the trust estate created under the will of Henry Friend, deceased, who died a resident of Chicago, on August 1, 1932.

The several contentions of the petitioners will be considered separately.

I. — AMORTIZATION OF LEASEHOLDS.

Facts. — At the time of his death on August 1, 1932, Henry Friend was the owner of real estate located at 6308-6310 and 6312-6314 South Halsted Street, Chicago. On October 30,1920, he leased to the L. R. Steel Co. the premises at 6308-6310 South Halsted Street for a period of 99 years. The lessee paid to the decedent $75,000 representing the value of the improvements to the real estate. It had the right under the lease to raze the buildings and erect new buildings thereon, the cost of which should not be less than $300,000. The lease provided for the payment of an annual rental of $15,000 net from November 1, 1922, to October 31, 2019. The S. S. Kresge Co. acquired the lease from the L. R. Steel Co. and a supplemental agreement was entered into January 19, 1925', between Henry Friend, lessor, and the S. S. Kresge Co., whereby the lessee was permitted to erect a building upon the premises of not less than two stories and costing not less than $125,000. Under the terms of the supplemental agreement the Kresge Co. was required to pay an annual rental of $18,000 a year net. The Kresge Co. built in 1925 a three-story and basement steel and reinforced concrete building upon the property.

On October 4, 1922, the decedent leased the premises at 6312-14 South Halsted Street to the F. W. Woolworth Co. The decedent and the F. W. Woolworth Co. entered into a supplemental lease dated January 31, 1923. The first Woolworth lease demised the premises for 25 years from January 1,1924, to December 31,1948, at an annual rental of $20,000 net. The second Woolworth lease demised the premises from the end of the period covered by the first Woolworth lease, January 1, 1949, for 25 years until December 31, 1973, at an annual rental of $25,000 net. In pursuance of the Woolworth leases the F. W. Woolworth Co. built, in 1924, a two-story brick and wood joist building upon the premises at a cost of $125,000. The useful life of this building was less than the term of the leases.

Opinion — It is the petitioners’ contention in these proceedings that the estate of Henry Friend acquired upon his death, on August 1, 1932, leasehold estates upon the two properties, 6308-6310 and 6312-6314 South Halsted Street, and also reversionary estates in respect of the properties. They contend that the respondent determined the values of these estates separately in the determination of the estate tax liability of the estate of Henry1 Friend and that a very large value was placed upon the leasehold estates and a very nominal value upon the reversionary estates. They contend that the estate is entitled to deduct from the capitalized value of the leasehold estates a reasonable amount for the amortization of those leasehold estates during the life of the leases and that the taxable income from the properties was the net rents received less reasonable amounts for amortization; that on August 1, 1932, the value of the lessor’s right to receive the rents under the Kresge lease was $224,730, or the product of $18,000 times 12.485, the present value of an annuity of $18,000 for 87 years and 3 months, the duration of the Kresge lease; that this amount, amortized on a straight-line basis for 87 years and 3 months would result in an annual amortization allowance of $2,575.70. They further claim that on August 1, 1932, the value of the lessor’s right to receive rents under the Woolworth leases was $255,725, computed by adding the present value of an annuity of $20,000 for 16 years and 5' months, the duration of the first Woolworth lease ($20,000 times 9.010, or $180,200), to the present value of an annuity of $25,000 for 25 years deferred 16 years and 5 months, the duration of the second Woolworth lease ($25,000 times 3.021, or $75,525). They further contend that these amounts amortized on a straight-line basis for the respective periods of 16 years and 5 months and 41 years and 5 months would result in annual amortizations of $10,976.65 and $1,823.54, respectively; that the lessor’s rights to receive rents with respect to the two properties under the Kresge and Woolworth leases are wasting assets subject to depreciation under section 23 (1) of the Kevenue Act of 1934, having bases for depreciation equal to their respective values on August 1, 1932, and rates determined by the terms of the leases from August 1, 1932; that the petitioners are accordingly entitled to deduct from taxable income for each of the taxable years 1934 and 1935 as such amortization of a wasting asset the sum of $15,375.89.

