author: Oppee:

text:
    Clinton Davidson, Petitioner, v. Commissioner of Internal Revenue, Respondent. Estate Planning Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent. Flora S. Davidson, Petitioner, v. Commissioner of Internal Revenue, Respondent. Clinton Davidson, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 93500, 93501, 93502, 93503, 93504.
    Promulgated February 13, 1941.

      Albert Hubsehman, Esq., Louis Goldring, Esq., and Garl Bhermcm, Esq., for the petitioners.

      George R. Bherrif, Esq., and Richard D. Dmican, Esq., for the respondent.
   OPINION.

Oppee:

By his notice of deficiency for 1934 respondent included in petitioner’s income:

* * * the net income for 1934 of Estate Planning Corporation, after disallowance of a deduction claimed for bond interest in amount of $24,000.00. The income of Estate Planning Corporation appears to consist entirely of original commissions on life insurance policies and annuity insurance policies sold by you (and your sub-agents) under contracts in your name personally. In view of the nature of the income involved, it is held by this office to be taxable in your hands, subject to the ordinary and necessary business expenses attaching thereto as provided by the income tax law.
********

Even before the decisions in Helvering v. Horst, 311 U. S. 112, and Helvering v. Eubank, 311 U. S. 122, it was clear that income from personal services to be performed in the future was taxable to the earner, regardless of his anticipatory assignment, and irrespective of the validity of that assignment for general purposes apart from questions of taxation. Lucas v. Earl, 281 U. S. 111. It is now settled that the same rule' applies to compensation for services already rendered, Helvering v. Eubank, supra, or to income from property. Helvering v. Horst, supra. The question, then, is simplified to the point where the decisive issue here is the determination of the person who is to be treated, for tax purposes, as the earner.

We institute this inquiry as to who earned the income in question with an examination of the services for which it was paid; for it seems to us to follow that, when this has been ascertained, the one who performed the services will be disclosed as the one who earned the compensation therefor. The income involved is insurance commissions; that is, remuneration comparable to brokerage paid by insurance companies for procuring purchasers from them of insurance policies. It is the person who performs this service, the agent procuring the application for insurance, to whom for this service the insurance company is indebted for the commission. McCloskey v. Thompson, 26 Misc. Rep. 135; 56 N. Y. S. 1076; Esterly-Hoppin Co. v. Burns, 135 Minn. 1; 159 N. W. 1069; Morehead v. Reem, 236 N. W. 802 (Mich.). The facts amply demonstrate to our mind that in the comparatively intricate plan of operation adopted by petitioner and the corporation no one but petitioner can be said to conform to that description of the earner of the insurance commissions. Not only was he the one designated by the insurance company as its agent to take the application, but the insurance contracts were treated as his business, he was designated by the corporation and the insured as the one to whom the commissions were to be paid by the insurers and he and not the corporation received the checks representing such payments, which were made payable to him. The services of obtaining the application for insurance for which in its simplest terms the commission is paid as compensation upon acceptance were thus treated by all the parties as having been rendered by petitioner. We can not say that upon this record he was not the contributor of the services for which the income was received. Supporting this conclusion are the circumstances that petitioner and not the corporation was licensed to carry on an insurance brokerage business; that the insurance companies and their general agents, as a matter of practice, decline to appoint corporations as agents; and that it would have been illegal for the corporation to intervene in the transactions as the procurer of the insurance business. McKinney’s Consolidated Laws of New York, Annotated (1917), Bk. 27, Insurance Law, sec. 91. That this is virtually conceded to be correct appears to us to follow from a statement of petitioner’s position in the reply brief:

* * * The statute was strictly complied with in that the commissions were paid by the life insurance corporation to, and each application was procured by, a licensed agent [petitioner],
****** *
* * * The arrangement was exactly to the contrary. The corporation was not to act as the life insurance agent. Its services were in a peculiarly different field, i. e., estate planning. It did not receive the payments as commissions from the insurance carrier. It received the payments from Davidson on the basis of his contract with it.

To this it may be added that petitioner’s receipt of the payments in question erects at the threshold a compelling inference that as recipient of the income he was taxable upon it. National City Bank of New York v. Helvering (C. C. A., 2d Cir.), 98 Fed. (2d) 93; North American Oil Consolidated v. Burnet, 286 U. S. 417. Not only as a matter of factual burden of proof arising generally by virtue of the prima facie correctness of respondent’s determination, but as a true legal presumption to be overcome by persuasive argnment, we think this casts upon petitioner the necessity of showing that the 'legal effect of the transaction was to preclude his ownership of the funds received by him. In our view no satisfactory basis for such a conclusion has been established. That he might have, become the debtor of the corporation is an irrelevant consideration on this aspect of the case; for that would be no more than an offsetting deduction, a distinct contention which we shall separately consider hereafter. As an assignment of all or part of the commissions the transaction would not only have been without legal effect under petitioner’s contract with the insurer and under the controlling regulation of the domicile, Wyatt v. McNamee, 52 Misc. Rep. 127; 101 N. Y. S. 790, but, as we have seen, would also be ineffectual even assuming its validity, in any examination of tax incidence.

It may be recognized that activities which for present purposes we shall assume to have been those of the corporation were an essential inducement and preliminary to petitioner’s success in obtaining the insurance business and receiving the compensation of which it was the root. In this phase of the matter an expenditure ordinarily and necessarily incurred by him would, in the usual circumstance, constitute the ground for a deduction as business expense. It may not be allowed, however, unless it is both ordinary and necessary, and compensation for services must be reasonable; and where as here it is the offshoot of an arrangement between an individual and his controlled corporation, it must survive more than the usual scrutiny for this to be established. Botany Worsted Mills v. United States, 278 U. S. 282; Alexander Sprunt & Son, Inc. v. Commissioner (C. C. A., 4th Cir.), 64 Fed. (2d) 424. We consider that the assignment to the corporation of the entire amount of the original commissions was not reasonable compensation to it for any contribution which it made to the earning of those commissions. As the originator and proprietor of a business writing upward of $4,000,000 of insurance annually, it is inconceivable that petitioner would have made such an arrangement at arm’s length with a stranger. We are, accordingly, unable to determine that the payments due the corporation under the contract were the true measure of petitioner’s expense and correspondingly deductible.

In the absence of any other gauge of a reasonable offset for the expense of obtaining the business, we might have been relegated to the figure which the corporation itself paid out for those purposes as the nearest approximation thereto. To a comparable deduction, however, petitioner was held to be entitled by respondent’s original determination. The deficiency notice charged petitioner only with the net income of the corporation, with the result that petitioner’s income was in turn reduced by the amount of such expenditures as were involved in the inducing operations conducted by the corporation. It was not petitioner’s burden to prove in detail the propriety of the deductions thus permitted. Only two items of corporation expense were disallowed in this determination, of which one was interest on the corporation’s bonds. While it is true that in litigation by which respondent is presumably bound it has been decided that the corporation was entitled to such a deduction, Estate Planning Corporation v. Commissioner (C. C. A., 2d Cir.), 101 Fed. (2d) 15, a corresponding result does not necessarily follow as to the individual petitioner. For the question is to what extent the payment he made to the corporation was an ordinary and necessary accompaniment of his business as an insurance agent and a fair measure of the expense incurred in obtaining insurance customers for him. While advertising, salaries of agents, cobrokerage, fees to lawyers and accountants, and even general office rent and overhead can be seen to have some connection with the procurement of petitioner’s insurance business, petitioner has not shown that payment of interest on the corporation’s bonded indebtedness, which was based in the first instance on a somewhat nebulous item of good will acquired from petitioner, see Estate Planning Corporation v. Commissioner, supra, can have any such connection. Since this item ivas disallowed in the original determination and petitioner carries the burden of showing its correctness, that part of the corporation’s expenditures is to be excluded from the amount of petitioner’s payment to it which we find to have been a reasonable disbursement by petitioner for securing the business from which his income arose. The same applies to the comparatively small item of the corporation’s organization expense.

