William L. Powell Foundation v. Commissioner , 21 T.C. 279 ( 1953 )

William L. Powell Foundation, Petitioner, v. Commissioner of Internal Revenue, Respondent

William L. Powell Foundation v. Commissioner

Docket No. 35422

United States Tax Court

21 T.C. 279; 1953 U.S. Tax Ct. LEXIS 24;

November 23, 1953, Promulgated

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Decision will be entered under Rule 50.

The petitioner, a religious and charitable foundation, accepted the gift of two United States Government bonds totaling $ 15,000 upon the proviso that it pay the income of such bonds, or the income of the proceeds thereof, to the wife of the donor during her lifetime. Such bonds were subsequently converted into cash by the petitioner and the proceeds invested in real estate mortgages. Since 1943 there was no segregation of the proceeds of the bonds from the general assets of the petitioner. They were intermingled with various mortgage investments. The maximum rate of interest earned by petitioner on such mortgages during 1943 through 1950 was 5 per cent. There were losses of interest on various mortgages during that period. During the fiscal year ended January 31, 1950, interest payments on four mortgages were in arrears. The petitioner paid the income beneficiary $ 750 (5 per cent on $ 15,000) during its fiscal year ended January 31, 1950, and each of the years since 1943. Respondent determined that a part of petitioner's income inured to the benefit of a private individual and that it was, therefore, not entitled to exemption from taxation under section 101 (6). Petitioner contends that it paid the income beneficiary no more than was required by the income proviso.

Respondent notified petitioner in 1948 that it was not entitled to exemption under section 101 (6), and affirmed this ruling in 1949. Petitioner filed its income tax return for its fiscal year ended January 31, 1950, on December 4, 1950, attaching thereto a statement denying the correctness of respondent's ruling.

1. Held, a part of petitioner's income inured during the taxable year to the benefit of a private individual, and petitioner is not entitled to exemption from Federal income taxation under section 101 (6).

2. Held, further, petitioner's failure to file a timely return was due to willful neglect, and not due to reasonable cause.

Frank C. Olive, Esq., and George S. Olive, C. P. A., for the petitioner.

George E. Gibson, Esq., and Elmer E. Lyon, Esq., for the respondent.

Rice, Judge. Arundell, Murdock, Johnson, and Tietjens, JJ., dissent.

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RICE

This proceeding involves a deficiency in income tax for the taxable year ended January 31, 1950, of $ 397.62 and a penalty of $ 99.41 asserted against the William L. Powell Foundation (hereinafter referred to as the petitioner).

The issues to be determined are: (1) Whether petitioner has complied with the requirements of section 101 (6) of the Internal Revenue Code during the taxable year ended January 31, 1950, and is therefore exempt from Federal income taxation as a religious and charitable foundation; and (2) whether petitioner is liable for a 25 per cent penalty under section 291 (a) of the Internal Revenue Code for delinquency in filing its return for the taxable year ended January 31, 1950.

The respondent has conceded that he was in error in including the full amount of $ 316.86, which was received as dividends from domestic corporations, in the taxable income of petitioner for the taxable year ended January 31, 1950; and a dividend received credit in that amount will be allowed to the petitioner in a recomputation under Rule 50.

Some of the facts were stipulated.

FINDINGS OF FACT.

The stipulated facts are so found and are incorporated herein.

Petitioner is an Indiana corporation, organized on February 5, 1926, and is located in Lebanon, Indiana. Its tax return for the year here involved, petitioner's fiscal year ended January 31, 1950, was filed with the collector of internal revenue for the district of Indiana on December 4, 1950.

William L. Powell was a member of the Central Christian Church in Lebanon, Indiana. Prior to 1926, he was worth from $ 100,000 to $ 125,000. Desiring to make some gifts to the church, conferences were held with James C. Darnall (hereinafter referred to as Darnall), his close friend and business advisor, and the Board of the Church. Petitioner corporation was thereupon organized and its articles of incorporation, at paragraph 2, provided as follows:

The purposes for which said corporation is organized, are to promote religious, educational and charitable purposes, and in order to promote such purposes, to acquire by gift, devise, purchase or otherwise and to hold for investment or in trust, sell or dispose of any money, business, real estate, stocks, bonds or other securities or evidences of indebtedness created by any other corporation or corporations organized under the laws of the State of Indiana or any State in the United States and also all bonds or evidences of indebtedness of the United States or any county, State or municipality therein, or any evidences of indebtedness of any person or persons, firm, partnership or association.

