Opinion
Docket No. 24517.
1951-10-4
ROSE J. LINDE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Frank C. Scott, C.P.A., for the petitioner. R. G. Harless, Esq., for the respondent.
In the year 1944, the estate of petitioner's deceased husband received from cooperatives proceeds from the liquidation of certain of their ‘wine pools‘, in which decedent had held interests, and payment of certain sums of money due and owing the decedent on the date of his death. The administration of the estate was terminated in 1944. In the same year these amounts were distributed to the petitioner as sole legatee under the decedent's will, and in the year 1945 the cooperatives paid to the petitioner other proceeds from the 1945 liquidation of certain of the wine pools. The total proceeds received in 1944 and 1945 on liquidation of some of the wine pools exceeded the appraised value for Federal estate tax purposes of decedent's interests therein. Held, (1) that section 126 income is taxable to the recipient thereof, so that any such income received by the estate of the decedent is taxable to it and, as such income is not ‘income of the estate,‘ the provisions of section 162(c) are inapplicable thereto; (2) that the proceeds received by the petitioner in 1945 from liquidation of the wine pools did not constitute ‘items of gross income in respect of a decedent‘ taxable under section 126 of the Code, since the liquidation of the wine pools did not take place until after the decedent's death, at which time petitioner held the property interests in the pools; and (3) that the amount by which liquidation proceeds, both those received by decedent's estate in 1944, and currently distributed to petitioner, and those received by petitioner in 1945, exceeded the fair market value of petitioner's interests in any unliquidated portions of the wine pools when she acquired them by bequest constitute capital gains taxable to her when received in 1944 and 1945. Frank C. Scott, C.P.A., for the petitioner. R. G. Harless, Esq., for the respondent.
Respondent determined deficiencies for the taxable years 1944 and 1945 against the petitioner in the amounts of $274 and $379.97, respectively, computed as follows:
+-----------------------------------------------------------------------------+ ¦ ¦1944 ¦1945 ¦ +-------------------------------------------------------+----------+----------¦ ¦Tax as reported due on return and paid by the ¦ ¦$10,761.47¦ ¦petitioner ¦ ¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦Adjustment in the amount of tax due made by the ¦$12,024.00¦28,391.44 ¦ ¦respondent (increase) ¦ ¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦ ¦12,024.00 ¦17,629.97 ¦ +-------------------------------------------------------+----------+----------¦ ¦Amount of tax assessed by respondent October 1947, and ¦ ¦ ¦ +-------------------------------------------------------+----------+----------¦ ¦paid by petitioner ¦11,750.00 ¦17,250.00 ¦ +-------------------------------------------------------+----------+----------¦ ¦Balance due—amount of deficiency ¦274.00 ¦379.97 ¦ +-----------------------------------------------------------------------------+
Petitioner claims as overpayments the additional assessments which she paid in the amounts of $11,750, for the taxable year 1944, and $17,250 for the taxable year 1945 in the amount of $4,336.40.
The following questions are presented:
(1) Are the proceeds from the liquidation of wine pools and other amounts, which were owing petitioner's deceased husband when he died, received in 1944 by the decedent's estate and, upon termination of the administration of the estate in December 1944, distributed to petitioner as sole legatee, taxable to petitioner in 1944 under section 126 of the Internal Revenue Code?
(2) Do the proceeds received by the petitioner in 1945 in liquidation of her deceased husband's interests in certain wine pools, which she had acquired by bequest, constitute items of gross income in respect of the decedent taxable to petitioner, the recipient thereof, pursuant to the provisions of section 126 of the Code?
(3) If the answer to either (1) or (2), supra, is in the negative with respect to the wine pool payments, are the amounts by which any of the liquidation proceeds, both those received by decedent's estate in 1944, and currently distributed to petitioner, and those received by petitioner in 1945, exceed the fair market value of the petitioner's interests in the pools when she acquired them (the appraised value of decedent's interests in the pools for Federal estate tax purposes) taxable to her in the years 1944 and 1945 and, if so, are such amounts taxable to her as ordinary income or as capital gains?
FINDINGS OF FACT.
Part of the facts were stipulated and they are so found.