It is true that by amended answer respondent seeks to increase the deficiency so determined by including in petitioner’s income all of the corporation’s gross income without offset for any disbursements. Since, in our view, however, respondent has failed satisfactorily to prove the amount of the commissions received by petitioner, apparently the only justification for a charge against him on that theory, and since respondent has in other respects failed to sustain his burden of proving the absence of petitioner’s right to deductions, we are of the opinion that the attempt to increase the deficiency can not succeed. There are implications that not all of the insurance premiums which eventually found their way to the corporation were paid to Davidson in the first instance. But it is clear that the great bulk were, and if this was something less than all, petitioner, on whom rested the burden, has not shown to our satisfaction the extent by which this total should be diminished. However, he has made it clear that a small fragment of the corporation’s receipts represented payment for its services, not insurance commissions. As to these amounts petitioner’s income should not be increased. The result is that the amount originally determined, adjusted for payments which were shown to have been received by the corporation as compensation for its services and not through insurance premiums, is chargeable against petitioner as his income. To that extent respondent’s determination is approved.

What has been said applies to the period prior to March 1, 1935. As of that date petitioner entered into a different arrangement with the corporation under which he himself received and retained the commissions and paid to the corporation for its services its own expenses plus 10 percent.- We are not prepared to say that this arrangement was so apparently unreasonable as to require that it be disregarded. The amount so paid to the corporation was, it is time, charged back to petitioner in respondent’s original deficiency determination by attributing to him the entire net income of the corporation, which included the sums so paid by him, or at least that was its effect. But if petitioner took the amount of this payment as a deduction from his own income as a business expense, a fact as to which the record is silent, respondent did not determine that it was unreasonable, since he made no attempt to disallow it as such. The factual basis for his determination was that “the income of Estate Planning Corporation appears to consist entirely of original commissions on life insurance policies and annuity insurance policies sold by you.” To the extent that petitioner has shown that a part of the corporation’s income consisted of his payment to the corporation for its services, and of a small item of other compensation for services similar to that involved in 1934, he has successfully demonstrated the error of respondent’s assumption of fact. And, of course, if petitioner did not deduct his payments to the corporation from his own income, charging him with it again would be doubly unjustified. For that part of 1935, therefore, during which petitioner was operating under the new contract, the respondent’s original determination is disapproved and for reasons similar to those already expressed his request for an increased deficiency is rejected.

With respect to the corporation, its taxable income should be adjusted to reflect the payments which are being charged to the individual petitioner.

The notices of deficiency also charge petitioner with the net income of the partnership, Davidson & Co., “because its gross income was derived largely from personal services rendered by” petitioner. This issue must be determined in favor of petitioner. It appears that the other members of the partnership contributed both capital and services to the business of the enterprise. In this situation we can not say that elements requiring the recognition of the partnership for tax purposes are lacking. Walter W. Moyer, 35 B. T. A. 1155. Bespondent’s inclusion of the proportionate parts of the partnership income in those of petitioner’s wife and son is sustained, as petitioners concede it must be on that result.

Under the notices of deficiency and in the condition of the pleadings the issue as to the trust income, both with respect to the attempt to attribute it to petitioner under sections 22 (a) and 168 and 187, raised for the first time on brief, and with respect to the inclusion of the distributive shares in the respective incomes of the beneficiaries of the trust, appears to be no more than an alternative contention. The notice of deficiency in the case of Clinton Davidson, Jr., states respondent’s position to be:

The income of the trust consisted of amounts paid to it by Estate Planning Corporation, allegedly as interest on bonds. * * * For the taxable year 1934, it is being held by this office that due to the nature of the income reported by Estate Planning Corporation, it is taxable not to the corporation but to the assignor of such income. Pending a final decision in these matters, the amount received by you from the trust is being included as interest income to you, in order to protect the interests of the Government.

The notice of deficiency in the Flora Davidson case is similar. Since we have determined the primary issue in respondent’s favor, it is unnecessary to consider his arguments for the application to petitioner of the sections in question. Our disposition of petitioner’s liability likewise carries with it the necessity of eliminating the items of trust income in adjusting the deficiencies determined against petitioner’s wife and son.

Petitioner’s motion for judgment, upon which decision was reserved at the hearing, is accordingly denied and the proceedings will be disposed of in accordance with the foregoing opinion.

Decisions will be entered under Rule 50.

       A “single policy” contract awarded to petitioner and conceded to be typical commences :
      ORIGINAL
      (For Agent)
      January 5th, 1935.
      Mr. Clinton Davidson New York City
      Deae Sie : It is hereby agreed to allow you the following commissions on the premiums not exceeding in amount in any one year the first year’s premium as paid in cash to the Society on Policy No. 9655,006 * * *.

       For example, a memorandum to, one of the insurance companies, giving detailed informa, tion about a “prospect,” inclosed in a letter signed by petitioner as president of the corporation, while itself unsigned is worded throughout in the first person singular.

       The Corporation’s directors resolved that “* * * all commissions allowed1 him [petitioner] by Insurance Companies on initial premiums of policies written during that peiúod to be turned over by him to the Company * * And when petitioner terminated this arrangement with the corporation his letter to it stipulated :
      “2. Xou are to formulate such plans in connection with my insurance business for estates of the same character that has been heretofore furnished by your corporation."’

       A typical “single policy’’ contract recites:
      “a. No assignment of this agreement or of commissions hereunder shall be valid unless authorized in advance in writing by the Society [Insurer].’’


source: Caselaw Access Project

author: Artjndell :

license: Public Domain

text:
    The Peoples Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97143.
    Promulgated February 13, 1941.

      H. H. 'Runt, G. P. A., for the petitioner.

      John R. Stivers, Esq., for the respondent.
   OPINION.

Artjndell :

The petitioner contests the whole of the deficiencies asserted here on the basis of section 3798 of the Internal Revenue Code, which is set out in the margin. The portion of the section claimed to be applicable is to be found in subsection (b) and provides that when depositors of a bank have released it from a portion of its deposit liability, accepting in lieu thereof a lien on its future earnings, no tax shall be assessed or collected by the United States which shall diminish the assets available and necessary to the full payment of such claims. The statute invoked, however, can have no application in the instant case. The release of the petitioner from liability for 50 percent of the deposits, given by the depositors in their agreement with the petitioner, was unconditional. Moreover, by express provision of that agreement, the contract entered into by the stockholders and the depositors, looking to reimbursement for the canceled deposits before the stockholders claimed any dividends, is not binding on the petitioner. In these circumstances, no lien on petitioner’s future earnings may be said to exist in any legally recognizable form.

The agreement of petitioner’s stockholders, standing alone, does not lend support to petitioner’s argument. There is an indication, it is true, in that agreement that the future earnings of the bank were the contemplated source from which the depositors should be reimbursed for their canceled deposits, and, where such an indication is present in certain situations, the courts have created equitable liens under principles stated in Walker v. Brown, 165 U. S. 654, 664:

The doctrine may be stated in its most general form that every express execu-tory agreement in writing, whereby the contracting party sufficiently indicates an intention to make some particular property, real or personal, or fund, therein described or identified, a security for a debt or other obligation, or whereby the party promises to convey or assign or transfer the property as security, creates an equitable lien upon the property so indicated, which is enforceable against the property in the hands not only of the original contractor, but of his heirs, administrators, executors, voluntary assignees and purchasers or encumbrancers with notice.

See also United States v. Butterworth-Judson Corporation, 267 U. S. 387; Ingersoll v. Coram, 211 U. S. 335, 368.

The present facts do not present a situation appropriate for the application of this doctrine. The contracting parties, the stockholders, are without power to bind the bank’s future earnings, which become petitioner’s property as they arise and remain so until the declaration of dividends. Southern Pacific Co. v. Lowe, 247 U. S. 330; In re Sutherland, 23 Fed. (2d) 595, 599; Central of Georgia Railway Co. v. Central Trust Co. of New York, 135 Ga. 472; 69 S. E. 708.

