Ledyard v. Commissioner , 44 B.T.A. 1056 ( 1941 )

ESTATE OF LEWIS CASS LEDYARD, JR., DECEASED, UNITED STATES TRUST COMPANY OF NEW YORK, EXECUTOR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Ledyard v. Commissioner

Docket No. 99249.

United States Board of Tax Appeals

44 B.T.A. 1056; 1941 BTA LEXIS 1240;

July 18, 1941, Promulgated

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1. Petitioner's decedent was at the time of his death a member of a law partnership and executor and trustee of estates. He and the partnership kept their books and filed their returns on the cash basis. A successor partnership took over the incompleted work of the decedent's firm and in subsequent years paid to petitioner the decedent's share of the collections made for work done by the predecessor partnership. Subsequent to decedent's death various courts allowed fees for services rendered by the decedent as executor and trustee during his lifetime, all of which were collected by petitioner. Held, following Helvering v. Enright,312 U.S. 636">312 U.S. 636, that the amounts received by the petitioner constitute accrued income to the decedent within the meaning of section 42 of the Revenue Act of 1936, which does not violate the Fifth and Sixteenth Amendments.

2. Dividends declared before the decedent's death to stockholders of record, and payable on specified dates, after death, and interest on bonds and notes earned before but not payable until after death, held to be accrued income under section 42, supra, following Helvering v. McGlue, 119 Fed.(2d) 167.

3. Petitioner's decedent for several years prior to his death served as director of several corporations. A suit was instituted against him and other directors of the corporations for alleged misconduct as directors. The suit was pending at the time of decedent's death. About one year later judgment was entered against petitioner, which judgment was paid. Held, that the amount is deductible under section 43 of the statute.

Allin H. Pierce, Esq., Will R. Gregg, Esq., and John H. Young, Jr., Esq., for the petitioner.

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

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DISNEY

This proceeding involves the redetermination of a deficiency of $371,675.25 in income tax for 1936. In an amendment to his answer to the petition respondent alleges that the taxable income of the petitioner should be increased by the net amount of $20,280.89 and asks for an increased deficiency arising from the inclusion of the additional income. The stipulation of facts is incorporated herein by reference as a part of our findings of fact. The material portions thereof will be set forth in the findings of fact made from other evidence of record. The issues are (a) whether the last sentence of section 42 of the Revenue Act of 1936 is constitutional; (b) whether amounts received by petitioner for services rendered by the decedent as a member of a law partnership, and as executor and trustee and as dividends on stock, constitute income accrued at the time of decedent's death; and (c) whether the amount of a judgment against petitioner for alleged misconduct of the decedent as director of a bank accrued as a deduction at the time of decedent's death.

FINDINGS OF FACT.

The petitioner is the duly appointed executor of the estate of Lewis Cass Ledyard, Jr., who died testate on May 1, 1936, a resident of Syosset, New York.

The decedent and the petitioner at all times important kept their books and filed their income tax returns on the cash and calendar year bases.

Partnership Income.

At the time of his death the decedent was a member of the law firm of Carter, Ledyard & Milburn, the books of which, and predecessor partnerships of the same name of which the decedent had been a member, were kept on the cash basis.

The partnership agreement, dated December 31, 1935, provided that the net earnings of the firm included not only earnings from services rendered by it after January 1, 1936, but amounts received by it thereafter for services rendered by predecessor partnerships; that the decedent was entitled to 16.85 percent of the net earnings of the partnership; and that the death of any partner would work a dissolution of the partnership. Other provisions of the partnership agreement, in so far as material here, provided as follows:

The affairs of the firm shall be liquidated in the event of dissolution caused by the death of a partner by a majority in interest of the surviving partners * * *. * * * the estate of a partner who dies shall not be entitled to any part of any earnings received after the dissolution of the frim for services performed after such dissolution but shall be entitled to receive in full satisfaction of his interest in the firm only such partner's due proportion of all earnings actually collected prior to such dissolution and not theretofore paid to him and his due proportion of all earnings received after such dissolution for services performed prior thereto. A majority in interest of the * * * surviving partners * * * shall determine with respect to all earnings received after the dissolution of the firm what proportion thereof, if any, is received for services performed prior to such dissolution and the decision of such majority in interest of the surviving * * * partners shall be final and conclusive upon all persons having any interest therein.

