Commissioner of Internal Revenue v. Kann's Estate ( 1949 )

BIGGS, Chief Judge.

■ Mrs. Bertha -F. Kann, the decedent, sold certain securities to-her children in'return for their unsecured promises to pay her life annuities. The question presented for our determination is: Did the Tax Court err in holding’¹ that the decedent realized no taxable gain under. Section 111(a) of the Internal Revenue Code, 26 U.S.'C.A. § 111(a), and the applicable regulation on the ground that annuity contracts undertaken by individual obligors do not have an ascertainable fair market value as a matter of law? The pertinent statute and regulation are in the margin.² See also Section 22 of the -Internal Revenue Code, 26 U.S’.C.A. § 22, set out in note 3.³

As the Tax Court pointed out, it -is no-t necessary to decide whether the entire capital is to ibe recouped before any amount becomes taxable, J. Darsie Lloyd v. Commissioner, 33 B.T.A. 903; Frank -C. Deer-ing v. Commissioner, 40 B.T.A. 984, or. whether a 3% ⁴ annual return on an investment computed at insurance company rates, Anna L. Raymond v. Commissioner, 40 B.T.A. 244, affirmed 7 Cir., 114 F. 2d 140, certioriari denied 311 U.S. 710, 61 S.Ct. 319, 85 L.Ed. 462, is to be charged as ordinary income under Section 22(b) (2) until the capital expended has been <re-covered. See Maude Gillespie v. Commissioner, 43 B.T.A. 399, reversed on other grounds, 9 Cir., 128 F.2d 140. The question at bar turns on the meaning to be ascribed to the phrase “fair market value” in Section 111(b) and the 'regulation.

The petitioner would have us change what we believe to be a salutary rule of law established by the Board of Tax Appeals in the Lloyd case, supra, that where both the annuitant’s life span and the obligor’s ability to pay are uncertain no fair market value should be ascribed to the contract or obligation. That rule was again enunciated in the Deering case, supra, and was viewed with approval in Bella Hommel v. Commissioner, 7 T.C. 992. To elaborate a little, the Tax Court has held in the instant case, as in 'the past, that where obligors are individuals, whether rich or poor, their obligations to pay in the future do not possess such standing as to come within the purview of the statute, that such obligations possess no value by way of ordinary business. It should be noted that this court took a similar view in Evans v. Rothensies, 3 Cir., 114 F.2d 958, and in Cassatt v. Commissioner, 3 Cir., 137 F.2d 745, wherein, it will be observed, the Commissioner took a position diametrically opposed to that which he seeks to maintain in the case at bar. See also Burnet v. Logan, 283 U.S. 404, 51 S. Ct. 550, 75 L.Ed. 1143. Like the Tax Court we think that there is little to be gained by giving up the principle, now well established, that an agreement by an individual to pay a life annuity to another has no “fair market value” for purpose of computing capital -gain. In conclusion we state parenthetically that there is little in the record which can support the Commissioner’s view that the transactions between Mrs. Kann and her children were ordinary arm’s length business transactions. See the Raymond case, supra.

The decision of the Tax Count will be affirmed.

1 In an unreported decision.

2 “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 loss 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.

“(c) Recognition of gain or loss. In the case of a sale or exchange, the extent to which the gain' or loss determined under this section shall be recognized for the .purposes of this chapter, shall be determined under the provisions of section 112.”

Treasury Regulations 103, promulgated under the Internal Revenue Code: “Sec. 29.111-1. Computation of gain or loss.— Except as otherwise provided, the Internal Revenue Code regards as income or as loss sustained, the gain or loss realized from the conversion of property into cash, or from the exchange of property for other property differing materially either in kind or in extent. The amount realized from a sale or other disposition of property is the sum of any money received plus the fair market value of any property which is received. The fair market value of property is a question of fact, but only in rare and extraordinary cases will property be considered to have no fair market value. The general method of computing- such gain or loss is prescribed by section 111, which contemplates that from the amount realized upon the sale or exchange there shall be withdrawn a sum sufficient to restore the adjusted basis prescribed by section 113(b) and sections 29.113(b) (1)-1 to 29.113(b) (3)-2, inclusive (i. e., the cost or other basis provided by section 113(a), adjusted for receipts, expenditures, losses, allowances, and other items chargeable against and applicable to such cost or other basis). The amount which remains after the adjusted basis has been restored to the taxpayer constitutes the realized gain. If the amount realized upon the sale or exchange is insufficient to restore to the taxpayer the adjusted basis of the property, a loss is sufficient in the amount of the insufficiency. The basis may be different depending upon whether gain or loss is being computed.”

3 Internal Revenue Code:

“Sec. 22. Gross income.

“(a) General definition. ‘Gross income' includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or ■ interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *

“(b) Exclusions from gross income. The following items shall not be included in gross income and shall be exempt from taxation under this chapter: * * m * *

(2) Annuities, etc. * * * Amounts received as an annuity under an annuity or endowment contract shall be included in gross income; except that there shall be excluded from gross income the excess of the amount received in the taxable year over an amount equal to 3 per centum of the aggregate premiums or consideration paid for such an: nuity (whether or not paid during such year), until the aggregate amount excluded from gross income under this chapter or prior income tax laws in respect of such annuity equals the aggregate premiums or consideration paid for such annuity. * * * ”

4 During the years 1939 and 1940', inclusive, the taxable years in question, Mrs. Kann received through the annuities $24,672 a year, the total amounting to $39,344. She did not include as taxable income on her income tax returns for these years any portion of the annuities which she received. The respondents in the instant case, learning that the decedent had not included in her income tax returns as taxable income 3% of the consideration which she paid for the annuities in accordance with Section 22(b) (2) of the Internal Revenue Code, 26 U.S.C.A. § 22(b) (2), filed amended returns and paid the additional taxes as reflected by the amended returns.