In the alternative they make the contention that the business depression was at a very low point on August 1, 1932; that on that date a reasonable and fair rental for the land at 6308-6310 South Halsted Street, unimproved and unencumbered by any lease, would have been $14,000 per annum net to the owner under a lease of 30 years or more, sufficient to make it worth while for the lessee to erect a suitable improvement; and that on the same date a reasonable and fair rental for the land at 6312-6314 South Halsted Street, unimproved and unencumbered by any lease, would have been $12,500 per annum net to the owner under a lease of 30 years or more. They tben contend that the excess rental receivable by the estate under the terms of the leases was amortizable over the terms of the leases. Upon this basis they contend that the excess rental receivable on the Kresge property had a value on August 1, 1932, of $49,940 and on the Woolworth property $67,575 plus the present value of an annuity of $12,500 per year for 25 years commencing 16 years and 5 months after August 1, 1932, the life of the second Woolworth lease, or $37,760. Upon this alternative basis they claim that the amortization deductible in each of the years 1934 and 1935 was $5,600.

Section 22 of the Revenue Act of 1934 defines “gross income” as including gains, profits, and income derived from “rent, * * * or gains or profits and income derived from any source whatever.” Section 23 (1) permits the deduction from gross income of:

(1) Depeeciation. — A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. * * *

We are not dealing here with the case of a taxpayer who has acquired by purchase or by inheritance a right to receive a periodic sum of money for a term of years. Clearly if a taxpayer had invested money in acquiring such right he would be entitled to deduct from the rents received each year an aliquot part of the cost of his investment; for he would be entitled under the statute to recover back the cost of his investment without being taxed thereon.

What we are dealing with here is the case of an estate which owns the fee of real estate which is advantageously leased. The estate had the fee simple title to the real estate located at 6308-6314 South Halsted Street. In a fee simple title all lesser estates, rights, titles, and interests merge. William, Robert Farmer, 1 B. T. A. 711. We think it immaterial that for the purpose of determining the tax liability in these proceedings the respondent determined the value of the fee by separately valuing the right to receive rentals over the terms of the leases and the remainder interests.

Petitioners claim the right to deduct an amount for amortization under section 23 (1) of the taxing statute. But an allowance for exhaustion obtains only where exhaustion actually exists. If a man’s estate is not exhausted there is no ground for a claim for exhaustion. We can not see wherein the estate of Henry Friend was in any wise exhausted during the taxable years in respect of the properties under consideration. The estate did not own the buildings. They had been erected at the expense of the lessees. The petitioners do not even claim that they are entitled to an allowance for depreciation in respect of the buildings. There is no showing here that the value of the estate’s fee in the premises was in any wise lessened during the years 1934 and 1935. There is no showing that the rental value of the premises at the expiration of the leases will be any less than it was upon the dates of the execution of the leases.

The courts and the Board have repeatedly held that the mere right to receive income is not subject to exhaustion even though the right is limited to a term of years. In God/mm v. Miles, 28 Fed. (2d) 823; certiorari denied, 278 U. S. 654, the court stated in part as follows:

(1) It is contended for the plaintiff that, because the income ceased with her death, even though she had the right of appointment as to the principal, she was entitled to have a deduction from the tax because of exhaustion. With this contention we cannot agree. That the amount paid to the plaintiff is income is clearly settled by the Supreme Court of the United States, in the ease of Irwin v. Oavit, 268 U. S. 161, 45 S. Ct. 475, 69 L. Ed. 897. A careful study of this case would seem to settle the question of exhaustion, depreciation, or obsolescence against the plaintiff’s contention.
■ * * * ibe contention that the value of the estate was each year depleted by exhaustion is intriguing rather than logical. What the plaintiff received and was entitled to receive was not the corpus of the property but the increment annually accruing therefrom. It is nowhere suggested that the corpus of the property, from which the income was derived, was in any way depleted. There is no destruction or diminution by use of the property which furnishes (he source of the income, and to allow an abatement for any portion of the taxes accruing each year because of the limited time of the plaintiff’s enjoyment of tho income would not only defeat the reiterated purpose of Congress as expressed in, various provisions of the act, but would invite as well as permit, to an unlimited extent subterfuges whereby those entitled to large incomes could avoid their just obligations to the government.

In our opinion there is no more merit to the petitioners’ alternative contention than there is to their main contention. The mere fact that the property was advantageously rented at the date of the death of the decedent does not in our opinion give rise to any claim for an allowance for exhaustion.

II.-REASONABLE ALLOWANCES FOR DEPRECIATION.