The income of the partnership was derived from fees paid by clients for legal services, a portion of which consisted of annual or monthly retainers, the amounts of which were agreed upon in advance, and the remaining fees were received in respect of specific matters.

Upon the death of the decedent the partnership was dissolved and liquidated in accordance with partnership agreement, and immediately thereafter a new successor partnership was formed under the same name by the surviving partners. The successor partnership took over the incompleted work of its predecessor and carried the matters to completion. In some instances nothing remained except collection of the fee and the other matters were in various stages of completion.

Allocations of fees between the former and successor partnerships were made by the partner who had charge of the work. He considered the nature and amount of work done, its importance and the general result achieved for the client. The proposed allocation was then considered by all of the partners at their next meeting. If any partner suggested a revision, the subject was openly discussed. Revisions as a result of the discussion were not infrequent. In particularly difficult cases a committee was, at times, appointed to make a recommendation to the partnership. Under the method followed by the partnership, the amount of its fee was not determinable until the work had been substantially completed. No allocation of a fee between former and existing partnerships was ever made until the amount of the fee was determined.

In his determination of the deficiency the respondent included in gross income the amount of $150,037.84 as income from the partnership. Of this amount $34,990.19 represents decedent's distributive share of the net income collected by the partnership in 1936 prior to his death, which petitioner concedes constitutes taxable income to the decedent in 1936. The remaining amount, $115,047.65, represents payments made to petitioner from fees collected by the successor partnership in respect of matters which it took over upon the decedent's death and carried to completion. The correct amount of payments made by the partnership to the decedent's estate from fees collected after May 2, 1936, to May 29, 1940, was $134,534.95. The amount received each year by the petitioner was returned as income of the estate.

The interest of the decedent in the partnership was returned by the executor for estate tax purposes at an estimated value of $281,778.12.

Executor's and Trustees's Commissions.

The decedent at the time of his death was executor of two estates and trustee of thirteen trusts. A short time after petitioner qualified as executor of the decedent's estate, accounting proceedings were instituted in all of the trusts and estates for the purpose of relieving decedent's estate of any liability for fiduciary acts of the decedent. In these proceedings accounts were rendered to the courts for the acts of the decedent and his cotrustees or coexecutors under the trusts and estates and requests were made that the courts fix and allow compensation for the services which the decedent had performed. All of the accountings filed in the courts were made necessary by reason of decedent's death. In one proceeding the court rejected the claim of petitioner for an allowance of compensation for services rendered by the decedent as a cotrustee of four trusts.

The various courts allowed, on dates from September 8, 1936, to December 12, 1939, commissions aggregating $459,934.55, of which $392,096.56 was on principal and $67,837.99 on income. All of the allowances were computed at the statutory rates for receiving and paying out principal and income.

None of the wills and trusts, with one exception, contained a provision for the amount of compensation of the executor or fixed the method or time of payment thereof. In the exceptional case the will provided that the fiduciary should be entitled to his compensation, notwithstanding the fact that he might resign or die before the termination of the trust and that the trustees upon receipt of property could deduct their commissions without making application therefor to any court. Pursuant to that authority the trustees of this trust had taken all of their commissions on principal prior to the decedent's death and took their commissions on income at the end of each year after rendering an informal accounting to the beneficiaries. In none of the trusts or estates was there an agreement among the cotrustees or coexecutors on a division of the commissions.

The decedent and the petitioner collected $603,396.12 as executor's and trustee's commissions for services rendered by the former as executor or trustee prior to his death. Of this amount $143,461.57 was collected by the decedent, and the items constituting the remainder of $459,934.55 ($392,096.56 as commission on principal and $67,837.99 on income) were collected by petitioner in the years in which they were allowed by the courts in 1936, 1937, 1938, and 1939 in accordance with the laws and practice in the State of New York in cases where an executor or trustee dies before the completion of his duties, and pursuant to accounts filed by the petitioner with the courts after the death of the decedent. The amount of commissions allowed on income was with respect to income received by the trusts and estates after the last annual accounting of the decedent. No request had been made by the petitioner to any court or beneficiary for the allowance of the commissions prior to the decedent's death.

