author: ARUndell:

text:
    Estate of Nellie L. Rhodes, Deceased, Carey W. Rhodes, Former Executor and Sole Beneficiary and Distributee of Said Estate, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106944.
    Promulgated August 29, 1941.

      Samuel H. Rome, Esq., for the petitioner.

      E. M. Woolf, Esq., for the respondent.
   OPINION.

ARUndell:

This proceeding is before us on the motion of counsel for the respondent to dismiss for lack of jurisdiction. The motion was originally based on failure of the petitioner to allege his exec-utorship and improper verification. These defects were cured by the filing of an amended petition at the hearing. Counsel for the respondent thereupon moved to dismiss on the ground that Rhodes, who signed the petition, having been discharged as executor, has now no authority to represent the estate.

Nellie L. Rhodes died testate on February 22, 1936. Carey W. Rhodes, the surviving husband, was appointed executor and is the sole beneficiary under the decedent’s will and the sole distributee of her estate. He filed with the collector for the first district of Illinois a joint income tax return for the period January 1 to February 22, 1936. As executor he filed with the same collector an income tax return for the estate of the decedent for the period February 22 to December 31, 1936. He filed with the respondent a formal notice of fiduciary relationship under section 312 (a) of the Revenue Act of 1936. He stated therein that he was the duly qualified and acting executor of the estate of the decedent and that the notice was being given with respect to any income tax imposed by the Revenue Act of 1936 or any prior acts, and specifically as to the income tax liability of the estate for the taxable year ended December 31, 1936.

Carey W. Rhodes completed administration of the decedent’s estate and was discharged as executor on October 16,1939. He did not give the respondent notice of the termination of his fiduciary capacity.

The deficiency notice, dated January 18,1941, and pertaining to income tax liability of the decedent for the year ended December 31, 1936, was addressed to: “Estate of Nellie L. Rhodes, Deceased, Mr. Carey W. Rhodes, Executor, 160 North La .Salle Street, Chicago, Illinois.” The amended petition now before us was captioned the same as this opinion.

The respondent bases his motion to dismiss on the case of Estate of Joseph B. Dabney, 40 B. T. A. 216. The petitioner’s resistance to the motion rests on section 312 of the Revenue Act of 1936, which provides:

(a) FTduciart of Taxpaxee.—Upon notice to the Commissioner that any person is acting in a fiduciary capacity such fiduciary shall assume the powers, rights, duties, and privileges of the taxpayer in respect of a tax imposed by this title (except as otherwise specifically provided and except that the tax shall be collected from the estate of the taxpayer), until notice is given that the fiduciary capacity has terminated.
⅜ * * * * * *
(c) Manner of Notice.—Notice under subsection (a) or (b) shall be given in accordance with regulations prescribed by the Commissioner with the approval of the Secretary.

The Dabney case, supra, involved similar facts in that a petition was filed by a discharged executor. That case arose in a state where, as in Illinois, an executor upon discharge becomes fumctus officio in so far as local law is concerned. Hulburd v. Commissioner, 296 U. S. 300. But in the Dabney case, while mention was made of section 281 (b) of the 1926 Act, which is the same as section 312 (a) of the 1936 Act, there was no argument on or discussion of the effect of the imposition of continuing liabilities and duties. It was not shown in that case whether or not the former executor had notified the Commissioner of his discharge. Consequently, the Dabney case differs on the facts. The opinion does not reach the point urged by the petitioner in this proceeding, and is not controlling authority if section 312 has the effect claimed by the petitioner. ■ , .

Section 312 of the Revenue Act of 1928, which is like the section we are considering, has been judicially construed in Sanborn v. Commissioner, 108 Fed. (2d) 311, affirming 39 B. T. A. 721. There, as here, the fiduciaries failed to give the Commissioner notice of discharge and, after discharge, prosecuted a proceeding before this Board. When the Commissioner sought to enforce a transferee liability against the former executrix she resisted on the ground that the fiduciary proceeding before the Board was a nullity because of lack of jurisdiction and that therefore the statute of limitations had intervened to bar transferee liability. The Circuit Court, after quoting the statute, called attention to the provisions of the Commissioner’s regulations which, under both the 1928 and 1936 Acts, provide that “when the fiduciary capacity has terminated, the fiduciary in-order to be relieved of any further duty or liability as such, must file with the Commissioner written notice that the fiduciary capacity has terminated as to him accompanied by satisfactory evidence of the termination of the fiduciary capacity”, art. 1241, Regulations 74; art. 312-1, Regulations 94. The court concluded that there was no merit in the claim of lack of jurisdiction and said:

* * * Since the executors never gave the notice required by Section 312 (a) and (c) to divest themselves of the powers and duties of the taxpayer with respect to the tax, they were clothed with such powers and duties at all times during the pendency of the proceeding initiated by them before the Board and thereafter. The statute clearly provides for the continuation of the powers and duties of a fiduciary with respect to a tax until á specified notice is given. It does not provide that notice of termination of fiduciary capacity contained in a petition filed with the Board shall be deemed the equivalent of the statutory notice. It does not authorize the Commissioner to waive the statutory notice. His admission that a fiduciary has been discharged is not an admission that the statutory responsibility of that fiduciary with respect to a tax has been terminated.

In Tooley v. Commissioner, 121 Fed. (2d) 350; (reversing 42 B. T. A. 977, on another point), the transferee raised a jurisdictional question similar to that in Sanborn’s case, supra. The former executor, Dollar, had notified the Commissioner of his fiduciary capacity, but not of its termination. The court held:

* * ■ * Dollar’s fiduciary capacity and power to conduct the proceeding before the Board therefore continued during that proceeding. The fact that he recited in his petition before the Board that he was no longer executor of Mr. Botts’ will was not the notice to the Commissioner' required by the statute and the regulation. * * *

The quoted Circuit Court cases require a holding in this case that the former executor’is the proper person to file a petition for redeter-mination based upon a notice of deficiency directed to him in his fiduciary capacity. The facts herein are such that there were continuing liabilities and duties upon Rhodes, including the right of petition to the Board. Accordingly, the respondent’s motion to dismiss will be denied.

Order will be entered denying motion to dismiss.


source: Caselaw Access Project

author: Disney,

license: Public Domain

text:
    Quintana Petroleum Company.

    Docket Nos. 100314-100321.
    Promulgated June 5, 1941.

       Opinion, See p. 624.

   Disney,

dissenting: I cannot agree with the conclusion reached by the majority as expressed in the first paragraph of the headnote, holding that a portion of the net proceeds from the operation of an oil and gas lease paid in accordance with the terms of the assignment requiring the assignee to pay the assignor one-fourth of the proceeds from operation, constitutes a capital expenditure and not a legal deduction from gross income. In Galatoire Bros. v. Lines, 23 Fed. (2d) 676, it was held by the Circuit Court of Appeals for the Fifth Circuit that payments comprising 50 percent of the profits of a business, under the terms of a lease, were paid for the use of rented premises for the entire term of the lease and must be prorated throughout the entire term and allowed as deductible expenses in accordance with the proration. I cannot distinguish that case, in principle, from the present proceeding and in my opinion the payment of a portion of the net profits was properly considered and reported by the petitioner as payment of rentals, for which deduction should be allowed.

Nor can I believe that section 114 (b) (3) of the Revenue Act of 1936 and Regulations 94, article 23 (m)-l (g) should be interpreted as the respondent has done. The statute, specifying the percentage of depletion to be allowed, refers to and bases same upon “the gross income from the property during the tamable year” [Italics supplied.] I think a fair interpretation of the remainder of the sentence, as to exclusion from gross income of rents or royalties paid or incurred, requires that the expression “during the taxable year” be inferred and understood to follow and modify “gross income” just as it does earlier in the sentence—in other words, that" only rents and royalties paid or incurred (by the taxpayer in respect to the property) durimg the taxable year should be excluded from gross'income in computing the 27½ percent depletion. The history of this subject indicates to me that Congress intended to simplify a previously difficult matter by allowing computation to be made only upon what was done during the taxable year, and not to complicate it by requiring consideration' of other matters such as bonus payments paid in acquiring a lease in an earlier year, necessitating allocation and apportionment as contended by the respondent. I think a more practicable, working rule was intended and that the petitioner’s view should be sustained. I therefore dissent.


author: ARNold:

text:
    Lamm Lumber Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102774.
    Promulgated September 3, 1941.

      Charles E. McCulloch, Esq., Thomas B. Stoel, Jr., Esq., and H. Edwin Nowell, C. P. A., for the petitioner.

      B. M. Coon, Esq., for the respondent.
   ARNold:

This proceeding involves an income tax deficiency of $16,558.93 for the year 1936, of which $6,953.37 is normal tax and $9,605.56' is surtax on undistributed profits. Petitioner reported a net loss for the calendar year, but respondent, by virtue of various adjustments, determined a net income of $54,089.16. Petitioner challenges respondent’s determination in the following particulars: (1) The inclusion in 1936 gross income of $20,000 representing income received as damages for breach of contract; (2) the disallowance of $14,000.04 as salary to petitioner’s president; (3) the disallowance of $28,130.50 representing depletion or amortization of a $200,000 deposit allegedly paid in connection with the acquisition of the right to cut cex’tain timber; and (4) the proposed assessment of a surtax on undistributed profits. The facts and opinion with respect to each issue will be treated separately.

FINDINGS OP PACT.

Petitioner is an Oregon corporation, with its principal place of .business at Modoc Point, Klamath County, Oregon. At all times material hereto it was engaged in the logging and lumber manufacturing business. Its facilities were sufficient for a complete operation and consisted of a logging railroad, complete logging equipment, a sawmill plant, including kilns, a planing mill, and the townsite at Modoc Point. Wilfred E. Lamm has been president and manager of petitioner since its organization. Petitioner filed its income tax return for 1936 with the collector of internal revenue for the district of Oregon. Its books were kept and its return filed on the accrual basis.

Issue 1.

FACTS.