In the absence of an indication on the part of Congress to use the term “lien” here in some special sense, see Revenue Act of 1938, Conference Committee Report, 75th Cong., 3d sess., H. R. 2330, it must be taken as used in the customary legal sense in which we have considered it. It thus can have no application to the facts present here and the petitioner’s claim under section 3798 of the Internal Revenue Code for immunity from the deficiencies for all the years here involved must be denied.

There remains for disposal the question of whether petitioner is entitled for the year 1936 to deduct, as ordinary and necessary business expense, the sum of $15,897.64 paid to the petitioner’s depositors in partial liquidation of their released deposits. The respondent contends that the petitioner did not pay the sum sought to be deducted, but that such amount was paid by its stockholders.

The stipulation of the parties entered herein states plainly that the petitioner’s stockholders paid the $15,897.64 for which the deduction is sought, and a sample of the check used in making the payments is offered in substantiation. If we stop here, in the absence of further proof as to the source from which the stockholders derived these funds, the petitioner may not have the deduction, since the payments were made by another. New Colonial Ice Co. v. Helvering, 292 U. S. 435; Morris Plan Co. of Binghamton, 26 B. T. A. 772; see section 23 (a) of the Revenue Acts of 1934 and 1936.

It may be assumed that the petitioner furnished the funds for the payments to the depositors; however, the way to the allowance of the deduction is still not clear, since the payment of these funds by petitioner to its stockholders did not in itself constitute payment of the old deposit liabilities but was rather a distribution to petitioner’s stockholders of its earnings and was therefore in the nature of a dividend for which no deduction may be allowed. The present situation does not, so far as we are shown, differ greatly from that presented in Morris Plan Co. of Binghamton, supra, where the taxpayer had been saved from insolvency through advances made to it under a contract by which its stockholders deposited their stock with trustees who were to hold such stock and collect dividends thereon and out of these dividends were to pay off the advances. The taxpayer claimed as a deduction certain amounts paid by it to the trustees and used by them to discharge interest due on the advances. It was held that petitioner’s action did not constitute the payment of interest but merely the distribution of a dividend, for which no deduction may be allowed. So far as the facts in the instant case have been disclosed, they bear close similarity to those in the case cited; in both instances the agreements relative to the payment of the obligations were made not in the name of the taxpayer, but in the names of their stockholders; in neither case did the taxpayer appear as a party to the agreement or assume any obligation thereunder; in both cases the role of the taxpayer was merely to distribute its earnings to its stockholders, without participation in the use to which they were thereafter put. Although in the instant case it does not appear how the amounts in question were distributed to the stockholders, in the absence of evidence on this point it must be assumed that distribution was made through the declaration of a dividend. The similarity between the two cases is thus further confirmed.

In these circumstances it must be held that petitioner is not entitled to the deduction which it claims.

Decision will he entered far respondent.

       SEC. 3798. EXEMPTION OF INSOLVENT BANKS FROM TAX.
      (a) Whenever and after any bank or trust company, a substantial portion of .the business of which consists of receiving deposits and making loans and discounts, has ceased to do business by reason of insolvency or bankruptcy, no tax shall be assessed or collected, or paid into the Treasury of the United States on account of such bank, or trust company, which shall diminish the assets thereof necessary for the full payment of aU its depositors; and such tax shall be abated from such national banks as are found by the Comptroller of Currency to be insolvent; and the Commissioner of Internal Revenue, when the facts shall appear to him, is authorized to remit so much of the said tax against any such insolvent banks or trust companies organized under State law as shall be found to affect the claims of their depositors.
      (b) Whenever any bank or trust company, a substantial portion of the business of which consists of receiving deposits and making loans and discounts, has been released or discharged from its liability to its depositors for any part of their claims against it, and such depositors have accepted, in lieu thereof, a lien upon subsequent earnings of such bank or trust company, or claims against assets segregated by such bank or trust company or against assets transferred from it to an individual or corporate trustee or agent, no tax shall be assessed or collected, or paid into the Treasury of the united States on account of such bank, or trust company, such individual or corporate trustee or such agent, which shall diminish the assets thereof which are available for the payment of such depositor claims and which are necessary for the full payment thereof.
      *******


author: Black:

text:
    Avery R. Schiller and Dorothy C. Schiller, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101380.
    Promulgated February 13, 1941.

      Avery B. Schiller pro se.

      T. G. Iliston, Esq., for the respondent.
   OPINION.

Black:

The Commissioner has determined a deficiency of $470.93 in the income tax liability of the petitioners for the year 1936. This deficiency results principally from the determination by the Commissioner that a gain of petitioners in the taxable year of $3,400 was ordinary income and taxable in full, instead of capital gain taxable only to the extent provided in section 117 of the Revenue Act of 1936, as claimed by petitioners in their income tax return filed for the taxable year. The Commissioner, in his deficiency notice, stated with reference to his adjustment of this particular item as follows:

The Bureau holds that the assignment by you to the Public Service Company of New Hampshire of your right “in and to all dividends”, and the delivery of your stock to the aforesaid company “to be held by it only as collateral to this covenant” does not constitute a sale of such stock, and therefore you would not be entitled to treat the amount received from the Public Service Company of New Hampshire in reimbursement of the loss sustained on this stock and deducted by you in the taxable year 1932 in the amount of $3,400.00 as coming under the provisions of section 117 of the Revenue Act of 1936. The amount of $3,400.00 is therefore 100% taxable in the year 1936 and not subject to the limitations under section 117 of the Revenue Act of 1936.

The petitioners by an appropriate assignment of error contest the foregoing action of the Commissioner. There were other adjustments made by the Commissioner which petitioners do not contest and which are, therefore, not in issue. Apparently petitioners have already paid this latter part of the deficiency.

The facts were stipulated and we adopt the stipulation as our findings of fact and state herein such of the facts as we deem necessary to an understanding of the issue to be decided.

The petitioners are husband and wife and reside at 11T0 Union Street, Manchester, New Hampshire.

The petitioners duly filed a joint income tax return on the cash basis for the calender year 1936 with the collector of internal revenue for the district of New Hampshire, which showed a total tax due of $1,440.18.

The principal occupation of Avery R. Schiller, sometimes hereinafter referred to as petitioner, from 1930 to 1936, inclusive, was that of an executive of the Public Service Co. of New Hampshire, Manchester, New Hampshire, which company is a part of the New England Public Service Co. group. This latter group was during 1929, 1930, and 1931 related to the Middle West Utilities and other systems forming the so-called Insull group. Middle West Utilities organized a holding company known as Associated Employees Investments, Inc., the assets of which were stocks of Middle West Utilities, Insull Utilities Investment Co., and other related companies. The capital of Associated Employees Investments, Inc., was provided in part by employees of the various utility companies who had been solicited to purchase such stock. During the years 1930 and 1931 Avery R. Schiller purchased 140 shares of stock of Associated Employees Investments, Inc., from the Public Service Co. of New Hampshire at a total cost of $3,400.

For the taxable year 1932 Avery It. Schiller claimed as a deduction, in the joint return, his investment in the Associated Employees Investments, Inc., stock in the sum of $3,400. This deduction was claimed on the ground that the said stock was worthless in the taxable year 1932. The Commissioner of Internal Revenue allowed the amount of $3,400 as a loss on worthless stock in computing the petitioners’ taxable income for that year.

