McCahan v. Commissioner ( 1937 )

RENA S. MCCAHAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

McCahan v. Commissioner

Docket No. 79039.

United States Board of Tax Appeals

35 B.T.A. 943; 1937 BTA LEXIS 817;

April 23, 1937, Promulgated

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The petitioner, as executrix of an estate, in course of administration, paid estate and inheritance taxes in excess of the total amount of taxable items of gross income of the estate. During the same years she distributed to herself, as beneficiary under the will, several amounts which were designated as distributions of principal and as distributions of tax-exempt income. Held, the estate had no taxable income and the petitioner was not liable for tax upon such distributions.

W. C. Alexander, Jr., and F. R. Wadlinger, Esq., for the petitioner.

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

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MILLER

This proceeding arises on respondent's determination of deficiencies in petitioner's income taxes of $24,298.48 for the year 1932 and $825.63 for 1933.

FINDINGS OF FACT.

The essential facts are as follows:

The petitioner is executrix and beneficiary under the will of William J. McCahan, Jr., deceased, and one of the trustees, as well as a beneficiary, of a trust created thereby. The will was duly probated in the office of the Register of Wills of Philadelphia County, Pennsylvania, on April 13, 1932, and letters testamentary were granted to petitioner.

Those paragraphs of the will which dispose of the testator's property, read as follows:

FIRST ITEM: I give, devise and bequeath to my wife, RENA S. MCCAHAN, and her heirs, all of the real estate of which I may die seised, wheresoever situate.

SECOND ITEM: I give and bequeath to my wife, RENA S. MCCAHAN, absolutely, one-half of my personal estate.

THIRD ITEM: The remaining one-half of my personal estate I give and bequeath to my wife, RENA S. MCCAHAN, and THE PHILADELPHIA TRUST COMPANY IN TRUST, with power to retain the investments of which my estate may consist at the time of my death, so long as the Trustees shall deem proper, and with power to convert and re-invest, and to pay over the net income arising therefrom to my wife, RENA S. MCCAHAN, during her life, without liability for her debts, contracts or engagements, and without power to assign, transfer or anticipate the same. I give to my wife, RENA S. MCCAHAN, power to dispose of the principal of this trust by last Will and Testament. On failure to exercise this power of appintment, I direct that on the death of my wife the principal of the trust shall be distributed to and among my heirs, according to the Intestate laws of the State of Pennsylvania, as they now exist.

After April 3, 1932, the date of decedent's death, his estate was in the course of administration until the final distribution thereof was approved by the Orphans' Court on June 1, 1934. The estate at the time of death, consisted of real estate of a value of approximately $65,000 and personal property of a value of approximately $4,750,000.

On April 3, 1932, the date of death, the balance in decedent's banking account was $190,041.17, in addition to which there were checks and cash items for collection in excess of $20,000. During the calendar year 1932 and after April 3, 1932, there were distributed to the petitioner pursuant to the terms of the will, the following amounts of cash: April 29, $5,000; May 2, $480; June 5, $5,000; October 17, $50,000; December 27, $4,100; making a total of $64,580. At the time of each distribution there were ample available funds of the principal or corpus of the estate from which to make such distributions. At the time of each distribution, except the first two, there were also ample available funds of income of the estate. Upon the checks used to make such distributions, which were drawn on or after October 11, 1932, was typewritten, in each instance, "Acc. Distribution Principal" or other abbreviations of those words. The amounts of these distributions were charged on the books of account of the estate as distributions of principal, and in the schedule of distributions filed by petitioner as executrix of the estate in the Orphans' Court of Philadelphia County these amounts were duly credited as distributions of principal.

The income received by the estate of William J. McCahan, Jr., for the year 1932 was $154,572.84, composed of: Dividends, $101,345.20; interest, $18,414.36; taxable interest on Liberty bonds, $341.77; Municipal and tax-free bond interest, $34,471.51. In arriving at the amount of income set out above, no consideration is given to inheritance and estate taxes paid. Such taxes were paid as follows: April 21, 1932, register of wills, Philadelphia, inheritance tax, $100,000; August 20, 1932, Treasurer of the State of New Jersey, transfer inheritance tax, $11,588.22; December 6, 1932, register of wills, Philadelphia, inheritance tax, $25,000; a total of $136,588.22.

During the year 1932 the estate of William J. McCahan, Jr., received interest on First Liberty Loan and municipal bonds in the sum of $34,471.51. On December 16, 1932, petitioner, as executrix, paid over to herself the sum of $34,471.51, by check, upon the face of which was typewritten "Distribution tax-free Income." This sum was entered on the estate books as interest from this source, and was carried in petitioner's account as executrix, filed with the Orphans' Court, as income paid over to her.