In December 1929 the Kesterson Lumber Co., sometimes referred to herein as the Lumber Co., contracted with petitioner for the shipment of logs over petitioner’s railroad. Prior to November 1934 the Lumber Co. defahlted on its contract and on November 5, 1934, petitioner filed suit in the Circuit Court of the State of Oregon for the County of Klamath for $375,000 damages.

Pursuant to notice the creditors of the Lumber Co. held a meeting on October 24, 1935, for the purpose of considering petitioner’s claim for damages. At this meeting the creditors agreed to a proposal which had resulted from negotiations between the parties litigant that the suit be settled by the Lumber Co. transferring certain items of equipment to the petitioner. Following the creditors’ meeting and under date of October 25, 1935, petitioner’s counsel received the following letter from counsel for the Lumber Co.:

The Kesterson creditors hare authorized me to settle the Lamm claim on Lamm’s terms, with a slight modification. They are willing that he should have the jammer, and I believe he wanted some cats and atheys. They are willing to give him three cats and atheys in addition to the -jammer. They feel that turning over more cats and atheys would cripple the Kesterson operation unduly.
It will be necessary to get confirmation from the home offices of several of the creditors. I will prepare a written form of consent to be circulated among the creditors as soon as you advise me whether this proposal is acceptable.
* * * * * . # *
Please tell Mr. Lamm that the Southern Pacific attorney who attended the meeting said that Southern Pacific would like the Kesterson ties on the Long-Bell Unit to go with the steel. He didn’t think this would make any practical difference to Lamm, because of course Southern Pacific would grant Lamm the use of the ties.

Pursuant to their understanding the parties litigant filed the following stipulation, dated October 29, 1935, with the Circuit Court:

Whereas, the plaintiff and defendant have reached an agreement of settlement in the above entitled cause; and,
Wheeeas, there are certain acts yet to be performed on the part of the defendant in performing said agreement;
Thehefobe, It Is Heeeby Stipulated by and between L. Orth Sisemore, of attorneys for defendant, and Wm. Kuykendall, of attorneys for plaintiff, that the above entitled cause be continued until the performance of said agreement above mentioned, the above entitled cause to be dismissed upon the performance of said agreement.

On October 29,1935, the court continued the case in order “to give the defendant an opportunity to perform the, terms and conditions of the above mentioned agreement.”

The value of the equipment that petitioner received under the agreement of settlement was $20,000. The equipment consisted of one McGiffert log loader, or jammer, three caterpillar tractors, arches, and winches, and certain railroad accessories.

Petitioner was advised by letter, dated November 20, 1935, that the Lumber Co. would be glad to help petitioner acquire title to the railroad accessories, but that the Southern Pacific Co. was insisting upon conveyance of the accessories to it as a condition to the cancellation of the Lumber Co.’s contract to purchase steel rail from the Southern Pacific Co.

By letter dated December 21, 1935, petitioner offered to cooperate with the Southern Pacific in securing its steel and in logging certain timber before tearing up the tracks if Southern Pacific would release the Lumber Co. from its rail contract so as to permit the transfer of the railroad accessories to petitioner. Such an arrangement was worked out with the Southern Pacific.

At the time the settlement was agreed to the log loader or jammer was in charge of and standing on the tracks of the Great Northern Railway Co. Both parties immediately notified the Great Northern Railway Co. that the jammer had become the property of the petitioner. Physical possession of the other equipment was taken by petitioner in March or April 1936.

Title to the equipment was not transferred until on or about May 19, 1937. Throughout the period between October 1935 and the transfer of title the Lumber Co. was engaged in securing formal consents to the transfer from its creditors. Its efforts were complicated by the fact that late in 1932 or early in 1933 it had transferred its assets, including the above equipment, to a new corporation, the Kesterson Lumber Corporation. The latter had not assumed the liabilities of the Lumber Co., and before releasing title it attempted to force the best possible terms out of petitioner consistent with the stipulation filed in court. In a letter dated March 24, 1936, it suggested that, in case all creditors did not approve the deal, petitioner should pay the corporation a rental of $350 per month on the jammer and $200 per month for each tractor and the arches that went with them, the equipment to be returned at petitioner’s expense on demand.

In reply thereto petitioner, by letter dated March 26,1936, informed the Kesterson Lumber Corporation that it was “not concerned with the method of accounting between your new corporation and the old company”, and that it would not pay “rental on the equipment nor have any strings tied to it other than acknowledging that title is to remain with you a reasonable time in order to allow you to obtain written approval of creditors.” The letter further stated:

There have been so many delays to the transfer heretofore, all of which now seem to be cleared up except confirmation in writing by your creditors of their verbal approval which we have been told was one hundred percent, that we feel there is no logical reason for withholding delivery, in view of our willingness to await transfer of title.
Will you, therefore, please arrange for release of equipment immediately.

The Kesterson Lumber Corporation replied to petitioner on March 28, 1936, as follows:

Tour communication of March 26th, in reply to ours of March 24th is received.
Tour anxiety to settle “completely and quickly” the law suit which you brought against the Kesterson Lumber Company is a condition that may be desirable, but certainly you have retarded any early settlement by your failure to meet with the creditors of the Kesterson Lumber Company when the meeting was called last October, for the purpose of permitting you to present your claim and try and effect a settlement. Subsequent to the creditors meeting you demanded other equipment which was also demanded by the Southern Pacific Co., and your negotiations with the Southern Pacific Co., to secure the additional property was not completed, as far as the Kesterson Lumber Company knew, until receipt of a letter from the Southern Pacific Co. dated March 5th, 1936.
On March 11th, 1936, the attorneys handling the settlement between the creditors of the Kesterson Lumber Company, — Williamson and Wallace of San Francisco — had prepared and mailed to the creditors a statement and creditors agreement for their execution.
Tou have been crowding our attorney, Mr. MeColloch since last October for the title to the equipment, which is contemplated being turned over to you as soon as we have written authority from the creditors to make the settlement with you.
Mr. MeColloch advised us that he saw no objection to permitting you to use the equipment and we consented with him that if the equipment would be of assistance in starting your operations this spring, that we would permit the Corporation to let you use the equipment pending the settlement between your claim and the Kesterson Lumber Company creditors. That was the spirit in which Mr. McColloch wrote you on March 20th.
We wrote you on March 24th to clarify the understanding and suggested a certain rental for equipment in case the Kesterson Lumber Company creditors did not approve the settlement as finally submitted. Your reply leads us to believe that you are not willing to accept the free use of the equipment until the Kesterson Lumber Company settlement between creditors was finally determined. If you consider our permitting the free use of the equipment as a delivery of the equipment from the Kesterson Lumber Company, the Kesterson Lumber Corporation cannot turn the equipment over to you.
We are still willing to be helpful, but the Corporation has nothing to do with the affairs of the Company, and will not engage in any controversy between the creditors and claimants of the Company. In case you want the use of the equipment the Corporation is perfectly willing to give you the use of it without charge, and if you do not wish to agree to any rental charge pending settlement between the Kesterson Lumber Company creditors and will agree to return the equipment to the Corporation at Klamath Falls at any time at their request, such an arrangement will be satisfactory.
You may have been informed that the Kesterson Lumber Company creditors agreed one hundred percent to the recognition of your claim and a division of the property, according to the plan that was submitted to them as of March 11th, 1936, but there has been no such statement made to you by any member of the Kesterson Lumber Company. You know that all the creditors were not present at the creditors meeting in October and you also know that some of the principals of the creditors represented were not present.
We trust we have made ourselves clear as to the logical reasons for wanting an understanding about the title to the equipment before it is turned over for your use and of our willingness to cooperate.

On April 6,1936, petitioner and the Kesterson Lumber Corporation executed an agreement in "which petitioner “acknowledges receipt this day of the following equipment from the Kesterson Lumber Corporation:

1 McGiffert Log Loader with all parts and accessories.
3-60 H. P. Caterpillar Tractor complete (ones as agreed).
3 Logging Archer with tracks (Lamm Choice)
3 Williamette winches (Lamm’s choice)
All railroad and other equipment on Long Bell Timber tract except steel rail belonging to either S. P. Company or Great Northern Company.
Lamm Lumber Company agrees that this is the property of Kesterson Lumber Corporation. Use is granted to Lamm Lumber Company, by the Kesterson Lumber Corporation for an indefinite period.
It is understood that the Kesterson Lumber Corporation will use its best efforts to get the title to this property into the name of the Kesterson Lumber Company, and when that is accomplished to further use their efforts to transfer absolute title to Lamm Lumber Company in pursuance of a stipulation entered into between Lamm Lumber Company and Kesterson Lumber Company, in a certain suit in the Klamath County Circuit Court, under date of October 29,1935.

By bill of sale dated May 19,1937, the Lumber Co. transferred title to the log loader, tractors, and arches. The instrument specifically refers to the equipment as “heretofore, about the 1st of January, 1936. delivered by the grantor herein-to the grantee herein, and since then and now being in the possession of the grantee.”

On May 20, 1937, the damage suit against the Lumber Co. was dismissed with prejudice.

By appropriate entries on its books as of December 31, 1935, petitioner accrued the value of the equipment as income of that year, and included the $20,000 as income in its tax return for 1935.

OPINION.

The question here is whether petitioner properly accrued the value of the equipment as income for 1935. No question is presented regarding the amount or that the amount was realized either in 1935 or 1936. Being on the accrual basis of accounting, petitioner considered that the settlement agreement fixed its right to receive the income in 1935 and that the difficulties of the Lumber Co. in fulfilling its responsibilities in no way jeopardized its right to receive the equipment.

Respondent contends that the facts and circumstances herein show that it was during 1936 that the equipment to be delivered was definitely fixed and delivery made. Not until then was petitioner fully justified, according to respondent, in accruing the income on its books and in noting the actual physical receipt of the income. He cites, among others, our decisions in Sowers Manufacturing Co., 16 B. T. A. 268; Commercial Electrical Supply Co., 8 B. T. A. 986; Emanuel Solomon Ullmann, 30 B. T. A. 764; affd., 77 Fed. (2d) 827; certiorari denied, 296 U. S. 631; Biggins Estate, Inc., 30 B. T. A. 814; reversed, 88 Fed. (2d) 1011; and Herman J. Sternberg, 32 B. T. A. 1039.

