Commissioner of Internal Revenue, Petitioner, v. Estate of Fred T. Murphy, Deceased, Detroit Trust Company and Edward S. Reid, Jr., Executors, and Mary E. Murphy, Surviving Wife, Respondents.commissioner of Internal Revenue, Petitioner, v. Mary E. Murphy, Respondent.commissioner of Internal Revenue, Petitioner, v. Frederick M. Alger, Jr., and Suzette Dewey Alger, His Wife, Respondents.commissioner of Internal Revenue, Petitioner, v. Frances Alger Boyer, Respondent.commissioner of Internal Revenue, Petitioner, v. Frederick M. Alger, Jr., Respondent.commissioner of Internal Revenue, Petitioner, v. Harold R. Boyer and Frances Alger Boyer, His Wife, Respondents, 229 F.2d 569 (6th Cir. 1956)
Annotate this CaseThese petitions to review present in the main identical questions of fact and of law and were consolidated for hearing in this court. The Commissioner in every case determined deficiencies in income tax. The Tax Court refused to sustain the Commissioner, deciding in one case that there was neither overpayment of tax nor deficiency in tax. In all other cases the Tax Court decided that overpayments of income tax existed. The Commissioner attacks these decisions upon the ground that (1) the Tax Court erred in holding that the payment of an assessment liability upon stock of the First National Bank-Detroit constituted an investment by the executors of the estate of Frederick M. Alger, Sr., deceased, within the meaning of Section 29.113(a) (5)-1(d) of Treasury Regulations 111; (2) the Tax Court erred in determining that certain refunds paid to the legatee under the will of Irene S. Moffat constituted capital gain rather than ordinary income.
The facts are not in controversy. As found by the Tax Court and stipulated by the parties, they are as follows:
In 1933 Detroit Bankers Company, sometimes hereinafter referred to as Detroit Bankers, was a Michigan corporation owning substantially all of the capital stock of several national banks, including First National Bank-Detroit, sometimes hereinafter referred to as First National. On the occasion of the so-called Michigan "bank holiday" which commenced on February 14, 1933, Detroit Bankers and most of its subsidiary banks, including First National, failed and were placed in receivership. Detroit Bankers was dissolved in 1933.
The Commissioner of Internal Revenue determined that the capital stock of Detroit Bankers became worthless in 1933. The parties have stipulated that such stock was a capital asset in the hands of the legatees and their predecessors in title.
On or about May 16, 1933, the Comptroller of the Currency levied the 100% statutory assessment upon the stockholders of First National, payable to the bank's receiver, and the receiver in turn proceeded to enforce the assessment against the stockholders of Detroit Bankers upon the theory that they were the true and beneficial owners of the stock of First National. After extensive litigation it was finally determined in Barbour v. Thomas, D.C.E.D. Mich. 1933, 7 F. Supp. 271, affirmed 6 Cir., 1936, 86 F.2d 510, certiorari denied 1937, 300 U.S. 670, 57 S. Ct. 513, 81 L. Ed. 877, that the stockholders of Detroit Bankers were proportionately liable with respect to this assessment.
Subsequent to said litigation, and by reason of said assessment, the stockholders of Detroit Bankers were compelled ultimately to make payments to the receiver of First National at the rate of $14.055775 per share of Detroit Bankers stock owned by them, for which payments they were given receipts. Payments by a stockholder totalling the full amount of $14.055775 per share constituted as to him a discharge in full of all liability with respect to said assessment.
On or about September 18, 1942, a plan of liquidation, which had been prepared at the instance of a so-called First National Bank-Detroit Committee for the purpose of liquidating the bank's remaining assets, was formally adopted with the approval of the Comptroller of the Currency and the District Court. In conjunction with the plan, First Liquidating Corporation was created to take over and liquidate the remaining assets of First National still held by the receiver. On or about December 1, 1942, it took over such assets from the receiver.
The sole purpose of First Liquidating Corporation was to purchase substantially all the remaining assets of First National from the receiver of that bank and liquidate them in accordance with the plan of liquidation without pecuniary gain or profit or income to First Liquidating Corporation or its stockholders. After providing for the repayment of all loans and other sums obtained for financing the purchase and liquidation of the assets, the plan provided that any remaining proceeds of liquidation should be distributed in the following order: (1) To the persons who made payment to the receiver of First National on account of assessments on the stock of that bank, ratably in proportion to the amount paid by each such person on the principal of such assessment without interest, and (2) any surplus remaining should be distributed among the stockholders of First National.
After payment in full of all prior amounts required to be paid by the plan of liquidation, First Liquidating Corporation during 1945, 1948 and 1949 made certain pro rata distributions out of the proceeds of liquidation of the assets acquired from the receiver of First National, with respect to the assessments that had been paid on the stock of First National. The distributions so made * * * amounted in the aggregate to 86% of the amount of the assessments paid. In each of the years 1946 and 1948 the distributions amounted to 25% of the amount of the assessments which had been paid. Those made in 1949 amounted to 36% of the amount of such assessments.
