Docket Nos. 20016 20066.
Henry Mannix, Esq., and William W. Lowell, Esq., for the petitioners. Rigmor O. Carlsen, Esq., for the respondent.
A financial settlement and separation agreement between husband and wife providing for certain periodic payments to the wife made binding on the husband's estate, which agreement was entered into shortly prior to commencement of a divorce action, held incident to the divorce and payments made under it of the character described in section 22(k); held, further, that such payments constitute taxable income to the divorced wife under section 171(b) and constitute allowable deductions to the former husband's estate under section 162(b). Henry Mannix, Esq., and William W. Lowell, Esq., for the petitioners. Rigmor O. Carlsen, Esq., for the respondent.
The Commissioner determined deficiencies against the Estate of Daniel G. Reid, of $12,866.78 income tax, for the taxable year 1942, and of $13,861.95 income and victory tax, for the taxable year 1943. The Commissioner determined a deficiency against petitioner Margaret C. Izrastzoff of $17,221.30 income and victory tax, for the taxable year 1943 and the year 1942 also is involved because of the provisions of the Current Tax Payment Act of 1943.
These proceedings were consolidated.
The principal issues are (1) whether annual payments totaling $30,000 in each of the years 1942 and 1943 received by petitioner Margaret C. Izrastzoff pursuant to a separation agreement between petitioner and her former husband, now deceased, constitute taxable income to that petitioner, and (2) whether petitioner Estate of Daniel G. Reid is entitled to deductions for the payments made in said years to petitioner Izrastzoff.
FINDINGS OF FACT.
Certain of the facts have been stipulated, are so found, and the stipulations are incorporated herein by preference.
The income tax returns of the Estate of Daniel G. Reid and Margaret C. Izrastzoff for the years 1942 and 1943 were filed with the collector of internal revenue for the third district of New York.
The petitioner, Margaret C. Izrastzoff, (hereinafter referred to as Margaret), is the divorced wife of the late Daniel G. Reid, (hereinafter referred to as Daniel), whose estate is also a petitioner herein.
The parties were married on August 10, 1910, at Paris, France. Prior to marriage Margaret had been an actress. At the time of marriage she was 26 years old, 25 years younger than her husband who was a man of great wealth.
The couple took up their residence in New York City as husband and wife. No children were born of the marriage. During at least three years prior to January 19, 1919, serious marital difficulties had been developing which culminated on that date in Margaret's leaving her husband with the determination never to return. She afterward never saw or communicated directly with Daniel, who died in 1925.
About the time Margaret left him, Daniel was divorce minded and during the period extending from January 1919 and into May 1919 he employed two firms of detectives to develop evidence on which a divorce action could be based. The attention of the detectives was particularly directed to the relationship between Margaret and a certain man whom she had met the previous November.
Friendly relations existed between Margaret and this man and when Margaret left her husband she went to live at a hotel in New York where this man also lived and they saw a great deal of each other. In early April 1919 they both moved to another hotel in New York and around the middle of that month they went together by train to San Francisco where they both lived at the same hotel until early May. Margaret's purpose in going to California was to establish a permanent residence there. In 1926, the year following Daniel's death, Margaret married the man in question.
On February 28, 1919, Margaret instituted a suit for legal separation against Daniel in the Supreme Court of the State of New York, County of New York, and shortly thereafter attorneys for the parties began negotiation of a financial settlement and separation agreement between them.
The separation agreement finally concluded consisted of two documents dated March 27, 1919, which were executed by the parties on March 27, March 31 and April 5, 1919.
The main agreement provided in its important parts as follows:
FIRST: Mr. Reid will pay to Mrs. Reid, for the purpose of providing her with a suitable home or for such other use as she may choose to make of the amount, the sum of Two hundred thousand dollars ($200,000) on the execution and delivery of this agreement.
SECOND: Mr. Reid, his heirs, executors, administrators or assigns, will pay or cause to be paid to Mrs. Reid the net sum of Thirty thousand dollars ($30,000) per annum, which shall be payable in four quarterly installments of Seven thousand five hundred dollars ($7,500) each, beginning on the 1st day of April, 1919, and continuing during the lifetime of Mrs. Reid.
FIFTH: Mrs. Reid accepts the provisions for her support and maintenance made in compromise and in lieu of her right of support and maintenance, counsel fees, and any and all claims for allowances of every kind or nature against Mr. Reid or his estate, and she expressly agrees that if at any future time she should bring any suit against Mr. Reid for a separation or divorce upon any ground whatsoever, either in the United States or in any foreign country, she will not make any claim against him for allowances, alimony, or counsel fees, but that she accepts the provisions herein made in lieu of and in full satisfaction and discharge of any and all claims against Mr. Reid and his estate in such suit or otherwise.