The petitioner, Rose J. Linde, formerly Mrs. Rose J. Lange, resides at Lodi, San Joaquin County, California. She duly filed her income tax returns for the years 1944 and 1945 with the collector of internal revenue for the first district of California.
Petitioner was the sole beneficiary and executrix of the estate of her deceased husband, Herman C. Lange (sometimes hereinafter referred to as the decedent), who died December 10, 1943.
The petitioner filed an income tax return on behalf of the decedent for the period January 1 to December 10, 1943, on the cash receipts basis, the same method as was regularly employed by the decedent. As executrix of the decedent's estate, she filed a fiduciary income tax return for the period December 10, 1943, to November 30, 1944. Both such returns were filed with the collector of internal revenue for the first district of California. The administration of the decedent's estate was terminated December 19, 1944, and in that month all the property of the estate was distributed to petitioner as sole beneficiary under the decedent's last will and testament.
Decedent, during his lifetime, was a farmer. He owned and operated vineyards located in the vicinity of Lodi, San Joaquin County, California. In order better to market wine grapes grown in his vineyards, he acquired membership interests in the East-Side Winery and the Cherokee Vineyard Association, cooperative marketing associations organized under the provisions of chapter 4 of the Agricultural Code of the State of California as nonprofit cooperative marketing associations. Their principal purpose was the processing of their members' grapes into wine and other grape products and the marketing of these products on behalf of its members. Decedent also held memberships in other marketing associations, including the Lodi Winery.
Both the East-Side Winery (hereinafter sometimes called the East-Side) and the Cherokee Vineyard Association (hereinafter sometimes called the Cherokee) operated in a similar manner. In order to market his grapes through these associations, a grower was required to become a member and membership was limited to growers. The rights and duties of the members, as well as those of the associations, were defined in the articles of incorporation and the by-laws of each association, the marketing agreements between the members and the associations and, in the case of Cherokee Vineyard Association, a membership agreement. The relationship between the associations and their members in the actual marketing operations was governed largely by the terms of the marketing agreements. The forms of the marketing agreements of each association read in part as follows:
1. East-Side Winery:
This (marketing) agreement between the EAST-SIDE WINERY, hereinafter called the ‘Association‘ and the undersigned, hereinafter called the ‘Grower,‘ Witnesseth:
(1) That the Association shall buy and the Grower shall sell to the Association each and every year after the date of this agreement, such number of tons of grapes as may be agreed upon from time to time between the Association and the Grower, it being understood and agreed that the Grower shall have the privilege of selling and delivering to the Association from time to time such proportion of all the grapes which the Association shall from time to time, decide to accept and receive, as the number of shares of stock held by the Grower shall bear to the total issued and outstanding stock.
(3) The Association agrees to manufacture such grapes, together with the grapes delivered by other growers, into wine, brandy or such other products as the Association may determine and to sell such wine, brandy or other products and pay over ratably the net amount received therefrom as payment in full to the Grower after making such deductions to cover cost of manufacturing, advances, the cost of receiving, pooling, handling, grading, processing, financing, advertising, storing, insuring, selling, marketing and building assessments, debts and other charges, as determined by the Board of Directors from time to time; and for organization, operating and maintenance expenses, stock in a central agency and reserves, but such reserves shall not exceed five per cent of the gross sales price, which reserves may be used by the Association for any proper purpose.
(6) The Grower further agrees that the Association shall have the power to borrow money for any purpose of the Association on the pools of wine, brandy or any other product held in storage by the Association; and shall exercise all other rights of ownership without limitation and may sell or pledge for its own account or as security for its own debts or otherwise all or any part of any such pools or warehouse receipts, account sales or other documents covering said pools of wine, brandies or other products or received on account thereof.
(7) It is agreed that the charter, the by-laws now or hereafter in effect and this contract constitute the entire agreement between the Association and the Grower.
(10) The Association shall have the right to make pools of each kind of wine and of the wine made from each kind of grapes or to blend the same as in the opinion of the Board of Directors may seem best and settlements with the Grower shall be made at such time or times as the Board of Directors may elect and settlement shall be made upon the basis of the amount of moneys received from sale or sales of the product from each pool or pools respectively, rather than upon the basis of the tonnage of grapes delivered.