The rule regarding the accrual of income is stated in Estate of G. A. E. Kohler, 37 B. T. A. 1019, 1029, as follows:

* * * Income accrues when the amount of it and the right to it are fixed, provided the right is not contingent, and provided that there is a reasonable expectation that payment will be made in due course.

When accounts are kept and returns filed on the accrual basis “it is the right to receive and not the actual receipt that determines the inclusion of the amount in gross income. When the right to receive an amount becomes fixed, the right accrues.” Spring City Fowndry Co. v. Commissioner, 292 U. S. 182.

Here, the right to receive property of an estimated value of $20,000 became fixed in 1935. The fact 'that the property was not received until a subsequent year did not affect the right to receive, but constituted satisfaction or discharge of the obligation to deliver.

After carefully weighing the evidence adduced and the fact that the agreement in settlement was with the Lumber Co. and not the Lumber Corporation, it is our opinion that petitioner has brought itself within the rule and properly accrued the income for the year 1935. We can find no denial in the correspondence, the agreement of April 6,1936, or the bill of sale of petitioner’s right to receive the equipment as fixed by the agreement of settlement in October 1935. Thereafter, the details of performance caused embarrassment to both parties litigant, but these details were no more burdensome than those confronting the taxpayer in Continental Tie & Lumber Co. v. United States, 286 U. S. 290, where the Supreme Court held the amount of an award should be estimated and accrued, despite details which might influence the amount thereof. Here, petitioner knew the amount and was justified in its expectation at the close of 1935 that the Lumber Co. would comply with the agreement.

We can not attach the same evidentiary value to delivery that respondent does. Delivery under the agreement of settlement constituted payment, and it is well settled that a taxpayer on the accrual basis must report items of income as they accrue without regard to the time of payment. Sowers Manufacturing Co., supra; Spring City Foundry Co. v. Commissioner, supra. As we understand the evidence, petitioner’s right to receive the equipment was never questioned. The delay in securing formal written consents from creditors and the dispute over the manner of selecting the tractors, arches, and winches merely emphasize the difficulties faced by the Lumber Co. in performing. These difficulties were largely self-imposed by the transfer of assets without provision for creditors, and the record shows that petitioner assisted in satisfying one creditor by arranging separately with the Southern Pacific Co. for the railroad accessories which otherwise might have been claimed by the Southern Pacific.

Our examination of the cases cited by respondent convinces us that they are not controlling and are distinguishable. On this issue we sustain the petitioner. Continental Tie & Lumber Co. v. Commissioner, supra; Automobile Insurance Co. of Hartford v. Commissioner, 72 Fed. (2d) 265.

Issue 3.

FACTS.

In 1926 petitioner’s directors fixed the annual salary of W. E. Lamm at $24,000. During 1930, 1931, and 1932 Lamm accepted certain wage cuts, along with petitioner’s employees, but withdrew his entire salary as reduced. Beginning with the year 1933 and through the taxable year, Lamm withdrew less than the amounts credited to him as salary, for reasons hereinafter set forth. The salary credited to him and the salary paid for the years 1933 to 1936, inclusive, were as follows:

The difference between the salary credited or accrued on petitioner’s books and the salary paid was credited to an account payable to Lamm. This indebtedness has not been paid by petitioner nor forgiven by Lamm, who fully expects to collect the total amount thereof.

In 1933 petitioner’s obligations included approximately $320,000 to three banks, in addition to other obligations in a substantial amount. Under date of May 16,1933, it entered into a subordination agreement with certain of its creditors whereby interest was reduced from 8 percent to 6 percent on obligations totaling $440,000, the maturities were extended, and the obligations due the other creditors were subordinated to the obligations due the banks. Contemporaneously therewith petitioner and the banks executed an agreement whereby petitioner transferred its chattel mortgages, warehouse receipts, and other property to the bank, which already held a mortgage on petitioner’s real property, as collateral security for its obligations then existing or thereafter created, and granted broad powers to the banks with respect to the security deposited and the management and control thereof. Pursuant to the terms of the agreement and in the supervision of petitioner’s operations, the banks limited the cash withdrawals by Lamm to $10,000 per year. Since 1933 the petitioner has reduced its obligations to the banks to $150,000, and the banks, subsequent to the taxable year, permitted Lamm to increase the amount of his cash withdrawals.

In April 1933 petitioner contracted with the Long-Bell Lumber Co. for the cutting of 300,000,000 feet of timber. The contract, hereinafter more fully set forth, provided that the Long-Bell people should be entitled to additional stumpage payments under certain circumstances not here material. In determining the extent to which the Long-Bell Co. would. participate, petitioner included as a part of its cost of operation the annual salary of $24,000 accrued on its books for the services of its president and general manager. For each of the years 1933 to 1936, petitioner settled with the Long-Bell Lumber Co. upon the basis of a salary for Lamm of $24,000 per year, without objection on the part of the latter company.

For 1936 petitioner accrued on its books and deducted on its income tax return a salary of $24,000 for W. E. Lamm. The respondent disallowed $14,000.04 thereof for the reason that it did not constitute an ordinary and necessary expense paid or incurred during the taxable year.

The salary accrued on petitioner’s books for 1986 constituted reasonable compensation for the personal services rendered by petitioner’s president and general manager, and was an ordinary and necessary expense of the taxable year.

OPINION.

The question here is whether petitioner is entitled to deduct the entire salary accrued on its books, or only that portion thereof actually paid. We do not understand that the reasonableness of the salary accrued is questioned. Respondent contends that there is no justification for petitioner accruing more than could be paid, that no more than $10,000 could be paid in view of petitioner’s critical financial condition and in view of control exercised over it by the banks, and that at the close of the year there was no reasonable ground for believing that the $14,000 would ever be paid.

The evidence shows that petitioner’s financial condition in 1933 was bad, but that it was not considered hopeless by its bank or other creditors. Arrangements were made during 1933 with the banks and some of its other creditors to reduce the interest rate on $440,000 of petitioner’s obligations from 8 percent to 6 percent, and petitioner’s operations were continued under the supervision of the banks. Under the arrangement the banks have exercised almost complete control over petitioner since May 1933, and it was pursuant thereto that Lamm’s salary withdrawals were limited to $10,000 per year. The results have justified the belief of creditors that petitioner’s financial condition was not hopeless. Its obligations have been substantially reduced, and earnings of approximately $50,000 were anticipated for 1940. An officer of the bank testified that petitioner was in a comparatively easy condition today, provided the creditors continued to go along with them. And he testified that the banks intended to continue going along with petitioner, advancing credit as before under the agreement of May 16, 1933.

That the salary accrued represented a real and substantial liability of the petitioner, as to the unpaid portion thereof, is demonstrated by the recognition accorded the accrual by the Long-Bell Lumber Co. under its timber-cutting contract with petitioner. By this contract the Long-Bell people were entitled to participation in the profits from timber cut, under certain prescribed conditions. In determining the amount of the latter’s participation Lamm’s accrual salary was always included as a part of each year’s operating costs without objection, which indicates that the Long-Bell Lumber Co. considered the payment a reasonable expense of the operation.

The liability of petitioner for the salary accrued is established by the directors’ action in 1926. The accrued but unpaid salary was and is carried as an account payable to Lamm, who testified that the indebtedness had not been forgiven and that he expected to collect the same. Delay in payment can not defeat the accrual where all events had happened which fixed the liability. The personal services were rendered by Lamm in 1936 and the liability accrued in that year. We are of the opinion that the accrual herein was proper and that the deduction of $24,000 should be allowed. Benton County Hardware Co., 10 B. T. A. 869. Furthermore, it is our opinion that the salary constituted an ordinary and necessary expense of petitioner’s business operations.

Issue S.

FACTS.

On its return for the taxable year petitioner deducted $28,130.50 representing “Depletion, of deposit on Timber Contract 42,195,760 ft. at 66%$ per M.” The deduction so claimed grew out of the transactions hereinafter set forth.

Under date of August 24,1929, petitioner and the Long-Bell Lumber Co., a Missouri corporation, executed an agreement, effective as of August 23,1928, whereby petitioner agreed to purchase approximately 600,000,000 feet of timber on approximately 24,294.37 acres of land in Klamath and Lake Counties, Oregon. The purchase price of land and timber was fixed by article II at $3,600,000, of which $3,400,000 was payable in 25 stated installments, the last installment being due December 31, 1939. Petitioner paid $200,000 of the purchase price with the execution of the contract, which provided that this payment “shall always remain intact and inapplicable to payment for cutting privileges until used to make the last payments on the contract price.”

The contract further provided that in case of a default by petitioner which continued for 180 days, the Long-Bell Lumber Co. could terminate the contract and all rights of petitioner by notice in writing, and retain as part of the liquidated damages for the default all sums l>reviously paid under the contract. No provision was made by the contract for any participation by the Long-Bell Lumber Co. in the profits from the operation.

During 1930 and 1931 petitioner cut 30,000,000 feet and 10,000,000 feet of timber, respectively, under the aforesaid contract. In the fall of 1931 it suspended operations and in 1932 it became apparent that operations could not be continued under the original contract. Negotiations respecting the contract were entered into with the Long-Bell Lumber Co.’s representative on the Pacific coast and later in the year petitioner’s president and its secretary went to Kansas City, Missouri, where a new agreement was reached by the contracting parties. At no time after suspension of operations was petitioner notified in writing by the Long-Bell Lumber Co. that it elected to terminate the original contract.

By letter dated December 8, 1932, the president of the Long-Bell Lumber Co. advised petitioner’s president as follows:

I herewith hand you the memorandum of our discussions, with reference to the timber contract now existing between our companies and an intention to amend the same.
It is our mutual intent to extend this memorandum into a new contract upon completion of certain negotiations familiar to both of us.