In December 1936 the Public Service Co. of New Hampshire addressed a letter to its employees offering to pay to its employees an amount equal to the loss sustained by them on their stock purchases of Associated Employees Investments, Inc., provided the employees would assign to the Public Service Co. of New Hampshire their rights to the dividends, if any, on their stock in Associated Employees Investments, Inc. Avery R. Schiller accepted the offer and received the sum of $3,400 in the taxable year from the Public Service Co. of New Hampshire. A copy of the offer by the Public Service Co. of New Hampshire to its employees under which petitioner received the payment of $3,400 is as follows:

Associated Employees Investments, Inc. was organized in the latter part of 1930, through the Middle West Utilities Company, which at that time controlled the Public Service Company of New Hampshire. At the request of Middle West Utilities Company, the stock of Associated Employees Investments, Inc. was offered to all of the officers and employees of Public Service Company of New Hampshire and its subsidiary companies.
It appeared in 1932 that the stock of Associated Employees Investments, Inc. was probably worthless. The Company is now informed that the stock may now have some slight value, possibly about one dollar per share. Serious attention has been given to the losses suffered by employees of Public Service Company of New Hampshire and its subsidiary companies because of the purchase of the stock of Associated Employees Investments, Inc. with the result that Public Service Company of New Hampshire hereby offers to pay to each employee the amount of his or her loss on the investment made, either directly or through assignment of wages, in stock of Associated Employees Investments, Inc.
Employees are requested to sign the enclosed form of receipt and assignment. This receipt and assignment, together with the certificates for stock of Associated Employees Investments, Inc. should be presented to the company. The certificates of stock should not bo signed in any place. Both the receipts and certificates should be delivered to Thomas L. Skinner, Treasurer of the Company, or to the local Manager. If any employee is unable to produce his certificate, he is requested to explain the circumstances to Mr. Skinner or to the local Manager. It is the intention of the company that arrangements will be made with all employees so that the amount of their losses in the investment in Associated Employees Investments, Inc. may be paid to them.

Petitioner, Avery E. Schiller, upon receipt of the $3,400 in question, made the following assignment to the Public Service Co. of New Hampshire:

Know Am, Men by These Presents, that I, Avery R. Schiller residing at 1170 Union Street, Manchester, N. H., in consideration of the sum paid to me by Public Service Company of New Hampshire, of Manchester, New Hampshire, hereinafter acknowledged, hereby assign to the said Public Service Company of New Hampshire, its successors and assigns, all my right, title or interest, in and to all dividends which may be now due, or which may hereafter become due, either in liquidation or otherwise, on all shares of the capital stock of Associated Employees Investments, Inc., now owned by me, or to which I may in any way be entitled because of any payments made under my subscription or subscriptions therefor.
And I do hereby represent that I have subscribed and paid for 140 shares of said stock and I have also subscribed for 60 other shares of said stock on which I have paid ¡P-and for which certificates were never received.
And I do for myself, my heirs, executors, administrators, and assigns, covenant that if at any time I shall receive any dividends on any of said stock that then, and in that event, I will pay to Public Service Company of New Hampshire, or its successors or assigns, a sum equal to the dividends which I shall have received.
I am delivering, herewith, to Public Service Company of New Hampshire, to be held by it only as collateral to this covenant, all certificates for all shares of the capital stock of Associated Employees Investments, Inc. standing in my name 'except
No exceptions
I acknowledge receipt of $3,400 from Public Service Company of New Hampshire, and in consideration thereof I hereby release and discharge the said Public Service Company of New Hampshire and all its ofiicers, directors, servants and employes from any and all claims, demands and actions, and causes of action, which I may now or hereafter have against them or any of them in respect to or in any way connected with or relating to said shares.

No dividends, liquidating or otherwise, have ever been paid on the stock of Associated Employees Investments, Inc., since 1931.

In schedule C of the petitioners’ return for the taxable year 1936 the petitioners reported this transaction as a sale or exchange subject to the provisions of section 117 of the Revenue Act of 1936 and reported as taxable income therefrom the amount of $1,360.

On the facts which have been stated above, we think the Commissioner must be sustained.

In 1932 petitioner determined that the stock which he owned in Associated Employees Investments, Inc., was worthless and on the joint income tax return which petitioners filed for that year they deducted the full amount of the loss. It was not a capital loss deductible only in part but was an ordinary loss deductible in full. Cf. Mont S. Echols, 24 B. T. A. 1127; affd., 61 Fed. (2d) 191. Respondent treated petitioners’ loss as an ordinary loss and allowed it in full as a deduction on petitioners’ joint income tax return for 1932. In 1936 petitioner was reimbursed in full for the loss suffered in 1932. It has been held that when collections are made upon accounts or bonds previously charged off as bad debts in whole or in part, such amounts when collected represent taxable income. Askin & Marine Co., 26 B. T. A. 409; affd., 66 Fed. (2d) 776; Putnam National Bank, 20 B. T. A. 45; affd., 50 Fed. (2d) 158. Likewise it has been held that taxes deducted in a prior year, where the deduction was allowed, are income to the taxpayer in the year when refunded. See Estate of William H. Block, 39 B. T. A. 338; affd., 111 Fed. (2d) 60, and cases there cited.

Petitioners do not dispute the soundness of the principle announced in the above cases and concede that the $3,400 in question was income when received in 1936, but they contend that it was income from the sale or exchange of capital assets and that the gain therefrom was taxable only to the extent of the percentages provided in section 117 (a) of the Revenue Act of 1936, printed in the margin. It, of course, requires no citation of authorities to support the proposition that, if the $3,400 which petitioner received from the Public Service Co. of New Hampshire in 1936 represented the consideration received from a sale of stock which petitioners made to the Public Service Co., .it would be income received from the sale of capital assets and would be taxable at the rates provided in section 117 (a), supra.

However, we do not think that the facts in the instant case show •that petitioner made a sale of the stock to the Public Service Co. What happened, we think, was substantially this: Petitioner and other employees of the Public Service Co. had been induced to invest •their savings in stock of Associated Employees Investments, Inc., and in 1932 this stock became worthless because of the collapse of the Insull companies. Petitioner took his full loss in that year on his income -tax return and the Commissioner allowed it. The Public Service Co. apparently felt itself under obligation to reimburse petitioner for his loss, and in 1936 it did so, and under the cases above •cited petitioner was under legal obligation to return this $3,400 received in reimbursement as taxable income. Manifestly the Public •Service Co. did not pay this $3,400 as the consideration for a transfer of the title to the stock. The stock had little, if any, value. As a •matter of fact no transfer of the title to the stock has been made from petitioner to the Public Service Co. It is only held by the latter as collateral to the dividend covenant. All that has been •transferred by petitioner to the latter is the right to receive any •dividends paid, liquidating or otherwise, on the Associated Employees ■Investments, Inc., stock. None has ever been paid and, for aught the record shows, none will ever be paid. On this issue we sustain •the respondent.

Decision will be entered wider Rule 50.

       SEC. 117. CAriTAL GAINS AND LOSSES.
      (a) General Rule. — In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be tahen into account in computing net income:
      100 per centum if the capital asset has been held for not more than 1 year;
      80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years;
      60 per centum if the capital asset has been held for more than 2 years but not for more than 5 years:
      40 per centum if the capital asset has been held for more than 5 years but not for more than 10 years;
      30 per centum if the capital asset has been held for more than 10 years.


author: KeRN :

text:
    Cecil B. Highland, Executor, Estate of Virgil L. Highland, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98726.
    Promulgated February 13, 1941.

      L. R. Lynch, Esq., for the petitioner,

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

KeRN :

The petitioner claims the expenses here in question as deductible from the estate’s gross income tmder section 23 (a) of the Xtevenue Acts of 1934 and 1936, as applied to estates under section 162 of the same acts. The respondent has denied them on the ground that they are properly expenses of administering the estate and, therefore, capital in nature, and are not necessary and ordinary expenses incurred in the conduct of a trade or business. The respondent makes six points any one of which, it is said, would prove fatal to petitioner’s contention. They are, (1) that the expenditures were administration expenses; (2) that they were purely an expenditure for the benefit of the legatees; (3) that the estate was not in trade or business during the years in question; (4) that the services for which the fees were paid were given in part for retaining voting control of a business; (5) that they have already been deducted from the gross estate as capital expenditures; and (6) that if any of the payments is not deductible, all must be held so, because no allocation has been made between them.