None of the amount collected by the petitioner was included in the final income tax return of the decedent. In eleven of the thirteen trusts the commissions were allowed and were, together with commissions allowed on August 5, 1937, for another trust, included in the estate tax return at values equal to the amount allowed and collected. In the other trust there was no award or collection until December 1937 and nothing was reported in the estate tax return. In the case of the two estates the commissions were reported in the estate tax return at estimated amounts within several hundred dollars of the total amount allowed and collected in 1938 and 1939.

Dividends.

In his determination of the deficiency respondent included in decedent's gross income as dividends the amount of $15,926.50, of which $12,926.50 was received by the decedent in 1936 prior to his death and is conceded by petitioner to be taxable income of the decedent. The remaining amount of $3,000 constitutes taxable dividends received by the petitioner as the record holder of the stock, $500 pursuant to a declaration of a New Jersey corporation on April 22, 1936, to ist stockholders of record on May 15, 1936, and payable on June 1, 1936, and $2,500 in accordance with a declaration made by the First National Bank of the City of New York on March 10, 1936, to stockholders of record on June 15, 1936, and payable on July 1, 1936.

Director's Liability.

The decedent was a director of the Chase National Bank of the City of New York for several years prior to May 4, 1933, when he resigned. At the time of his death he was a codefendant in an action upon an unliquidated claim then pending in the Supreme Court of the State of New York, New York County, and after his death petitioner was substituted for him as a defendant. The complaint alleged that the decedent had incurred liability to the plaintiffs by reason of his conduct as a director of the bank. The allegation was denied by the decedent in his answer to the complaint.

On or about June 24, 1937, a judgment was entered against the petitioner in the proceeding in the amount of $250,000, which amount, plus $3,087.35 for expenses, was paid by petitioner on June 25, 1937. The payment was approved by the Surrogate's Court on July 13, 1939. In his determination of the deficiency the respondent disallowed the payment as a deduction upon the ground that the amount had not accrued at the date of the decedent's death.

Interest.

The respondent included in the decedent's gross income as interest the amount of $13,304.29, of which $782.50 was collected by the decedent in 1936 prior to his death and is conceded by petitioner to be taxable income of the decedent for 1936. The remaining amount, $12,521.79, was received by the decedent's estate and was earned but not paid or payable at the time of the decedent's death. The additional amount of $847.79 of like income was received by the petitioner, but was not included in income by the respondent. The amount of $13,369.58 in controversy was collected by the petitioner as the holder of the bonds and notes at the time when the interest became payable.

OPINION.

Constitutional Question.

DISNEY: The petitioner argues that the last sentence of section 42 of the Revenue Act of 1936 ^{Sixteenth Amendment and violates the Fifth Amendment.}

Whether or not the respondent's action as to the income items involved herein violates the Fifth Amendment is fully answered in Estate of Wilton J. Lambert,40 B.T.A. 802">40 B.T.A. 802. In that case the decedent, an attorney, kept his books on the cash method of accounting and died in 1935 with accruable amounts owing to him for services rendered during his lifetime. We held that the last sentence of section 42, supra, did not violate the Fifth Amendment.

Decisions of this Board and the courts are uniform in holding that the effect of section 42 is to put the decedent on the accrual basis of reporting income in his final return. Lillian O. Fehrman, Executrix,38 B.T.A. 37">38 B.T.A. 37; Estate of Wilton J. Lambert, supra;Estate of G. Percy McGlue,41 B.T.A. 1186">41 B.T.A. 1186; Herder v. Helvering, 106 Fed.(2d) 153; Helvering v. Enright,312 U.S. 636">312 U.S. 636. The accrual method of accounting and reporting income is not new. It has been a part of income tax laws since the 1916 Act. The constitutionality of the method was apparently assumed in United States v. Anderson,269 U.S. 422">269 U.S. 422, and in United States v. American Can Co.,280 U.S. 412">280 U.S. 412. The accrual basis of accounting authorized by the Revenue Act of 1918 was held in Weed & Bro. v. United States, 38 Fed.(2d) 935; certiorari denied, 282 U.S. 846">282 U.S. 846, not to violate the Sixteenth Amendment. Other cases hold that a deceased partner's distributive share of partnership profits not reduced to possession constitutes income includable in the final income tax return of the decedent who had kept his books on the cash basis. Bull v. United States,295 U.S. 247">295 U.S. 247; Guaranty Trust Co. v. Commissioner,303 U.S. 493">303 U.S. 493. The constitutionality of section 42 was not questioned in Helvering v. Enright, supra, but the Court held that a right to receive in the future partnership income earned by the efforts of the decedent prior to his death is accruable as income and taxable, with cash actually received, in the final return of the deceased partner. Like income is involved herein. A tax imposed upon it is clearly within the Sixteenth Amendment, and we so hold.