The memorandum mentioned provided in part as follows:

(1) The existing contract to be amended, with the consent of the Central Republic Bank & Trust Company, Trustee, in the Long-Bell mortgage, by a contract containing, among others, the terms and provisions indicated in this memorandum, such amendment to supersede the existing contract.
(2) The amendment is to be dated December 81, 1932, and is to be effective from and after that date.
sic * * * ^ a-. %
(18) As part of the consideration of the new contract, Long-Bell shall retain as its own the $200,000.00 heretofore paid by Lamm under the existing contract, and, on account of which, no timber has been cut.

Subsequent thereto the parties executed a contract, dated December 31, 1932, although actually signed April 25, 1933, which provided that upon approval of this agreement by the Long-Bell Lumber Co.’s trustee, the old agreement “shall become and be null and void and of no further force or effect, except that the Seller [Long-Bell Lumber Co.] shall retain as its own, without accountability to the Purchaser therefor, the sum of Two Hundred Thousand Dollars ($200,000.00) heretofore paid by the Purchaser to the Seller pursuant to the provisions of Article II of said agreement, and the Purchaser shall be under no further or any obligation to the Seller, and/or its assigns, or at all, on account of or growing out of said prior agreement.”

The agreement provided, among other things, that 300,000,000 feet of timber should be cut and paid for at $3 per 1,000 feet, and that the Long-Bell Lumber Co. should receive additional stumpage payments from gross income and receipts, under circumstances not here material.

Based on the memorandum of December 8,1932, petitioner’s auditor at the close of the year 1932 prepared the following journal voucher, dated December 31,1932:

Lamm Lumber Company Journal Voucher Date 12/31/32
Debit — New Long Bell cutting contract-$200,000. 00
Credit Stumpage-$200,000.00
Explanation — Attach all supporting papers to this voucher. By agreement of Dec. 8 - 1932 the initial advance of $200,000 in 1928 is recognized as a consideration moving to the execution of the new cutting contract and is therefore transferred„to new a/c No. 483.

Petitioner has consistently treated the $200,000 as part payment for cutting rights to 300,000,000 feet of timber, and each year since 1932 it has charged off a proportionate part thereof, using a basic rate of 66% cents per 1,000 feet of timber cut. For 1936 it charged off $28,130.50, based upon 42,195,760 feet of timber cut at 66% cents per thousand.

OPINION.

Respondent denies that petitioner is entitled to write off the $200,000 payment under any provision of the statute, regardless of whether the amount written off be called amortization, depletion, or depreciation. He contends that the $200,000 was forfeited in 1932 or 1933 and that a tax deduction would be allowable only in the year in which the loss occurred.

Petitioner’s position is that both parties to the original contract recognized the impact of the depression and the desirability of amending the original agreement so that cutting operations could be resumed. It points out that Long-Bell took no steps to cancel the agreement or to declare petitioner in default. Petitioner relies particularly upon that portion of the memorandum of December 8, 1932, which recites that the $200,000 payment should be retained by Long-Bell as part consideration of the new contract. It is urged that the $200,000 was retained by Long-Bell under the new agreement, which canceled the earlier contract, and that the amount retained represented cost to petitioner of the contract.

We can not agree with petitioner’s contention. The memorandum must give way before the agreement signed April 25, 1933, by the contracting parties. 'What transpired between December 8, 1932, and April 25, 1933, we do not know, but the contract canceled the earlier agreement except as to the $200,000, which Long-Bell “shall retain as its own, without accountability” to petitioner therefor. In our opinion the final agreement constituted a mutual release of their rights by the contracting parties under the prior agreement except that the $200,000 paid by petitioner was forfeited to Long-Bell Lumber Oo. We are unable to find any language in the amended contract indicating that the $200,000 previously paid represented the cost of the new contract. The consideration for the new contract was stated therein as $3 per thousand, plus additional stumpage payments under prescribed circumstances. On this issue the respondent is sustained.

Issue J¡..

FACTS.

By the agreement of May 16, 1933, petitioner transferred certain personal property to the American Trust Co.,, hereinafter referred to as the bank, and the other bank creditors, as collateral security for any new advances and as collateral security for any indebtedness, obligations, liabilities, or demands against petitioner then existing or thereafter created. The bank was authorized and empowered to treat the property deposited with it as virtually its own for the purpose of recovering the indebtedness owed it by the petitioner. In addition to the above personal property the bank held a $250,000 first mortgage on petitioner’s real property and plant, which it renewed in 1935.

In the conduct of the business under said agreement the bank took warehouse receipts covering all of petitioner’s lumber inventory. During the period 1933 to 1936, inclusive, warehouse receipts and/or trust receipts covered all of petitioner’s lumber. Each month a new warehouse receipt was issued to the bank covering petitioner’s lumber. As lumber was needed by petitioner the bank would release warehoused lumber under trust receipts which required petitioner to hold the proceeds in trust for the bank. The early trust receipts were issued for half a million feet, but the amount was gradually increased to as much as three million feet by 1940. The proceeds from petitioner’s sales of lumber for 1936 were reported on its tax return as in excess of $976,000 and over $900,000 thereof was deposited with the bank.

From time to time after the bank assumed supervision of petitioner it advanced various sums to the latter as working capital. Any sums repaid by petitioner on its indebtedness were to be applied under the agreement as follows:

9. All sums received and applied by the Bank hereunder shall be first applied to the repayment of all sums advanced to the undersigned by the Bank subsequent to the date hereof and no such sums shall be applied to the payment of the sums now owing the above named three banks and hereinabove referred to until all sums advanced by the Bank subsequent to the date hereof, together with the interest thereon, shall be repaid in full. The Bank at its election is hereby authorized to release and return to the undersigned any security which may at any time be held by it hereunder and may return and pay to the undersigned for operating costs any sums that may come into its possession hereunder and shall not be obliged to apply the same to the debts herein set forth and the Bank shall not be responsible or accountable, for the proper use of any such sums which may be so returned.

No part of the sums repaid were applied against petitioner’s indebtedness of May 16,1933, as long as any new advances remained unpaid.

At January 1,1936, new advances by the bank to petitioner totaled $65,000. . During 1936 petitioner paid $55,000 to the bank which was credited against the new advances. The sum repaid represented proceeds from sales of lumber in petitioner’s inventory subject to warehouse receipts held by the bank. The total indebtedness of petitioner to the bank at January 1, 1936, was $395,000 direct, consisting of a $250,000 first, mortgage, $80,000 unsecured loans, and $65,000 of new advances, plus $10,169.41 indirect, which, represented a trade acceptance discounted for petitioner.

During 1936 and prior thereto the bank exercised close supervision of petitioner’s disbursements. At the beginning of operations under (he agreement the bank received daily reports; later, it received weekly reports. Frequent conferences were held with W. E. Lamm by an official of the bank, who examined practically every transaction made by petitioner. Before any capital expenditure could be made permission had to be obtained by petitioner from the bank. The bank frequently limited petitioner as to the amount of inventory it might build up, and restricted the amount of cash salary that W. E. Lamm could withdraw from the business. Under the agreement the bank could at its election shut down petitioner’s operations through a foreclosure, a calling of the loans, and a refusal of additional credit.

The agreement of May 16, 1933, contains no provision which expressly deals with the dispositions of petitioner’s earnings and profits of the taxable year, or which expressly deals with the payment of dividends.

OPINION.

The issue presented by the pleadings is whether petitioner is entitled to a credit under section 26 (c) of the Revenue Act of 1930. Petitioner has argued the issue under the provisions of section 26 (c) (2), set out in the margin, and we shall limit our discussion in accordance with the argument presented.

One of the conditions prescribed by statute for granting the credit is that there be a provision in a written contract executed prior to May 1, 1936, which “expressly deals with the disposition of earnings and profits of the taxable year.” If the contract contains no such provisions, or if the contract fails to require earnings and profits “to be paid within the taxable j'ear in discharge of a debt, or” etc., the credit can not be allowed. Helvering v. Moloney Electric Co., 120 Fed. (2d) 617.

We do not understand petitioner to contend that its contract of May 16,1933, “expressly” deals with earnings and profits of the taxable year. It contends that not only all earnings and profits of the taxable year were required to be paid to the bank, but its entire gross receipts as well; that after returning operating costs the bank was required by paragraph 9 to apply all sums to payment of advances made since May 16,1933, and then to payment of debts existing on that date; that petitioner in fact paid $55,000 from the proceeds of lumber sales during the taxable year on its indebtedness; and that petitioner not only had no right to disburse any receipts to its stockholders until the bank was paid, but it had no possible opportunity to make any such distribution. Petitioner cites and relies on our decisions in G. B. R. Oil Corporation, 40 B. T. A. 738; Strong Manufacturing Co., 41 B. T. A. 1273 (appeal pending, C. C. A., 6th Cir.); Joell Co., 41 B. T. A. 825; and Michigan Silica Co., 41 B. T. A. 511 (appeal pending, C. C. A., 6th Cir.). See also Baltimore Steam Packet Co., 44 B. T. A. 629.

The various contracts considered in the cited cases use language which, while not expressly mentioning “earnings and profits” in so many words, yet was thought to be comprehensive enough in meaning to include “earnings and profits of the taxable year.” Respondent’s regulations, article 26-2 (c) of Regulations 94, likewise recognize that words of equivalent meaning can be used in a contract without defeating the credit, e. g., “net income”, “net earnings”, or “net profits.” But no similar terms are to be found in the instant contract.

As a practical matter, the bank controlled the petitioner’s operations without any express right to its earnings and profits. The bank protected itself by releasing lumber to petitioner under trust receipts and when the security was sold the proceeds came back to the bank: In this manner it actually acquired the proceeds of petitioner’s sales, but it permitted the use thereof in petitioner’s business so long as there was no deviation from the plan adopted to work out the indebtedness. Although the bank officials and petitioner conducted the business in such manner that the earnings and profits of petitioner were applied on the petitioner’s indebtedness, such application was not required by any provisions of a written contract which “expressly deals with the disposition of earnings and profits of the taxable year.” We can spell out no such provision in the contract of May 16,1933.