In order to obtain such distributions, it was necessary for the claimants to surrender the original receipts, unless First Liquidating Corporation was willing to accept other evidence.
During 1933 Frederick M. Alger, Sr., owned 7,185 shares of stock of Detroit Bankers with a cost basis of $281,743.26. He died on December 31, 1933, and in the joint income tax return filed for him and his wife (now Mrs. Mary E. Murphy) for that year the cost of the shares was deducted as a loss but no tax benefit was obtained from the deduction. At the death of Frederick M. Alger, Sr., these shares passed to his estate along with a liability of $14.055775 per share for the assessment on the stock of First National. In the estate tax return filed for the estate of Frederick M. Alger, Sr., the 7,185 shares of Detroit Bankers stock were valued at zero and deductions were taken and allowed as debts of the decedent on account of the assessment liability with respect to the 7,185 shares. In 1936 and 1937 the executors of the estate used funds of the estate to pay the assessment liability of $101,990.74 but took no deduction for such payment in the income tax returns of the estate for either of those years.
Under the will of Frederick M. Alger, Sr., one-quarter of the residue of his estate was distributable to Frances Alger Boyer, one-quarter to Frederick M. Alger, Jr., and one-half to Mary E. Murphy. The residue included the aforesaid 7,185 shares of Detroit Bankers stock together with all rights and liabilities in respect of such shares and assessments thereon and receipts for such assessments. All items included in the residue were distributed in the aforesaid proportions, the 7,185 shares (with the aforesaid inclusions) being divided and distributed as follows:
In issue below was the question whether the residuary legatees realized ordinary income during the years in controversy as a result of the distributions received by them * * * as aforesaid. Finding that the 7,185 shares of stock of Detroit Bankers had a fair market value of zero on the date of decedent's death, the Tax Court held that, although such zero basis would normally be the basis to heirs or legatees under Section 113(a) (5) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 113(a) (5), the assessment payment constituted an investment by the executors which, under the provisions of Section 29.113(a) (5)-1(d) of Treasury Regulations 111, increased the basis of the shares to the legatees. Accordingly, the Tax Court concluded that, since the distributions received by the legatees did not exceed such increased basis, the legatees did not receive taxable income through the medium of those distributions.
On July 4, 1944, Irene S. Moffat died owning 667 shares of Detroit Bankers stock. It was stipulated that she had not deducted the cost of these shares or received any tax benefit by reason of their having become worthless in 1933. It was also stipulated that with respect to this stock she had paid an assessment of $9,375.20 on First National stock and that she had deducted the amount of that assessment in the year of payment and had derived full tax benefit from the deduction.
Under the will of Irene S. Moffat, Mary E. Murphy received the entire residue of her estate. Included in said residue were the 667 shares of Detroit Bankers stock, together with all rights and liabilities in respect of such shares and assessments thereon and receipts for such assessments. Such shares and rights in the assessment payments were valued for probate, state inheritance tax, and federal estate tax purposes at $500.25, or 75 cents per share, and that amount is the basis of the shares and rights in the hands of Mary E. Murphy.
In 1946, 1948 and 1949, Mary E. Murphy received the following amounts in respect of said shares and rights on account of the distributions described above:
In issue in the court below was the question whether ordinary income or capital gain treatment should be given to the gain which, as residuary legatee, Mary E. Murphy realized as a result of the distributions received by her * * * as aforesaid. * * * The Tax Court held that the distributions constituted distributions in liquidation of Detroit Bankers which should be regarded as payment in exchange for the stock of Detroit Bankers under Section 115(c) of the Internal Revenue Code of 1939. Accordingly, the Tax Court concluded that the excess of such distributions over the basis of the 667 shares to Mary E. Murphy should be taxed as a capital gain to her.
Joseph F. Goetten, Washington, D. C., H. Brian Holland, Ellis N. Slack, Robert N. Anderson, Washington, D. C., on the brief, for petitioner.
Berrien C. Eaton, Jr., Detroit, Mich., Edward S. Reid, Jr., Miller, Canfield, Paddock & Stone, Detroit, Mich., on the brief, for respondents.
Before SIMONS, Chief Judge, and ALLEN and MARTIN, Circuit Judges.
ALLEN, Circuit Judge.
The Commissioner urges that the Tax Court in deciding that his determinations of deficiencies were incorrect, improperly computed the basis for determining gain or loss on the Detroit Bankers stock received by certain residuary legatees of Frederick M. Alger, Sr., deceased. Under Section 113(a) (5) of the Internal Revenue Code of 1939, the Commissioner points out, the basis (Unadjusted) of property transmitted at death is the fair market value of such property at the time of acquisition, that is, at the date of decedent's death, Treasury Regulations 111, Section 29.113(a) (5)-1. This value in the instant case was zero. The Tax Court held that the basis was cost and that the assessments should be treated as additional cost of the stock. The Commissioner asserts that this conclusion is erroneous, upon the ground that the basis is not affected by events, such as the payment of assessments by the estate, occurring between the time of decedent's death and the receipt of property by the legatees.