Facts. — The following table shows the amounts of depreciation and amortization allowances claimed on the tax returns filed for 1934 and 1935 and the amounts allowed by the respondent:

Eeasonablc allowances for depreciation for each of the years 1984 and 1935 are as follows:

6308-14 South Halsted Street-
6426-48 South Halsted Street_$8,000.00
6352 South Halsted Street_ 899.68
1467 Michigan Avenue- 3,000.00
3243 Lawrence Avenue_ 4,000.00
6710 North Ashland Avenue- 700.00

Opinion. — We have stated in the first part of our report why we t.binb- that the petitioners are not entitled to an allowance for amortization in respect of the properties at 6308-6314 South Halsted Street. At the hearing of these proceedings counsel for the petitioners and the respondent agreed that the correct depreciation allowance for 6352 South Halsted Street was $899.68 and for 6710 North Ashland Avenue, $700. In the determination of the deficiencies the respondent did not change the cost basis for the determination of the depreciation on the properties at 1467 Michigan Avenue and 3243 Lawrence Avenue. He did, however, change the rate. From a consideration of all of the evidence in these proceedings we are satisfied that the depreciation allowance claimed in the return was correct, namely, $3,000 on the property at 1467 Michigan Avenue, and $4,000 on the property at 3243 Lawrence Avenue.

The property at 6426-6448 South Halsted Street consists of 12 stores. In the income tax returns filed depreciation was claimed at the rate of 6 percent upon a valuation of $53,507. The respondent reduced the rate to 4 percent. In 1933 an examination was made of these properties and it was decided that it would be more profitable for the estate to raze the buildings and erect new buildings from which larger rents could be obtained. It was found that the roof of one of the buildings needed renewal. It was decided, however, to wait a few years before this was done. In 1937 it was found that all of the roofs would have to be renewed and it was decided to raze all of the buildings in that year. The only portions of the old buildings which were utilized in the construction of the new buildings were a few of the walls in good condition and some of the footings. At the hearing of these proceedings counsel for the Government admitted that a reasonable allowance for depreciation was 20 percent a year upon the valuation at the date of the death of the decedent, August 1, 1932, of $40,000. Upon the basis of the entire evidence the Board has concluded that the depreciation sustained each year is $8,000. Therefore, the petitioner is entitled to an allowance for depreciation for each of the taxable years under review of $16,599.68.

III. — Legal Expenses.

Facts. — In the estate’s income tax return for 1984 there were deducted certain amounts for legal expenses. The respondent in the determination of the deficiency disallowed $1,290.35 on the ground that this represented capitalizable costs relating to the title to the property. The evidence shows, however, that the amount of $1,290.35 was expended by the estate in connection with the default of one Weinstein, the tenant of the petitioners in the building at 6426 South Halsted Street and sublessor of the stores comprising said building. Upon the withdrawal by Weinstein the petitioners feared that rents would be collected by him from the sublessees, and, in order to protect their rights against the sublessees, the petitioners found it necessary to apply to a court of equity for a receiver, to hold hearings, to prepare various documents, and to make numerous expenditures for attorneys’ fees, master’s fees, court reporter’s costs, and other similar items. The estate owned title to the property long before the year 1934 and the expenditures had no relationship to the ownership of the property.

Opinion. — Since the evidence shows that the amount of $1,290.35 was paid to protect the estate’s interest in the rents collectible upon the property at 6426 South Halsted Street, the Board is of the opinion that the amount represents an ordinary and necessary expense of earning income and is a legal deduction from gross income.

IV. — Deductions Accrued and Paid Prior to Decedent’s Death.

Facts. — During the year 1934 the estate paid $9,970.37 for taxes on various parcels of real estate which had become a lien on the several properties prior to the death of the decedent. The respondent disallowed the deduction of these taxes in the determination of the deficiency.

Opinion. — The action of the respondent in disallowing the deduction of these taxes is clearly correct. They represent claims against the estate of the decedent. They are not legal deductions from the gross income of the estate. Roy J. O'Neil et al., Executors, 31 B. T. A. 727; Herbert G. Perry et al., Executors, 32 B. T. A. 513; and Jacob S. Hoffman, Estate, 36 B. T. A. 972.

V. — Amounts oe Income Distributed to the Decedent’s Widow.

Facts. — During the calendar years 1934 and 1935 the estate of Henry Friend paid the sum of $14,000 each year to Emma Friend, the wife of the decedent and the mother of the petitioners herein. These sums were deducted from the net income of the estate for the calendar years 1934 and 1935 and the deductions were disallowed by the respondent in the determination of the deficiencies.