Our examination and comparison of the contracts in the cited cases with the present contract convinces us that the cited cases are not controlling. The contract provisions here were drafted to insure payment from collateral deposited or to be deposited. The provisions thereof make no mention of earnings, net earnings, net income, profits, net profits, proceeds, net proceeds, or earnings and profits, nor is any similar terminology used indicating an intent to definitely tie earnings to the payment of debts. That such a policy may have been adopted or followed by debtor and creditor is immaterial. Petitioner must establish its right to the credit by bringing itself strictly within the provisions of the statute. Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46. On this issue we sustain the respondent.

Decision will he entered under Bule 50.

       SEC. 26. CREDITS OF CORPORATIONS.
      In tlie 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.—
      * * v * + * *
      (2) Disposition op profits op 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 the 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. For 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.


author: Disney :

text:
    Saxon Trading Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103964.
    Promulgated September 3, 1941.

      Knox B. Phagan, G. P. A., for the petitioner.

      F. S. Gettle, Esq., for the respondent.
   OPINION.

Disney :

This proceeding involves personal holding company surtax for the taxable year 1937. The Commissioner determined a deficiency of $6,907.41 and a penalty of $1,726.85, all of which is in issue. The questions at issue are whether the petitioner is a personal holding company and whether it is subject to the surtax and penalty. A stipulation of facts was filed wherein the parties agreed, and we find as follows:

The petitioner herein is Saxon Trading Corporation, a corporation organized under the laws of the State of New York, with its principal office at 598 Madison Avenue, New York, New York. It filed its income tax return for the calendar year 1937 with the collector of internal revenue for the third district of New York.

The taxes in controversy are personal holding company taxes and penalties for the calendar year 1937 under section 351 of the Revenue Act of 1936, as amended by the Revenue Act of 1937.

The taxpayer was organized in the year 1924 with no par value stock and a paid-in capital of $768,444.17, which was the stated value of its no par stock. Soon after its organization the capital of the taxpayer suffered substantial impairment. At the beginning of the year 1937 its total deficit amounted to $373,223.07.

During the year 1937 the taxpayer received as interest on notes, mortgages, bonds, and bank deposits $16,880.24 and taxable dividends of $1,225, making a total of $18,105.24. Its allowable deductions totaled $5,984.95, so that its net income without the deduction of any capital loss was $12,120.29.

During the year 1937 the taxpayer sustained capital losses from the sale of bonds totaling $14,487.50.

In the computation of personal holding company surtaxes for the year 1937 there has been allowed as a deduction from net income $2,000 on account of capital losses and a net income is determined for such year of $10,120.29. After the deduction of $643.75 as Federal income tax the adjusted net income for personal holding surtax purposes is $9,476.54, on which a surtax is computed in the sum of $6,907.41.

The capital stock of the petitioner corporation was owned throughout the entire taxable year 1937 as follows:

Theodore Haebler_ 750 shares
Louis M. Ebling-125 shares
Katharina L. Stephens_125 shares

On June 12, 1940, notice of deficiency was mailed to the taxpayer in which deficiency in personal holding company tax of $6,907.41, together with a penalty of $1,726.85, was determined.

In addition to such stipulated facts, we find further, from allegations admitted and documents in evidence, as follows:

The officers of the petitioner in filing petitioner’s return, Form 1120, for the taxable year, answered “No” to the question: “Is the corporation a personal holding company within the meaning of section 351 of the Revenue Act of 1936, as amended by the Revenue Act of 1937? If so, an additional return on Form 1120H must be filed.” In 1939 a revenue agent checked over the books and records of the corporation, insisted that the corporation file Form 1120-H, personal holding company report, and set up additional tax and penalty in the amounts above recited.

The petitioner was in the taxable year a personal holding company, all of the capital stock of which was owned directly by three individuals. Its entire income for that year consisted of dividends and interest.

Though in filing its income tax return the petitioner denied that it was a personal holding company, and the respondent on brief suggests such question, neither the petition nor petitioner’s brief raise that issue. At all events, there can be no doubt, on the record, and we find that petitioner is such personal holding company, under section 351, Revenue Act of 1936 as amended by the Act of 1937, for all of its stock was directly owned by only three individuals, and all of its income consisted of dividends and interest. The only question posed by petitioner’s brief is whether section 1 of the Revenue' Act of 1937, amending and supplementing section- 351 of the Act of 1836 is unconstitutional, as urged by the petitioner, with the ancillary question as to whether the 25 percent penalty was properly applied under section 291 of the Revenue Act of 1936. The petition had also suggested that dividend credit should be allowed because of a deficit, and therefore impossibility of paying dividends.

In the brief, the situation before us is this: The petitioner had net income of $12,120.29, with capital losses of $14,487.50, of which only $2,000 was allowable as deduction (section 117 (d), Revenue Act of 1936), leaving a taxable net income of $10,120.29, but an actual net loss of $2,367.21, in addition to a large deficit at the beginning of the taxable year. In this situation the petitioner argues that when applied to it the applicable provisions of the statute amount to confiscation, unconstitutional as being, offensive to the Fifth Amendment to the Constitution of the United States. That was in substance the situation and the contention in Foley Securities Corporation v. Commissioner, 106 Fed. (2d) 731, affirming 38 B. T. A. 1036, for there as here the corporation started the year with a deficit and the court considered the fact that under the statute personal holding companies with capital impairment were placed in a worse condition, as to the surtax, than those without such impairment. The court did not feel justified in finding unconstitutionality. Nor do we. The fact suggested by the petitioner, that the Foley Securities Corporation case arose before section 1 of the Revenue Act of 1937 omitted the right of stockholders to elect to include their pro rata shares in income (sec. 351 (d), Revenue Act of 1936) does not, in our opinion, suffice to distinguish this case from the Foley Securities case as to constitutionality. We do not find the act unconstitutional. It is apparent that under its provisions the petitioner, to escape from the surtax upon the net taxable income of $10,120.29, must demonstrate a right to a dividend credit. This it can not do because of any idea of state statute forbidding dividends to be paid without earnings, Midland Cooperative Wholesale, 44 B. T. A. 824, nor because of charter provisions even if proved, which was not done. Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46. We hold that the petitioner is not entitled to credit under section 26 (c) (1) of the Revenue Act of 1936 and has not shown error by the Commissioner in determining the deficiency of $6,907.41.

Did the respondent err in adding $1,726.85 as-the 25 percent penalty under section 291, Revenue Act of 1936 ? The petitioner in filing its income tax return answered “No” to the question whether it was a personal holding company. The question and answer were followed immediately by a notice that “If so, an additional return on Form 1120H must be filed.” This was clear notice of the requirement, set up in Regulations 94, article 291-1, within the authority of the statute. Even if the petitioner had proved its statement that failure to file Form 1120-H was due to misunderstanding of the meaning of section 351, Revenue Act of 1936, as amended, such misunderstanding would not constitute the reasonable cause required as excuse. Lone Pine Lawn Corporation, 41 B. T. A. 638; R. Simpson & Co., 44 B. T. A. 498. However, such statement was not proven. Therefore, the Form 1120-H finally filed more than the one year after required by law, was properly not considered as sufficient and we need not pass upon the other items in which the respondent says it was lacking, such as signatures and oath. We find no error in the assertion of the 25 percent penalty.

Decision will ~be entered for the respondent.


author: Smith:

text:
    Forstner Chain Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104998.
    Promulgated September 4, 1941.

      John A. Conlin, C. P. A., for the ptititoner.

      R. H. Transue, Esq., for the respondent.
   OPINION.

Smith:

The petitioner seeks a dividends paid credit pursuant to the provisions of section 27 (f) of the Revenue Act of 1936. This section provides:

(f) Distributions in Liquidation. — In the case of amounts distributed in liquidation the part of such distribution which is properly chargeable to the earnings or profits accumulated after February 28, 1913, shall, for the purposes of computing the dividends paid credit under this section, be treated as a taxable dividend paid.

Section 27 (g) provides, however:

(g) Preferential Dividends. — No dividends paid credit shall be allowed with respect to any distribution unless the distribution is pro rata, equal in amount, and with no preference to any share of stock as compared with other shares of the same class.

Respondent contends that the credit claimed is not allowable because the distribution involved was preferential within the meaning of section 27 (g). The petitioner contends that the; distribution was not preferential because of the waiver of rights by the stockholders to whom no distribution was made. In May Hosiery Mills, Inc., 42 B. T. A. 646; affd., 123 Fed. (2d) 858, section 27 (g) was held to be a limitation upon section 27 (f). Upon the authority of that case, we must sustain the respondent in his disallowance of the dividends paid credit to the petitioner in this1 proceeding. Cf. Monte Glove Co., 44 B. T. A. 539.

Decision will be entered for the respondent.


text:
    George A. Ohl, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105103.
    Promulgated September 4, 1941.

      J. G. Shipman, Esq., for the petitioner.

      A. H. MonaceTli, Esq., for the respondent.
   opinion.

Smith:

This proceeding is for the redetermination of deficiencies for 1936,1937, and 1938 in the amounts of $246.50, $94.62, and $156.11. respectively. Petitioner alleges that the respondent erred in not allowing him a personal exemption of $2,500 as the head of a family in each of the taxable years and in not allowing him a $400 credit for a dependent.

The petitioner is a resident of Newark, New Jersey. He filed his income tax returns for the years 1936, 1937, and 1938 with the collector at Newark.

The petitioner is president and treasurer and principal owner of George A. Ohl & Co., a manufacturing company, and the Northern Real Estate Co., a real estate holding company.

In 1914 petitioner’s wife was granted a limited divorce from him by a decree of the Court of Chancery of New Jersey and was given an allowance of $120 a week, which the petitioner has continued to pay up to the present time. Petitioner and his wife have not lived together since that time. During the taxable years 1936, 1937, and 1938 petitioner’s wife lived in a house in Newark which she rented from the petitioner for $65 a month. The petitioner retained one room in the house where he kept his fishing tackle and other personal possessions. Pie made his residence on his farm nearby, but occasionally spent a night in his room at the house which his wife occupied.

For many years petitioner has been the sole support of an invalid sister, to whom he sends $100 a month. During 1936, 1937, and 1938 this sister resided next door to another sister in Eatontown, New Jersey, in a house which she rented from the Northern Real Estate Co. for $20 a month.

