Opinion
No. 346.
June 20, 1945.
Appeal from the District Court of the United States for the Southern District of New York.
Action by Henry L. Blum against Joseph T. Higgins, Collector of Internal Revenue, to recover income taxes paid. From a judgment for defendant, 57 F. Supp. 140, plaintiff appeals.
Affirmed.
In 1921, the taxpayer received from the Northwestern Mutual Life Insurance Company two endowment policies in the aggregate amount of $150,000. The policies provided for a payment of premiums by the taxpayer over a period of fifteen years, at the end of which time the taxpayer would be entitled to the face amount of the policies unless before then the insured elected one of the settlement options. The policy also provided for cash surrender values over the fifteen-year period. The insured was given the right to designate beneficiaries and contingent beneficiaries with the right of revocation and change.
The settlement options contained in the policies read as follows:
"The Insured shall have the right, with the privilege of revocation and change, to elect in lieu of payment in one sum, either Option `A,' `B' or `C,' or that the amount payable be distributed under two or more of said options * * * [The insured elected Option A.]
"Option A: To have the whole or any part not less than $1000 of the net proceeds of this Policy at the death of the Insured, if within the Endowment Period, retained by the Company until the death of the last surviving Beneficiary or Contingent Beneficiary, the Company in the meantime to pay interest thereon annually at the rate of three per cent. of the amount so retained, the first payment being due one year after the death of the Insured. At the time any interest payment becomes due, the Beneficiary, provided the Company shall not have been specifically directed to the contrary by the Insured, shall have the right, upon due surrender of this Policy, to withdraw the amount so retained.
"Option B: To have the whole or any part not less than $1,000 of the net proceeds of this Policy at the death of the Insured, if within the Endowment Period, paid in a specified number of annual installments as per the first Table below, which shall apply pro rata per $1,000 of the amount to be so paid, the first installment being payable immediately. At any time when an installment is due, the Beneficiary, provided the Company shall not have been specifically directed to the contrary by the Insured, shall have the right upon due surrender of this Policy, to commute the installments remaining unpaid on the basis of three per cent. compound interest.
"Option C: To have the whole or any part not less than $1,000 of the net proceeds of this Policy at the death of the Insured, if within the Endowment Period, paid in either 10, 15, 20 or 25 stipulated annual installments of an amount corresponding in the Table below to the age of the Beneficiary at the date of the death of the Insured, provided that if the Beneficiary shall survive to receive the number of installments selected, similar installments shall be continued during the lifetime of the beneficiary. The Table shall apply pro rata per $1,000 of the amount to be so paid, the first installment being payable immediately. If there be two or more Beneficiaries the proceeds, unless otherwise directed by the Insured, shall be divided into a corresponding number of equal parts and the annual installments to each beneficiary determined in accordance with the Table below for the age attained. Payments under Option `C' are not subject to commutation.
* * * * *"All payments under Options `A' and `B,' and the stipulated payments under Option `C,' will be increased by such annual dividends as may be apportioned by the Company.
"Subject to the release of any existing assignment of this Policy, the foregoing Special Provisions shall, on written request and suitable endorsement hereon by the Company, apply to the net proceeds payable as the cash surrender value hereof.
"The foregoing Special Provisions shall also apply to payment at the end of the Endowment Period when, subject to the provisions thereof, the Insured may elect in lieu of payment in one sum, either Option `A,' `B' or `C,' or that the amount payable be distributed under said options, and may himself be the Beneficiary, or may designate any other person or persons to be the Beneficiary or Beneficiaries thereunder. A Contingent Beneficiary or Beneficiaries may also be designated as provided in this contract."
On July 30, 1936, a few days before the maturity date of the policies, the taxpayer named himself as beneficiary and elected that settlement be made with him in accordance with the provisions of Option A (supra), except that payments were to be made at monthly intervals with the privilege of withdrawal at those times of the principal "in whole or in part." At the time of the election the taxpayer was no longer an insurable risk.
The insurance company had made it a practice to permit an insurer to switch from one option to another even after an election of options had been made and put into effect, but there was no contractual obligation on the part of the insurance company to permit such changes.
Option C, as described above, would pay higher annuity installments than any annuity contract available at that time or since that date. Moreover, the annuity contract under that option included the right to dividends which the company declared. And at the time of the maturity of the policy and thereafter, the company has not issued annuity policies in amounts over $25,000 and the other insurance companies have similarly limited their sales of annuities.
During the endowment period, the taxpayer paid premiums in the aggregate amount of $133,723.50. In 1936, when the endowment period ended, the taxpayer, although he had received no cash under the policies, reported the difference between the premiums paid and the face amount of the policy, $16,276.50, as income. Thereafter, he filed a timely claim for refund of the taxes paid on the $16,276.50. The Commissioner disallowed the claim and the district court upheld the Commissioner's ruling.
Proskauer, Rose, Goetz Mendelsohn, of New York City (Norman S. Goetz and Wilbur H. Friedman, both of New York City, and Gerald Silbert, of Brooklyn, N.Y., of counsel), for plaintiff.
John F.X. McGohey, of New York City (Stanley H. Lowell, of New York City, of counsel), for defendant.
Before L. HAND, AUGUSTUS N. HAND, and FRANK, Circuit Judges
1. Since the taxpayer did not receive any of the proceeds of the insurance policy in 1936 and since he was on a cash basis, he realized no taxable gain on the policies in that year unless the doctrine of constructive receipt is applicable. The taxpayer is considered in constructive receipt of income if it is available to him "without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is made." Treas. Reg. 94, Art. 42-2.
2. The taxpayer contends that the constructive receipt doctrine is inapplicable here because the taxpayer would have had to surrender valuable rights in order to obtain the proceeds of the policies in 1936. We do not agree. The taxpayer's rights, after electing Option A, were to leave the moneys on deposit with the company at three per cent interest during the taxpayer's lifetime, and he could withdraw the principal on any interest day — once a month. We think this does not differ from a sum of cash. True, the insurance company did maintain the practice of permitting an insured who had elected one option to change to another. And if the policy had given such a right, we should probably say that the insured had not constructively received the proceeds of the policy, for this right to change the options B and C would have presented a valuable legal privilege which would have to be surrendered if cash were chosen instead of Option A. But that possibility of conversion from one option to another is not part of the insurance contract; it is not even a revocable offer on the part of the company. At any time, even after the insured had requested a change from one settlement form to another, the insurance company could refuse to permit the change. It would seem therefore that the taxpayer would be called upon to surrender no legal right or privilege in order to take cash instead of Option A.
3. The taxpayer argues that our decision in Commissioner of Internal Revenue v. Pierce, 2 Cir., 146 F.2d 388, dictates a contrary result. We think that decision not pertinent. We are not here deciding that the taxpayer received the proceeds of the policy constructively and purchased Option A therewith. We are holding that, after having chosen Option A, the taxpayer is in a position where he had the equivalent of a sum of available cash.
4. The taxpayer also contends that the difference between the amount received under the policy and the premiums paid should be taxable as capital gains rather than ordinary income. The statute seems clearly to indicate that the difference is taxable as ordinary income, and the Third and Ninth Circuits have so held. Bodine v. Commissioner of Internal Revenue, 3 Cir., 103 F.2d 982, 987; Avery v. Commissioner of Internal Revenue, 9 Cir., 111 F.2d 19, 23.
Affirmed.