Nos. 42688, 42689.
January 11, 1937.
Thomas R. Dempsey, of Los Angeles, Cal. (A. Calder Mackay, of Los Angeles, Cal., on the briefs), for plaintiffs.
Guy Patten, of Washington, D.C. and Robert H. Jackson, Asst. Atty. Gen., for the United States.
Before BOOTH, Chief Justice, and GREEN, LITTLETON, WILLIAMS, and WHALEY, Judges.
Two suits by Edna L. McNaghten and by Gladys Janss Pollock against the United States.
Judgment for each plaintiff in accordance with opinion.
For the year 1927 plaintiffs, who were beneficiaries of a trust created by the will of Arthur Letts who died in 1923, filed income tax returns in which they included as corporate dividends certain distributions made to them by the trustees of the Letts trust. Upon this income plaintiff McNaghten paid an income tax of $58,531.19 and plaintiff Pollock paid a tax of $56,232.17. Thereafter the Commissioner of Internal Revenue in his final determination, on the basis that there had been a capital gain to the trust, taxed plaintiffs on their distributions at capital gain rates and refunded to McNaghten $526.75 and to Pollock $2,303.13. Plaintiffs here seek to recover the balance of the tax paid in the amounts of $58,004.44 and $53,929.04, respectively. Recovery is claimed on the ground that plaintiffs, as beneficiaries under a testamentary trust, were not subject to tax upon the whole or any part of the net income of said trust.
Special Findings of Fact.
1. Plaintiffs are citizens and residents of California. March 15, 1928, they filed their respective income tax returns for 1927 showing income taxes of $58,531.19 and $56,232.17, respectively. These amounts were paid in four equal installments of $14,632.80 and $14,058.05, respectively, on March 15, June 15, September 15, and December 15, 1928.
Each of plaintiffs included in her return an item of $353,791.74 as taxable dividends received as a beneficiary of a trust under the will of Arthur Letts, deceased.
2. Thereafter, upon audit and review of plaintiffs' returns for 1927, the Commissioner of Internal Revenue on April 25, 1930, issued and mailed his 30-day letter in which he proposed a deficiency in tax for 1927 against each plaintiff in the amount of $162,794.11. Thereafter, on May 6, 1930, plaintiffs filed written protests to the proposed deficiencies, respectively, and a conference was held in connection therewith on May 31, 1930, between plaintiffs' representative and the Commissioner, as a result of which the proposed deficiencies were never assessed or collected and were abandoned.
3. February 6, 1931 each plaintiff filed a claim for refund for 1927 in which they asked for the refund of $58,531.19 and $56,232.17, respectively. Each claim, after reciting the facts above set forth, stated as follows:
"Claimant is informed that the Bureau of Internal Revenue is considering taking the position that all of the distributions made by Holmby Corporation to its shareholders subsequent to January 1, 1924, were in the nature of liquidating dividends and represented a return of capital to the extent of the basis of said stock in lieu of taxable dividends.
"Claimant does not acquiesce in this proposed determination of the Bureau and is filing this claim as a protection of her rights against the running of the statute of limitations, but in the event that it is finally decided by the Commissioner of Internal Revenue, the United States Board of Tax Appeals, or any court of competent jurisdiction that all of said distributions represented return of capital to the extent of cost or other basis of said shares and that no part thereof represented taxable dividends, then claimant respectfully requests that her net income for said year be reduced by the amounts reported as taxable dividends received from said trust ($355,528.42) and that her capital net gain be increased by the amount of her beneficial share of the amount received by said trustees in excess of their cost or basis of said shares ($75,051.89) and respectfully requests that her net tax liability be adjusted accordingly and refund be made to her of the amount of tax overpaid for said year."
Thereafter, on March 14, 1931 each plaintiff filed an amendment to her claim for refund, amending and supplementing the claim filed on February 6, 1931, as follows:
"Claimant is informed that the Bureau of Internal Revenue is considering taking the position that the net income of the trust which was created under the last will of Arthur Letts (deceased) of which Arthur Letts, Jr., Malcomb McNaghten, Harold Janss, Harry R. Philp, and John G. Bullock are trustees, is taxable to the trustees, and not taxable to the beneficiaries, and that the trustees should have filed form 1040 and paid the tax due thereon.
