Johnston v. Commissioner ( 1935 )

COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Johnston v. Commissioner

Docket No. 79029.

United States Board of Tax Appeals

33 B.T.A. 551; 1935 BTA LEXIS 734;

November 26, 1935, Promulgated

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SECTION 44(d), REVENUE ACT OF 1932 - TRANSMISSION OF INSTALLMENT OBLIGATIONS AT DEATH. - At the time of filing the 1932 return of the decedent, who died owning installment obligations, the form for filing the bond required by article 355, Regulations 77, was not available. Thereafter deedent's executor offered to file a bond, and prior to the hearing of this proceeding the distributees reported in their returns the proceeds of the installment obligations. Held, that under circumstances here the treatment of the installment obligations as resulting in gain to the decedent under section 44(d) is unwarranted.

William P. Smith, Esq., for the petitioner.

Hartford Allen, Esq., for the respondent.

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ARUNDELL

Respondent determined a deficiency of $17,598.94 in income taxes for the calendar year 1932 against the taxpayer. This proceeding for redetermination of that deficiency was submitted upon the pleadings. The following facts are thus established.

FINDINGS OF FACT.

1. On March 15, 1933, petitioner, the duly qualified executor of the estate of F. M. Johnston, deceased, filed a 1932 income tax return for the decedent, including therein the income and deductions of the decedent from January 1 to February 5, 1932, both inclusive, the return showing ordinary net income of $10,438.65, capital gain of $43,069.53, and tax liability of $6,088.43. Errors on the face of the return, discovered and corrected by the collector of internal revenue at Pittsburgh, resulted in adjusting the ordinary net income to $10,695.81 and tax liability to $6,043.27, which latter amount was duly paid.

2. At the date of death, the decedent was the owner of three promissory notes made by Dickson Q. Brown, dated February 2, 1925, for $100,000 each, payable, respectively, on February 2, 1934, February 2, 1935, and February 2, 1936.

3. These notes, aggregating $300,000, were the unpaid part of a series of notes received by the decedent in 1925 as consideration upon the sale of certain oil property.

4. The decedent exercised the option of reporting profit upon the installment basis from that sale of property in 1925, and the Commissioner of Internal Revenue determined that 46.50724 percent of the amount received in payment of each note represented taxable income, and that of this amount, 3.43771 percent represented gain with respect to assets held less than two years and 43.06953 percent represented gain upon assets held more than two years.

5. The petitioner, as executor, transferred to his mother, and to himself, as sole residuary legatees, under the will of the decedent, the three remaining notes, aggregating $300,000, prior to the filing of the decedent's 1932 Federal income tax return.

6. The residuary legatees reported in their individual income tax returns the portion of the principal of those notes representing gain, and included such gain as taxable income for the year or years in which the principal sums were paid to them, namely, the note maturing in 1934, being paid in 1933, was reported in the distributees' income tax returns for 1933, and the 1935 and 1936 notes, being paid in 1934, were reported by the distributees in their income tax returns for 1934.

7. The executor did not report any profit upon the aforesaid unpaid notes in the final income tax return of the decedent.

8. Subsequent to the filing of the 1933 income tax returns by the distributees, the executor learned for the first time of the requirement of article 355 of Regulations 77, providing for the filing of a bond on form 1132 at the time of filing the final income tax return of a decedent in cases where the unrealized gain represented by installment obligations transmitted at death is to be reported by beneficiaries or distributees. Regulations 77 were promulgated February 10, 1933, and released to the public on February 27, 1933. The printed form 1132 became available to the public April 26, 1933.

9. Immediately after learning of the requirements of article 355, Regulations 77, i.e., on May 1, 1934, and prior to any review or consideration of the final return of the decedent or the 1933 returns of the distributees by the Commissioner, the executor advised the Commissioner, in writing, of his desire to comply with the requirement for filing bond as provided in article 355, Regulations 77, and requested that he (the executor) be advised as to the exact amount of the bond under the circumstances required and the proper place for filing.

10. By letter dated June 4, 1934, the Commissioner notified the executor that a bond would not be accepted, and no bond was filed.

