Kellogg v. Commissioner , 42 B.T.A. 64 ( 1940 )

F. W. KELLOGG, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Kellogg v. Commissioner

Docket No. 95135.

United States Board of Tax Appeals

42 B.T.A. 64; 1940 BTA LEXIS 1056;

June 13, 1940, Promulgated

---

">*1056 Petitioner was indebted in the sum of $130,000 to a corporation of which he held a majority stock interest. In 1931 he entered into an agreement with the corporation pursuant to which he assigned to it all his interest in policies insuring his life in the total sum of $200,000, and the corporation agreed to carry the indebtedness until his death and collect from the proceeds of the policies, and further agreed to pay the premiums on the policies, charging these advances to petitioner's account but receiving no interest thereon. In 1935, when these advances totaled $43,533.60, the corporation was liquidated and as a distribution in such liquidation, petitioner's indebtedness in this amount, payable upon his death, was distributed to him and thereby canceled, and the policies were reassigned to him. Held, the value to petitioner of this distribution was less than the face amount of such account. Warren Service Corporation v. Commissioner, 110 Fed.(2d) 723.

Vernon M. Brydolf, Esq., for the petitioner.

Harry R. Horrow, Esq., for the respondent.

---

KERN

">*64 This proceeding involves a deficiency in petitioner's income tax">*1057 liability for the year 1935 determined by respondent in the sum of $5,776.89, arising by reason of respondent's determination that an account receivable of the Kellogg Investment Co. against petitioner which was distributed to him in the liquidation of the company and thereby canceled should have been valued at its full amount, to wit, $43,533.60. Petitioner in his return had treated the account as payable in the future and, therefore, calculated the present value in a lesser amount, to wit, $26,424.90.

All of the facts herein were stipulated by the parties.

FINDINGS OF FACT.

We adopt as our findings the facts as stipulated. This stipulation reads as follows:

1. The Kellogg Investment Company was incorporated under the laws of the State of California on January 23, 1929, and was dissolved under and in accordance with the laws of the said State in December, 1935.

2. Upon dissolution of said corporation, the directors, to the best of their ability, determined the fair market value of all assets of the corporation, and distribution thereof was made to the stockholders on December 11, 1935, upon the basis of such determination.

">*65 3. The President of said">*1058 corporation was F. W. Kellogg, the petitioner herein, who also owned sixty percent of the outstanding capital stock.

4. On or about October 31, 1931, the said F. W. Kellogg borrowed from the said corporation the sum of $110,000, for which he gave his unsecured personal promissory note dated October 31, 1931, payable on demand, with interest at the rate of six per cent per annum.

5. As of November 20, 1931, William S. Kellogg, son of F. W. Kellogg, and also a stockholder in said corporation, owed the corporation the sum of $20,000, for which he had given his unsecured promissory note, payable on demand, with interest at the rate of six percent per annum.

6. Petitioner, on November 20, 1931, owned five insurance policies, of a total face amount of $200,000 ordinary life insurance which he had taken out on his own life. In said policies he reserved the right to change the beneficiaries thereof, secure the cash surrender value thereof, and exercise all rights and privileges under said policies. On November 20, 1931, he sent the following letter to the Board of Directors of the Kellogg Investment Company:

"November 20, 1931

To the Board of Directors of the

KELLOGG INVESTMENT">*1059 COMPANY

Pasadena, California.

Gentlemen:

I herewith submit the following proposition for your attention:

There is due at the present time by me to the Kellogg Investment Company the sum of $110,000.00 for which the company holds my unsecured personal note dated October 21, 1931, payable on demand with interest at the rate of 6% per annum.

At the present time I am carrying a total of $200,000 regular straight life insurance on my life in the following companies:

COMPANY NAME	POLICY NUMBER	PRINCIPAL	ANNUAL PREMIUM	APPROXIMATE NET ANNUAL PREMIUM
Pacific Mutual Life Ins. Co	442298	75,000.00	4,350.00	1,083.75	3,266.25
Pacific Mutual Life Ins. Co	388027	30,000,00	1,598.50	420.90	1,177.60
Pacific Mutual Life Ins. Co	428665	20,000.00	1,122.50	284.20	838.30
Lincoln National Life Ins	159535	50,000.00	2,789.50	0	2,789.50
Lincoln National Life Ins	159536	25,000.00	1,494.25	0	1,494.25
		200,000.00	11,354.75	1,788.85	9,565,90

">*1060 To provide the Kellogg Investment Company with security for my present unsecured loan with the provisions for the immediate cash payment of the loan in the event of my death and to relieve me of the payment of premiums on the aforementioned life insurance policies for approximately the next ten years, I propose the following:

That I will assign over to the Kellogg Investment Company all of my interest in the aforementioned $200,000 life insurance policies, which policies are all free and clear from any loans or encumbrances, as security for my present loan, subject to the following conditions:

FIRST: That the principal of my present note for $110,000, also a note for $20,000 which I will execute to the Kellogg Investment Company on December 31, 1931, (in lieu of a $20,000 note now held by them and signed by Wm. S. Kellogg), ">*66 be carried by the Kellogg Investment Company until my death and then collected from the proceeds of the aforesaid life insurance policies.

