Nicholson v. Commissioner

George James Nicholson, Petitioner, v. Commissioner of Internal Revenue, Respondent. George J. Nicholson, Petitioner, v. Commissioner of Internal Revenue, Respondent

Nicholson v. Commissioner

Docket Nos. 109954, 112307

United States Tax Court

3 T.C. 596; 1944 U.S. Tax Ct. LEXIS 149;

April 10, 1944, Promulgated

---

In both cases decision will be entered under Rule 50.

1. In determining a gift tax for 1940, the Commissioner held that prior gifts in 1935 were gifts of future interests and that therefore no $ 5,000 exclusions in respect thereof were permissible. Held, that, since the gifts of 1935 were gifts in trust, the income of which was only expendable in the discretion of the trustee for the maintenance and education of the minor beneficiary, and the beneficiary had no right to corpus or income until he arrived at the age of thirty, they were gifts of future interests and no $ 5,000 exclusions were permissible.

2. A petition which assigns error in that the Commissioner has determined the value of a gift and alleges that the petitioner neither admits nor denies that the valuation is correct, "but asks for a determination of the true value," does not comply with Rule 6, and the Commissioner's determination of value must be sustained.

3. Periodic receipts in 1937, 1938, and 1939 by the taxpayer under a contract of 1931 whereby he sold shares for a lump sum in excess of his basis and future annual "royalties," held, not royalties, but sale price of the shares, which are properly taxable in their entirety not as ordinary income, but as capital gain.

4. In 1935 the taxpayer by a written instrument "transferred" to his wife individually and to her in trust for his sons fractions of the "royalty to which I am entitled" under the 1931 contract; and in 1937, 1938, and 1939 the obligor paid such amounts directly to the wife and the taxpayer omitted them from his taxable income. Held, the amounts were paid to the wife by virtue of an assignment of future income and are properly included within his gross income as capital gain.

Edgar W. Pugh, Esq., for the petitioner.

Melvin S. Huffaker, Esq., for the respondent.

Sternhagen, Judge.

---

STERNHAGEN

In Docket No. 109954, the Commissioner determined a deficiency of $ 1,873.64 in gift tax for 1940, and in Docket No. 112307, deficiencies of $ 3,550.43, $ 942.68, and $ 2,274.25 in income tax for 1937, 1938, and 1939. As to the gift tax deficiency, the petitioner (1) assails the disallowance of two exclusions in determining net gifts for 1935, and (2) asks a determination of the value of the 1935 gifts. As to the income tax deficiencies, he assails (3) the treatment of periodic receipts as ordinary income instead of capital gain, and (4) the inclusion in his income of a portion of similar amounts received by his wife as a result of assignments in 1935 to her individually and as trustee for their two sons.

FINDINGS OF FACT.

Petitioner is a resident of Detroit, Michigan, where he filed his income tax returns.

From December 21, 1906, to July 20, 1928, he acquired 296-47/48 of the 2,479-47/48 shares of Manistique Lime & Stone Co. November 20, 1926, he made a contract to purchase 1,635 Manistique shares for $ 90,000, to be paid in monthly installments of $ 300 until November 1, 1928, and $ 416 thereafter until the purchase price was paid.

Manistique was engaged in the general quarry and limestone business and owned a substantial acreage of limestone lands. Petitioner individually owned or held under purchase contracts a substantial acreage of unproven lands. During the latter part of 1927 Inland Steel Co., hereafter called Steel, desired to obtain a supply of limestone located in the Upper Peninsula of Michigan and to secure a permanent source of supply for crushed limestone and to test petitioner's unproven lands. November 1, 1927, an agreement in writing was made between Manistique, petitioner, and Steel, in which Manistique and petitioner agreed to transfer to a new corporation to be formed (Inland Lime & Stone Co., which will hereafter be called Lime) certain lands and the assets and liabilities of Manistique, which was to be dissolved and surrender its charter. By the agreement Steel was to advance $ 125,000 to Lime for the payment of liabilities and an additional sum not to exceed $ 1,500,000 for the construction of a new crushing plant, railroad, loading dock, and in general such plant, equipment, and working capital as would be required to produce annually during the season of navigation 500,000 tons of stone for the steel industry and 500,000 tons for other outlets. Lime was to repay, with interest, out of its first earnings. The shareholders of Manistique and of Steel were each to receive 50 percent of the Lime shares. Lime was directed by petitioner to pay all his dividends to the vendors on his obligation for the 1,635 Manistique shares. Steel was given the option until noon of December 31, 1928, to accept the agreement.

