Klein v. Commissioner

OPINION.

Stbenhagen :

The statement of facts, none of which is in dispute, presents two questions for decision; first, what portion, if any, of the $5,000 received each year by each petitioner is income; and, second, whether any part of these taxes is barred by the statute of limitations.

The respondent has included the entire amount of $5,000 received by each petitioner each year under the contract in her income. The petitioners contend that none of the amount is income. In our opinion the truth lies between.

When Leon Klein died he transferred in fraesenti some part of his valuable estate to these petitioners. Whether this transfer was under the will or had been by descent in intestacy, its value was something which came to them by distribution of their father’s estate and not by way of income. The will was proved and admitted to record on January 2, 1913, after which petitioners might have contested it, Ill. Pub. Acts, 1871-2, p. 775; ch. 148, par. 7, Callaghan’s Ill. Stats. Blit something more than mere inequality of distribution would have been required to set it aside. Donnan v. Donnan, 236 Ill. 341; 86 N. E. 279; McGrady v. McGrady, 298 Ill. 129; 131 N. E. 251. Thereafter, by the contract of April 19, 1913, each petitioner converted this property into other property, thus realizing gain or loss of the difference between what under the contract she acquired and what she had from the estate (with proper adjustments for the value on March 1, 1913). These past values we are not concerned with, for presumably they were correctly taxed at that time. The significant fact now before us is that the value of what petitioners acquired by contract on April 19, 1913, became the capital basis for measuring any subsequent gain or loss in respect thereof.

The only amount in issue is the annual sum of $5,000. By stipulation, the value on April 19, 1913, of this annuity payable during the probable life of Rosalinda Klein is fixed at $57,753.50, which was to be paid to each in semi-annual installments for approximately fifteen years. It is not such a situation as arose in Irwin v. Gavit, 268 U. S. 161, where the annuity was received from a principal fund established under a will and without cost. See also Heiner v. Beatty, 17 Fed. (2d) 743, decided February 23, 1927. Here each annual - amount of $5,000 represents in part a return of the cost of April 19, 1913, and in part a gain. The amount of the gain is therefore properly to be included in each petitioner’s income each year, until the annual payments of principal aggregate $57,753.50.

The petitioners contend that no part of the annual payments of $5,000 is income until after they aggregate $57,753.50; and the argument is sought to be pointed by the fact that Rosalinda Klein’s life was necessarily uncertain and that her early death might have meant the failure of their realizing the $57,758.50. Platt v. Bowers, 13 Fed. (2d) 951; Warner v. Walsh, 15 Fed. (2d) 367, are cited. The argument is in our opinion unsound. The amount of $57,753.50 is presumably arrived at by discounting the annual payments to a present basis on April 19, 1913, and thus assuming that the prospect of receiving $5,000 in each future year was of a lower value in 1913. When actually received in each year the $5,000 consists of the principal value of 1913 of such payment, plus the discount, the latter being the gain taxable as income. The allocation would vary from year to year, the capital steadily getting smaller and the gain larger. This is readily computable by reference to discount tables and the parties are directed to present the allocation for each year.

The decision of Platt v. Bowers, supra, involves a contract the terms of which are not clearly stated, and the learned court seems to have regarded the present value of serial payments as equal to the face amount payable in the future. The decision in Warner v. Walsh, supra, is based upon the assumption that section 4 of the Revenue Act of 1916 and section 213 (b) (2) of the Revenue Act of 1918 require that all annuity payments under an insurance contract must be treated as capital until the purchase price is recovered. This seems to us to read into those statutes something not fairly within their terms. They provide only that so much of each payment as is a return of cost shall not be taxed as income; but this is a long way from saying that each payment is a return of cost in its entirety until cost is recovered. The statutes provide neither that the first payments are all income nor that they are all return of cost; but they indicate rather that each payment is partly one and partly the other, and that the income part is all that is to be included in gross income. This is consistent with the normal theory of purchased annuities, and seems to us to be fairer than to regard the first payments as wholly tax free and the latter payments as wholly taxable. The theory of apportionment is applicable to periodic payments just as it is to the ascertainment of gain in the sale of lots in a subdivided tract of land, of retail goods purchased in bulk, and other situations under the statute.

Since the foregoing decision would subject to tax a portion of each ’annual amount of $5,000 received from 1916 to 1922 in so far as they are involved in this proceeding, it is necessary to consider the petitioner’s contention that the alleged deficiencies for the years up to and including 1919 must be disallowed because collection thereof is outlawed by the limitation provisions of the several statutes involved. Counsel for both parties were expressly requested to submit briefs on this question. At the request of both parties extension of time for filing such briefs was granted. Subsequently additional extensions were refused because there had not been a sufficient show of diligence. At the appointed time the brief of counsel for petitioners was filed, but none has been filed in behalf of respondent. We thus have but the argument of one side to consider. Whether we are to assume that the respondent concedes that the statute bars the deficiencies or that he leaves the question to be investigated by the Board without the assistance of counsel is not clear. We reject the latter alternative. It is the duty of counsel to ascertain the considerations and authorities supporting one side or the other and of the Board to judge.

If the Board’s refusal to grant further extensions of time is relied upon it should be said that periods fixed for procedure are to be taken seriously and there is no justification for waiting as in this case until the approximate time of expiration in reliance upon a further extension.

The argument of the petitioners in support of the view that the deficiencies for the years 1916, 1917, 1918, and 1919 are barred by the limitation provisions of the statute and therefore must be disallowed, is persuasive, and judgment should go in their favor for those years. We therefore so decide.

There is no deficiency for 1916, 1917, 1918, and 1919. For 1920, 1921, and 1922 the $5,000 annual payments should be allocated as between taxable income and nontaxable return of cost in accordance with the computation submitted by the parties as hereinbefore stated.

Judgment will be entered on BO days’ notice, under Rule 50.

Artjndell, Marquette, Smith, and Trussell dissent.