"Claimant does not acquiesce in this proposed determination of the Bureau of Internal Revenue, but in the event that it is finally decided by the Commissioner of Internal Revenue, the United States Board of Tax Appeals, or any court of competent jurisdiction that said sum ($353,791.74) did not constitute taxable income to claimant on account of the net income of said trust being taxable income of the trustees, or that the total distributions of Holmby Corporation were in the nature of liquidating dividends and therefore a return of capital, as explained in claimant's claim for refund filed on or about February 6, 1931, for said year, then claimant respectfully requests that her net taxable income be reduced by said sum of $353,791.74 and that her tax liability be adjusted accordingly and refund be made to her of the amount of tax so overpaid."
4. Thereafter, upon final determination of plaintiffs' tax for 1927, the Commissioner of Internal Revenue eliminated the item of $353,791.74 as taxable dividends, and in lieu thereof found a capital (net) gain for each of the plaintiffs for 1927 of $429,940.68 which represented a portion of the gain derived by the trustees from the liquidation of the Holmby Corporation upon which he computed the tax at 12 1/2 per cent. In this determination the Commissioner explained his computation as follows:
"The profit of $429,940.68 is the difference between $2,099,701.51, the liquidating dividends received in 1927, and $1,669,760.83 representing the remainder of the cost of this stock as reduced by liquidating dividends received from the Holmby Corporation in prior years.
"Dividends of $353,791.74 from the Holmby Corporation reported on your original return have been eliminated for the reason that this office holds that the distribution made by the corporation was a liquidating distribution."
Thereupon the Commissioner issued certificates of overassessment in which he found overassessments in favor of plaintiffs of $526.75 and $2,303.13, respectively, which were refunded — the claims for refund being allowed in the aforesaid amounts respectively and the balance thereof rejected on a schedule signed July 9, 1932.
5. Plaintiffs' father, Arthur Letts, Sr., died testate May 18, 1923, leaving a last will and testament which was duly probated in the superior court of the state of California in and for the county of Los Angeles. By the terms of this will it was provided that certain properties described therein be distributed to Arthur Letts, Jr., Malcolm McNaghten, Harold Janss, J.G. Bullock, and Harry G.R. Philp as trustees of the trust therein created, each of whom duly qualified and acted in such capacity until May 18, 1933. The will provided that the trustees should hold such property in trust for a period of ten years from the date of the death of the testator, the income of the trust estate during that time to be paid in certain proportions to the beneficiaries of the trust. Each of these plaintiffs' interest as a beneficiary under the terms of the trust was 30 per cent. of all income payments and a like percentage of the corpus upon distribution. The trustees were empowered to hold, control, sell, convey, mortgage, loan, lease, invest, and reinvest and otherwise manage the trust property as to them might seem best, to the end that the trust estate should produce the maximum income therefrom, and to collect and receive all income from the trust property; and from the gross income derived from the trust property to pay and discharge all taxes, costs, charges, and expenses incurred in the administration of the trust, and to pay and distribute the net income from the trust to the beneficiaries therein named semiannually or more frequently if in the judgment of the trustees same could be done without inconvenience to the reasonable management of the trust estate. A copy of said will is in evidence as Exhibit H-1, and is made a part hereof by reference.
6. August 20, 1925, the estate of Arthur Letts, deceased, was distributed and the trustees then received, among other properties, 69,168 shares of Holmby Corporation stock as a part of the aforesaid trust. This stock had a fair market value of $7,215,605.76, or $104.32 a share, on May 18, 1923, the date of the death of Arthur Letts.
About 1921 Arthur Letts organized the Holmby Corporation under the laws of California for the particular purpose of having the corporation acquire, manage, and operate sundry properties then owned by him. By April 1923 he had transferred substantially all of his properties to this corporation. In addition to decedent, Arthur Letts, Jr., Malcolm McNaghten, Harold Janss, and J.G. Bullock were the directors of the Holmby Corporation, and are the same persons designated in the will of decedent as trustees of the trust therein created. At the time of the death of Arthur Letts, Sr., the Holmby Corporation had outstanding 138,440 shares of common capital stock, all of which, except 104 shares, was owned by said Arthur Letts. The 104 shares were owned as follows: Arthur Letts, Jr., 101 shares; Malcolm McNaghten, 1 share; Harold Janss, 1 share; J.G. Bullock, 1 share.