2. Cherokee Vineyard Association:
This (marketing) agreement between the CHEROKEE VINEYARD ASSOCIATION, hereinafter called the ‘Association‘ and the undersigned, hereinafter called the ‘Grower.‘ WITNESSETH:
Section 1. In consideration of covenants herein contained, the Association buys and the Grower sells to the Association, annually from the date of the signing of the Membership Agreement of which this is a part, the number of tons of grapes stated in the Membership Agreement, divided between the varieties therein specified.
And the Grower agrees to deliver such grapes to the plant of the Association or to any such other place as the Association may direct, but if deliveries required to be made distances greater than to the plant the Association will pay the difference between the reasonable cost of delivery to the plant and the reasonable cost of delivery to the place designated.
Section 2. The Association agrees that on the delivery of grapes hereunder that it may make such advances to the Grower on such grapes as in the discretion of the Directors may be justified by marketing conditions.
Section 3. The Association agrees to receive, sell or process, manufacture and convert such grapes together with the grapes delivered by other growers into wine, brandy or such other products as the Association may determine and to sell such wine, brandy or other products and pay ratably the net amount received therefrom as payment in full to the Grower after making deductions to cover cost of manufacturing, advances, interest upon advances, the cost of receiving, pooling, handling, grading, processing, financing, advertising, storing, insuring, selling, marketing and building assessments, as determined by the Board of Directors; and for organization, operating and maintenance expenses, stock in a central agency, Revolving Fund retains and reserves, but such reserves shall not exceed five (5) per cent of the gross sales price, which reserves may be used by the Association for any proper purpose.
Section 6. The Grower further agrees that the Association shall have the power to borrow money for any purpose of the Association on the pools of wine, brandy, or any other product held in storage by the Association; and shall exercise all other rights of ownership without limitation and may sell or pledge for its own account or as security for its own debts or otherwise all or any part of any such pools or warehouse receipts, account sales or other documents covering said pools of wine, brandies or other products or receivables on account thereof.
Section 8. It is agreed that the Articles of Incorporation, the By-Laws now or hereafter in effect and this agreement, constitute the entire agreement between the Association and the Grower.
Pursuant to such agreements, members delivered to the associations' wineries a certain quantity of grapes. The grapes were then commingled with those of other members and became part of what was termed a ‘wine pool‘ of that particular year. Each member was assigned a percentage of interest in the pool in proportion to the quantity of grapes he had delivered after certain adjustments were made for the variety of his grapes and, in some instances, sugar content. The associations crushed the grapes, processed them into wine, brandy, and other grape products and then marketed these products. In their processing and marketing operations, the associations incurred various processing, selling, and administrative expenses. They sometimes borrowed money to meet these current expenses. Ultimately, however, all of their expenses and loans were paid out of the returns from the sales of products and the net proceeds were currently returned to the members of the pools in proportion to their previously determined percentages of interest therein.
The procedure whereby the wine products were sold, the expenses set off against the sales proceeds, and the amounts payable to the members computed and distributed to them is called ‘liquidation‘ of the pools. The period of time which elapsed between the delivery of the grapes to the wineries and the complete liquidation of the pools varied, depending upon the type of wine product which was being processed and the time consumed in marketing the wine products.
Because of the peculiar nature of East-Side's 1938 pool, its liquidation consumed a period of years; however, in keeping with its normal procedure, East-Side completely liquidated its 1942 and 1943 pools within a period of about 18 months after the grapes were delivered to its winery. Cherokee aged some of its wine products and also marketed them through a central association, so that a period of six to seven years elapsed before its pools were completely liquidated. The associations did not wait until all of the products of the wine pools were sold to make payments to members, however, and as sales were made, expenses set off against these sales, and the net proceeds computed, such net proceeds were currently distributed to the members.
For the vintage years 1937 to 1943, decedent was a party to marketing agreements with the Cherokee Vineyard Association and the East-Side Winery, and on his death held interests in several of their pools. When liquidation proceeds became payable, the associations paid the decedent's share of the proceeds to his estate in 1944 and to the petitioner in 1945.