SECOND: That the Kellogg Investment Company pay all future premiums on the aforementioned life insurance policies as they become due and charge the same to my account.

THIRD: That the advances for premiums">*1061 mentioned in the preceding paragraph will be added to the principal of my present note for $110,000 and the entire amount collected from the proceeds of my life insurance policies.

FOURTH: That I will continue to pay interest at the rate of six per cent per annum on my present note for $110,000 and I will also pay six per cent per annum on the $20,000 note to be executed December 31, 1931, as noted above, until paid, but that no interest will be charged me on amounts advanced to pay the future premiums on the aforementioned life insurance policies.

FIFTH: That whenever my indebtedness to the Kellogg Investment Company on the present note due by me to the company in the amount of $110,000, and the $20,000 note to be executed December 31, 1931, plus advances to pay premiums on the aforementioned life insurance policies, shall equal the sum of $200,000 (the total of the aforementioned life insurance policies) I will pay on demand to the Kellogg Investment Company any sums over and above the $200,000 advanced by said company to pay the premiums on the above mentioned life insurance policies.

SIXTH: That in the event of my death, if the total of my indebtedness to the Kellogg Investment">*1062 Company does not equal the total of $200,000, the amount of the life insurance policies assigned to the company, the Kellogg Investment Company will, after deducting the amount of my indebtedness to it, pay to my beneficiaries, heirs or estate the balance of the proceeds of such policies.

Very truly yours,

[Signed] F. W. KELLOGG"

7. The proposition set forth in this letter was accepted by the Board of Directors of the Kellogg Investment Company, and that in accordance therewith the beneficiary in said policies was changed to the Kellogg Investment Company, and from that date the premiums on the policies were paid by the Kellogg Investment Company in accordance with the above agreement.

8. Said policies had the following cash surrender values on November 20, 1931, and December 11, 1935:

Company	Policy Number	Date issued	Amount	Cash Value 11-20-31	Cash Value 12-11-35
Pacific Mutual	#442298	11-17-21	75,000.00	19,575.00	27,975.00
Pacific Mutual	#388027	4- 8-20	30,000.00	8,190.00	11,430.00
Pacific Mutual	#428665	5-28-21	20,000.00	5,060.00	7,280.00
Lincoln Life	#159536	3-16-25	25,000.00	4,000.00	7,375.00
Lincoln Life	#159535	3-16-25	50,000.00	8,800.00	15,000.00
			200,000.00	45,625.00	69,060.00

">*1063 9. At the time of distribution of the assets of the corporation in liquidation, a total of $43,533.60 had been paid in premiums by the corporation on said policies under said agreement.

10. Said sum was carried on the books of the corporation as an account receivable of the corporation.

11. At the request of petitioner, Oscar Swenson, Assistant Actuary of the Pacific Mutual Life Insurance Company of California, a corporation, calculated the present value as of December 9, 1935, of an amount of $43,533.60 available on petitioner's death. Based on petitioner's age, namely 69 years, and using ">*67 the American Experience Table of Mortality, with various interest rates, said present value was determined to be as follows:

Interest rate	Value
3%	$33,364.59
4%	30,763.02
5%	28,461.83
6%	26,424.90
7%	24,596.48
8%	22,985.74

12. On the basis of such calculations, said asset of $43,533.60 was at the time of distribution considered by the Directors of said corporation to have a market value of $26,424.90.

13. In the liquidation of said corporation, said asset of $43,533.60 was distributed to petitioner and the indebtedness in that amount">*1064 was thereby cancelled. As a part of said cancellation, petitioner, by mutual agreement with said corporation, cancelled the contract set forth in paragraph six hereof and said corporation reassigned to petitioner said policies.

14. That the two above mentioned promissory notes in the principal sum of $110,000 and $20,000 were appraised by the Board of Directors as having a fair market value of the amount of principal due, and that other stockholders took said promissory notes at said market value upon liquidation.

The fair value to petitioner in the taxable year of the cancellation of his indebtedness to the Kellogg Investment Co. in the sum of $43,533.60, payable on petitioner's death, calculated by using the American Experience Table of Mortality, with an interest rate of 6 percent, was $26,424.90.