The respondent concedes in his brief that the petitioner was the sole support of his sister, that the sister was physically incapable of earning a livelihood and had no means of her own, and that accordingly the petitioner is entitled on her account to a credit for dependents of $400 per year.

The petitioner contends that he is also entitled to the statutory personal exemption of $2,500 as “head of a family” under section 25 (b) (1) of the Revenue Acts of 1936 and 1938. Section 25 (b) (1) of the Revenue Act of 1936 reads as follows:

SEC. 25. CREDITS OF INDIVIDUALS AGAINST NET INCOME.
****** *
(b) Credits tor Both Normal Tax and Surtax. — There shall be allowed for the purposes of the normal tax and the surtax the following credits against net income:
(1) Personal exemption. — In the case of a single person, a personal exemption of $1,000; or in the ease of the head of a family or a married person living with husband or wife, a personal exemption of $2,500. A husband and wife living together shall receive but one personal exemption. The amount of such personal exemption shall be $2,500. If such husband and wife make separate returns, the personal exemption may be tabea by either or divided between them.

“The head of a family” is defined in the Commissioner’s regulations (article 25-4 of Regulations 94) as follows:

Art. 25-4. Personal exemption of head of family. — 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, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation. * * *

These regulations have been upheld as correctly interpreting the statute. Alfred E. Fuhlage, 32 B. T. A. 222; Mary H. Walton, 37 B. T. A. 620; Annette Loughran, 40 B. T. A. 262; Harry P. Kishner, 42 B. T. A. 456.

The evidence in the instant case is that the petitioner did not support or maintain either his divorced wife or his dependent sister in his own household. Petitioner made his residence at his farm while his wife and sister both maintained separate residences. Although the petitioner supported both of them, he did not exercise any family control over either of them.

In Harry P. Kishner, supra, we said:

The quoted regulation does not require absolutely and under all conditions that a taxpayer and his dependents reside continuously in one household, but if separate homes are maintained, reasonable necessity therefor must appear in order to entitle the taxpayer to the personal exemption allowable to the “head of a family.” That petitioner does not come within any of the exceptions mentioned in respondent’s regulations is too obvious to require discussion, but the examples stated do not purport to be all-inclusive. We have had occasion to allow the exemption in other circumstances, where reasonable necessity appeared for the maintenance of separate homes.

Apparently the sister maintained a séparate residence purely as a matter of preference and not by any necessity of circumstances. At any rate the evidence does not show any valid reason why she might not have made her residence with the brother. Cf. William Lee Tracy, 39 B. T. A. 578; Hassard Short, 39 B. T. A. 567; also, Estate of Grace Adams Howard, 42 B. T. A. 449.

In Sidney Williamson Kirtland, 39 B. T. A. 959, and Meier S. Block, 37 B. T. A. 945, two of the cases relied upon by the petitioner, there were dependent minor children, as well as a divorced wife, whom the taxpayers supported and over whom they exercised family control. See also Claude S. Rucker, 42 B. T. A. 32.

In the circumstances here we sustain the respondent in the determination that the petitioner is not entitled in any of the taxable years involved to the personal exemption of $2,500 as the head of a family.

Decision will be entered under Rule 50.


author: Arundell :

text:
    Orange Securities Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104499.
    Promulgated September 4, 1941.

      Charles M. Trammell, Jr., Esq., for the petitioner.

      F. L. Van Haaften, Esq., for the respondent.
   OPINION.

Arundell :

The issues enumerated at the outset are considered here in their order and without restatement.

Issue No. 1.

First for consideration is the basis for computing gain or loss on the settlement of the Beeman notes in the taxable year 1937. The value of the stock received in settlement, it is agreed, was $80,000; the division between the parties is the basis of the notes, whether $98,700, their face value, as contended by the petitioner, or $5,720, as argued by the respondent. As grounds for its contentions the petitioner claims now that the notes received by Giles in 1926 had a market value at that time equal to their face amounts, and that Giles was in error in failing to then report gain equal to the difference between the cost of the land and the total of the notes. Accordingly, it is contended, the proper basis of the notes in Giles’ hands was $98,700, which is also the basis of the petitioner. Furthermore, since the Commissioner’s agent became aware of the 1926 transaction before the statute of limitations had run against Giles and failed to compel him to report gain in 1926, it-is argued that there is no ground for estoppel.

The respondent’s answering arguments are that the notes had no fair market value in 1926 and, alternatively, that the petitioner may not now claim value for them since its transferor failed to report gain on the transaction by which he acquired them.

It seems clear that, if the notes had a fair market value in 1926, gain was realized by Giles then in the sum of the difference between the cost of the land sold, $5,720, and $98,700, the amount for which it was sold. Thomas F. Prendergast, Executor, 22 B. T. A. 1259; Mer ritt J. Corbett, 15 B. T. A. 698; affd., 50 Fed. (2d) 492; Wray-Dickinson Co., 6 B. T. A. 269. The petitioner’s evidence is presented in an attempt to show such market value. That evidence, however persuasive in the absence of contradictory proof, need not be considered in the view which we take of this case.

The petitioner’s transferor, Giles, in 1926, by his failure to report gain on the sale of the land, in effect declared that the notes had no fair market value at that time. This was a determination-of fact which he was in a position to make accurately. Responsibility for the error, if indeed there was error, may not be shifted to the Commissioner by a showing that an agent became casually aware of the sale and accepted Giles’ treatment of the notes as having no fair market value. In some cases the Commissioner’s knowledge and investigation of the facts becomes as broad as the taxpayer’s, and his failure to compel adjustment makes the error his as well as the taxpayer’s. In those instances we have refused to apply any theory of estoppel. R. E. Baker, 37 B. T. A. 1135; affd., 115 Fed. (2d) 987; Estate of William Steele, 34 B. T. A. 173. See also Helvering v. Williams, 97 Fed. (2d) 810; Hawke v. Commissioner, 109 Fed. (2d) 946. The facts in the instant case do not extend so far.

Having thus dealt with the Government on the position thereby assumed by him, Giles may not now repudiate it in order to reap some tax benefit. Some measure of consistency must be required in transactions such as the present, where a conclusion once reached has a continuing effect in the determination of tax liability in later years. See Larkin v. United States, 78 Fed. (2d) 951; Crane v. Commissioner, 68 Fed. (2d) 640; Askin & Marine Co. v. Commissioner, 66 Fed. (2d) 776. See also Dallas Title & Guaranty Co., 119 Fed. (2d) 211; Doneghy v. Alexander & Jones, 118 Fed. (2d) 521; Robinson v. Commissioner, 100 Fed. (2d) 847. See Ruth B. Rains, 38 B. T. A. 1189; Commissioner v. Farren, 82 Fed. (2d) 141. See also Stearns Co. v. United States, 291 U. S. 54.

The present case, so far considered, resembles closely and,’we think, is largely controlled by Alamo National Bank of San Antonio, Executor, 36 B. T. A. 402; affd., 95 Fed. (2d) 622; certiorari denied, 304 U. S. 577. The taxpayers there'in 1921 received in. the liquidation of a corporation, in which they owned stock, a franchise to bottle and sell Coca-Cola in a specified territory. Liquidating dividends were reported in their returns, but neither the books of the corporation nor the returns made any mention of the franchise. The taxpayers did not pay any tax for the year 1921 on account of receiving the franchise as a liquidating dividend. In 1931, in reporting gain on the sale of that franchise, they sought to use as a basis its claimed market value in 1921. We pointed out there that the taxpayers, by their failure to report the receipt of the franchise in 1921, had taken the position that the franchise had then no fair market value. Having taken that view, the taxpayers were required to adhere to it in all of its tax consequences. In those circumstances, we declined to pass on whether the franchise had market value in 1921 and held that the taxpayers must use their own previously declared valuation of zero as a basis.

The Circuit Court of Appeals for the Fifth Circuit, in affirming that result, said:

* * * In income taxation what is done in one tax year is sometimes projected into another where the same fact must govern. There being continuity, there ought to be consistency in treatment. If, for instance, a sale is made on deferred payments, and the taxpayer returns it as an installment sale, charging himself only with the cash collection, and the Commissioner acquiesces, the taxpayer could not in later years refuse to pay on the deferred collections by asserting that he stated the facts wrongly in the first instance and ought to have paid on all then, unless he should offer to correct also the first tax settlement. * * *
* * * Whether it be called estoppel, or a duty of consistency, or the fixing of a fact by agreement, the fact fixed for one year ought to remain fixed in all its consequences, unless a more just general settlement is proposed and can be effected. * * *

The petitioner argues in part that this reasoning can not apply since Giles’ failure to report gain in 1926 was based on his belief that the transaction constituted an installment sale on which no gain need be reported in that year, as provided in section 212 (d) of the Revenue Act of 1926 and articles 44 and 45 of Regulations 69. Both parties are agreed that the sale did not fall within these provisions of the law. See Thomas F. Prendergast, Executor, supra; Walnut Realty Trust, 23 B. T. A. 850; G. C. M. 12148, C. B. XII-2, p. 57. Cf. E. M. Funsten, 44 B. T. A. 1166. Giles, however, made no report whatsoever of the transaction in 1926, and the only evidence on this point is that found in a letter of protest written by petitioner in 1938. The statement there made is none too clear, but it rather indicates that Giles considered the notes as having no fair market value in 1926 and for that reason failed to report the transaction.

