Gould v. Commissioner , 14 T.C. 744 ( 1950 )

Howard Gould, Petitioner, v. Commissioner of Internal Revenue, Respondent

Gould v. Commissioner

Docket No. 15051

United States Tax Court

14 T.C. 744; 1950 U.S. Tax Ct. LEXIS 215;

April 28, 1950, Promulgated

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Decision will be entered under Rule 50.

Deductions -- Interest. -- Certain annual payments made in consideration of the payees' deferment of the payment of principal amounts due in settlement of action for breach of fiduciary duty, held to be interest and deductible under section 23 (b), Internal Revenue Code.

James O. Wynn, Esq., for the petitioner.

John J. Madden, Esq., for the respondent.

Tyson, Judge.

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TYSON

Respondent determined a deficiency in petitioner's income tax in the amount of $ 11,619.42 for the calendar year 1941. The amount in controversy is $ 22,800, since petitioner claims an overpayment of $ 11,180.58.

The only question presented is whether respondent erred in disallowing as a deduction an amount of $ 30,000 claimed on petitioner's return as interest paid on indebtedness. Further adjustments made by respondent to petitioner's income that are not here in dispute included an increase in dividend income and a reduction of the capital loss allowed.

The proceeding has been submitted upon the pleadings, oral testimony, and a stipulation of facts, including exhibits. The stipulation, included herein by reference, is adopted as a part of our findings of fact, but only such portions thereof as are deemed necessary to the disposition of this proceeding are set forth in those finding.

FINDINGS OF FACT.

Petitioner is an individual, residing in New York, New York. He filed his income tax return on the cash basis for the calendar year 1941 with the collector of internal revenue for the second district of New York. The return showed a tax due in the sum of $ 249,360.27, which petitioner paid in equal quarterly installments on March 15, June 15, September 15, and December 15, 1942. Respondent and petitioner executed timely agreements extending the time within which respondent might assess a tax for the year 1941 to June 30, 1947. On November 2, 1944, petitioner filed a claim for refund, alleging that he had erroneously failed to claim on the return involved herein a deduction in the amount of $ 19,206.10 paid as nontrade and nonbusiness expenses. The petition herein was filed on June 30, 1947. In determining petitioner's income tax liability for 1941, respondent allowed the $ 19,206.10 deduction, but disallowed the claim for refund because of his disallowance of an item of $ 30,000 characterized on the return as interest paid on indebtedness.

Petitioner is a son of Jay Gould, who died testate in New York in 1892. Jay Gould was survived by six children: George, Edwin, Helen (afterwards married and thereafter known as Helen Gould Shepard), Howard (the petitioner herein), Anna (afterwards married and thereafter known as the Duchesse de Talleyrand and hereinafter sometimes referred to as such), and Frank. Following Jay Gould's death, letters testamentary were issued to the four eldest children, who were then adults, viz., George, Edwin, Helen, and Howard. Jay Gould's will gave his residuary estate, valued at exceeding eighty million dollars, to his executors, the four eldest children, in trust to divide into six equal shares for his six children, each of whom was to receive the income from his or her trust for life, with a special testamentary power of appointment as to the principal to his or her issue; if the power of appointment was not exercised, then to his or her issue by the New York laws of intestacy; or if the child died without issue, then the principal of his or her trust would pass to the surviving children of the testator or the issue of any deceased child per stirpes. The four eldest children were named trustees of the six trusts so provided for, except that none of them was to act as trustee of the trust for his or her benefit. The will further provided that each of the four eldest children was to receive $ 10,000 per year for his or her services as executor and trustee, in lieu of statutory commissions. Petitioner was paid $ 10,000 annually for such services from January 1, 1895, to January 1, 1922.

In 1916 an administration action for an accounting and construction of the will, for instructions of the court as to their future course in the administration of the residuary estate, and for other incidental relief was filed by the executors and trustees in the Supreme Court of New York. Prior to the commencement of this action the executors and trustees had made no judicial accounting in any court of their proceedings, either as executors or as trustees. The residuary estate of the testator had not been divided into six trusts as directed by the will, but had been dealt with as a whole. Objection to the accounting was entered by the two youngest children, Anna and Frank Gould, who were not trustees, and by many of the remaindermen. During the pendency of this action George Gould was removed as a trustee, two of the other three trustees, Edwin and Howard (the petitioner herein), were permitted to resign, and corporate trustees were appointed for all six of the trusts directed to be established by the testator.