Partnership Income.

The sole point for discussion under this issue is whether the amount of $134,534.95, paid to the petitioner as the decedent's proportionate share of partnership profits on collections made after his death, is accruable within the meaning of section 42, supra. The proceeding was submitted prior to Helvering v. Enright, supar. The briefs filed by each party discuss at considerable length various cases of the courts and this Board, some involving the controlling statute, as to when income is accruable. No useful purpose would be served by discussing their interpretation of the decisions relied upon by them, in view of the more recent decision of the Supreme Court in the Enright case.

In the Enright case the respondent's decedent was at the time of his death a member of a law partnership which kept its books and filed its returns on the cash basis each calendar year. Also, the decedent, like the petitioner here, was on the cash basis. The partnership agreement entitled the estate of any deceased partner to receive his share of, among other things, "outstanding accounts and the earned proportion of the estimated receipts from unfinished business", and provided for a valuation of the items by the decedent's executor and the senior surviving partner, the amount of which was payable by the surviving partners in equal installments within eighteen months. The will of the decedent directed his executor to accept the valuation placed on his interest by the senior surviving partner and to accept payment upon such terms as the valuing partner deemed necessary for liquidation out of the business. There was a further understanding that the estate would receive what was ultimately realized out of the valued assets.

The question before the Court was whether the valuation placed upon the decedent's interest in partnership earnings prior to his death, which amount was returned by the executor for Federal estate and New Jersey inheritance tax purposes, constituted accrued income within the meaning of section 42 of the 1934 Act, which reads the same as section 42 of the 1936 Act. In holding that the income had accrued, the Court said, inter alia:

* * * There was no customary accounting system to determine whether the value of services rendered should be accrued before payment. Under such circumstances, we are of the view that items of partnership income properly accured should be included in the income tax return of the deceased partner. This will cause the accrued items of partnership return to be included in the income tax return of a deceased partner, whether the partnership method is accrual or cash. Furthermore, an accrual of compensation for the unfinished business seems sound in view of the purpose of the enactment of § 42.

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* * * Accruals here are to be construed in furtherance of the intent of Congress to cover into income the assets of decedents, earned during their life and unreported as income, which on a cash return, would appear in the estate returns. Congress sought a fair reflection of income.

* * * The completion of the work in progress was necessary to fix the amount due but the right to payment for work ordinarily arises on partial performance. Accrued income under § 42 for uncompleted operations includes the value of the services rendered by the decedent, capable of approximate valuation whether based on the agreed compensation or on quantum meruit. The requirement of valuation comprehends the elements of collectibiltiy. The items here meet these tests and are subject to accrual.

The effect of the Court's opinion was, in general, to approve as an accrual, for inclusion in the final income tax return of the decedent, the value of the interest of the decedent in earnings of the partnership prior to his death, an asset of decedent at the time of his death, even though the amount had not been accrued or distributed by the firm. In that proceeding, as here, there was a large volume of uncompleted work, consisting of pending cases, taken over by the successor partnership. Here the partnership agreement made no provision for placing valuation on the decedent's share of partnership earnings, though not actually collected, and the income taxed to the decedent by respondent is based upon payments made to the petitioner from cash collections after the termination of the partnership, not upon a valuation of the decedent's interest as of the date of his death. These payments were made pursuant to the partnership agreement under which the estate of a deceased partner was entitled to his "due proportion of all earnings received after such dissolution for services performed prior thereto."