SIXTH: This agreement shall not in any particular be affected, abrogated or impaired should either party obtain an absolute divorce from the other.
ELEVENTH: The parties hereto mutually promise and agree that this agreement shall be binding upon themselves, their heirs, executors, administrators, representatives and assigns.
The supplemental agreement provided in part:
Mrs. Reid hereby expressly agrees that she will not institute, either in the United States or in any foreign country, any action or suit for divorce or separation or for any cause whatsoever existing at any time before or at the date of this agreement which would reflect injuriously on the character, morals or reputation of Mr. Reid for acts done in the past, provided, however, that she is at liberty to institute, either in the United States or in any foreign country, any action or suit for divorce or separation for desertion or injure grave as understood by the French Courts, subject to the limitation that any such action shall not reflect injuriously on the character, morals or reputation of Mr. Reid for acts done in the past, and Mrs. Reid agrees that any violation of this covenant on her part shall terminate any and all liability or obligations on the part of Mr. Reid to make to her any further payment or payments under and pursuant to the terms of said other Agreement between the parties hereto bearing even date herewith. But this covenant shall not be construed to prevent Mrs. Reid from asserting any defense or counterclaim as she may be advised in any action brought against her by Mr. Reid.
Just prior to execution of the separation agreement the detectives reported to Daniel that Margaret had stated that she was going to move to a hotel in New York to stay until final settlement and then establish residence in another state for the purpose of securing a divorce.
Late in April 1919 the detectives reported they had evidence of adultery in San Francisco by Margaret and on May 12, 1919, Daniel began suit for divorce in the Supreme Court of the State of New York, New York County, alleging upon information and belief, various acts of adultery involving Margaret in April 1919, both in New York and San Francisco. In this action Margaret filed an answer denying the adulterous acts and counterclaiming for divorce on the ground of Daniel's adultery.
On October 10, 1919, while the above action was pending Margaret filed a divorce action of her own in New York which was marked off the calendar by stipulation and order on January 7, 1922.
The first divorce action came to trial in February and March, 1920 on both the complaint and the counterclaim. Daniel appeared by his attorney who stated Daniel intended to introduce no evidence on his behalf. On March 22, 1920, an interlocutory judgment of divorce was entered in Margaret's favor which became final three months later.
In neither action did Margaret ask for alimony. During the trial she was asked whether she wished alimony and she said no. She gave this answer because she understood that she was bound by her separation agreement not to ask for alimony or make any claims in lieu of it in any future divorce action.
On March 4, 1921, Daniel established an inter vivos trust and transferred to the trustees assets for the purpose of making the payments called for in the separation agreement. Margaret was not a party to this trust instrument. On January 5, 1926, the executors of Daniel's estate filed a Federal estate tax return on which they reported as part of the decedent's gross estate an amount of $240,635.15 on account of decedent's interest under this trust indenture. The value of decedent's interest was ultimately determined to be $299,625.88 for Federal estate tax purposes, an amount arrived at by deducting from the total assets of the trust the commuted value of the $30,000 payable annually to Margaret.
In the 1930's the income of the inter vivos trust became insufficient for the required payments to Margaret and in 1938 the Surrogate's Court, New York County, decreed that certain of the assets of the Estate of Daniel G. Reid, which had been transferred to a testamentary trustee be retransferred to the executrix of the estate and segregated for the purpose of providing sufficient funds for the executrix to pay over to Margaret during her lifetime the sum of $30,000 per year. The decree further provided that the executrix could deduct from any installment the amount Margaret received on account thereof from the inter vivos trust.
For the taxable years 1942 and 1943, Margaret C. Izrastzoff filed individual income tax returns showing the receipt of no income.
Fiduciary income tax returns were filed by the Estate of Daniel G. Reid for the taxable years 1942 and 1943, showing no income or victory tax due. The return for 1942 showed the receipt of $9,031.19 as income from Rhea Reid Topping and Sherman C. Holaday as trustees of the March 4, 1921, trust, and $37,430.67 as dividends. A deduction was taken for the payment of $30,000 to Margaret C. Izrastzoff as alimony. The return for 1943 showed the receipt of $14,069 as income from said trustees of the March 4, 1921, trust, and $37,430.67 as dividends. A deduction was taken for the payment of $30,000 to Margaret C. Izrastzoff as alimony. The return for 1943 showed the receipt of $14,069 as income from said trustees of the March 4, 1921, trust, and $33,220.92 as dividends. A deduction was taken for the payment of $30,000 to Margaret C. Izrastzoff as alimony.