Following is a summary of the wine pools in which the decedent held an interest, the payments made, and any excess proceeds received over and above the appraised value for Federal estate tax purposes:
+----------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦ ¦ ¦Excess of ¦ +-----------+----+----------+----------+---------+----------+----------¦ ¦ ¦ ¦Fair ¦ ¦Excess ¦ ¦proceeds ¦ +-----------+----+----------+----------+---------+----------+----------¦ ¦ ¦ ¦market ¦ ¦of ¦ ¦received ¦ +-----------+----+----------+----------+---------+----------+----------¦ ¦ ¦ ¦value when¦Proceeds ¦proceeds ¦ ¦in 1945 ¦ +-----------+----+----------+----------+---------+----------+----------¦ ¦ ¦Year¦acquired ¦received ¦received ¦Proceeds ¦(when ¦ +-----------+----+----------+----------+---------+----------+----------¦ ¦Name of ¦of ¦by ¦by ¦in 1944 ¦received ¦added to ¦ +-----------+----+----------+----------+---------+----------+----------¦ ¦association¦pool¦petitioner¦decedent's¦over ¦by ¦any 1944 ¦ +-----------+----+----------+----------+---------+----------+----------¦ ¦ ¦ ¦for ¦estate in ¦Federal ¦petitioner¦proceeds ¦ +-----------+----+----------+----------+---------+----------+----------¦ ¦ ¦ ¦estate tax¦1944 ¦estate ¦in 1945 ¦over ¦ +-----------+----+----------+----------+---------+----------+----------¦ ¦ ¦ ¦purposes ¦ ¦tax ¦ ¦Federal ¦ +-----------+----+----------+----------+---------+----------+----------¦ ¦ ¦ ¦ ¦ ¦valuation¦ ¦estate tax¦ +-----------+----+----------+----------+---------+----------+----------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦valuation ¦ +----------------------------------------------------------------------+
East-Side Winery 1938 $1,256.40 $1,256.40 East-Side Winery 1942 14,000.00 14,047.19 $47.19 East-Side Winery 1943 62,470.00 42,568.65 $36,184.34 16,282.99 Cherokee Vineyard Assn 1937 (1 ) 106.09 Cherokee Vineyard Assn 1938 896.00 1,028.13 132.13 346.21 346.21 Cherokee Vineyard Assn 1939 106.09 82.95 299.74 276.60 Cherokee Vineyard Assn 1940 855.05 561.48 467.89 174.32 Cherokee Vineyard Assn 1941 3,294.78 2,548.64 1,183.30 437.16 Lodi Winery * 1938 (1 ) 2.64
to a situation where section 126 income was received by an estate and currently distributed to a beneficiary was recently before this Court in the Estate of Ralph R. Huesman, 16 T.C. 656. In that case taxpayer-estate in its income tax return reported the receipt of section 126 income. The amount of such income was immediately distributed to the beneficiary under a testamentary trust set up in accordance with the provisions of the decedent's will. We held that the taxpayer-estate was not entitled to a section 162 deduction for the amount of section 126 income paid over to the beneficiary, since such section 126 income was not income of the estate but rather its corpus, a claim of the estate which collection of corpus. Relying on that case we hold that petitioner is not taxable on any amounts of section 126 income which may have been received by the decedent's estate and distributed to her in 1944.
The second issue concerns the question whether the total proceeds received by the petitioner in 1945 in liquidation of the wine pools in which she held bequeathed interests constitute ‘income in respect of a decedent‘ taxable to her under section 126.
Since the administration of decedent's estate was terminated in 1944, petitioner as sole legatee acquired from the estate the right to receive any section 126 income payable. Accordingly, any such income received by her in 1945 is taxable to her in accordance with the provisions of section 126(a)(1)(C) set out above. The only question remaining is whether such proceeds received by her in 1945 are items of gross income in respect of a decedent.
Respondent contends section 126 is applicable to those proceeds because they consisted of deferred purchase payments for grapes sold by the decedent to the associations during his lifetime. Evidence exists to support this contention. The marketing agreements contained language to the effect that the ‘member sells and the association purchases‘ wine grapes. Furthermore, the associations took legal title to, and otherwise exercised the rights of ownership over, the grapes delivered. We believe, however, that a consideration of the provisions of the marketing agreements as a whole, the manner in which the associations operated, and the purpose of the cooperative efforts indicates that the parties never intended a sale of grapes to take place.