During the year 1933 the estate of William J. McCahan, Jr., received interest on First Liberty Loan and municipal bonds as follows: January 1, to March 22, $18,958.75; from March 22, to July 1, $18,887.50; from July 1, to September 14, $19,252.50; from September 14, to December 19, $19,162.02; a total of $76,260.77. The petitioner, as executrix, paid over to herself, by checks, exactly the same amounts as these tax-exempt items received by the estate, to wit: on March 22, 1933, $18,958.75; on July 1, 1933, $18,887.50; on September 14, 1933, $19,252.50; on December 19, 1933, $19,162.02. Upon these checks was typewritten in each instance "income on tax-exempt securities", or similar language to indicate the source and tax-exempt character of this income.

The total income received by the estate of William J. McCahan, Jr., for the year 1933 was $246,386.72, composed of: dividends, $138,310.40; interest, $31,178.05; taxable interest on Liberty bonds, $637.50; a total of $170,125.95; exclusive of interest on First Liberty bonds and municipal bonds in the sum of $76,260.77. The inheritance and estate taxes and property taxes paid by the estate during the year 1933 were as follows: March 22, collector of internal revenue, Philadelphia, estate tax, $87,878.95; March 29, register of wills, Philadelphia, transfer inheritance tax, $68,714.14; November 1, register of wills, Philadelphia, transfer inheritance tax, $25,000; December 7, register of wills, Philadelphia, transfer inheritance tax, $25,000; February 20, receiver of taxes, Philadelphia, Pennsylvania, personal property tax for year 1933, $7,073.52; a total of $213,666.61.

Petitioner acted on the advice of counsel, and all care was taken to earmark the distributions made in both years by designating them as distributions of capital or as tax-exempt income in the checks used to distribute the various amounts, by proper entries in the estate's books, in the final account, and in the schedule of distributions filed by petitioner as executrix with the Orphans' Court of Philadelphia County.

In addition to the distributions referred to above, there was distributed to petitioner in the year 1933 the sum of $11,327.82. The petitioner did not report in her income tax returns for 1932 and 1933 any of the distributions described above, except the item of $11,327.82 which she reported as income in her 1933 return. On or about February 21, 1934, petitioner filed a claim for refund of the sum of $2,072.02 income taxes paid by her for the year 1933 on the sum of $11,327.82 referred to above. This refund has not been allowed.

The respondent conceded that the first two distributions made in 1932, totaling $5,480, were made from the corpus, but determined that all the rest in that year and all the distributions in 1933 were made from income of the estate. Certain of these distributions however, represented income from First Loan Liberty bonds and other tax-exempt sources. Respondent, accordingly, treated all the estate's income as a general fund, found a ratio of tax-exempt to total income, and, on this basis of allocation, determined that a certain proportion of the total distribution carried with it the tax-exempt character. He taxed the balance of the distribution as nonexempt and so found a deficiency against the petitioner. The same method was followed as regards the distributions made in 1933.

Petitioner, as executrix, claimed and was allowed deductions in respect of taxes in 1932 which left no estate income subject to normal tax, and only $8,360.76 subject to the surtax; and in 1933, after like deductions for taxes, no taxable income remained. In neither year did the estate claim any deduction in respect of distributions made to the petitioner as beneficiary.

The petitioner is entitled to a loss for the year 1933 in the sum of $3,700 on 162 shares of stock of the Commercial National Bank of Philadelphia owned by her.

OPINION.

MILLER: There were at all times sufficient available funds in the corpus of the estate to pay to petitioner all of the amounts which she received from the estate. The amounts distributed to her were designated as distributions of capital or as distributions of tax-exempt income, except $11,327.82 returned by her as taxable income in 1933. Respondent's contention is that there was taxable income in the hands of the executrix, which was distributed to petitioner; that neither the availability of principal funds nor the various designations of the distributions as principal and as tax-exempt income can prevent tax liability. Respondent's contention can not be upheld. During each of the two years involved, the taxable items of income of the estate of William J. McCahan, Jr., were completely exhausted by the payment of estate and inheritance taxes. These were properly paid from the income of the estate. Revenue Acts of 1928 and 1932, secs. 162 and 23(c); ^{Hamilton E. Shaver et al.,; . See also .}

The income of the estate having been thus exhausted, there remained no taxable income for distribution to the petitioner. In the Sitterding case, as in the instant case, the petitioner was both a legatee and a beneficiary of a testamentary trust under the will. There, as here, the estate paid both Federal estate taxes and state inheritance taxes in excess of the net income. In that case, as distinguished from the instant case, payment of such taxes was charged on the books against the principal or corpus of the estate and the amounts distributed to the petitioner as beneficiary were charged against gross income. The Board held that, as the distributions in the Sitterding case were paid out of income and received by the beneficiary as income, they were properly included by the respondent in the gross income of the petitioner. On appeal, the court held that as the estate did not collect enough total income to pay the state and Federal taxes properly chargeable against it, it followed that "there was no income to be distributed for that year and therefore no income to be taxed either to the estate or to the heirs."

The facts in the Sitterding case were much more favorable to the respondent's position than are the facts in the instant case, as the intention of both fiduciary and beneficiary there was that the distributions should be regarded as from income and they were so designated on the books. In the instant case they were expressly and uniformly designated as from the corpus, or as tax-exempt income.