No contention is made by petitioner that the value of the deceden's right to a proportionate share of partnership earnings for services rendered by its members prior to his death is less than the amount of $134,534.95 which was included in decedent's income by respondent and is in controversy. Such evidence as there is of record discloses a value considerably in excess therof. The interest was returned by the executor, the petitioner herein, for estate tax purposes at an estimated value of $281,778.12, or about twice the amount based upon actual receipts over a period of four years subsequent to decedent's death. This evidence of value is sufficient to sustain the findings of respondent that $134,534.95 was accruable as income in the final income tax return of the decedent. Estate of George W. Wickersham,44 B.T.A. 619">44 B.T.A. 619. In sustaining the respondent on this issue we do not decide whether, without evidence of value of the right to partnership earnings, on accrual may be made based entirely upon actual receipts subsequent to the termination of the partnership.

Executor's and Trustee's Commissions.

The parties are in agreement that section 285 of the Surrogate's Court Act and section 1548 of the Civil Practice Act of the State of New York, prescribing rates of compensation for executors and testamentary trustees and trustees of trusts inter vivos, are applicable only to living fiduciaries and that compensation to a deceased fiduciary is discretionary with the court. See Matter of Bushe,227 N.Y. 85">227 N.Y. 85; Matter of Barker,230 N.Y. 364">230 N.Y. 364; Matter of Rosenberg,124 Misc. 434">124 Misc. 434; 207 N.Y.S. 557">207 N.Y.S. 557; Matter of Mohr,167 Misc. 523">167 Misc. 523; 5 N.Y.S.(2d) 239. The contention of petitioner under this issue is that no amount should be included in income for accrued commissions for service rendered by the decedent as executor and trustee, upon the ground that it is impossible to determine in advance of a decree what amount will be allowed within the broad discretionary power of the court.

The petitioner contends that Estate of G. Percy McGlue, supra, is indistinguishable and controlling. That case involved the accrual, under section 42, of commissions earned by the coexecutor of two estates in the District of Columbia, where the proper court has discretionary power to award, upon the final settlement of the estate, a fee of from 1 to 10 percent of the value of the estate. In one of the estates no application had been filed for commissions prior to the hearing and consequently nothing had been allowed by the court or collected. The amount included in the decedent's final return for accrued commissions was based upon the estimate made in the estate tax return for deduction purposes. In the other estate no accounting was filed and no allowance of commissions was made until after the decedent's death. The amount so allowed was included in the decedent's final return by the Commissioner. The indefiniteness of the amount, if any, that would be allowed by the court was a factor leading to our conclusion that the fees had not accrued to the executor at the time of his death. Upon appeal the court, following the rationale of the Enright case, reversed the Board. Helvering v. McGlue, 119 Fed.(2d) 167.

We are referred, however, to decisions of courts of New York denying commissions to fiduciaries who had failed to properly perform their duties. Petitioner does not contend and no evidence was offered to show that the decedent did not at all times faithfully perform his duties as a fiduciary. A witness for the petitioner, with experience before courts in the matter of commissions for services rendered by deceased trustees and executors, testified that when a trustee is entitled to anything he is usually awarded commissions at the statutory rate. All of the commissions allowed by the courts after decedent's death were computed at the statutory rates.

The facts here do not differ in any material respect from Helvering v. McGlue, supra, following which we sustain the respondent except that, in accordance with the stipulation and amended answer, the amount should be decreased by $54.20.

Dividends.

The petitioner contends that as the dividends declared prior to decedent's death were not payable or paid until thereafter, the right to receive the dividends had not become fixed at the time of decedent's death, and, therefore, they were not accruable as income, citing Estate of G. Percy McGlue, supra, in which we held, upon like facts, that the dividends were not accrued income. On appeal the court reversed the Board upon the ground that, as the declaration of the dividend created a corporate debt under the laws of New York, the right to the dividend had accrued at the time of death.