Having reached that conclusion, however, there remains the question of whether the present taxpayer is compelled to adhere in 1937 to a basis determined by its transferor’s act in 1926. We think that it must be held bound here as Giles would be bound. The petitioner received conveyance of the notes in a tax free transaction within section 112 (b) (5) of the Revenue Act of 1928. Its basis became that of its transferor’s. See 113 (a) (8). That basis we have found to be the basis of the land to Giles. The petitioner literally “stepped into the shoes” of its transferor and must assume all the consequences which, attach. Portland Oil Co. v. Commissioner, 109 Fed. (2d) 479; Birren & Son, Inc. v. Commissioner, 116 Fed. (2d) 718. The first cited case, indeed, is very similar to the present case and, we think, is largely determinative of the issue here. The taxpayer there acquired in 1980 an installment contract in a tax free transfer. Its transferor had acquired the contract in 1929 as the result of a sale in that year. The contract provided for a number of payments, beginning on January 1, 1930. In reporting the 1929 sale the trans-feror treated the transaction as an installment sale and consequently reported no gain. The debtor paid up the contract in 1931 and in reporting gain on the settlement the taxpayer claimed that the trans-feror made a completed sale in 1929, at which time all gain should have been taxed. The taxpayer accordingly claimed a “stepped-up” basis. The court held, in these circumstances, that the transferor would be “precluded from asserting, after the Statute of Limitations has run as to 1929, that the sale actually took place in 1929.” It ruled, further, that this applied as well to the transferee-taxpayer:

I£ Section 118 (a) (7) or 113 (a) (8) requires the petitioner to take over the contract on the basis as it would be in the hands of the transferor, Bu-Vi-Bar, then petitioner is in no better position than Bu-Vi-Bar to assert that the sale to the Continental Oil Company took place in 1929. This conclusion involves no judicial disregard of the “corporate fictionnor is it strictly a case of applying an estoppel against an innocent third person who was not responsible for the representation upon which the estoppel was founded. The conclusion follows, rather, from the statutory requirement of Section 113 that in certain eases where the transferor retained control, as defined, of the corporation acquiring the property,, the transferee steps into the shoes of the transferor so far as the tax basis for the property is concerned.

This reasoning applies with equal force here. The basis “as it would be in the hands of the transferor” is clearly the cost of the property to Giles. The petitioner may not treat it otherwise. Cf. Jamieson v. United States, 10 Fed. Supp. 321. Accordingly, the respondent’s action on this first issue must be sustained.

Issue No. 2.

The payment of $5,000 to James L. Giles by petitioner in 1937, for particular services rendered over a period of some seven years, is questioned by the respondent as unreasonable and excessive compensation. Proof is made by the petitioner of the extended and important character of the services rendered, consisting of securing the settlement of a long standing and overdue indebtedness owed by Beeman to the petitioner. It is shown that the payment of $5,000 special compensation for these activities was approved by the stockholders of the petitioner.

In view of these facts there appears to he no basis for holding unreasonable the sum paid to Giles for these activities. Salary as general manager was paid to him, it is true, during the taxable year, but the compensation in question was for services' of a special nature rendered over several years. Such extra compensation has frequently been approved when the extent and success of the efforts appear reasonably to warrant it. Heywood, Boot & Shoe Co. v. Commissioner, 76 Fed. (2d) 586; Guarantee Liquid Measure Co., 20 B. T. A. 758; Central Wisconsin Creamery Co., 15 B. T. A. 396. Accordingly, our decision on this issue must be for the petitioner.

Issue No. 3.

The final issue is whether interest paid by petitioner during both of the taxable years on loans negotiated by another is deductible by petitioner when it is shown as to certain of the loans that petitioner received properties representing proceeds of the loans under an agreement to pay the interest and as to the remaining loans that they were negotiated at petitioner’s request, and that petitioner received the borrowed funds and agreed to pay the interest arising thereon.

The principle that interest to be deductible must ,be paid on petitioner’s own obligations is not here questioned. Helen B. Sulzberger, 33 B. T. A. 1093; Morris Plan Co. of Binghamton, 26 B. T. A. 772. The efforts of the petitioner seem bent toward showing that the payments here in question were made pursuant to its own obligations, and, indeed, we have found that the petitioner gave its promise to pay the interest in question. But it is a different thing to agree to pay interest on the debt of another and to be required to pay interest on one’s own debt. Only in the latter case may the interest deduction be allowed. William H. Simon, 36 B. T. A. 184. Here, the petitioner was not indebted to the recipient of the interest, the insurance company, nor, so far as we have been shown, to Giles. The receipt of the properties representing loans made prior to its organization and of the proceeds of the loans made thereafter did not create an indebtedness; they appear to have been capital contributions in each case. Whether the payment of interest, promised by the petitioner as incidents of these transfers, be regarded as consideration for the transfer and thus a capital outlay, see Automatic Sprinkler Co. of America, 27 B. T. A. 160, or as a return on petitioner’s capital investment, see, e. g., Greensboro News Co., 31 B. T. A. 812, it is clear that they were not paid on an indebtedness of the petitioner and, in consequence, their deduction may not be allowed.

Accordingly, our decision on this issue must be for the respondent.

Decision will be entered under Rule 50.


author: Murdock :

text:
    Mary W. Pingree, Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket No. 104858.
    Promulgated September 5, 1941.

      Earle W. Carr, Esq., for the petitioner.

      James J. Haslam, Esq., for the respondent.
   OPINION.

Murdock :

The principal issue is whether that portion of the trust income from one-half of the corpus payable to the mother during her life is taxable to the petitioner. The petitioner has reported the income from the other one-half of the corpus which was payable to her. When the death of the mother terminates her life estate, the petitioner, if living, will receive and be taxable with the income from the entire corpus. The contention of the petitioner on this point is merely that the income payable to her mother during 1936 and 1937 is not taxable to the petitioner. The situation is not materially different from the simple case of a trust for the life of the mother. Indeed, the division of the corpus into two separate parts, the one to benefit the mother for life, may have resulted in two separate trusts. Cf. William B. McIlvaine et al., Trustees, 29 B. T. A. 304; affd., 78 Fed. (2d) 787; 296 U. S. 488; Lynchburg Trust & Savings Bank v. Commissioner, 68 Fed. (2d) 356; certiorari denied, 292 U. S. 640. Income of a trust currently distributable is ordinarily taxable to the life beneficiary, regardless of how the corpus may be used or distributed after the termination of the life estate. Sec. 162 (b), Revenue Act of 1936.

The Commissioner has shifted from one ground to another without ever advancing any sound basis for taxing to the petitioner the income from the trust payable to her mother for life. He cites no authority for the tentative position taken in the notice of deficiency that the income from the life trust for the mother is taxable to the petitioner because she retained the power to appoint by will the persons to whom the trust corpus would go after the life estate in the mother had terminated with her death. Decision of this part of the case is not dependent upon what may happen to the corpus after the death of the mother terminates her life estate. The question is, Why should the income payable to the mother during her life be taxable to the petitioner ? Had the petitioner created a simple separate trust for her mother for life, the income would not have been taxable to the petitioner even though she had thus retained full power to deal with the corpus after it had served the purpose of the trust. Cf. Helvering v. Wood, 309 U. S. 344; J. Edward Johnston, 41 B. T. A. 550, and cases cited therein. Here, where she retained less control over the corpus, there is certainly no greater reason to tax her on the income of the trust payable to her mother. Lady Marian Bateman, 43 B. T. A. 69. Cf. Sarah A. W. Coursey, 33 B. T. A. 1068.

The Commissioner, in his brief, no longer relies directly upon the ground advanced in the notice of deficiency. He makes several arguments, one of which is that the retained power to withdraw $1,000,000 from the trust corpus was a power of revocation within the meaning of section 166. This trust was irrevocable except as to the $1,000,000, which rvas less than one-fourth of the total corpus. Income taxable to a grantor under section 166 is limited to “the income from such part of the trust” as the grantor can revest in himself without the consent of any person having an adverse interest in that part of the corpus “or the income therefrom.” The interest of the mother was clearly adverse and her consent was required for the withdrawal of any funds. Thus, not even the income from the $500,000 subject to withdrawal from this one-half of the trust could be taxed to the petitioner under section 166. The possibility that the death of the mother would permit the petitioner to freely withdraw the $1,000,000 is immaterial, since the mother’s life estate would also terminate with'her death. Furthermore, see Marrs McLean, 41 B. T. A. 565; affd., 120 Fed. (2d) 942; Henry A. B. Dunning, 41 B. T. A. 1101; reversed, 118 Fed. (2d) 341, and cases there cited. Since the 1936 and 1937 income was distributable to the mother, it was not distributable to or held for the petitioner and section 167 could have no possible application. The cases of Altmaier v. Commissioner, 116 Fed. (2d) 162, and Graff v. Commissioner, 117 Fed. (2d) 247, cited by the Commissioner, dealing with accumulated income, are not in point.

The respondent, apparently, now places his chief reliance upon section 22 (a), claiming that the trust was for a short term, was controlled by the petitioner, was a mere assignment of income from property which the petitioner continued to own. The trustees were appointed for life and were in full control. The petitioner was not a trustee. The trust effected a very substantial disposition of the trust property and was not a mere assignment of income. The cases of Helvering v. Horst, 311 U. S. 112, and Harrison v. Schaffner, 312 U. S. 579, involving the assignment of income, are not in point. The respondent points to the advanced age of the life beneficiary in 1941 to show that the trust was like a short term trust. All trusts would eventually become short term trusts upon such a theory. The trust, as it benefited the mother, was created in 1922, was still in effect in 1941, and was to remain.in effect so long as she should live. Although she was 78 in 1936 and 83 in 1941, she was but 64 in 1922, when the trust was created to'benefit her for life. This case is unlike Helvering v. Clifford, 309 U. S. 331, relied upon by the respondent. The income distributable to the mother was not taxable to the petitioner.

The Commissioner mentioned as an alternative, in the notice of deficiency, that capital gains realized by the trust and accumulated would be taxable to the petitioner under section 167 because of her reserved power of appointment. The position has been abandoned, apparently, since it is not urged in the respondent’s briefs. Amounts thus accumulated were never to be distributed to the petitioner and, consequently, section 167 has no application. The respondent in his brief makes the new argument that the accumulations are taxable to the petitioner under section 167 because of her power to withdraw them as a part of the $1,000,000, and, also, that the income from $500,000 is taxable to her under section 166 because of her right to withdraw that amount from the corpus of the mother’s life trust. He cites no authority supporting these contentions. The facts show that there is no merit in them. They are made upon the theory that the mother had no interest adverse to the withdrawal of the $1,000,000. The interest of the mother was adverse to the withdrawal of any part of the $1,000,000, since one-half of it would have to come from the corpus supplying her income. Thus, as has been stated, section 166 has no application to the income from $500,000. The accumulations were never to be distributed to the petitioner except as she might withdraw them as a part of the $1,000,000. Since the mother had an interest adverse to such withdrawal and her consent was necessary to any withdrawal, the capital gains were not taxable to the petitioner under this theory.