The last will and testament of the decedent provided in part in paragraph tenth (b) and in paragraph tenth (f) as follows:

(b) After setting aside the trust funds hereinbefore in Section (a) of this Artices Tenth provided for, I direct said Trustees to divide all of said Trust Estate then remaining (which Trust Estate then remaining is hereinafter in this Will sometimes referred to as “Residuary Estate”) into two (2) equal parts, which parts are hereinafter sometimes referred to as Parts “A” and “B,” respectively.
(1) I Deject said Trustees to pay the entire net income arising from Part A to my wife, Emmia Friend, during the term of her natural life.
(2) I Direct said Trustees to divide Part B, or, in the event of the death of my said wife prior to my death, then said entire Residuary Estate, into as many shares as I shall have children living at the time of my death and lawful issue living at such time of any deceased child, such lawful issue of a deceased child, for the purpose of such division, to count as but one child, which shares are hereinafter sometimes referred to as “Shares” and each of which Shares is hereinafter sometimes referred to as “Share,” and I further direct that said respective Shares shall be designated by the names of my respective children living at the time of my death and by the name or names of my child or children, if any, who shall have died prior to the time of my death, leaving lawful issue surviving at the time of my death. I further Direct that each of such Shares shall constitute and be held by said Trustees as a separate trust fund.
(f) I Derect that none of the beneficiaries named in Article Tenth of this, my Last Will and Testament, shall be entitled to any income from said Trust Estate, or from the part thereof from which they may be entitled to income, until after the receipt of my Trust Estate by said Trustees from said Executors and the division of said Trust Estate by said Trustees as hereinbefore provided, but any and all income accruing until such division shall become and be a part of the corpus of the Trust Estate.

At the time that the will was drawn, and at the time of the decedent’s death, it was contemplated that the executors named in the will would be discharged and the trust estates established under the will would be created by the end of one year or 15 months after the decedent’s death. The money received by Emma Friend as a widow’s award under the statutes of Illinois was expected to be and was sufficient to maintain her for a period of 15 months after decedent’s death. As a result of certain litigation with the board of education of the city of Chicago, and as a result of the controversy over the Federal estate tax payable by the estate of the decedent, the executors were not discharged and the assets were not turned over to the trustees until after 1935. In 1934 Emma Friend, who had been estranged from the decedent at the time of his death and whose relationship with the petitioners, her children, was somewhat strained, demanded the payment of $14,000 a year from the executors. She had no other income during those years and the amount of $14,000 was necessary for her to live on. Emma Friend threatened, unless such sums were paid to her, to institute litigation against the estate. Conferences were held between the executors of the estate and Emma Friend and the executors agreed to pay her out of the income of the estate the sum of $14,000 a year until the estate should be closed, and the distributions made in pursuance thereof were forced by the threatened litigation, disharmony, and loss. Emma Friend returned for each of the years 1984 and 1935 the $14,000 received by her and paid income tax thereon.

Opinion. — The respondent contends that the amount paid by the estate to Emma Friend is not a legal deduction from the gross income of the estate. He relies upon article 1621 of Regulations 86, which provides that “An allowance paid a widow out of the corpus of the estate is not deductible from gross income.” Section 162 of the Revenue Act of 1934 provides in part as follows:

The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
(c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either 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 evidence in these proceedings shows that the net income of the estate was more than ample to pay the widow the $14,000 claimed by her. The trust estates which were set up under the will of Henry Friend provided that the widow should receive for life the income from one of the trust estates equaling one-half of the residuary estate. One-half of the income of the estate for each of the taxable years was largely in excess of $14,000.

The respondent points out that the will specifically provided that during the period of the administration of the estate all of the income should be collected and made a part of the capital which went to constitute the trust funds. But it clearly is the law of the State of Illinois that, where all of the parties in interest agree to a different distribution of the estate from that which is provided for by the will, the courts of Illinois will give sanction to such treatment. Thus in Van Zanten v. Van Zanten, 269 Ill. 491; 109 N. E. 986, the facts were that before the decedent’s death, there occurred the signing of a number of deeds purporting to convey certain parcels of decedent’s real estate to his children. There was never any delivery of these deeds. The decedent’s will devised all the decedent’s estate to his wife and after her death equally among the five children. A few days after the decedent’s death, after the will had been read, all of the children signed an agreement allocating to each child the parcel of land which he had occupied under the undelivered deeds. It further provided for the payment of $1 per year for each acre of land held by the various children to their mother for her support. In spite of this agreement all of the real estate of the decedent was transferred to one of his sons as executor and was included in his probate inventory. Later, another of the sons filed an appeal to remove the cloud on his title to the tract of land which he contended was his according to the agreement executed shortly after the decedent’s death. The Supreme Court of Illinois held that the agreement was valid and enforceable and had the effect of vesting title to the lands according to its terms in spite of the provisions of the decedent’s will to the contrary. The court said:

* * * The children were all adults, under no disability. They and the widow were the only persons haying any interest in the estate, except creditors, and it is not claimed that the rights of any creditor are involved. The widov) anú, children, could, hy agreement malee any disposition of the property they chose, regardless of the mil. Cotterell v. Coen, 246 Ill. 410 * * * Unquestionably the children, by their written instrument executed a few days after their father’s death, agreed to a different disposition of the estate from that made by the will, and, while the agreement was not signed by the widow, she was present when it was made, and knew of and acquiesced in it. * * * [Italics supplied.]