Nowhere in the marketing agreements or elsewhere is there mentioned a sales price or a method to compute a sales price. There never existed any understanding that the associations were in any way bound to return to the members a price measured by the reasonable value of the grapes delivered. On the contrary, it was the clear understanding of the parties, in keeping with the very purpose for which the associations were organized, that the members were entitled only to any net proceeds realized on the sale of the wine products of the pools after the associations had deducted any processing, marketing and other expenses. The only logical explanation for the use of the terminology that the ‘member sells and the association buys‘ grapes is that these were terms conveying legal title to the associations while members at all times retained an equitable property interest in the grapes or the wine in the pools in proportion to the quantity of grapes they had delivered. Passage of legal title in this manner facilitated both the subsequent hypothecation of the pools and the marketing of the wine products.
In other cases where members delivered their commodities to cooperative marketing associations organized under chapter 4 of the Agricultural Code of the State of California, and this same question arose as to the resulting relationship between the parties, the courts have held the relationship is one of trust. California & Hawaiian Sugar Refining Corp. Ltd. v. Commissioner, 163 F.2d 531; San Joaquin Valley Poultry Producers Association v. Commissioner, 136 F.2d 382; Bogardus v. Santa Ana Walnut Growers Assn., 108 P.2d 52.
FN* Only evidence introduced with respect to decedent's interest in the Lodi Winery pool.
An audit was made of the operations of East-Side during the calendar year 1943, when the 1942 pool was processed and marketed. The audit contained an analysis of 1942 pool liquidation payments received by members during 1943. This analysis shows that as of December 1943, the month in which decedent died, substantially all the wine in the 1942 pool had been sold. A value was assigned to the small quantity of unsold wine, added to the sales price of the wine sold, and from this total the various expenses were deducted, the remainder representing the total liquidation proceeds payable to the members. The unpaid balance of decedent's percentage of interest on December 31, 1943, was computed to be $14,047.19, the amount paid to the decedent's estate in 1944. East-Side's 1942 pool was completely liquidated during 1943 with the exception of actual distribution of some of the net proceeds due and owing members.
In the year 1944, Cherokee paid to the decedent's estate the amount of $126.13, a return of capital which decedent had invested in its revolving fund.
The following amounts due and owing decedent on the date of his death were received by his estate in 1944 and distributed to petitioner in that year:
+-----------------------------------------------------------------------------+ ¦(1) State of California refund of gasoline tax on fuel used for ¦$49.21¦ ¦farming ¦ ¦ +----------------------------------------------------------------------+------¦ ¦(2) U.S. Department of Agriculture Soil Conservation payments under ¦ ¦ +----------------------------------------------------------------------+------¦ ¦the Soil Conservation and Domestic Allotment Act ¦263.38¦ +----------------------------------------------------------------------+------¦ ¦(3) Payment by Northern California Fruit Company for overcharge on ¦ ¦ +----------------------------------------------------------------------+------¦ ¦fruit picking boxes ¦544.82¦ +----------------------------------------------------------------------+------¦ ¦(4) Northern California Fruit Company payment of the balance of the ¦ ¦ +----------------------------------------------------------------------+------¦ ¦sales price of grapes sold by the decedent in his lifetime ¦446.79¦ +-----------------------------------------------------------------------------+
The following income was included in the 1944 fiduciary income tax return of decedent's estate:
+---------------------------------------------------------------------------+ ¦(a) Interest on a savings account of the San Joaquin Building & Loan¦ ¦ +--------------------------------------------------------------------+------¦ ¦Association ¦$48.67¦ +--------------------------------------------------------------------+------¦ ¦(b) Interest on a note of W. J. and Emily Sellis ¦58.74 ¦ +---------------------------------------------------------------------------+
Both of these items of interest had been accrued at the date of decedent's death and were included in the estate tax return as assets of the estate.
In the fiduciary income tax return for the year 1944 filed on behalf of decedent's estate, the amounts by which the proceeds received in liquidation of the wine pools exceeded their appraised value for Federal estate tax purposes were reported as capital gains. The estate included what it computed to be the taxable portion of these gains in the petitioner's distributive income.
On her income tax return for the year 1945, petitioner reported as long term capital gains the amount which she computed to be the excess of certain of the wine pool payments received by her over and above the value of her interests in these pools when she acquired them.