In 1924 a referee was appointed to hear and determine the issues involved in the action begun in 1916. Prior thereto George Gould had died testate in New Jersey, exercising his testamentary power of appointment under Jay Gould's will in favor of his seven children by his first wife (hereinafter sometimes referred to as the children of George Gould). His executors were substituted as parties by order of the court over their contest of service. In a decision reported in Gould v. Gould, 126 N. Y. Misc. 54; 213 N. Y. S. 286, the referee found the four original trustees guilty of breach of trust for, inter alia, misuse of trust funds and for failure to divide the estate into six separate trusts as directed by the will, and held that they should reimburse the estate for losses resulting from their unauthorized conduct. The referee's opinion, rendered on November 10, 1925, did not set forth the sums due from the surcharged trustees, but, instead, directed the parties to submit findings in accord with the views expressed therein.

As a basis for a settlement that would prevent possible costly and protracted appeals, the following negotiations were entered into by all the parties in interest. Anna and Frank Gould demanded, among other things, that the surcharged trustees add $ 3,000,000 to the corpus of each of their trusts. Certain of the interested parties objected to increasing the corpus of 2 of the trusts only, on the ground that the trusts were primarily for the benefit of the remaindermen, and they insisted that, if the corpus of any of the trusts were to be augmented, all 6 trusts would have to be augmented equally. It was then proposed that $ 2,000,000 be added to the corpus of each of the 6 trusts, and in this connection it was pointed out: That 2 of the life beneficiaries, Helen, then 58 years old, and petitioner, then 55 years old, were without issue and appeared unlikely to have issue and that on their deaths without issue the corpus of each of their trusts, including the $ 2,000,000 so to be added, would be, under the cross-remainder provisions of Jay Gould's will, divided equally among his surviving children and the issue of any deceased child; that under those cross-remainder provisions, on the death of the first to die, of Helen or petitioner, $ 400,000 of the $ 2,000,000 addition would pass to each of the 5 remaining children of Jay Gould if living, or, if any were dead, to the remaining children of Jay Gould and the issue of such deceased child, or children, and, on death of the second to die, $ 500,000 would similarly pass to each of the then 4 remaining children of Jay Gould if living, or, if any were dead, to the remaining children of Jay Gould and the issue of such deceased child, or children; and that thus Anna and Frank Gould, or their respective issue, would each ultimately receive the benefit of $ 2,900,000 (instead of the $ 3,000,000 each demanded) through the payment into each of their trusts of the $ 2,000,000 and the final receipt by each of the $ 400,000 and $ 500,000 on the death of Helen and petitioner without issue. It was further proposed that if petitioner at his death had issue capable of taking under Jay Gould's will, and Helen had predeceased petitioner, Edwin, Helen, and petitioner or their executors or administrators would each pay a sufficient amount into the principal of each of Anna's and Frank's trusts and to George Gould's children as a group, to make up the sum of $ 500,000 that would otherwise have passed under the cross-remainder provisions of Jay Gould's will to each, Anna and Frank Gould and the children of George Gould as a group. Securities were to be deposited by Edwin, Helen, and petitioner in escrow to guarantee payment of those amounts if the contingency occurred. No contingent provisions were deemed necessary in the case of Helen, whom all the parties considered as being past the age when she could have issue.

The proposals above outlined were accepted by Anna and Frank Gould in lieu of their demands for $ 3,000,000 to be added to the principal of each of their trusts, but only on condition that the settlement agreement should also provide an obligation on the part of each, Edwin, Helen, and petitioner, to pay to each of them $ 18,000 annually on the $ 900,000 until the death of the first to die of Helen or petitioner, then $ 10,000 annually to each of them on $ 500,000 until the death of the survivor. The seven children of George Gould demanded that they receive similar treatment as to the $ 900,000 and the annual amounts payable thereon. To prevent an appeal by them from the order substituting the executors of George Gould as parties, their demand was acceded to.