After Mr. Letts' death one share of stock was transferred to Harry G.R. Philp, the remaining named trustee, who thereupon became a director of the Holmby Corporation. At the time of the distribution of his estate on August 20, 1925, under an order and decree of the superior court within and for the county of Los Angeles, state of California, Florence M. Letts Quinn, the widow of Arthur Letts, had distributed to her, among other properties, one-half of 138,336 shares of Holmby Corporation stock owned by decedent at the time of his death, or 69,168 shares. Shortly after the death of Arthur Letts, his heirs agreed among themselves that Holmby Corporation should be liquidated and its assets distributed to its stockholders as soon as the same could be done without sacrifice. On account of the expressed desire of the heirs, the Board of Directors of Holmby Corporation decided to liquidate its assets and distribute the proceeds thereof, as a result of which Holmby Corporation has been in process of complete liquidation ever since a date in 1923 shortly after the death of Arthur Letts.
7. Between May 18, 1923, and December 31, 1926, the Holmby Corporation distributed to the trustees $1,649,656.80, all of which was distributed from earnings and profits of this corporation. Of the abovementioned amount of $1,649,656.80 distributed by the Holmby Corporation to the trustees prior to December 31, 1926, there was distributed to each of the plaintiffs herein $15,522.99 during 1925 and $124,502.40 during 1926. The trustees filed their report with the superior court of California showing the foregoing distributions and that court entered its order approving the report as rendered. The foregoing amounts received by plaintiffs were returned by each of them in their respective income tax returns for 1925 and 1926. Plaintiff McNaghten paid an income tax of $4,385.83 for 1925 and $37,819.02 for 1926, or a total tax for the two years of $42,204.85; of the tax paid for 1925 the amount of $1,930.85 thereof was attributable to the foregoing amounts distributed to her by the trustees, and of the tax paid for 1926 the amount of $21,626.08 was attributable to the foregoing amounts distributed to her by the trustees. No part of the taxes paid by this plaintiff for 1925 and 1926 has been refunded to her and any recovery thereof is barred by the statute of limitation.
Plaintiff Pollock paid a tax of $4,805.24 for 1925 and $37,833 for 1926, or a total of $42,638.24 for the two years; of the tax paid for 1925 the amount of $2,012.31 was attributable to the above-mentioned amounts distributed to her by the trustees, and of the tax paid for 1926 the amount of $21,556.89 was attributable to the foregoing amounts distributed to her by the trustees. The amount of $9,458.25 of the taxes paid by this plaintiff for 1925 and 1926, in the amounts received by her on account of the distributions mentioned, has been refunded to her and recovery of the remainder of the taxes paid for 1925 and 1926 on such distributions is barred by the statute of limitation.
The trustees under the will of Arthur Letts filed a fiduciary return, Form 1041, for each of the years 1925 and 1926. No federal income tax returns were filed by such trustees on Form 1040 for either 1925 or 1926 and no income tax was paid by the trustees for such years on any income of the trust.
During 1927 the Holmby Corporation made further distributions to the trustees out of its earnings and profits amounting to $1,185,088.24, on the dates and in the amounts as follows: February 8, 1927, $899,184; March 19, 1927, $64,326.24; June 8, 1927, $74,941.50; September 2, 1927, $74,941.50; December 1, 1927, $71,695.
Immediately after the receipt of each of the aforesaid distributions from earnings and profits the Holmby Corporation, the trustees distributed the sum so received to the beneficiaries of the trust and each of the plaintiffs received $353,791.74 thereof. This is the same item referred to above as having been included as "Dividends" on plaintiffs' respective income tax returns for 1927.
8. May 17, 1927, the Holmby Corporation made a distribution of $1,920,700 in cash and bonds, and on October 11, 1927, it made a distribution of property of the value of $3,893,100 to the trustees who surrendered certificates representing 19,207 shares and 38,931 shares of capital stock of the Holmby Corporation, respectively, on these dates. The Holmby Corporation charged these distributions to its capital stock account. No part of either of the amounts was distributed by the trustees to plaintiffs or either of them, the trustees having retained the full amount thereof as part of the corpus of the trust estate.
9. October 4, 1928, the trustees filed their first account current and report with the superior court of California, showing fully all their acts in the administration of the trust. So far as it related to 1927 it disclosed the following:PRINCIPAL TRANSACTIONS 1927 May 17, Holmby Corporation Capital Distribution, 19,207 shares canceled. Appraised @ $97.46 per sh ........... 1,871,914.22 Taken up @ $100.00 per sh ........................ 1,920,700.00 48,785.78 Oct. 11, Holmby Corporation Capital Distribution, 38,931 shares canceled. Apprasied @ $97.46 per sh ........... 3,794,215.26 Taken up @ $100.00 per sh ........................ 3,893,100.00 98,884.74 This report also disclosed as "income receipts" for 1927 numerous items in the total amount of $1,222,011.64 consisting of interest on deposits, United States Treasury certificates and bonds, and dividends received from the Holmby Corporation. The report disclosed "income disbursements" during 1927 in the total amount of $1,214,375.81 consisting of numerous items of expense paid by the trustees in the management of the trust and the amounts distributed during this year to the beneficiaries of the trust. The distributions therein shown to have been made to the plaintiffs amounted to $353,791.74 each.