Fiduciary income tax returns were filed by Rhea Reid Topping and Sherman C. Holaday as trustees (trust of March 4, 1921) for the taxable years 1942 and 1943, showing no income or victory tax due. The return for 1942 showed taxable income from dividends in the sum of $9,292, nontaxable interest receipts in the amount of $2,250, and the distribution of $9,031.19 plus the $2,250 to the Estate of Daniel G. Reid as beneficiary. The return for 1943 showed taxable income from dividends in the sum of $14,081, nontaxable interest receipts in the amount of $2,250, and the distribution of $14,069 plus the $2,250 to the Estate of Daniel G. Reid as beneficiary.
The payments in controversy were made pursuant to a written instrument incident to a divorce.
In these consolidated proceedings the $30,000 annual payments in 1942 and 1943 were made to petitioner Margaret C. Izrastzoff, the divorced wife of the decedent, pursuant to a written instrument whereby because of the marital relationship a legal obligation to make such payments was imposed upon the former husband and his estate. The questions presented are whether such payments constituted taxable income to the divorced wife and constituted allowable deductions to the deceased husband's estate.
Section 162(b) of the Internal Revenue Code provides that an estate is entitled to a deduction of the amount of its income which is currently distributable to a beneficiary, and the amount so allowed as a deduction is includible in the net income of the beneficiary. Section 171(b) of the Internal Revenue Code provides that for the purpose of computing the net income of an estate and the net income of a divorced wife described in section 22(k) such wife shall be considered as the beneficiary of the estate and that a periodic payment under section 22(k) shall be included in the income of such beneficiary. Accordingly, the crux of the questions involved herein is whether the periodic payments are of the character described in section 22(k) of the Internal Revenue Code and more particularly whether the written instrument, imposing the legal obligation to make such payments, was ‘incident to‘ a divorce within the meaning of that section.
Both the petitioner Estate of Daniel G. Reid and the Commissioner contend that the agreement was ‘incident to‘ the divorce within the meaning of section 22(k). On the other hand, petitioner Izrastzoff vigorously asserts that the payments received by her pursuant to the agreement were not alimony, that she is simply a creditor of the estate of her deceased former husband, and that the agreement was not incident to the divorce.
To resolve these contentions resort is made to a number of recent decisions of this Court, among which are Robert Wood Johnson, 10 T.C. 647; George T. Brady, 10 T.C. 1192; Jessie L. Fry, 13 T.C. 658, and Helen Scott Fairbanks, 15 T.C. 62. Because the fact situations in cases of this character are so varied, a careful examination of the whole record is required in each in order to reach a proper conclusion. Cf. Joseph J. Lerner, 15 T.C. 379, which we think is distinguishable on its facts.
We do not think it necessary again to recite in detail the facts as found. The following sequence of events, however, convinces us that the agreement was incident to the divorce within the meaning of section 22(k). The husband was a man of extreme wealth. At the time of marriage he was almost twice the age of his wife. When the wife decided to leave her husband on January 19, 1919, she already had undergone several years of severe marital troubles and she left with the firm intention of never returning an intention fully carried out. From almost the moment his wife left, the husband set about uncovering grounds for divorce from her and employed detectives for that purpose.
On leaving her husband the wife took up residence in hotels where the man whom the husband later named as correspondent in a divorce action also lived. This couple was under surveillance by the husband's detectives during a period extending well beyond the date of the separation agreement in question for the purpose of developing evidence on which a divorce action could be based.
Against this background the wife began a separation action on February 28, 1919, and almost immediately attorneys for both parties began negotiating a financial settlement and separation agreement between them. These negotiations culminated in the agreement dated March 27, 1919, finally executed April 5, 1919. This agreement dealt in detail with the eventuality of a divorce, preserving to the wife the right to bring a suit for divorce for causes arising in the past for desertion or injure grave as understood by the French courts. This gave the wife wide latitude in choosing the forum and grounds for divorce. The agreement also preserved her right to assert any defense or counterclaim in any action brought against her by the husband and did not circumscribe the husband's right in any way to sue for divorce. The agreement provided for a lump sum payment of $2000,000 and annual payments of $30,000 to the wife for life, this obligation to be binding on the heirs, executors, administrators, or assigns of the husband. This agreement was accepted by the wife in lieu of her right to support and maintenance and she expressly agreed that in any future action for separation or divorce against her husband she would not make any claim against him for ‘allowances, alimony, or counsel fees‘. It was also provided that the agreement would not be affected or impaired should ‘either party obtain an absolute divorce from the other.‘ The very detail with which these paragraphs of the agreement with reference to a possible divorce action were worked out is strong evidence that divorce was very much in the minds of the parties.