The articles of incorporation also provided that the successors to the directors named in the articles "shall be elected by the official board of The Central Christian Church of Lebanon, Indiana or by its successors, assigns or by the church or organization of which said church becomes a part." Directors were always so chosen, and Darnall was both an officer and member of the board of directors of petitioner from its incorporation to the date of trial of this case.

Shortly before his death in January 1928, William L. Powell gave to Darnall three United States Liberty Loan Bonds with the request that they be delivered to the petitioner. They were transferred to the petitioner on January 23, 1928, together with the following instructions which had been written on the envelope containing the bonds:

Bond #39993 for $ 10,000.00

I hereby request that the income from this Bond or the proceeds thereof shall be paid annually to my Wife Ella P. Powell during her life time and at her death I request That one half of the annual income from this bond or its proceeds shall be used annually for religious, charitable or educational purposes and the other half of said annual income shall be added to the assets of William L. Powell Foundation. (signed) W. L. Powell.

Bond #39994 for $ 10,000.00

I hereby request that this bond and the proceeds thereof be used as follows, that the principal of said bond or its proceeds be kept as a Permanent fund and that one half of the interest on said bond or its proceeds be expended annually and the other half of said interest from said bond or its proceeds be added annually to the permanent fund. Said money to be expended in the United States. (signed) William L. Powell

Witness: W. J. Devol.

Bond #42532 for $ 5,000.00

The within bond is given by William L. Powell to the William L. Powell Foundation upon the following terms and conditions. The income from said bond or proceeds of same is to be paid to Mr. Powell during his life time and to his wife Ella P. Powell during her life time after which same become property of said Foundation.

The same after death of both Mr. & Mrs. Powell shall be used as follows: -- One half of the income from said bond or the proceeds of said bond is to be used annually for religious, educational or benevolent purposes anywhere in the United States of America and one half of said income is to be added to the principal.

The within bond is to be delivered to William L. Powell Foundation at the death of William L. Powell.

On or about January 25, 1928, petitioner converted bonds No. 39993 and No. 42532, in both of which Ella P. Powell had a beneficial interest, into bonds of like amount registered in petitioner's name. At the same time, bond No. 39994 was converted into a coupon bond. The three bonds earned 4 1/4 per cent interest both before and after conversion. This amounted to $ 637.50 per annum on the two bonds totaling $ 15,000, the income from which was payable to Ella P. Powell. The petitioner paid Ella P. Powell the amount of $ 637.50 during each of its fiscal years ending January 31, 1929 to 1936, inclusive.

In 1935, when the United States Government bonds which William L. Powell had donated to the petitioner were maturing, a decision had to be made as to whether or not the proceeds should be reinvested in new Government bonds which were paying 3 1/4 per cent. Darnall discussed the matter with Ella P. Powell, informing her of the substantial reduction in her income which would result from the purchase of Government bonds at that time. He suggested that the $ 15,000 be invested in real estate mortgages since the petitioner was currently earning 5 and 6 per cent on such mortgages. He stated that the decision as to how the proceeds of $ 15,000 of Government bonds were to be invested was being left up to her. Ella P. Powell was hesitant about the transfer of the principal from Government bonds to mortgages. She agreed, however, that petitioner should make this change after Darnall assured her that she could depend on receiving 5 per cent on the $ 15,000. She was familiar with the professional reputation of Darnall as a loan agent and abstractor, and knew that he personally passed on all mortgage loans made by the petitioner. Darnall reported her wishes on this matter to petitioner's board of directors. They then set aside, on December 12, 1936, three mortgages aggregating $ 15,000 in a fund designated "Ella Powell income fund." The following interest payments were received by petitioner on these three segregated mortgages during its fiscal years 1937 through 1942.