Thereafter on November 5, 1928, the superior court of California entered its order approving this report as rendered. A duly certified copy of this order is in evidence as Exhibit J and is made a part hereof by reference.
10. The trustees, under the will of Arthur Letts, deceased, filed a fiduciary return, Form 1041, for 1927, on which the following items of income and deductions were shown:
Interest on Bank Deposits, etc. (Item 2) ............. $196.75 Profit from Sale of Real Estate, etc. (Item 5) ..... -3,302.29 Dividends on Stock of Domestic Corporations (Item 6) ........................ 1,185,094.74 ------------- Total Income .......... 1,181,989.20
Taxes Paid (Item 10) ............ $184.33 Other Deductions Allowed by Law (Item 14) ...... 2,499.08 -------- Total Deductions ...... 2,683.41 ------------- Net Income (Item 16) .. 1,179,305.79
No federal income tax returns were filed by the trustees on Form 1040 for 1927, and no income tax was paid by them for that year on any income of the trust.
11. All the facts hereinbefore set forth in these findings, except those relating to matters occurring since 1930, were before the Commissioner of Internal Revenue and the defendant and were fully known to the Commissioner on or before July 1, 1930.
Plaintiffs contend that the amounts distributed by the Holmby Corporation out of its earnings and profits, being distributions in complete liquidation of that corporation, all constituted a return of capital to the trustees of the Arthur Letts Trust for the reason that, under section 201(c) of the Revenue Act of 1926 ( 44 Stat. 10, 11) they were in the nature of part payments in exchange for the stock upon which distributed and applied against and reduced the basis thereof in the trustees' hands, a basis which had not been wholly recovered by the end of 1927. Plaintiffs further contend that since all of such amounts were returns of capital to the trustees they did not represent income to plaintiffs under section 219(b)(2) of the act ( 44 Stat. 32, 33), and hence were not properly included in the net taxable income of plaintiffs as beneficiaries, even though actually distributed to them by the trustees.
Plaintiffs concede in the position they take that the trustees of the Arthur Letts Trust derived gains from two redemptions of stocks of the Holmby Corporation which took place during 1927, but they contend that such gains were taxable to the trustees alone since, as they insist, no part thereof was distributed to them as beneficiaries under the terms of the trust.
The facts as set forth in the findings disclose the manner in which the Commissioner of Internal Revenue finally disposed of the tax liability of plaintiffs for 1927 and the basis on which he rested his decision. Briefly stated, the Commissioner upon final determination of plaintiffs' tax liability for 1927 eliminated the amount of $353,791.74 included by them in their returns for that year as ordinary income received by them from the trustees subject to normal and surtax rates, and in lieu thereof found a capital net gain for each of the plaintiffs for 1927 in the amount of $429,940.68 which he taxed at capital gain rates of 12 1/2 per cent. and refunded to plaintiffs the amounts of $526.75 and $2,303.13, respectively. In doing this, however, the Commissioner of Internal Revenue did not properly interpret the decree of November 5, 1928, of the superior court of the state of California approving the distributions by the trustees to the beneficiaries, and likewise approving retention by the trustees as corpus of the amounts received by them in redemption of the stock. Freuler v. Helvering, 291 U.S. 35, 54 S.Ct. 308, 78 L.Ed. 634. In other words, the effect of the decree of the California court which had jurisdiction to determine the property rights of the parties under the trust was that the amounts distributed by the trustees to and received by the beneficiaries, plaintiffs herein, were distributable to the beneficiaries and that the amounts received and retained by the trustees in redemption of the stock constituted corpus in their hands and were not distributable to the beneficiaries. In this situation the Commissioner erred in taxing to plaintiffs any amount in excess of $353,791.74 held by the California court to be distributable to each of them. The Commissioner taxed each plaintiff with the amount of $429,940.68 for 1927, or $76,148.94 in excess of that properly taxable. Plaintiffs therefore have each overpaid the tax due for 1927 in the amount of $9,518.62, which the defendant concedes to be due. Counsel for defendant insists however that plaintiffs cannot recover this overpayment for the reason that the grounds stated in their claims for refund are not sufficient to support this suit. We think, however, that there is no merit in this contention of the defendant.