At the outset of the determination of these various claims for deduction it should be said that the line between expenses chargeable against the estate and deductible from the gross estate in computing the estate tax and those chargeable against income of the estate is, like most of such lines in the law, one which can not be drawn without difficulty and which, therefore, makes difficult generalization of the criteria applicable. In George W. Oldham et al., Executors, 36 B. T. A. 523, this Board had occasion to review many of our earlier decisions and to deduce from them the tests to be applied. Omitting the cases there cited, we quote what we there said, at page 529:

Ordinarily tlie fees and commissions of executors, administrators, attorneys, and other representatives of estates are regarded as administration expenses and are applied against the gross estate in determining the estate tax. Ordinarily such fees and commissions are not allowable as deductions in determining the net income of the estate. * * *
Where, however, such fees or commissions are paid for services rendered exclusively in carrying on the affairs of the estate as a business, rather than in preparing it for settlement and distribution, such payments constitute ordinary and necessary expenses and may be deducted for income tax purposes. * * *
Frequently, the facts of particular cases do not lend themselves to easy determination of the character of such expenses. Most solvent estates, such as the one in the instant ease, are going concerns, producing income; though it be no more than interest from a savings account, a bond or a promissory note, or rent from a farm or dwelling house. The normal and usual activities of the representative of the estate include the collection of such income, the paying of debts and taxes, the making of repairs, the execution of leases, the placing of insurance, in order to prepare the estate for distribution. The fact that such activities also constitute the ordinary incidents of carrying on business does not constitute the expenses thereof expenses which may be charged against income if they are a part of a normal and usual process of administration.
The test most frequently used to distinguish between the two types of expenses is whether the estate has been or is required to be kept intact beyond the period usually necessary for administration. If the process of administration goes forward in normal course, and distribution and settlement are completed within a usual and reasonable time, the expenses of the representatives of the estate are regarded as administration expenses. * * * On the other hand, in cases where, according to the provisions of the will or testamentary trust, it is necessary to continue the estate intact over a period of years, and to carry on its affairs as a business in the interim, the fees and commissions paid to representatives of the estate for such services constitute expenses, deductible for income tax purposes. * * * And where the will went further and, in addition to providing for the creation of a trust to run for a long period of time, provided for the payment to the executors of annual salaries out of the income of the estate, in lieu of fees, commissions, and compensations provided by law, it was held to be apparent that such payments were intended to be applied to the carrying on of a business and were properly chargeable against income. * * *
In distinguishing between the two types of expense, one of the text writers draws the line between “initial expenses” and “current expenses.” Montgomery & Magill, Federal Taxes on Estates, Trusts, Gifts, 1936-1937, p. 39. This suggestion is supported by the decision in Estate of William O. PeeJcham, supra, where the will required that the estate be kept intact for six years, and the action of the Commissioner in allowing as deductions for estate purposes only those executors’ commissions paid during the first three years of administration was held to be reasonable and proper. * * *
It is apparent, upon the facts of the PeelcJiam. case, that the services performed by the executors were no more for one purpose than the other during the two. periods of three years each. In fact, the final services of the executors, in distributing the estate, come within the second period. But- the apportionment made by the Commissioner, although more or less arbitrary, was equitable in its result and consistent with the principle frequently enunciated by the Board concerning expenses of estates kept intact beyond the ordinary administration period.
* sjs tfs * * * its
Another suggested basis for distinguishing between administration expense and income-producing expense, is that of the temporary character of the agent representing the estate and the limited duties which he has to perform. Thus, in Thomas H. Franklin et ail., Executors and Trustees, supra, the Board held that a fee paid to a temporary administrator was for services rendered in producing income from the estate during the taxable year, and hence, was deductible for income tax purposes. Where, as in the FranJolin case, the services of a temporary representative are clearly identifiable as income-producing, rather than as preparing the estate for distribution in normal course, then the expenses of such services should be charged against income. But the mere fact of temporary representation of the estate, without more, is of no importance. In several cases the expenses of temporary representatives have been held to be administration expenses. James D. Bronson et al., Trustees, 7 B. T. A. 127; affd., 32 Fed. (2d) 112; Estate of Caroline R. Rowland, 31 B. T. A. 194, 196.

With, this statement of general principles, we now come to a consideration of the particular deduction first claimed here. The fact -of the expenditures in these suits is not disputed. There were four suits here involved in respect of which attorneys’ fees were claimed, and some narration here of their scope and purpose may be helpful in an understanding of our opinion, even at the risk of needlessly repeating matters set out fully in our findings.

(a) Petitioner paid $3,522 in 1935 and $7,068.03 in 1936 as attorneys’ fees in two suits, similarly styled as Highland et al. v. Empire National Bank of Clarksburg et al., and in contemporaneous creditors’ suits and other proceedings. The first of these suits was decided by the State Supreme Court of Appeals on December 16, 1933, find is reported at 114 W. Va. 473; 172 S. E. 544; the second was decided on December 21, 1933, and is reported at 114 W. Va. 498; 172 S. E. 551. While the facts involved in these suits are related in detail in our findings, they are set out sufficiently fully for our purposes here in the state court’s opinions, which we shall therefore quote from or summarize.

In the first of these suits the purpose was to achieve the appointment of the petitioner, Cecil Highland, as one of the two voting trustees of the common stock of the Clarksburg Publishing Co., a very large proportion of which the estate owned; and later to enjoin the ;acts of Sperry, who was appointed voting trustee by his coexecutor, the Empire National Bank. This suit was successful. The precise point before the state court and the light which its decision throws •on our problem justifies quotation from its opinion (pp. 547, 548) :

* * * However, an examination of these eases, along with the eases that -are presently to be discussed, will disclose that the principle that each of ■several eoexecutors has the power to bind all in so far as the business of the •estate is concerned, is confined to functions arising in the ordinary course of •administration. Where the act under examination exceeds the powers of a personal representative acting in the ordinary course of administration and is not within the powers that could be exercised by such personal representative by reason of his status as such, but, to the contrary, involves an exercise of .judgment and discretion causing it to partake of the nature of the act of a trustee, the courts have almost uniformly held that the power is to be exercised .jointly and not severally. * * *
We believe that it is unmistakably established by tbe reading of the will of Virgil L. Highland that the powers conferred by him upon his executors far ■transcended the ordinary powers required in the administration of an estate. It would serve no real purpose to here specify in detail what they were, but it suffices to say that they were managerial in the highest degree. This will gives the executors the right to carry on the business of testator in all respects “as I ■could or might do if still living.”
As to the specific power of nominating a voting trustee of Clarksburg Publishing Company, we think, too, that that power partakes more of the function of trustee than it does of executors exercising powers essential to the administration of an estate. * * * So that it would be hard to think of & matter further removed from the ordinary duties of executors in the administration of an estate, than the duty to nominate a voting trustee for the Clarksburg Publishing Company.
So much for what can be gathered of the testator’s intention as inferred from the duties conferred upon his executors. * * *

In the second suit the purpose was to remove Sperry and the Empire National Bank as coexecutors. The petitioner, Cecil Highland, had many difficulties in administration of the estate with his coexecutors, which it is unnecessary to relate here, but among other things the coexecutors induced certain creditors of the estate to bring suit, in the defense of which by petitioner further attorneys’ fees were paid. In the second case before it the State Supreme Court of Appeals recited the extensive interest of the decedent in the Clarksburg Publishing Co., which published two daily newspapers; and the provisions of decedent’s will which directed his “executor and trustee to carry on any business or financial affairs in which I may be interested, individually, or with others, at the time of my death, as fully, and to the same extent, as I could or might do if still living * * and the further direction respecting payments to his widow and children; and the court upheld petitioner’s petition to appoint new trustees, stating its conclusion in part as follows (at page 553) :

The powers thus conferred being in the nature of a trust, as we have held in the companion case similarly styled, must be exercised jointly. 11 It. O. L. 491.