11. Under date of March 13, 1935, the Commissioner's deficiency letter was issued asserting additional tax due with respect to the decedent's final (1932) return, predicated upon the allegation that the unrealized profit contained in the three promissory notes transmitted at death was taxable to the decedent in amounts equivalent to the predetermined percentages, to wit: $129,208.59 as capital net gain on account of assets held more than two years, and $10,313.13 as ordinary gain on account of assets held less than two years by the decedent at the date of sale in 1925.

OPINION.

ARUNDELL: Section 44(d) of the Revenue Act of 1928 provided for the recognition of gain or loss on the transmission of installment obligations upon the death of the holder, and that enactment has been consistently held valid. ; affd., ; ; affd., ; . The same provisions were enacted in section 44(d) of the Revenue Act of 1932, with an added sentence ^{*739 a bond is filed to assure the return as income by the recipients of the installment obligations of the same amount as the decedent would have returned upon liquidation of the obligations. This provision was added to the Revenue Bill of 1932 by the Senate Committee on Finance for the express purpose of alleviating hardships resulting to the estates of decedents under section 44(d) of the Revenue Act of 1928. The report of the Finance Committee is set out in the margin. *554 gave statutory sanction to the installment basis of reporting income, it was an abuse of discretion on the part of the Commissioner to refuse to receive an amended return whereby the taxpayer sought to change from the installment basis to the deferred payment basis of reporting income, even though there was no statutory authority for amended returns. . In that case the taxpayer's original return showed a substantial net income, whereas the amended return showed a net loss. The court said:}

In view of the radical changes in the law, of which the petitioner had scant notice, if any, in fairness and justice to the taxpayer the returns should have been received and considered. Taxes are assessed on income and not on honest mistakes of the taxpayer. It was the duty of the Commissioner to do nothing arbitrary or unreasonable that would deprive petitioner of rights created by the new law and the regulations thereunder. It was a breach of discretion on the part of the Commissioner not to receive the amended return from [sic] 1925 under the circumstances disclosed.

The petitioner in this case is in a more favorable position than was the taxpayer in the Morrow, Becker & Ewing case. This petitioner is not seeking any diminution in the amount of income reported or taxes paid. True, by failing to comply literally with the statute and regulations the petitioner did not report all the income of his decedent, but he did thereafter attempt to comply by offering to file a bond, and prior to the hearing of these proceedings all the income was reported by the recipients of the installment obligations. The effect of sustaining respondent's position would be to assert a deficiency against this petitioner and then require refunds to those who have heretofore paid the tax. Such complicated procedure may be justified where there is clear statutory warrant for it, but it is not present here.

If a rule of strict and literal compliance with the respondent's regulations is to be applied, it should go all the way. The regulations, article 355 of Regulations 77, provide for the filing of a bond on form 1132 at the time of filing the final return of a decedent where the unrealized gain on installment obligations is to be reported by beneficiaries or distributees. Form 1132 did not become available until after the time for filing the decedent's return, and so literal compliance was impossible. Respondent argues that petitioner could have applied for the privilege of filing a bond or for an extension of time. But article 355 does not provide for the filing of an application for the privilege of filing a bond and any such application would not have been a strict compliance with the regulations. We do not understand that there is any duty on the part of a taxpayer to delay filing a return or to ask for an extension of time to file because the respondent's office is late in furnishing a form which is not a necessary part of the return. As matters stood at the time the return was filed on March 15, 1933, exact compliance with the regulations was impossible. The law does not require the impossible.

Summarizing, the petitioner could not comply with the regulations when filing the return; thereafter he did endeavor to comply, but his offer was refused by the Commissioner; all the income at the bottom of these proceedings has been reported; and nothing is to be gained by the procedure now proposed by the respondent. We hold that the respondent's refusal to accept the offer of a bond was arbitrary and that the determination of the deficiency was unwarranted.

Reviewed by the Board.

Decision will be entered under Rule 50.

LEECH

LEECH, dissenting: The decision of a hard case, upon apparent equitable grounds, frequently results in bad law. In my judgment, this is such a case, and the result reached in the majority opinion is wrong.

This Board has no equity powers. .

Our concern here is the legal income tax liability, for 1932, of the present petitioner - nothing else.

The controlling statute, itself, here, not any regulation, makes the filing of a bond the condition precedent to the relief petitioner seeks. The enjoyment of that relief depends wholly upon compliance with that statutory condition precedent. .