In determining the income tax liability of the petitioner for the year 1944, respondent computed the amount of petitioner's fiduciary income to be $47,945.81, an increase of $46,495.51 over that reported by her. The adjustments resulting in such increased income, with the exception of an increase of $21.87 with respect to certain dividends, interest, and rents, are the result of respondent's determination that the following items received by the estate in 1944 are items of gross income with respect to decedent and, as they were currently distributed to the petitioner, they are taxable to her in 1944 under section 126 of the Internal Revenue Code:
+-----------------------------------------------------------------------------+ ¦1. Total of the wine pool payments as set out above ¦$62,199.53¦ +------------------------------------------------------------------+----------¦ ¦2. Return of contributions made by decedent to the revolving fund ¦ ¦ +------------------------------------------------------------------+----------¦ ¦of the Cherokee Vineyard Association ¦126.13 ¦ +------------------------------------------------------------------+----------¦ ¦3. State of California refund of gasoline tax on fuel used for ¦ ¦ +------------------------------------------------------------------+----------¦ ¦farming ¦49.21 ¦ +------------------------------------------------------------------+----------¦ ¦4. U.S. Department of Agriculture Soil Conservation payments under¦ ¦ +------------------------------------------------------------------+----------¦ ¦the Soil Conservation and Domestic Allotment Act ¦263.38 ¦ +------------------------------------------------------------------+----------¦ ¦5. Payment by Northern California Fruit Company for overcharge on ¦ ¦ +------------------------------------------------------------------+----------¦ ¦fruit picking boxes ¦544.82 ¦ +------------------------------------------------------------------+----------¦ ¦6. Northern California Fruit Company payment of the balance of the¦ ¦ +------------------------------------------------------------------+----------¦ ¦sales price of grapes sold by the decedent in his lifetime ¦446.79 ¦ +-----------------------------------------------------------------------------+
All the adjustments made by the respondent in computing the tax liability of the petitioner for the year 1945 are the result of his determination that the total wine pool payments received by her in 1945 in the amount of $38,484.12 constitute items of gross income in respect of a decedent taxable to the petitioner under section 126 of the Internal Revenue Code.
OPINION.
HILL, Judge:
The first issue presents the question whether ‘items of gross income in respect of a decedent‘ taxable under section 126(a) of the Code can properly be taxed to the petitioner in 1944 where such items as the respondent seeks to tax (set out in our findings of fact above), were received by decedent's estate in 1944 and currently distributed to the petitioner as sole legatee.
Section 126(a) and the pertinent regulations thereunder read as follows:
SEC. 126. INCOME IN RESPECT OF DECEDENTS.
(a) INCLUSION IN GROSS INCOME.
(1) GENERAL RULE.— The amount of all items of gross income in respect of a decedent which are not properly includible in respect of the taxable period in which falls the date of his death or a prior period shall be included in the gross income, for the taxable year when received, of:
(A) the estate of the decedent, if the right to receive the amount is acquired by the decedent's estate from the decedent;
(B) the person who, by reason of the death of the decedent, acquires the right to receive the amount, if the right to receive the amount is not acquired by the decedent's estate from the decedent; or
(C) the person who acquires from the decedent the right to receive the amount by bequest, devise, or inheritance, if the amount is received after a distribution by the decedent's estate of such right.
Regulations 111, section 29.126-1:
Under section 126(a)(1), all such amounts to which a decedent is entitled as as gross income and which are not includible in computing his net income for his last taxable year or any prior taxable year shall be included, when received, in the gross income of the estate of the decedent or of the person receiving such amounts if such amounts are received in a taxable year ending after December 31, 1942, by the estate of the decedent or by a person entitled to such amounts by bequest, devise, or inheritance from the decedent or by reason of the death of the decedent. These amounts are included in the income of the estate and such persons when received by them, regardless of whether or not they report income on the basis of cash receipts and disbursements.
Nowhere in the above-quoted sections of the Code and Regulations is provision made for taxing section 126 income to any person other than the rightful recipient, or to a distributee where an estate receives such income and currently distributes it.
Respondent apparently relied on the provisions of section 162(c) as authority to tax section 126 income to petitioner. The applicability of section 162