The issues and contentions here made by plaintiffs with reference to the taxability to them of the distribution of $353,791.74 each in 1927 were considered and denied by the United States Board of Tax Appeals and the United States Circuit Court of Appeals for the Ninth Circuit in Arthur Letts, Jr., v. Commissioner of Internal Revenue, 30 B.T.A. 800, and in Id., 84 F.2d 760, 762, in which it was held that liquidating distributions to a trustee, and representing in his hands capital net gain under sections 208(a) and (b) and 219(a) of the Revenue Act of 1926 ( 44 Stat. 19, 32), are subject to the same provisions in the hands of the beneficiary when distributed to him, although distributable only as dividends on the trust corpus under the terms of the trust and the law of the state controlling its administration under section 208(e) of the same act ( 44 Stat. 19). We agree with those decisions and no useful purpose would be here served by a detailed discussion thereof. It is sufficient to state that Arthur Letts, Jr., was a beneficiary of the trust here involved and in 1927 received a distribution from the trustees in the same amount as each of these plaintiffs. In seeking a reversal of the decision of the Board of Tax Appeals Letts contended before the Circuit Court of Appeals, 84 F.2d 760, 762, that the $1,185,088.24 which the trust distributed to its beneficiaries in 1927 was distributed to them before the trust had recovered the cost of its Holmby Corporation stock or had derived any taxable gain therefrom; that, therefore, at the time it was distributed, the $1,185,088.24 was not income to the trust; and that, not being income to the trust, it was not taxable to the beneficiaries, though actually distributed to and received by them as income. With respect to this contention the court said "There is no merit in this contention. The time unit we are dealing with is the taxable year; in this case, the calendar year 1927. In that year the trust received taxable income to the amount of $1,432,939.28 and distributed to its beneficiaries, as income, $1,185,088.24. Whether it distributed the $1,185,088.24 before or after it received the $1,432,939.28 is immaterial. A beneficiary to whom income has been distributed by a trust cannot escape taxation thereon by showing that, at the time of such distribution, the trust itself had no income. Baltzell v. Mitchell (C.C.A.1) 3 F.2d 428, 431; Abell v. Tait (C.C.A.4) 30 F.2d 54, 56."
Neither of the plaintiffs herein is entitled to recover any amount in excess of $9,518.62. In oral argument counsel for defendant contended that judgments for these conceded overpayments should not be entered for the reason that the trustees of the Arthur Letts Trust did not pay any tax for 1927 upon the gain derived by them through the liquidating distributions made to the trust by the Holmby Corporation, which distributions were not distributable to the beneficiaries under the terms of the trust and the decree of the California Court, citing White v. Stone et al. (C.C.A.) 78 F.2d 136. However, under the facts and circumstances of this case, we find no justification for the application of the equitable principle for which defendant's counsel contends. In the case of White v. Stone et al., supra, the Commissioner determined and assessed the tax there involved in accordance with the decision of the Circuit Court of Appeals for the circuit in which the taxpayer resided, which decision was later reversed, while in the case at bar the Commissioner was bound by no interpretation of the law, except his own, with respect to the question before him. Moreover, all the facts necessary to a determination and assessment of taxes against the trustees and the beneficiaries of the Authur Letts Trust were before him and fully known by him on and prior to July 1, 1930, about 8 1/2 months before any statute of limitation would run against the legal assessment of any tax for 1927 against the trustees. He simply neglected properly to assess the tax and permitted the limitation statute to run. There were no representations of any kind by plaintiffs that misled, or could have misled, the Commissioner, and there is no basis for estoppel. In addition to this the amounts received by these plaintiffs in 1925 and 1926 were not taxable for the reason that they were liquidation distributions by the Holmby Corporation to the trust in respect of that corporation's stock, the basis of which stock had not then been recovered by the trust. Plaintiff McNaghten therefore overpaid $23,556.93 for 1925 and 1926 and plaintiff Pollock overpaid $13,110.95 for the same years. Any recovery of these overpayments is now barred.
Judgment will be entered in favor of each of the plaintiffs for $9,518.62 with interest as provided by law. It is so ordered.
BOOTH, Chief Justice, and WHALEY, WILLIAMS, and GREEN, Judges, concur.