OPINION.

KERN: The question raised in this proceeding has to do with the valuation of a distribution to a stockholder made in liquidation of a corporation. The applicable sections of the statute are sections 115(c), 111(a), and 111(b) of the Revenue Act of 1934, set out in the margin. ^{1940 BTA LEXIS 1056">*1065 The property received in liquidation by the taxpayer here was an account receivable of the corporation. The peculiarities of the ">*68 transaction consist of (a) the account being payable not presently but at some future time, (b) the account being payable by the petitioner - distributee, and (c) the account being made up of payments made by the corporation of premiums due on life insurance policies covering the life of petitioner and assigned to the corporation as a source for the repayment of other amounts owed by petitioner to the corporation.}

Respondent denies that the account was payable only out of the proceeds of the insurance policies, and contends, therefore, that the account was presently payable and was not payable at some future time. However, a careful reading of the letter from petitioner to the corporation, which embodies the terms of the contract out of which the account arose, and particularly the first, third, and fifth conditions thereof, convinces us that the advances made by the corporation for the purpose of paying the premiums upon the insurance policies were to be repaid only from the proceeds of the policies, at least until the advances together">*1066 with the interest on petitioner's notes totaled $70,000. This limitation as to the source of payment carried with it a limitation as to the time of payment. There would be no proceeds from the policies until petitioner's death; therefore, the account was not payable until petitioner's death. Treated as an asset of the corporation, it would obviously follow that its present value would be less than its face amount.

Respondent insists that the transaction be treated not as the receipt by the petitioner of a chose in action, but as the cancellation of an indebtedness which he owed. We question the accuracy of this position, ; but even though we accept respondent's contention in this regard as a correct basis for our reasoning, our conclusion must be contrary to that which he urges. The value to the petitioner of the cancellation of a debt not yet due is less than the value of a cancellation of a debt presently payable, if no interest is charged on the obligation to pay. A recent case which is squarely in point is ">*1067 , in which the Circuit Court of Appeals for the Second Circuit held: "The value of a release of an obligation to pay $125,000 in 1941, without interest, is obviously less than the value of the releae of a debt for like amount presently due, or of an obligation to pay the sum in 1941 with interest."

In that case the court directed the finding of the present worth in 1933 of an obligation to pay $125,000 in 1941 without interest. In this proceeding the stipulation discloses the method used by petitioner in determining the present value in 1935 of an account in the sum of $43,533.60 payable without interest on petitioner's death. Respondent does not object either in the pleadings or on brief to this method on the ground of its mathematical inaccuracy, but because of his contention, ">*69 discussed above, that the account was not limited as to source and time of payment, and because it should not be treated as a chose in action having a market value, but as the cancellation of an indebtedness. The argument of respondent as to this last point seems to be, in effect, as follows: Granting that the account">*1068 is receivable by the corporation only on petitioner's death, and, therefore, has a value to the corporation as an account receivable of less than its face amount, nevertheless, it does not follow that the value to petitioner of the cancellation of the account (an account payable as to him) is less than the face amount of the obligation canceled.

With this argument we can not agree. If the present value in 1935 to the corporation of an account receivable in the amount of $43,533.60, payable upon the death of petitioner, was only $26,424.94 (and there is nothing in the record to indicate a greater value), then it would follow that the present value in 1935 to petitioner of the cancellation of the same obligation would be the same amount. Cf.

The cases of ; ; and , cited by respondent, are not in point, because they involve the release of an obligation presently payable and not, as in this case, payable in the future.

We conclude that petitioner received in">*1069 the taxable year, as a distribution in liquidation of the corporation of which he held shares, the assignment of a chose in action in the face amount of $43,533.60, payable upon his death, the present value of which to petitioner in the taxable year was the sum of $26,424.90.

Reviewed by the Board.

Decision of no deficiency will be entered.

---

Footnotes

• *. The approximate annual dividends or return premiums on the policies issued by the Pacific Mutual Life Insurance Company are based on the dividends or return premiums received for the years 1930 and 1931. According to premiums paid on these policies from date of issue these dividends should increase by approximately $40.00 per year. ↩

• 1. SEC. 115. DISTRIBUTIONS BY CORPORATION.

  * * *

  (c) DISTRIBUTIONS IN LIQUIDATION. - Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117(a), 100 per centum of the gain so recognized shall be taken into account in computing net income. * * *

  SEC. 111. DETERMINATION OF AMOUNT OF, AND RECOGNITION OF, GAIN OR LOSS.

  * * *

  (a) COMPUTATION OF GAIN OR LOSS. - The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113(b) for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining lolss over the amount realized.

  (b) AMOUNT REALIZED. - The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received. ↩