The same rule was followed in Cole v. Cole, 292 Ill. 154; 126 N. E. 752, in which the decedent’s will gave the entire estate to the widow for life and after her death to various children in equal parts for life with remainders to their respective children and each other, depending upon survivorship. Upon the decedent’s death an appeal was filed to contest the will on the ground of incapacity, and all of the specifically named beneficiaries entered into an agreement for the equal division of the entire estate among the children in fee, appointing two “Commissioners” to make the division. Some of the parties brought a bill against the commissioners for the specific performance of the agreement and the court held that the agreement was valid, although contrary to the terms of the will.

Another case in which an agreement was approved and endorsed by the Illinois Supreme Court, although no resort to the courts had been made, was Wolf v. Uhlemann, 325 Ill. 165; 156 N. E. 384.

We conclude that the agreement made by the parties in interest is here controlling and that the $14,000 paid by the estate to Emma Friend in each of the years 1934 and 1935 was properly paid and is a legal deduction from the gross income of the estate.

Decisions will be entered under Rule SO.


author: StekNI-iageN :

text:
    Otto T. Mallery, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91535.
    Promulgated October 19, 1939.

      Peter V. D. Voorhees, Esq., Tracy 8. Voorhees, Esq., and Howard H. Yocwm, Esq., for the petitioner.

      Paul E. ’Waring, Esq., for the respondent.
   opinion.

StekNI-iageN :

The Commissioner disallowed a deduction in each year of the excess over the $5,000 exclusion, holding that the Otto Co. was not within the description of section 505 (a) (2) (B), Eevenue Act of 1932:

In computing net gifts for any calendar year there shall he allowed as deductions:
(a) Residents.- — In the case of a citizen or resident—
(2) Chabitabus, etc., gifts. — The amount of all gifts made during such year to or for the use of—
(B) a corporation, or trust, or community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, including the encouragement of art and the prevention of cruelty to children or animals; no part of the net earnings of which inures to the benefit of any private shareholder or individual.

The argument is that because to some extent the corporation used its funds to help petitioner’s relatives it must be regarded as outside the statutory category, citing Henry G. DuBois, 31 B. T. A. 239. That case held the corporation to be only a means for enabling its sole shareholder to deduct contributions to relatives which were not deductible if the contributions were made by him directly.

In our opinion the evidence in this case, which seems to be quite complete, shows that the corporation was consistently devoted entirely to making charitable donations. The help that was given to petitioner’s relatives was in small amounts and only because they were ill or destitute and not because they were related to petitioner. This does not appear in the DuBois case. The contributions were no less prompted by a charitable purpose than were those to the numerous other donees. Certainly, as shown by its charter and by the petitioner’s testimony, which was entirely credible, the purpose of its formation was entirely charitable, and we find nothing in the evidence of its activities to indicate that its operations were not exclusively so. It does not appear to have been organized primarily as a device for providing tax deductions, but altruistically as an instrument of charity, with no ulterior design. There is no reason to deny its charitable character under the statute because the principal organizer and financial backer is also the principal controller of its benefactions. See Havemeyer v. Commissioner, 98 Fed. (2d) 706. Of course the evidence must be reasonably convincing of the charitable purpose and operation of the corporation; but, that being-established, the gift tax deductions of contributions to it are as available to its sole or controlling organizer and sponsor as to others. In the DuBois case the evidence was held to indicate the purpose to provide petitioner with a tax deduction and thus the finding of the statutory condition of exclusive operation for charitable purposes could not be made. Here we tbink the evidence compels the finding.

James Sprunt Benevolent Trust, 20 B. T. A. 19, was a case where the purpose of the trust seeking exemption was found from the instrument and the testimony to be private beneficence to the founder’s blood relatives and not charity.

In our opinion, the contributions made by petitioner in the taxable years to the Otto Co. were deductions and their disallowance as such was error.

Decision will be entered for the petitioner.