(b) The third suit in question was brought by petitioner as executor against J. Hornor Davis (Highland v. Davis (W. Va.), 6 S. E. (2d) 922) and involved the expenditure by petitioner in 1935 of $1,000 and in 1936 of $4,750 in attorneys’ fees. In that case the Supreme Court of Appeals of West Virginia reaffirmed its decision in Highland v. Davis, 119 W. Va. 501; 195 S. E. 604, and reversed and remanded the case again to the trial court. The proceeding before the trial court was apparently still pending at the time briefs were filed in the instant tax proceeding. It appears that the purpose of this suit was the cancellation of a sale by Davis in 1935 of a block of common stock of the Clarksburg Publishing Co. which had been pledged by decedent to secure a note and had been repledged by his executors to secure a balance unpaid at his death. See the second Davis case at page 922. The ground alleged was fraud in the valuation and price paid by Davis for the note and pledged stock, which was bought without notice to petitioner. The appellate court “ascertained that there was no fraud independent of price”, and remanded, as already stated, the case to the trial court for determination of this question.

(c) The petitioner paid out of the income of the estate $800 in 1935 and $303.75 in 1936 as attorneys’ fees in the suit of E. A. Bowers against petitioner. Bowers sued for $8,500, but got only about $6,000 as counsels’ fees in prosecution for petitioner of the two cases discussed, supra, under (a). The attorneys’ fees here involved were incurred by petitioner, therefore, in attempting to reduce the cost of litigation.

(d) One more expenditure for attorneys’ fees falls under this heading — petitioner’s payment of $251.25 in 1936 in settling for about $10,000 the claim of Lillie Denham against the estate for about $17,000. The suit arose out of certain payments made by decedent as administrator of Denham’s estate which it was held should have been paid to the widow. The widow thereupon brought suit.

This concludes this group of deductions. It will be observed that since they differ materially in nature the same rule will not cover each of them.

(a) In the first of the two suits subsumed under this head, the purpose of the suit was to have a voting trustee appointed for certain stock of the Clarksburg Publishing Co., in which the decedent was heavily interested. This was obviously a matter connected with the carrying on of the business of the estate and not with its liquidation. The Publishing Co. published two daily newspapers, and the terms of decedent’s will on this point, fully set out in our findings, obviously contemplate the carrying on of this business by his executors, who were also made testamentary trustees for the purpose. The second suit, we think, falls in the same category. There the petitioner sued to have his coexecutors removed in order to protect and maintain the business enterprises of the estate, including the Publishing Co. The expense of defending creditors’ suits arose out of the same difficulties between the executors. We think that in both these cases, as the State Supreme Court of Appeals thought, the questions involved in the suits were the management of the estate’s assets as a business, and that the executors-trustees were, therefore, acting with full discretion as trustees rather than as executors. It follows, therefore, under the principles which, we laid down at the beginning of this opinion, that attorneys’ fees incurred in those suits were incurred in carrying on a business, and are, therefore, deductible from gross income.

The cases of Higgins v. Commissioner, 111 Fed. (2d) 795; Miller v. Commissioner, 102 Fed. (2d) 476; City Bank Farmers Trust Co., Trustee v. Commissioner, 112 Fed. (2d) 457; and George Vanderbilt Trust, 36 B. T. A. 967, cited and relied upon by respondent, may easily be distinguished on their facts from the instant proceeding. Here the petitioner was directed by decedent’s will to carry on his business and financial affairs, and the evidence shows that petitioner was actively engaged during the taxable years in carrying on the business enterprises in which the estate was interested. Clearly the petitioner was not in the role of a passive investor or mere conservator of property. See Pyne v. United States (Ct. Cls.) 35 Fed. Supp. 81; Marjorie Fleming Lloyd-Smith, 40 B. T. A. 214.

(b) The suit of Highland v. Davis, brought by petitioner, related also to the stock of the Clarksburg Publishing Co. It was twice brought before the Supreme Court of Appeals for West Yirginia, and is still pending, apparently, after reversal and remanding, in that court. Here the suit had nothing to do with management of the Publishing Co., however, but -was solely to set aside a sale of the stock held by the estate which had been pledged and sold under the pledge for a price considerably below what petitioner as an executor claimed to be the fair market value and without prior notice to him of the sale. The purpose of the suit or suits, in other words, would seem to have been to conserve assets of the estate, which is the duty of an executor in the administration and liquidation of the estate. Such a purpose has nothing to do with managerial administration of the estate as a going concern. We think, therefore, that the attorneys’ fees so incurred should have been charged to the estate and not to its income, and are not properly deductible from its gross income.

(c) The suit against petitioner brought by one Bowers, who had acted as petitioner’s counsel in the two suits covered under (a) above, had as its object the recovery of larger counsels’ fees in those cases than petitioner thought reasonable. Do petitioner’s attorneys’ fees paid in order to reduce attorneys’ fees in those two suits, which were instituted to protect business enterprises forming a part of decedent’s testamentary trust, fall into a different category from the fees there involved? Had Bowers’ claimed fee been paid, all of it would have been deductible under our'holding above. Do fees paid to reduce that fee retain the character of a testamentary trust carrying on business, or are they simply expenses to conserve assets of the estate and as such chargeable against the estate? The question is a close one, but we are of the opinion that these fees are deductible from gross income. The purpose of the litigation and its effect at as to conserve the estate’s assets, or, put another Avay, to save the estate a greater expense than was thought necessary, but the estate became involved in the litigation in the first place only because it was trying to manage certain voting stock of the publishing company in order to carry out the trustee’s intentions, and not through the process of administering the estate for liquidation or distribution. We think the business character of the primary suits, in other words, affects the character of this suit, and that the latter’s cost, therefore, is deductible from gross income.

(d) The cause of action in Denham’s suit arose out of acts done by the decedent in his lifetime. The claim was compromised, and the attorneys’ fees were paid in the suit which resulted in this compromise. The claimant’s right was against the decedent for his acts as executor of her husband and her claim on decedent’s death was, therefore, against his estate. We think that clearly in these circumstances the expense was chargeable against the estate and was not deductible from its gross income in the taxable year.

Petitioner paid $1,160.79 in 1935 and $203.50 in 1936 as miscellaneous expenses such as stenographic work in the two suits already discussed of Highland v. Empire National Bank and Highland v. Davis. In accordance Avith our holdings above on attorneys’ fees in these suits, we allow only such expenses as were incurred in the Empire National Bank suit, which were $674.74 for 1935, none being claimed for 1936. The rest we disalloAV.

Petitioner paid $1,164.15 in 1935 and $1,274.44 in 1936 as office expenses such as collecting rents, bookkeeping, correspondence, and general supervision of the estate’s property. He claims two-thirds of this sum, or $776.10 and $849.62 for the respective years, as a fair share attributable to the business of the estate. With the estate’s large interests there would seem to be no reason why such expenses would not constitute reasonable deductions, and although the respondent does challenge the allocation here made, it is obvious that precise allocation would be impossible, and the allocation made, although a rough approximation, seems on the testimony reasonable. We, therefore, alloAV the deductions claimed.

Finally, petitioner as executor paid to himself in his private capacity $117.13 in 1936 as reimbursement of certain small expenses incurred in the course of the litigation. No segregation is made of them and they must, therefore, be disallowed.

It may be added that all the disbursements in issue were duly reported by petitioner as executor in 1935 and 1936 to the commissioner of accounts of the state having jurisdiction and were duly confirmed by the commissioner and by the county court. Their payment is not, therefore, questioned, but only the effect in tax law of the purpose for which the suits in question were instituted or defended.