October 19, 1928, a supplemental agreement was made in which Steel accepted the agreement of November 1, 1927, as modified. The Manistique shareholders were to receive 49 percent of the Lime shares and Steel 51 percent; and if the employment of petitioner by Lime was terminated at any time, 25 percent of its shares were to be tendered by him to Steel for $ 100,000 cash forthwith, and $ 92,000 (less such dividends as had been paid for his account to the vendors), payable at the rate of $ 5,000 a year until paid, and "the sum of One Cent ($ .01) royalty per gross ton of stone produced."

Inland Lime & Stone Co., herein called Lime, was organized and petitioner became its vice president. In March 1931 his connections with it were severed. On March 5, 1931, petitioner and other shareholders of Lime made a written agreement whereby petitioner and others agreed to sell to Steel 49,000 shares of Lime, being all the shares issued to the shareholders of Manistique, in consideration for "a total royalty of Two Cents (2 cents) per gross ton of 2240 pounds on any and all grades or qualities of merchantable stone produced and shipped by" Lime from certain lands (none of which were owned by Nicholson), and $ 100,000 cash, petitioner's share being $ .01372376 per ton "royalty" and $ 92,623.20 cash. The 2-cent "royalty" payments were made by Steel and during the taxable years petitioner and other recipients thereof on their tax returns reported such "royalty" amounts as ordinary income.

In his income tax return for 1931 petitioner reported $ 75,152 capital gain on the sale of his shares. This was decreased by a revenue agent to $ 70,675.39, and the capital gain rate of 12 1/2 percent was applied. Neither petitioner nor the revenue agent took into consideration, in computing such capital gain, any value of petitioner's right under the contract of March 5, 1931, to receive a "royalty" of $ .01372376 per ton.

By instrument dated December 20, 1935, petitioner transferred to his wife, Ann E. Nicholson, as a gift, two-tenths of one cent per ton "of the royalty to which I am entitled" under the contract of March 5, 1931. He also transferred to his wife in trust for their son, George M. Nicholson, born March 21, 1911, a similar two-tenths of one cent per ton. The trustee was authorized to expend such portions of the royalty as she deemed expedient for the maintenance, support, medical care, or further education of the son until he attained the age of 30 years, at which time all of the money and property unexpended and accumulated, "together with the royalty hereby given," was to be transferred to the son. He also made a similar transfer to his wife as trustee for their son, Donald Bruce Nicholson, born May 30, 1924, with a similar authorization. The indenture also stated:

It is my intention that the gift hereby made shall be used by the trustee during the term of this trust in her discretion for any of the purposes herein specified without regard to any other sources of revenue available for similar purposes or to any obligation on part of the trustee as mother of my said son to support, maintain or educate him.

Thereafter, Steel mailed "royalty checks" directly to Ann E. Nicholson individually and as trustee for each of the sons. The amounts she received in the taxable years from Steel were (stipulated) as follows:

		As trustee for --
Year	Individually			Total
		George M.	Donald Bruce
1937	$ 5,056.18	$ 5,035.45	$ 5,035.45	$ 15,127.08
1938	2,498.25	2,488.01	2,488.01	7,474.27
1939	4,187.50	4,170.34	4,170.34	12,528.18

The amounts received by the trustee for George M. were distributed to him as received and were shown by him as income in his income tax returns.