	1937	1938	1939	1940	1941	1942
Bradshaw Note	$ 36.16	$ 149.25
Riley Note	449.55	445.50	$ 405.00	$ 405.00		$ 821.38
Gill Note	259.20	189.27		207.26
Total	$ 744.91	$ 784.02	$ 405.00	$ 612.26		$ 821.38

Petitioner made the following payments to Ella P. Powell during those years:

1937	1938	1939	1940	1941	1942
$ 697.18	$ 839.95	$ 750.00	$ 800.00	$ 750.00	$ 787.50

The treasurer's reports of the petitioner show the following deposits from the sale of United States bonds:

May 5, 1931	$  6,000.00 U. S. Bonds sold
May 10, 1935	6,000.00 U. S. Bonds redeemed
Oct. 31, 1935	11,000.00 U. S. Bonds sold
Mar. 4, 1939	2,785.45 U. S. Bonds and interest sold
	$ 25,785.45

The $ 15,000 in United States bonds which had been given by William L. Powell to the petitioner, with income proviso for Ella P. Powell, were included in the above amounts.

After the year ended January 31, 1942, when the last of the three segregated mortgages placed in the "Ella Powell income fund" had been paid off, the petitioner no longer segregated any mortgages. The Ella P. Powell funds became merged and intermingled with the funds of the petitioner. However, the petitioner "made it a business" to keep $ 15,000 of mortgage loans on hand for Ella P. Powell. At times, it borrowed money from the bank to enable it to acquire mortgages currently available, but for which its own liquid funds were insufficient, because existing mortgages had not yet matured.

Petitioner kept its books on a cash basis. The following schedule shows petitioner's net earnings for each of its fiscal years from January 31, 1936, to January 31, 1950, inclusive, together with the portion allocable to interest on mortgage loans, the amounts of charitable contributions, and the payments to Ella P. Powell for each of said years:

		Interest	Ella P.
	Net	received on	Powell	Charitable
Year	earnings	mortgage	payments	contributions
		loans
1936	$ 1,025.64		$ 637.50	$ 100.00
1937	554.86	$ 891.16	697.18	425.00
1938	943.62	895.05	839.95	416.03
1939	1,483.81	699.90	750.00	185.41
1940	1,597.12	902.06	800.00	119.00
1941	1,409.17	608.60	750.00	207.90
1942	2,088.02	1,268.51	787.50	162.00
1943	2,513.61	957.11	750.00	70.75
1944	2,465.61	402.87	750.00	70.75
1945	2,118.13	970.16	750.00	856.78
1946	1,146.60	869.30	750.00	235.00
1947	2,458.64	1,250.10	750.00	160.00
1948	2,531.67	938.49	750.00	360.00
1949	15,467.01	1,147.14	750.00	500.00
1950	1,993.07	2,106.40	750.00	695.00

From 1943 through 1950, the maximum amount of interest earned by petitioner on mortgage loans was 5 per cent. During this period petitioner paid to Ella P. Powell $ 750 per year, 5 per cent on $ 15,000, without making any deductions for expenses involved in the various mortgage transactions.

Delinquencies in interest payments by mortgagors occasionally resulted in eventual losses of interest on mortgages held by the petitioner. During the taxable year ended January 31, 1950, petitioner received no interest on four mortgage loans totaling $ 5,800. It held $ 41,555.92 in mortgages on January 31, 1950.

No part of the activities of petitioner consisted of carrying on propaganda, or otherwise attempting to influence legislation.

A claim for exemption under the provisions of section 101 (6) of the Internal Revenue Code was filed by the petitioner under date of May 18, 1948, on Form No. 1023 with the Commissioner of Internal Revenue. On October 12, 1948, the Commissioner advised the petitioner that it was not entitled to exemption under section 101 (6) of the Internal Revenue Code and prior revenue acts, and reaffirmed its ruling on November 8, 1949.

A part of petitioner's net earnings during the taxable year ended January 31, 1950, inured to the benefit of a private individual, namely, Ella P. Powell.

Petitioner filed its income tax return for its fiscal year ended January 31, 1950, on December 4, 1950, attaching thereto a statement denying the correctness of the respondent's determination that it was not entitled to exemption under section 101 (6). Petitioner's failure to file its return on or before the fifteenth day of the third month following the close of its fiscal year was due to willful neglect and not due to reasonable cause.

OPINION.