One or two questions raised by the respondent of minor import remain to be disposed of. We need add nothing to what has already been said in discussing the state court’s opinion in petitioner’s suit to remove his coexecutors in answer to the respondent’s contentiqn that such a suit had no relation to the income of the trust beyond pointing out that a business trust was contemplated by the will to manage decedent’s “going concern” property as well as to distribute it in due course to his beneficiaries, and that conservation of the trust’s assets was as much the duty of the trustees as producing income. See our discussion of a similar objection in Florence Grandin, 16 B. T. A. 515, 517. Nor do we think, for reasons already given, that the circumstances involved here are comparable to those in Crowley v. Commissioner, 89 Fed. (2d) 715 (6th Cir.), on which respondent relies. Furthermore, respondent’s contention that the suits for the removal of the two other executors and testamentary trustees were brought by the widow and children of decedent for their own benefit, and that petitioner was a party plaintiff merely fro forma and only in his personal capacity, is not borne out by the record. The facts are that petitioner as executor brought the suits in which the decedent’s widow and children were joined with him as parties plaintiff, and as such executor he paid the fees of the attorneys employed in regard thereto. The payment of such fees by him as executor was approved by the state court under whose jurisdiction the estate and testamentary trust were being administered.

Finally, it is suggested by respondent that the deductions claimed from 1935 and 1936 income here had already been claimed and allowed to the executors as deductions from the estate tax. Petitioner does not deny this, but points out that under our decision in Robert J. Kleberg et al., Executors, 31 B. T. A. 95, that fact is immaterial, if the deductions now claimed would have been otherwise properly deductible from the estate’s gross income. The Commissioner acquiesced in our decision in that case, in which we said at page 100:

* * * If an item is properly deductible under some provision of the estate tax law in determining the net estate subject to the tax, and the same item is also deductible under a provision of the income tax law in determining the net income of the estate subject to income tax, that fact does not militate against the allowance in either levy.

This case is concerned with deductions, as was the Kleberg case, and we know of no authorities to the effect that with regard to deductions the income tax and the estate tax must be read in fari materia.

No facts have been presented here which would support the doctrine of equitable recoupment, nor is that doctrine argued or even referred to by respondent.

Since no equitable ground such as equitable recoupment or the statutory impossibility of correction of the estate tax is shown to exist, we decide this issue in favor of petitioner on the authority of Kleberg's case.

Decision will be entered under Rule 50.


author: Van Fossan:

text:
    Estate of Charles H. Franklin, Deceased, Grace B. Franklin, Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101482.
    Promulgated February 13, 1941.

      John O. Evans, Esq., for the petitioner.

      P. M. Clark, Esq., for the respondent.

       SEC. 162. NET INCOME.
      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.

   OPINION.

Van Fossan:

The petitioner contends that the widow’s allowance paid by her as executrix of her husband’s estate to herself as his widow, out of income, pursuant to a probate court order, constitutes a deduction from income allowable under the provisions of section 162 (c) of the Kevenue Act of 1936. The respondent’s position is that such payment was a charge against the corpus of the estate and hence is not deductible.

It may be noted that although the amended court order directed a payment out of income, the facts do not reveal any practical substantiation of such fact. All receipts, either of principal or of income, were commingled in one common bank account. No allocation, identification or earmarking was made on the books. In view of other more basic considerations, however, we place no emphasis on this fact.

Section 15,553 of the Compiled Laws of the State of Michigan, 1929, as amended, is as follows:

Debts oí testator and family expenses; liability of estate; allowance for widow. See. 22. All the estate of the testator, real and personal, shall be liable to be disposed of for the payment of his debts, and the expenses of administering his estate, and the probate court may make such reasonable allowance as may be judged necessary for the expenses of the maintenance of the widow and minor children, or either, constituting the family of the testator, out of his estate, during the progress of the settlement of the estate, but never for a longer period than until their shares in the estate shall be assigned to them, nor for more than one (1) year in an insolvent estate. (Section 27.2653, Michigan Statutes Annotated.)

The case of Title Insurance & Trust Co., Executor, 25 B. T. A. 805, involving the California statutes, presented a situation essentially the same as the one now before us. The applicable sections of such statutes provided that if the property set apart were insufficient for the support of the widow or children, the court must take such reasonable allowance out of the estate as should be necessary for the maintenance of the family during the progress of the settlement of the estate. In that case we said:

There is no mention made in the statutes of income of the estate of the decedent.
The granting of family allowance is not dependent on the existence of income of the estate, but the statute (§1466), in certain instances and for a limited period, authorizes the proper court or a judge thereof to make such reasonable allowance “out of the estate” as shall be necessary for the maintenance of the family, according to their circumstances, during the progress of the settlement of the estate, although the estate may be insolvent.
The right of the widow to a family allowance is purely statutory. In re Welch’s Estate, 106 Cal. 427; 39 Pac. 805; In re McSwain’s Estate, 176 Cal. 280; 168 Pac. 117; Hills v. Superior Court in and for Los Angeles County, 207 Cal. 666; 279 Pac. 805.
The widow’s allowance is in the nature of a part of the cost of administration. 24 C. J. 230, 231 and note 98 on page 231, citing Deeble v. Alerton, 58 Col. 166; 143 Pac. 1096; Wilson v. Wilson, 55 Col. 70; 132 Pac. 67. It is not a claim or demand which must be presented in due form of law to the executor or administrator of the estate, but is an expense of administration. In re Cutting, 174 Cal. 104; 161 Pac. 1137.
In determining the value of the net estate subject to estate tax, section 403 of the Revenue Act of 1921 and the corresponding section 303 of the Revenue Act of 1924, allow as a deduction from the corpus of the estate administration expenses, claims against the estate and such amounts reasonably required and expended for the support during the settlement of the estate of those dependent upon the decedent as are allowed by the laws of the jurisdiction under which the estate is being administered.

In McKana v. Englund, 265 Mich. 214; 251 N. W. 308, the court held that the widow’s allowance (authorized by section 15,553) is a statutory provision pertaining to the administration of the estate, intended for her support and maintenance during the progress of administration. See Charles Lesley Ames, 14 B. T. A. 1061; affd., 49 Fed. (2d) 853.

We conclude, therefore, that the payment of a widow’s allowance is a cost of and attaches to the administration and settlement of the estate, irrespective of the source from which it came.

The petitioner argues that the estate of a decedent includes both its corpus and the current income therefrom. This is undoubtedly true, but since the income is a part of the estate and the widow’s allowance is an expense of its proper administration, such allowance is, under the statute, a charge against the entire estate and not against the income only. The fact that a probate court, by an amended order, directed payment from income does not alter the inherent character of the allowance. Mrs. Franklin received the “widow’s allowance” not as a legatee, heir, or beneficiary of the estate, but as the widow of the deceased and by virtue of the statute. As costs of administration, the payments in question were properly deductible in computing the Federal estate tax and, as the respondent represents, were so deducted. They do not, however, come within the deductions from income allowed by the statute.

The petitioner argues further that, if the widow’s allowance is a charge against the corpus, Mrs. Franklin received only that to which she was entitled under the terms of the decedent’s will and that thus the facts bring the case within the contemplation of the statute.

We are not impressed with this argument. We are dealing with an income tax case. Mrs. Franklin appears in three capacities — as executrix (the petitioner), as beneficiary under the will, and as widow. The estate was unsettled during the taxable years. No distribution of any kind had been made to Mrs. Franklin as a beneficiary. The allowances in question were payable and paid to her as widow, regardless of any provisions of the will -or any agreement to the contrary, and it was wholly within the discretion of the court to determine the amount thereof, if any. See Montgomery v. Trombley, 276 Mich. 439; 267 N. W. 648.

It is beside the point to argue that Mrs. Franklin might have been paid as a beneficiary all sums needed and deemed by her proper for her support. The fact is that she was paid nothing pursuant to the directions of the will, but she did receive $26,000 each year solely as a widow’s allowance granted in strict accord with statutory requirements.

Decision will be entered for the respondent.


author: Opper:

text:
    Kennedy Mining and Milling Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99507.
    Promulgated February 14, 1941.

      Henry D. Oostigan, Esg., for the petitioner.

      Harry B. Horrow, Esg., for the respondent.
   OPINION.