Petitioner, on or about March 15, 1936, after his attorney and his son, George M., had consulted someone in the Internal Revenue Bureau, filed a gift tax return for 1935, in which he reported the value of each gift as $ 16,570.26, or a total of $ 49,710.78, from which he deducted three exclusions, or $ 15,000, leaving a balance of $ 34,710.78, which was less than the specific exemption.

Subsequent to 1931 petitioner acquired a small royalty interest as an heir of his father, George Nicholson, Jr., a small portion of which he still owns. On May 28, 1940, he transferred to Steel a royalty interest of $ .00783078 per ton payable under the agreement of March 5, 1931, for $ 160,000.

On March 15, 1941, petitioner filed a gift tax return for 1940, in which he reported a gift of $ 40,000 in cash. The Commissioner, in computing petitioner's gift tax liability for 1940, determined that the net gifts for 1935 were $ 10,000 and that the 1935 gifts in trust were gifts of future interests, and the statutory $ 5,000 exclusions were therefore not applicable. He computed the net gifts subject to tax as follows:

Total gift	$ 40,000.00
Less exclusion
Included amount of gift	40,000.00
Specific exemption ($ 40,000 -- $ 34,710.78)	5,289.22
Net gift for 1940	34,710.78
Net gifts for 1935	10,000.00
Total net gifts	44,710.78

Petitioner in 1937, 1938, and 1939 received from Steel $ 15,536.17, $ 8,764.33, and $ 13,645.36 "royalty" payments and reported them on his returns as ordinary income. In recomputing petitioner's tax liability for such years the Commissioner added to petitioner's income as additional "royalty income" $ 19,016.55 for 1937, $ 8,308.10 for 1938, and $ 14,971.03 for 1939, paid as royalties by Steel to petitioner's wife individually and as trustee for their two sons.

OPINION.

Of these two cases, submitted at the same time, one assails a gift tax deficiency for 1940 and the other assails income tax deficiencies for 1937, 1938, and 1939. They involve different issues.

Docket No. 109954. Gift Tax for 1940.

1. The gift tax deficiency for 1940 is based upon the Commissioner's determination that in the taxpayer's return for 1935, when the first gifts in the series were made, he had erroneously taken two $ 5,000 exclusions upon the gifts in trust for his two sons. This is based on the statement that the two gifts were gifts of future interests and therefore were not the subject of exclusions. Such determination as to the 1935 exclusions may properly be made in adjusting a 1940 deficiency. . So the question is whether the 1935 gifts in trust were gifts of future interests. Clearly they were. In each trust the beneficiary had no present right to the income or the corpus. In the discretion of the trustee the income might be expended as she deemed expedient for his maintenance and education, but he had no right to it otherwise until he reached the age of thirty. This is enough to characterize the gift as a future interest within the revenue act and to preclude the exclusion. The determination on this point is sustained. ; ; ; ; .

2. In determining the deficiency the Commissioner made no determination of value of the gift in 1935, but adopted the value of $ 49,710.78 which the taxpayer used in his return. In the petition (4 (b)), the taxpayer assigns as error that "The Commissioner has determined the total gifts made in 1935 to have been $ 49,710.78," but among the allegations of "fact" appears only (5 (b)), "Petitioner neither denies or admits this valuation to be correct, but asks for a determination of the true value of the gifts made." The answer denies the error and the allegation of fact, and alleges that the determination of the Commissioner is based upon the gross value reported in the petitioner's gift tax return for 1935.