The compromise settlement was finally agreed to, on the basis of the negotiations as above set out, by all the parties to the action, including the corporate trustees and the guardians ad litem for infant remaindermen. As executed, the written agreement provided that petitioner, Edwin, Helen, and the estate of George Gould would pay $ 2,000,000 to the credit of the corpus of each of the six trusts. It further provided that each, petitioner, Edwin, and Helen, or their estates, would pay to each, Anna and Frank, and the children of George Gould taken as a group, $ 18,000 per year (or a total of $ 54,000) until the death of Helen or petitioner, then $ 10,000 per year (or a total of $ 30,000) until the death of the survivor:

* * * in order to make up for the loss of income resulting from the deferment of the vesting in possession of the aggregate $ 900,000 remainder interest with respect to each of them in the trust funds for the benefit for life of Helen G. Shepard and Howard Gould (or the guaranteed sum in lieu of the remainder interest in Howard Gould's trust as hereinafter provided).

It further provided as to the "guaranteed sum" just mentioned that, if petitioner died leaving issue entitled to take under Jay Gould's will and Helen had predeceased petitioner, then Edwin, or his estate, Helen, or her estate, and petitioner's estate each would pay $ 500,000, or a total of $ 1,500,000 to be divided into equal amounts as among the children of George Gould taken as a group, the principal of the trust for Anna, and the principal of the trust for Frank.

The agreement of compromise was executed by all the parties in interest on December 4, 1926, and filed with the court. Following the referee's report finding the compromise fair to all parties, the court entered judgment on May 28, 1927, approving the agreement and decreeing specific performance of its terms.

The amounts which the judgment and agreement of compromise required the four accounting trustees to pay into the six trusts were paid, and the securities which the judgment and agreement of compromise required to be deposited were so deposited.

Helen Gould Shepard died December 21, 1938, survived by no issue, and the $ 2,000,000 added to her trust as above stated passed to the other children of Jay Gould or their issue in equal amounts of $ 400,000.

Pursuant to said judgment, petitioner paid $ 18,000 per year to each, the Duchesse de Talleyrand and Frank Gould, and the seven children of George Gould as a group, or a total of $ 54,000 per year for the period June 1, 1926, to December 21, 1938. For the period between December 21, 1938, and December 31, 1941, petitioner, also pursuant to the judgment, paid $ 10,000 per year to each, the Duchesse de Talleyrand and Frank Gould, and the children of George Gould as a group, or a total of $ 30,000 per year. In his income tax returns for the years 1927 to 1940, inclusive, except in one year when he did not need it as a deduction, petitioner deducted the above amounts for the respective years in which they were paid and no deduction for any of those years ever was questioned by the respondent.

Respondent disallowed for 1941 the deduction for the payment of $ 30,000, which petitioner claimed as an interest deduction.

OPINION.

The primary question is whether petitioner is entitled under section 23 (b) of the Internal Revenue Code¹ to the claimed deduction of $ 30,000 as "interest * * * on indebtedness."

Do the facts bring the $ 30,000 within the controlling definition of the above quoted words of the statute given in Deputy v. Du Pont, 308 U.S. 488">308 U.S. 488, 498, that definition being "'Interest on indebtedness' means compensation for the use or forbearance of money"?

Inasmuch as Helen Gould died without issue some years prior to the taxable year and the $ 2,000,000 added to her trust, which included the $ 400,000 of the total final payment of $ 900,000 ultimately to go from her and petitioner's trusts to the children of George Gould as a group, the Duchesse de Talleyrand, and Frank Gould, had passed to those respective parties, we need consider, in answering the question posed above, only the status in the taxable year of petitioner with relation to such question. That status was as follows: From the payment of $ 2,000,000 made by petitioner into the corpus of the trust for his benefit, $ 500,000 of the total $ 900,000 final payment was to pass from that trust on his death without issue (Helen having predeceased him) to each, the children of George Gould as a group, Frank Gould, and the Duchesse de Talleyrand, and in the event of petitioner's dying survived by issue his estate was to pay $ 500,000 to the same parties, thus assuring their receipt of the final payment of the $ 900,000 originally provided for; until petitioner's death occurs the $ 500,000 paid into the corpus of his trust remains there, with petitioner as the owner of an equitable life interest therein and entitled to the use and benefit of the income therefrom; during this same period, i. e., until the death of petitioner, the children of George Gould as a group, Frank Gould, and the Duchesse de Talleyrand were deferring payment of the $ 500,000 unpaid portion of the total $ 2,900,000 which each was ultimately to receive under the agreement, $ 2,000,000 of the $ 2,900,000 having been paid in cash to each of their respective trusts immediately after the judgment; also during the same period petitioner annually was paying $ 30,000, or 6 per cent per annum, as compensation for the use of the deferred payment of $ 500,000. That the $ 500,000 was a deferred payment is shown by both the negotiations upon which the agreement of compromise was based and the following language in the agreement explaining that the annual payments of $ 54,000 or $ 30,000, as the case might be, were to be made:

* * * in order to make up for the loss of income resulting from the deferment of the vesting in possession of the aggregate $ 900,000 remainder interests with respect to each of them in the trust funds for the benefit for life of Helen G. Shepard and Howard Gould (or the guaranteed sum in lieu of the remainder interest in Howard Gould's trust as hereinafter provided).

It thus appears that in the taxable year the $ 500,000 was being used by petitioner's trust for his benefit as the equitable owner of a life estate in the corpus thereof, and that during the same period forbearance of the payment of the $ 500,000 was being made by the children of George Gould as a group, Frank Gould, and the Duchesse de Talleyrand. We conclude that, because of such use and deferment of the $ 500,000 and the payment as compensation therefor by petitioner of $ 30,000 during the taxable year, the $ 30,000 is brought within the definition of "interest * * * on indebtedness" as given in Deputy v. Du Pont, supra, and that petitioner is entitled to his claimed deduction for that amount under section 23 (b), supra. See also Commissioner v. Park, 113 Fed. (2d) 352.

We think there is no merit, under the facts and circumstances here, in respondent's contention that there must be added to the definition in Deputy v. Du Pont, supra, the requirement that "the money for the use or forbearance of which compensation is paid and claimed to be 'interest' must be owed by the person seeking a deduction under the statute" and that therefore, under the facts, the $ 500,000 did not constitute an indebtedness of petitioner.

While in the usual case the literal terms of the quoted alleged requirement may be applicable, there are other cases (which in contradistinction may be termed as unusual) analogous in principle to the instant case where it is not applicable, as, for instance, where interest was paid by the taxpayer on an indebtedness for which he had no personal liability, but which was represented by the amount of a mortgage upon real estate of which he was the equitable owner and the taxpayer was allowed a deduction for such interest, New McDermott, Inc., 44 B. T. A. 1035; see also Regulations 111, sec. 29.23 (b)-1; and where interest was paid by a parent corporation on the obligation of its subsidiary, the parent having no personal liability therefor, it was held that the parent and not the subsidiary received the benefit from the indebtedness, and, that being so, the obligation was the equitable liability of the parent. U. S. Fidelity & Guaranty Co., 40 B. T. A. 1010. In each of the above cases the payer of the interest involved received the benefit of an indebtedness for which he had no direct liability, as here the petitioner received the benefit of the indebtedness of $ 500,000 (upon which he paid the $ 30,000 here in question) through his life interest in the corpus of the trust of which $ 500,000 was a part, and we think the principle applied in those cases applies with equal force here. Cf. Joell Co., 41 B. T. A. 825.

We likewise think the contention of respondent, that payment of the $ 500,000 was contingent and for that reason the $ 30,000 paid by petitioner in the taxable year is not deductible, is without merit. There is nothing uncertain or conditional as to the ultimate payment of the $ 500,000 except the actual date thereof. The obligation to pay is certain and absolute and eventual payment is assured, since it is to be paid at the death of petitioner (than which no event could be more certain) either from the funds paid by the petitioner into his own trust if he dies without issue, or, if with issue, from his estate.

Since we have found the payment of $ 30,000 made by petitioner in the taxable year deductible as interest under section 23 (b), supra, we need not consider alternative contentions made by petitioner but not set out herein.

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.

  In computing net income there shall be allowed as deductions:

  * * * *

  (b) Interest. -- All interest paid or accrued * * * on indebtedness * * *.↩