As construed by the authorized regulation, obviously actual compliance was absent and literally impossible. But, it is said the present record discloses substantial compliance with the statute as construed by the pertinent regulation.

That regulation was clearly reasonable. It is not attacked in the majority opinion. It was promulgated by express statutory authority. So, I think, the rule adopted by the Board in reference to a somewhat comparable situation, in , and cited with approval many times since, is applicable here. This Board there said:

* * * Fortified with such a clear sanction in the statutory grant of power, the administrative determination in such a case must survive all but the strongest attack. Short of being arbitrary or capricious or based on a clear demonstration of error, the determination in any single instance ought not to be disturbed. This is not a matter of jurisdiction, for the Board clearly has the power of review, , but is rather an attitude of the Board in the exercise of its jurisdiction not to interfere lightly with general administrative matters which the Congress has entrusted to the Commissioner's discretion.

The inquiry here is not whether, if we were exercising our discretion on the acceptance or rejection of the proffered bond, we would have accepted it under the circumstances. We do not have that discretionary function. Nor is our inquiry whether the Commissioner's acceptance of the tendered bond would have exceeded his discretion. Our function is much more narrow. That function is to decide only whether the discretion, clearly existing in the Commissioner, was here exercised by him in an arbitrary and capricious manner.

The record discloses the following relevant facts:

1. February 2, 1925 - Installment sale made.

2. February 5, 1932 - Decedent died.

3. June 6, 1932 - Revenue Act of 1932 approved (retroactive to January 1, 1932, as to the pertinent provision).

4. February 9, 1933 - Regulations 77 promulgated.

5. February 27, 1933 - Regulations 77 released to public.

6. March 15, 1933 - Return filed for decedent.

7. April 26, 1933 - Form of bond first became available.

8. About March 15, 1934 - Legatees reported income on first note.

9. May 1, 1934 - Executor first learned of provisions for bond requirement and applied for Form 1132, the prescribed bond.

10. June 4, 1934 - Executor's application to file that bond denied.

11. March 13, 1935 - Deficiency letter mailed.

12. About March 15, 1935 - Legatees reported income on last two notes.

The majority opinion holds these facts constituted a compliance with the statute and regulation, so substantial, that the Commissioner was guilty of an abuse of his discretion in refusing to accept the bond here involved, which was tendered almost two years after the statute permitting its filing became law, and over one year after the regulations authorized by that law were promulgated and the form of the bond there prescribed became available to the public. And this conclusion is reached, though the taxpayer did nothing even in an attempted compliance with the statute or regulation until that late date, only because, until a few days before the bond was actually tendered, he did not know of the law. See , affirming ; certiorari denied, ; , affirming ; .

Under such circumstances, and in view of the cited rule the Board adopted in the Hamill case, and has since consistently followed, this record does not convince me that the refusal of the Commissioner to accept the petitioner's bond was arbitrary.

BLACK, SMITH, and MELLOTT agree with this dissent.

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Footnotes

• 1. This subsection shall not apply to the transmission at death of installment obligations if there is filed with the Commissioner, at such time as he may by regulation prescribe, a bond in such amount and with such sureties as he may deem necessary, conditioned upon the return as income, by the person receiving any payment on such obligations, of the same proportion of such payment as would be returnable as income by the decedent if he had lived and had received such payment. ↩

• 2. Your committee has added to section 44(d) a provision that the subsection shall not apply to the transmission at death of installment obligations if a bond is filed in the proper amount conditioned upon the return as income by any person receiving any payment on account of such obligations of the same proportion of such payment as would have been returnable by the decedent had he lived and received the same. It has come to the attention of your committee that considerable hardship sometimes occurs in the application of eixsting law to cases of decedents who die possessed of substantial amounts of installment obligations. In such cases the entire amount of the profit represented by the obligations must be reported as income in the return of the decedent for the year of his death. Your committee believes that if, for example, the estate of the decedent or his next of kin or legatees file a bond to return as income the proper proportion of the payments received by them on account of the installment obligations received from the decedent, the revenue will be properly protected. This section is accordingly amended to provide for such procedure. Rept. 665, 72d Cong., 1st sess., p. 21. ↩