On May 12, 1919, hard on the heels of the financial settlement, Daniel began a divorce action against his wife. She was served in California where she had gone to make her home. Margaret counterclaimed for divorce in this action and in October of the same year brought a suit of her own for divorce which was later dropped.
In the first action, which was tried in February and March 1920, the husband introduced no evidence and an interlocutory decree in favor of Margaret was entered. Margaret made no claim for alimony in the action, nor did the judgment mention alimony or make any mention of the settlement agreement. This omission, which is not controlling, Robert Wood Johnson, supra; George T. Brady, supra, was explained by Margaret's testimony that she did not ask for alimony because she already had her financial settlement and was not supposed to ask.
Despite Margaret's denials at the hearing before the Tax Court that the parties ever contemplated divorce or even spoke of it during the period the agreement was being negotiated, we conclude after a careful examination of the whole record that the settlement and separation agreement was entered into by the divorce and that the payments made under it were of the character described in section 22(k).
Having so concluded, the striking parallelism between the instant case and the recent case of Helen Scott Fairbanks, supra, so far as taxability of the wife, is concerned, is noted. The only distinction, which is not significant is that Fairbanks involved a property settlement agreement incorporated in a divorce decree, while this case involves such an agreement incident to divorce. Both agreements were binding on heirs, assigns, executors, and administrators of the divorced husband. Both cases involved parties divorced prior to 1942, the first year to which section 22(k) is applicable. The divorced wives in both cases survived their husbands who died prior to 1942, and in both the husbands had set up inter vivos trusts to which their wives were not party to make the periodic payments under the agreements. Following the rationale of Laughlin's Estate v. Commissioner, 167 Fed.(2d) 828, the wife was held taxable for the payments in the Fairbanks case and we decide she should be taxable here.
We conclude and hold that the $30,000 payments received by petitioner Margaret C. Izrastzoff in each of the years 1942 and 1943 constitute taxable income to her in each of those years under section 171(b) of the Internal Revenue Code, as determined by respondent, and further, that such payments constitute allowable deductions in each of those years to petitioner Estate of Daniel G. Reid, Deceased, under section 162(b) of the Internal Revenue Code, as contended by the petitioner.
On the issue as to whether the Estate of Daniel G. Reid is entitled to deductions for the periodic payments made to petitioner Izrastzoff, respondent apparently acquiesces in the estate's theory that since it was basically obligated to make the payments to the wife pursuant to the agreement, the income of the inter vivos trust used to help satisfy this obligation was constructive income of the estate; and, having so reported such trust income for income tax purposes the estate, if entitled to any deduction therefor, would be entitled to deduct the full amount of the payments, for, on brief, respondent states, ‘Were it not for the question of double deductions, * * * such reciprocal right of deduction on the part of the state would concededly exist.‘
Respondent does contend that the estate is not entitled to the claimed deduction for income tax purposes because of the previous allowance of the commuted value of such payments in determining the net estate subject to estate tax. In our opinion, such contention is effectively met and disposed of contrariwise by the decision of the Circuit Court of Appeals, Ninth Circuit, in Laughlin's Estate v. Commissioner, supra which held that the estate of the deceased husband was entitled to a deduction under section 162(b) for amounts paid under an agreement similar to the one here involved despite arguments that the estate had ‘already received the benefit of an estate tax deduction for the commuted value of its obligation to‘ (the wife), ‘and that double deductions should not be allowed.‘ The Court goes on to say, at page 830, ‘ * * * we cannot ignore the clear mandate of the statute allowing the income tax deduction here claimed‘.
Respondent, however, argues, in effect, that the Laughlin case does not give full consideration to the well established general ‘policy against double deduction under federal tax laws.‘ This argument is not well taken. The deduction for the wife's commuted interest in the inter vivos trust was taken for estate tax purposes in 1926. The deduction here claimed is for income tax purposes and is based on a statute enacted years afterward. Deduction of the same items for estate tax purposes and income tax purposes is permissible. It was held in Robert J. Kleberg et al., Executors, 31 B.T.A. 95, that an item properly deductible under some provision of the estate tax law for the purpose of determining the net subject to tax could also be deducted under a provision of the income tax law in determining the net income of the estate. See also Adams v. Commissioner, 110 Fed.(2d) 578; Estate of Virgin L. Highland, 43 B.T.A. 598; affd., 124 Fed.(2d) 556; Estate of M. M. Stark, 45 B.T.A. 882.
Reviewed by the Court.
In Estate of Daniel G. Reid, Deceased, decision will be entered under Rule 50. In Margaret C. Izrastzoff, decision will be entered for the respondent.