The effect of the opinion of the Board in the Sitterding case is that the fiduciary may elect to pay estate and inheritance taxes from the principal or corpus and to distribute the income; whereupon, he having so elected, the income so distributed comes into the hands of the beneficiary subject to tax. The effect of the decision of the Circuit Court of Appeals for the Fourth Circuit is that the fiduciary has no such power of election, that the payment of such taxes in excess of income automatically exhausts the income and leaves none to be distributed. Both decisions are consistent with the proposition that if the fiduciary elects - as he has power to do - to exhaust the income in paying such taxes, there is no income to distribute to the beneficiary, and none to tax. That is the situation here.

Relying upon the case of , respondent contends that the estate and inheritance taxes should have been paid out of funds other than income; that, although the distributions were designated as distributions of principal and there were ample available principal funds for distribution, nevertheless this was a mere matter of bookkeeping. The opinion in the case of , expressly states that during the process of administration, estate tax, paid or accrued during a given year, is a proper deduction from the gross income of the estate in determining the income of the estate subject to tax. Then the opinion goes on to say:

* * * in the instant case the payment of the estate tax reduced the residue or remainder from which income would be derived, but what we are concerned with is income which has been earned by the remainder or residue of the estate. As to this income, the will specifically provides that such income, after deducting all necessary and proper charges and expenses, shall be paid over to the beneficiaries named, one of whom was the petitioner's decedent. The Federal estate tax paid was not a charge or expense incident to the earning of the income which would be distributed, but was a tax imposed on the transfer of the estate and as such was a charge against the estate rather than a charge against the income which the will provided should be distributed to the beneficiaries. [Italics supplied.]

The will of William J. McCahan, Jr., contained no such special provision. The second item of the will is an absolute bequest of one-half the personal estate and is sufficient in itself to authorize a distribution of available principal or corpus far in excess of the amounts actually distributed. Secs. 21, 49(b), 1917, Pa. Laws, 447, 488, 515 (Fiduciaries Act, June 7, 1917); Pa. Stats., Laws 1920, secs. 8509, 8596. The third item creates a trust, names the petitioner and another as trustees, and provides for the payment of the net income arising therefrom to the petitioner as the beneficiary thereof. The will does not provide for payment of net income of the estate by the executrix to petitioner, but in the third item provides for payment by trustees of the net income of the trust. The facts of the instant case tell us nothing about the income from that trust or even that the trust had any income. There is not even anything to indicate that the executrix had yet distributed to the trust the property specified in the third item, during the course of administration. Obviously, the Esselstyn case has no application to this situation.

The case of , relied upon by respondent, is one in which the testator bequeathed to his executors certain property in trust and directed the executors to pay the income thereof to the taxpayer. It was apparently assumed by the court and by all parties that the amount distributed was distributed as income. The opinion states:

In a refund claim filed March 8, 1928, it was contended that the income received by the taxpayer from the estate was not taxable to him, or, in the alternative, it was contended that appellee was entitled to deductions for the $60,000 of New York transfer tax which became due and was paid in 1923. It was the last alternative which was urged in this suit * * *. The opinion rendered below ([D.C.] seems to rest upon the basis that the income received from the estate was not taxable.

It is apparent therefore that the question presented in the instant case was not even considered in Neither was the question considered in , the other case relied on by respondent.

Since there is nothing in the will which indicates that the estate's income, undiminished by charges or expenses properly deductible from it, was to be paid to petitioner, it follows that the estate, after payment of estate and inheritance taxes (which, in the absence of such a testamentary provision, were properly chargeable to the estate's income), had no income to distribute in the years in question; and the distributions must, therefore, have been from the corpus of the legacy. The bookkeeping entries are immaterial.

Petitioner raises another contention, that since the estate took no deduction for any distributions made to the petitioner, as allowed under section 162 of the Revenue Act of 1932, such distributions would not, in any event, whether corpus or income of the estate, be taxable to petitioner as distributee. In view of our conclusion, consideration of this question is unnecessary.

Our conclusion requires, it should be added, that the sum of $11,327.82 returned by petitioner as taxable income in 1933 should also be treated as corpus and that the tax erroneously paid thereon be refunded, since petitioner's claim for refund was made within the statutory period. Sec. 322(d), Revenue Act of 1936.

A further deduction from petitioner's income in 1933 in respect of $3,700 which was stipulated as the amount of a loss in that year should be considered in the redetermination.

Reviewed by the Board.

Decision will entered under Rule 50.

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Footnotes

• 1. SEC. 162. NET INCOME.

  The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual except that * * *.

  SEC. 23. DEDUCTIONS FROM GROSS INCOME.

  In computing net income there shall be allowed as deductions:

  * * *

  (c) * * * For the purpose of this subsection, estate, inheritance, legacy and succession taxes accrue on the due date thereof, except as otherwise provided by the law of the jurisdiction imposing such taxes, and shall be allowed as a deduction only to the estate. ↩