We have held that a dividend declared in December 1922 payable on January 1, 1923, is accrued income in 1922. Archer Maynard Campbell,6 B.T.A. 60">6 B.T.A. 60. Other decisions of the Board hold that the general rule is that a declaration of a dividend creates a debt from the corporation to the stockholders. W. E. Caldwell Co.,6 B.T.A. 47">6 B.T.A. 47; Callanan Road Improvement Co.,12 B.T.A. 1109">12 B.T.A. 1109. The rule prevails in New Jersey. Stevens v. U.S. Steel Corporation,68 N.J.E. 373; 59 Atl. 905; Beattie v. Gedney,99 N.J.E. 207; 132 Atl. 652. Accordingly, following Helvering v. McGlue, supra, we sustain the respondent on this issue.

Director's Liability.

Section 43 of the Revenue Act of 1936 provides as follows:

The deductions and credits (other than the dividends paid credit provided in section 27) provided for in this title shall be taken for the taxable year in which "paid or accrued" or "paid or incurred", dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period. In the case of the death of a taxpayer there shall be allowed as deductions and credits for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly allowable in respect of such period or a prior period.

Petitioner admits upon brief that at the time of decedent's death the liability had not become fixed or determinable. Its contention is merely that if sections 42 and 43 are construed to include "all amounts attributable to the decedent's lifetime activities", then the amount of the judgment, plus expenses incidental therto, constitutes an accrued item.

The amount was not claimed as a deduction in the return of the decedent. In the statement attached to the deficiency notice respondent, in answering an alternative contention of petitioner that the item represented an accrued expense of the decedent at the time of his death, stated that neither the decedent during his lifetime nor the petitioner thereafter admitted liability under the suit and held, citing lucas v. American Code Co.,280 U.S. 445">280 U.S. 445, that the expenses did not accrue at the date of the decedent's death and therefore were not deductible under section 43. Upon brief the respondent, without extended argument, contends that, while the rights forming the basis of the complaint may have existed at the time of death, they were not accrued at that time, and that the evidence fails to show that "the item is one of a nature for which the statute permits deduction."

Up to the time of this suggestion in respondent's brief the only issue made by the pleadings, or suggested in the deficiency notice, was whether the item was properly accruable. Nor was any suggestion made at the hearing that the item might not be a properly deductible item, because not an ordinary and necessary expense of business, or loss in a transaction in business or in a transaction entered into for profit, or otherwise. On the contrary, the opening statements indicate that the trial was pitched, as to this item, on the question of accruability. We therefore consider only that question.

Undoubtedly the matter of liability in the suit pending against the decedent at the time of his death was not accruable under ordinary concepts of accounting. However, the Enright case plainly imports into this matter, on account of the impact of section 43, a concept which differs from the ordinary accounting idea of accruability. Assuming, as the parties upon hearing assumed, that the facts in connection with the suit and judgment constitute proper basis for an allowable deduction, other than upon the question of accruability, in our opinion the Enright case impels us to hold that the item was accruable within the intendment of section 43. It is obvious that all facts upon which judgment was finally rendered had taken place prior to the decedent's death, and the amount was later rendered definite by the rendition and payment of judgment in a certain amount, just as the compensation for the decedent's services as executor and trustee was rendered definite by the payment of fees therefor after his death. A fair reflection of income requires, we think, that the item of judgment be placed in a category of deductions corresponding to the items of income. Section 43 covers deductions in a manner obviously intended to be parallel with the income covered by section 42, and the Supreme Court in the Enright case said: "Congress sought a fair reflection of income." Such an end would be frustrated unless the meaning of "accrued" is applied, as broadened by that case, alike to income and deductions. We conclude and hold that the respondent erred in denying the deduction of the amount of judgment rendered for director's liability and the expenses incident thereto in the total amount of $253,087.35.

Interest.

The only contention of petitioner under this issue is that the amount is constitutionally free from tax as accrued income. We have held that section 42, supra, does not violate the Fifth Amendment and is within the Sixteenth Amendment. The interest was earned prior to death and payable thereafter. It clearly constitutes accrued income under section 42, supra, and we so hold.

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 42. PERIOD IN WHICH ITEMS OF GROSS INCOME INCLUDED.

  * * * In the case of the death of a taxpayer there shall be included in computing net income for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period. ↩