The Commissioner makes in his brief another argument never theretofore advanced. He says that one-half of the capital gains are taxable to the petitioner under section 167 (a) (2) because it was within the discretion of the trustee to treat those gains as income and distribute them. He assumes that one-half of the gains were from that part of the corpus set aside for the petitioner and thus could have been distributed to her. The trust deed gives the trustees power to decide what is income and what is principal. They determined that the capital gains were principal and not distributable as income, which was in accordance with the law of Massachusetts. Theodore B. Plunkett, 41 B. T. A. 700; affd., 118 Fed. (2d) 644. The Board has held that the local law is not controlling and section 167 (a) (2) applies where capital gains are subject to such a discretion in trustees. Malcolm W. Greenough, 29 B. T. A. 315; H. Cecil Sharp, 42 B. T. A. 336; Georgia B. Lonsdale, 42 B. T. A. 847. But the Circuit Court of Appeals for the First Circuit, to which this case could go on appeal, has gone both ways on this point. It affirmed the Greenough case, 74 Fed. (2d) 25, and recently, in Commissioner v. O'Keeffe, 118 Fed. (2d) 639, seems to have taken the opposite view. We are not going to decide the question here because it has not been fairly and properly raised either by the pleadings or the facts in the record. The Commissioner should have pleaded this issue, and since he failed to do so, we need not decide it. If all of the gains were on the property in the mother’s one-half of the trust, the issue is not present. Regardless of who had the burden of proof, we may not assume that the petitioner, had she known any such issue was involved, would not have produced proof that none or less than one-half of the capital gains came from her one-half of the corpus.

The petitioner was not taxable on any income of the trust, so far as this record shows, except that which was actually distributed to her and about which there is no dispute. The petitioner states that the other issues need not be decided once the above decision is reached. That seems to be correct. The respondent expresses no disagreement. The other issues are whether the trust is entitled to deduct as expenses of a business under section 23 (a) trustees’ commissions and other expenses which in fact were paid. Allowance or disallowance of these items would not change the amount distributable and taxable to the petitioner if the trust is not to be disregarded.

Decision will be entered under Rule 50.


text:
    Charles J. Stamler, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103976.
    Promulgated September 5, 1941.

      Charles J. Stamler pro se.

      A. H. MonacelU, Esq., for the respondent.
   OPINION.

Smith:

The question presented by this proceeding is whether the petitioner is entitled to deduct from his gross income for 1937 the $3,832.58 which represents the petitioner’s investment in the Morris Avenue property at Elizabeth, New Jersey, at the time of the transfer in 1937. The amount was deducted in the petitioner’s income tax return as a bad debt. In his deficiency notice the respondent states:

It is held that:
(1) The amount of $3,832.58 deducted on your return as a bad debt represents a gift and accordingly is not an allowable deduction.

The petitioner contends that the deed of his interest in the Morris Avenue property to his sister-in-law was not intended as a gift and that the respondent is in error in disallowing the deduction as a gift. The petitioner contends that he deeded the property under an agreement with his brother that he should be relieved from making any payments for back taxes, interest, and curtail of the mortgage, and that the consideration for the transfer was such assumption of the petitioner’s liabilities by his brother. The petitioner now claims that the loss is a legal deduction from his gross income of 1937.

We think it entirely immaterial whether the respondent was in error in his determination that the transfer of petitioner’s interest in the property in 1987 constituted a gift on the part of the petitioner. If it was a gift the deduction taken is clearly not allowable. The question for decision is whether the petitioner is entitled to the deduction of $3,832.58, or any part thereof.

Section 24 of the Revenue Act of 1936 provides in part as follows :■

(а) General Rule. — In computing net income no deduction shall in any case be allowed in respect of—
* * * * * * *
(б) Loss from sales or exchanges of property, directly or indirectly, (A) between members of a family, * *. *

It is not material in this case whether the consideration for the transfer was an adequate consideration. We assume that it was. But clearly under the statute the petitioner is not entitled to the deduction of the loss; for it was a transfer between members of a family, the sister-in-law being merely the nominee of the brother. The respondent did not err in disallowing the deduction.

Decision will be entered for the resfondent.


author: Black: :

text:
    James D. Robinson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104734.
    Promulgated September 5, 1941.

      Sidney J. Hayles, G. P. A., for tbe petitioner.

      J. Marvin Kelley, Esq., for tbe respondent.
   OPINION.

Black: :

The applicable statutes and regulations are printed in the margin.

There is no question but that petitioner was out of pocket the $4,853.10 which he claimed as a deduction from his gross income on his 1937 income tax return. One thousand dollars of this amount he paid in cash to R. Clyde Williams and the other $3,853.10 he paid to Fenner & Beane to make good a loss in a stock trading account carried in the name of R. Clyde Williams which had been guaranteed by petitioner and was operated and conducted for Williams’ benefit by petitioner.

But, while there is no doubt that petitioner paid out the funds which he claims as a deduction, were these expenditures “ordinary and necessary expenses paid or incurred * * * in carrying on any trade or business” within the meaning of section 23 (a), printed in the margin? We think that question must be answered in the negative and that the Commissioner must be sustained in his dis-allowance of the claimed deduction.

We think that what happened, as disclosed by the evidence, was approximately this: Williams was a valuable officer and employee of the First National Bank of Atlanta and petitioner knew it. Williams had received a favorable offer from a New York bank which he was about to accept and petitioner, as an officer and director of the bank, did not want the bank to lose his services. Therefore he proposed to the directors of the bank that the bank pay Williams an increase in salary so as to hold him. This the directors declined to do in 1937. Petitioner, knowing that Williams was a valued employee of the bank and would be of great assistance to petitioner when he became president of the bank in 1938, a fact which seemed to have already then been agreed upon, rather than lose Williams’ services, decided that he would pay out of his own pocket an amount which would hold Williams. This he did, as detailed in our findings of fact. In making such an expenditure we think that petitioner was incurring something in the nature of a personal expense rather than an ordinary and necessary business expense. Throughout the year 1937 Williams was an officer and employee of the First National Bank of Atlanta and not of petitioner. The bank did not of course have the right to deduct as a business expense the amounts which petitioner paid to Williams, for the simple reason that the bank did not pay these amounts.

We fail to see, however, where the relationship of employer and employee ever existed between petitioner and Williams. It is true that petitioner, as vice president of the bank at a salary of $19,000 in 1937, was engaged in business. Ralph C. Holmes, 37 B. T. A. 865. In that case we said:

* * * It may well be that deductible “ordinary and necessary expenses in carrying on a trade or business” would be few and for between for a taxpayer engaged in carrying on a business as executive officer ot a corporation. The most of such deductions that we can think of would be those allowable only to the corporation. However, there are some which would be allowable as deductions to the individual, if he pays them out of his own personal funds, such for example as those involved and allowed in the Peoples-Pittsburgh Trust Co. case and the Hurt case. * * *

We may pause long enough here to remark that the expenditures made by petitioner in the instant case are not of the nature of those involved in Peoples-Pittsburgh Trust Co. et al., Executors, 21 B. T. A. 588, and Mrs. A. B. Hurt et al., Executors, 30 B. T. A. 653. In the Ralph G. Holmes case, supra, we denied the taxpayer the deductions which he sought as ordinary and necessary business expenses on the ground, first, that they were made after Holmes ceased to be the chief executive officer of the Texas Co. and, second, that, even assuming that his remaining as a director of the corporation of which he had formerly been president constituted the carrying on of a business, the expenditures in question could not be allowed as deductions, because they were extraordinary in character for a director to pay out of his own personal funds and were not shown to be “ordinary and necessary” business expenses. From our decision the taxpayer filed petition for review to the Second Circuit, but later dismissed his appeal on March 15, 1939. Thus our decision in that case stands.

While the expenditures involved in the Holmes case were different from those involved in the instant case, yet we think the rationale of our opinion in the Holmes case should govern here. Just as the expenditures involved in the Holmes case were not ordinary in the conduct of the business of being director of a corporation, but were extraordinary, so do we think that the payments made by petitioner io Williams in 1937 out of his own personal funds were not ordinary expenditures for him to make as an officer of the bank, but were extraordinary in character, and are not deductible by petitioner as ordinary and necessary expenses in- carrying on his business of being one of the chief executive officers of the bank. We may remark in this connection that petitioner made no more such payments to Williams after 1937. In 1938 the bank increased Williams’ salary and doubtless received full deductions for all amounts paid to him as ordinary and necessary business' expenses of the bank.

Petitioner does not^claim that the $3,853.10 which he paid to Fenner & Beane in 1937 pursuant to his guarantee of Williams’ account is deductible as a loss under section 23 (e) (1) or (2) of the Bevenue Act of 1936. It seems clear that the amount would not be so deductible even if petitioner had claimed it on that ground, because the loss was not incurred in trade or business as provided by section 23 (e) (1) and it was not incurred in a transaction entered into for profit as provided by section 23 (e) (2). Any profits which might be obtained in the operation of the account were to go to Williams and nob to petitioner. For the reasons above stated, we sustain the Commissioner.

Decision will be entered for the respondent.

       Revenue Act of 1936—
      SEC. 23. DEDUCTIONS FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      (a) Expenses. — Ail the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; * * *
      SEC. 24. ITEMS NOT DEDUCTIBLE.
      (a) Genekap Rule. — In computing net income no deduction shall in any case be allowed in respect of—
      (1) Personal, living, or family expenses ;
      * * * « * * *
      AM. 23 (a)-l. [Regulations 94.] Business expenses. — Business expenses deductible from gross income include the ordinary and necessary expenditures directly .connected with or pertaining to the taxpayer’s trade or business, * * *