The principal issue herein is whether any "part of the net earnings" of petitioner has inured "to the benefit of any private shareholder or individual" during petitioner's taxable year ended January 31, 1950, and thus prevented petitioner from obtaining exemption from Federal income taxation as a religious and charitable foundation under section 101 (6) of the Internal Revenue Code. ^{*36 The petitioner was undoubtedly organized with a predominantly religious and charitable purpose in mind. Petitioner's capital was acquired in 1928 as a gift from William L. Powell in the form of three United States Government bonds, two of $ 10,000 denomination and the third -- $ 5,000. The donor specified that one-half the income from the bonds, or the income of the proceeds thereof, be donated annually to charitable or religious enterprises and the other half be added to the corpus. However, there was a qualification to the gift of the $ 5,000 and one of the $ 10,000 bonds; namely, that during the lifetime of the donor's wife, Ella P. Powell, the income of these bonds, or the income of the proceeds thereof, be paid to her. Thus, until her death, she was to receive the income from a specific three-fifths of petitioner's assets, the income from one-fifth was to be expended for charitable purposes, and that from the remaining one-fifth was to be added to corpus.}

It has been established that property may be transferred to a charitable trust with the proviso that all or part of the income of such property be paid to a private individual for a stated term. Such payments are a charge upon the specific assets transferred, and the donee retains its tax-exempt status under section 101 (6). Lederer v. Stockton, 260 U.S. 3">260 U.S. 3 (1922); Emerit E. Baker, Inc., 40 B. T. A. 555 (1939); Edward Orton, Jr. Ceramic Foundation, 9 T. C. 533 (1947), affd. 173 F. 2d 483 (C. A. 6, 1949).

It is respondent's contention that the petitioner disregarded the terms of the gift imposing a charge on certain of its assets, and that the petitioner paid to the income beneficiary more than the actual income of such assets, thereby disbursing a part of the net earnings of its general assets to a private individual. The petitioner has failed to prove that such was not the case during the taxable year 1950 and is, therefore, not entitled to exemption from taxation under section 101 (6).

Upon analyzing the record, it appears certain that the income beneficiary was paid a sum in excess of the amount actually earned by the specific assets charged with the burden of producing an income for her benefit. By its failure to segregate the specific assets donated for this purpose from the balance of its general assets, the petitioner has rendered it impossible to determine the actual income of these specific assets. These specific assets were intermingled with the general assets of petitioner which were invested in mortgage loans bearing an interest rate of 5 per cent. But when we take into account the various losses and expenses incident to these various mortgage investments, it is apparent that petitioner's net income from this source was less than 5 per cent. Thus, there have been delinquencies in interest payments by mortgagors, occasionally resulting in eventual losses of interest during the period 1943 through 1950. In the fiscal year ended January 31, 1950, there were four mortgages, totaling $ 5,800, on which no interest payments were received. In addition, to determine its net income from mortgage investments, petitioner should also have deducted the interest expenses it incurred when it borrowed money from the bank to enable it to make opportune mortgage investments prior to the maturity of its current mortgages. As a result of these losses, interest expense, and other incidental expenses, petitioner's net income from its mortgage investments must necessarily have been less than the 5 per cent rate stated on the face of the mortgages, and the 5 per cent paid to the income beneficiary. By paying her a higher rate of interest than that actually earned on its mortgage investments, a part of the income of its general assets inured to her benefit.

Petitioner was required to file a return stating its taxable income for the fiscal year ended January 31, 1950, on or before the fifteenth day of the third month following the close of that fiscal year, since it had not established its right to exemption under section 101 (6). It did not file its return until December 4, 1950, and at that time attached a statement denying the correctness of the determination of the Commissioner of Internal Revenue that it was not entitled to exempt status under section 101 (6). A claim to exempt status under section 101 (6), despite a contrary ruling by the Commissioner of Internal Revenue, cannot relieve a taxpayer of the duty of filing a timely return. See Credit Bureau of Greater N. Y. v. Commissioner, 162 F. 2d 7 (C. A. 2, 1947). Petitioner has failed to introduce any evidence that its tardy filing was due to "reasonable cause and not due to willful neglect." Sec. 291 (a) of the Internal Revenue Code. The Commissioner's assessment of a 25 per cent delinquency penalty must, therefore, be sustained. Murray Humphreys, 42 B. T. A. 857, 880 (1940), affd. 125 F. 2d 340 (C. A. 7, 1942), certiorari denied 317 U.S. 637">317 U.S. 637 (1942).

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 101. EXEMPTIONS FROM TAX ON CORPORATIONS.

  The following organizations shall be exempt from taxation under this chapter --

  * * * *

  (6) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation;↩