By these pleadings no issue was raised. The petition, although purporting to assign error in the determination of value of the gifts (without specifying valuation) alleges no fact to support the assignment. Thus the petition as to this point was demurrable. Rule 6 (e) provides that the petition shall contain statements of facts upon which the petitioner relies to sustain the assignments of error. This is not complied with by the statement of the petition that, without admitting or denying the correctness of the valuation which petitioner had himself used, petitioner asks for a determination of the true value. Even if the valuation used by the Commissioner in the deficiency notice had not been a mere adoption of that found in the taxpayer's return and had been an independent valuation by the Commissioner, it could only be changed in a proceeding before this Court after the taxpayer assailing it had shown by evidence that it was in fact incorrect and had by evidence proved the correct value. No such evidence is in this record, so the valuation of $ 49,710.78 must be sustained both on the pleadings and on the evidence.

In Docket No. 109954, the Commissioner's determination of deficiency in gift tax for 1940 is sustained.

Docket No. 112307. Income Tax for 1937, 1938, and 1939.

3. The taxpayer in each of the years 1937, 1938, and 1939 actually received $ 15,536.17, $ 8,764.33, and $ 13,645.36 from the Steel Co. pursuant to the 1931 contract whereby he sold his Lime shares. The amounts received were part of the 2 cents a ton consideration called "royalty" in the contract. This was a misnomer; these payments were not royalties. They were not payments to petitioner for the use of his land. They were part of the sale price of the shares. .See also . The use of the word "royalties" by the parties to the sale does not operate to give the payments that character, since the evidence shows clearly that the word was used to describe the periodic payments of the sale price for the shares.

There is no dispute about the amounts which were received, and there is in this record no room for dispute of the Commissioner's determination that the cost or basis of the shares sold was entirely received in years before the tax years. The remaining basis was therefore zero and the entire amount received in each year was income. The taxpayer treated the amounts in his return as ordinary income. He now claims that the amounts received were not income, and makes an involved argument which refers back to 1931 and the valuation used by the revenue agent in the audit for that year, contending that there was recognition then that the contract right to receive the future periodic payments had value but that such value could not be ascertained. This, however, does not establish that the basis for the payments received in 1937, 1938, and 1939 had not been completely recovered in prior years, as it undoubtedly was. Hence the payments received in those years were all taxable.

The only question is whether they are taxable as ordinary income or as capital gain. Clearly they are capital gain, since, as we have seen, they are periodic payments for the property sold in 1931. Revenue Act of 1928, sec. 101.

4. Because the taxpayer, by reason of the gifts in 1935 to his wife and in trust for his sons of fractions of the payments to be made to him by Steel, failed in 1937, 1938, and 1939 to receive these amounts himself, he omitted them from the income reported on his returns. The Commissioner, in making the deficiency determination, added them to petitioner's income for those years, and the taxpayer protests. Since, as we are holding, all additional amounts of the periodic receipts were income classed as capital gains, the effect of the gifts is merely that of assignments of the right to receive future income. By this means the taxpayer no more escapes the burden of the tax than he would if he had assigned the right to receive future compensation for services () or the interest from retained bonds (). There was no gift or assignment of a capital fund, as in , whereby the transferor taxpayer transferred the property source of the income as well as the income itself -- the tree as well as its fruit. There was only a transfer of the "royalty," that is, of the forthcoming payments for the property, Lime shares, which the taxpayer had sold and the gain upon which was his when realized. The tax upon such gain he could not shift by an anticipatory assignment.

It must be held therefore that the taxpayer's income included not only the capital gain which he himself actually received from Steel, but also so much of the gain as was paid by Steel to his wife for herself and as trustee for the sons. These amounts are stipulated as $ 15,127.08 in 1937, $ 7,474.27 in 1938, and $ 12,528.18 in 1939.

In his brief the taxpayer for the first time suggests that the deficiency is barred by the statute of limitations. This was not pleaded and the evidence was not directed to an issue in litigation. The mere fact that the deficiencies were determined more than three years after the returns, which might serve as a prima facie case under proper pleadings, does not permit a reversal of the determination. Given a proper issue, the Commissioner might have proven a waiver or otherwise overcome the apparent applicability of the statute of limitations.

In both cases decision will be entered under Rule 50.