Opper:

Petitioner since prior to March 1, 1913, has been the proprietor and operator of a gold mine. For many years antecedent to 1932 its practice had been to accumulate the tailings or refuse consequent upon its! extraction process in a surface deposit. During the two taxable years which confront us, an improved metallurgical process was being applied to the accumulated tailings with a consequent addition to petitioner’s gross and net income. Prior to 1934 petitioner had claimed depletion deductions on the unit basis but in that year elected percentage depletion, which was the method used by it for computing deductions in the instant taxable years. The issue, said to be one of first impression, is whether under such circumstances, within the provisions of the Eevenue Acts of 1934 and 1936, section 114 (b) (4) , depletion based upon the income so received by petitioner from the sale of mineral from the tailings deposit may be deducted by it.

In order to test the scope of respondent’s grounds for rejection of the depletion allowance, we shall first assume contrary to what is shown that petitioner’s method of deducting depletion, from its inception, was the percentage method. Such a deduction involves the prerequisites not only of a depletable asset and its exhaustion but of the existence of income therefrom; and the amount of the depletion is computed in the first instance and limited in the second by the size of the gross income from the property and of the taxpayer’s net income therefrom, respectively. Thus if, d,ue to petitioner’s methods of operation, either the gross proceeds or the net income, or both, were a smaller sum in any year, its depletion allowable in that year would have been proportionally reduced. And it is recognized by both parties that the mere extraction and actual depletion of mineral property does not either entitle the owner to depletion at that time nor prevent him from benefiting by it later when the ultimate step — recovery of income from the property — is taken. Inspiration Consolidated Copper Co., 11 B. T. A. 1425; National Petroleum c& Refining Co., 28 B. T. A. 569. It seems to us necessarily to follow that this would be so whether the process of extraction were completed but the product resulting remained undisposed of until later years; or, as occurred in petitioner’s case, the process of extraction fell into two steps, was partially completed and brought about partial sales in one year, and the postponed and refined process of extraction made possible further sales in a subsequent year.

If this would have been the case and if petitioner would be entitled to the depletion claimed, had it taken percentage depletion from the beginning, it would appear that respondent’s objection limits itself to two considerations which are the result of the change in petitioner’s claim of depletion occurring in the year prior to those before us. These considerations are, first, that by this change from unit to percentage depletion, petitioner will obtain a benefit which it could not have had, had it remained on the unit basis; and, second, that such a procedure might in some other case permit the recovery by a taxpayer of more than his investment or other depletable basis. The first consideration seems to us to be irrelevant, for in granting to taxpayers the privilege of electing the method of depletion to be adopted, which Congress conferred by the 1984 Act, no condition was imposed preventing the exercise of the election for any such reason as that it constituted a change from a previous method, or that it would offer a greater benefit than would otherwise exist. It was to be assumed that taxpayers would elect that method which would effect the most beneficial deduction; and respondent himself does not extract from the legislation any comparable condition of consistency. Regulations 86 and 94, art. 28 (m)-5. If, therefore, petitioner’s change to> the percentage basis was required in order to confer upon it the- benefit it here seeks, that would still fall short of any inhibition against its use of the method selected.

Nor does the second consideration appear to us to be more persuasive. It has been recognized without qualification that percentage depletion has no relation to cost, value, or recoverable basis. See, e. g., I. T. 2327, VI-1 C. B. 18. While broadly and generally designed to permit a taxpayer to recoup by way of depletion its investment in mineral property, percentage depletion is concerned only with and calculable only by the income received in the year in which the depletion is claimed. It can not but be evident that such a computation will have no specific connection with amounts which any taxpayer has actually invested or might otherwise be able to recover from the capital value of mining property. See Commissioner v. Elliott Petroleum Corporation (C. C. A., 9th Cir.), 82 Fed. (2d) 193. To say, therefore, as respondent does, that this allowance must be rejected because theoretically it might return an amount greater than the figure originally adopted for the mineral content of the ore from which the tailings emerged would appear to be a fallacious conclusion based upon a premise which may or may not be true, but in either event is immaterial. Even this, however, is a length to which we need not extend the present opinion, since under the record before us it appears to be conceded that this petitioner, granting it the allowances claimed, will still fall short of recovering the originally computed basis.

Nor is it of any greater consequence that some of the tailings may have been the residue of ores removed from the mine at a time when no percentage depletion was allowable to petitioner. For the time of receipt of the income determines not only the year for which percentage depletion is to be deducted, but the currently applicable law which is to be invoked. Crews v. Commissioner (C. C. A., 10th Cir.), 89 Fed. (2d) 412; National Petroleum & Refining Co., supra.

We are of the opinion, therefore, that under the percentage system petitioner did not exhaust its right to depletion with respect to any of the product of its mine until all of the income from that product had been received; that it was entitled to compute that depletion upon the gross and net income from the property, including such amounts as it received in later years through improvements in the process of extracting ores, all of which were the product of its own mining property ; and that the facts that such a result could not be reached under the unit or some other method and that petitioner’s adoption of the method which does permit the deduction was a change from its previous method are immaterial. Both are options freely granted by Congress. If they inequitably discriminate in favor of owners of mineral properties, that is a situation which only Congress can remedy.

For reasons which will now appear to be obvious, cases cited by respondent are inapplicable. In Atlas Milling Co. v. Jones (C. C. A., 10th Cir.), 115 Fed. (2d) 61, both the District Court, 29 Fed. Supp. 942, and the Circuit Court of Appeals emphasized that they did not purport to pass upon a situation where the tailings deposit remained the property, and the income therefrom remained the income, of the owner of the mine from which they had originally been extracted. Granting that a tailings deposit is not a mine as the court there held, it does not follow, of course, that its contents are not the product of the mining property, that minerals extracted therefrom did not have their origin in the mine, or, as respondent argues, that income from the sale of such minerals when ultimately recovered is not income from the mining property. See also Carl M. Britt, 43 B. T. A. 254.

The difficulty in the Atlas and Britt cases, that the taxpayer there was not the owner of the mining property and hence had had no original depletable interest in the minerals in place, can not disturb us here. Helvering v. Bankline Oil Co., 303 U. S. 362; Helvering v. Elbe Oil Land, Development Co., 303 U. S. 372; Darby-Lynde Co. v. Alexander (C. C. A., 10th Cir.), 51 Fed. (2d) 56; certiorari denied, 284 U. S. 666; Palmer v. Bender, 287 U. S. 551; and Consumers Natural Gas Co., 30 B. T. A. 1263; affd. (C. C. A., 2d Cir.), 78 Fed. (2d) 161; certiorari denied, 296 U. S. 634, are inapposite for a similar reason. The economic interest of this petitioner in the tailings and in the minerals to be extracted therefrom was identical with the interest it had maintained through its ownership of the mine from beginning to end of the extractive process; and when it finally received the proceeds of the minerals contained in the tailings it received income from the contents of the mine to exactly the same extent as the income it had previously received from the earlier and more rudimentary refining process. It follows that respondent’s disallowance of petitioner’s claim was error and should be reversed.

Decision will be entered under Rule 50.

       SBC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
      * * * * * * *
      (b) Basis foe Depletion.—
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      (4) Percentage depletion for coal and metal mines and sulphur. — The allowance for depletion under section 23 (m) shall be, in the case of coal mines, 3 per centum, in the case of metal mines, 15 per centum, and, in the case of sulphur mines or deposits, 23 per centum, of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property. * * *

       SBC. 114. BASIS BOR DEPRECIATION AND DEPLETION.
      *******
      (b) Basis Fern depletion.—
      *******
      (4) Percentage depletion for coal and metal mines and sulphur. — * * * A taxpayer mating his first return under this title in respect of a property shall state whether he elects to have the depletion allowance for such property for the taxable year for which the return is made computed with or without regard to percentage depletion, and the depletion allowance in respect of such property for such year shall be computed according to the election thus made. * * *■