This argument overlooks the fact that the statute and regulations specifically authorize adjustment to basis due to events occurring after death. Sub-section (b) of Section 113 of the 1939 Code is entitled "Adjusted Basis" and reads as follows:
"The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided.
"(1) General rule. Proper adjustment * * * shall in all cases be made —
"(A) For expenditures, receipts, losses, or other items * * *."
The sweeping phrase "whenever acquired" broadens the adjustment provisions, so far as the time element is concerned, to include property transmitted at death. Moreover, the payment of the assessments constituted "expenditures." In addition U. S. Treasury Regulation 111, Section 29.113(a) (5)-1(e) recognizes that adjustment to basis may be made for events occurring after death for, referring to Subsection (b) of Section 113, it authorizes the executor to make and maintain records showing in detail all items for which adjustment to basis is required by that section.
The Commissioner also contends that the Tax Court erred in holding that the payment of the assessments by the fiduciary makes the transaction an investment in Detroit Bankers stock within the meaning of Section 29.113(a) (5)-1(d) of Treasury Regulations 111. The assessments, however, created new property rights not existing at the death of the testator, namely, rights to the refund distributions evidenced by the receipts surrendered by the legatees. The payment which created these rights was, within the ordinary meaning of the word, an investment. 48 C.J.S., Investment, pp. 760-762.
If the legatees had directly owned First National stock the payment of the assessments would have been an additional cost of the stock. Tuttle v. United States, 101 F. Supp. 532, 122 Ct. Cl. 1; First National Bank in Wichita v. Commissioner of Internal Revenue, 10 Cir., 46 F.2d 283. In the Wichita case the sole question was whether an assessment made on the shares of capital stock of a national bank to repair a loss on its capital might be deducted from gross income by a taxpayer. The question was decided in the negative. The Tax Court rightly accepted as settled law the doctrine that an assessment placed by law on the owners of bank stock must be treated as additional cost of the stock to the stockholder. To hold, as the Commissioner urges, that, because the payment was made by the executors with funds which equitably belonged to the legatees, the legatees should be taxed, is to disregard the fact that under this record the legatees are rightly treated as proportional owners of the assets in the estate and as though they themselves had paid the assessments. The liquidating distributions were received by the legatees in lieu of cash originally contained in the estate.
In view of the ownership of the entire stock of First National by Detroit Bankers, under which ownership the legatees, owners of Detroit Bankers, were liable for assessments on First National stock, Barbour v. Thomas, supra, the Tax Court rightly held that the assessments paid were to be regarded as additional cost to the legatees for their stock in Detroit Bankers.
Finally, the Tax Court found as a fact that no tax benefit was derived from deductions taken in returns for 1933 as losses sustained in that year on Detroit Bankers stock. It considered that, because of this, while the subsequent distributions were in the nature of capital recoveries, the deductions claimed and earlier allowed did not effect an offset of taxable income. We are in accord with this conclusion. The actualities of the case are that this estate suffered a tremendous financial loss. The cost basis of all the shares was over $400,000, the total assessment was over $150,000, the total distribution was some $133,000. There remained a very substantial portion of the legatees' cost basis which had effected no offset in taxable income. Since there was no income tax benefit the Tax Court properly made an adjustment to basis and its decision upon this feature of the case was correct.
A further question raised by the Commissioner is whether the distributions to Mary Murphy, legatee of Irene S. Moffat, constituted capital gain or ordinary income. The Tax Court held that the receipt of these shares by Mary Murphy as legatee from Irene S. Moffat constituted capital gain. While the Tax Court found that no sale or exchange of a capital asset had been made, Section 117, Internal Revenue Code, it concluded that the transaction came within the purview of Section 115(c), Internal Revenue Code, which provides that amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock. The Commissioner contends that the amounts received were not in liquidation of a corporation.
"The incidence of taxation depends upon the substance of a transaction. * * * To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress." Commissioner of Internal Revenue v. Court Holding Co., 324 U.S. 331, 334, 65 S. Ct. 707, 708, 89 L. Ed. 981.
Applying this doctrine to these transactions we conclude that the Tax Court was clearly correct in deciding that the distributions were in liquidation of Detroit Bankers. The First Liquidating Corporation was founded for the express purpose of liquidating the assets of First National, whose entire stock was owned by Detroit Bankers. The distributions received were made from the proceeds of the liquidation. Detroit Bankers was dissolved in 1933. The Tax Court rightly regarded the distributions as received in the liquidation of Detroit Bankers and thus as received in payment in exchange for stock within the meaning of Section 115(c).
The decision of the Tax Court is affirmed.
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