Chase v. Commissioner , 19 B.T.A. 1040 ( 1930 )

JESSIE CHASE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Chase v. Commissioner

Docket No. 35942.

United States Board of Tax Appeals

19 B.T.A. 1040; 1930 BTA LEXIS 2272;

May 21, 1930, Promulgated

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As residuary legatee of her brother's estate the petitioner, in 1924, 1925, and 1926, received interest from a corporation which was indebted to her brother for unpaid salary over a period of years. The corporation was under no legal obligation to pay the interest. Held, the interest received was a gift and not subject to income tax.

Ellwood Colahan, Esq., for the petitioner.

J. Kiley, Esq., for the respondent.

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SMITH

The respondent has determined deficiencies in income tax due from the petitioner for the years 1924, 1925, and 1926 of $100.60, $1,240.81, and $4,942.76, respectively. The question in issue is whether the petitioner is liable to income tax upon amounts paid to her by a corporation, representing interest on unpaid salary for back years due her brother, who deceased January 8, 1924; the corporation making the payments being under no obligation to pay the interest. The facts were stipulated.

FINDINGS OF FACT.

The petitioner is a resident of New York City, and is the residuary legatee of her brother, George Chase, who died a resident of the City County, and State of New York on January 8, 1924.

George Chase was at the time of his death and for a long period prior thereto dean of the New York Law School, an incorporated educational institution located in the City and State of New York.

During a period of approximately 10 years beginning in 1907, the New York Law School became financially involved. It had acquired a building located at 172-4 Fulton Street, New York City, for a large amount of money, which building was mortgaged for approximately $500,000. The school failed to earn sufficient to pay the mortgage interest and other charges for salary, etc.

With a view to helping the law school through this difficult period of its affairs and to prevent foreclosure of the mortgage, George Chase, during the period beginning in 1907, agreed voluntarily that the unpaid balance of his salary from time to time should be treated as an advance or a loan to the law school to be repaid out of the assets of the law school if it ultimately became possible to do so.

These transactions were not evidenced by note or other writing and no agreement was made to pay interest nor was any demand made therefor by the decedent at any time during his lifetime.

During this period beginning in 1907 the decedent advanced to the law school as unpaid salary a total of $93,400.

After the outbreak of the World War financial conditions of the law school became still more serious until finally, in July, 1918, it was necessary to sell its building on Fulton Street and close the school. After the sale a surplus remained over expenses amounting to about $30,000 and, at a meeting of the board of directors of the law school held on August 13, 1918, the following resolution was adopted:

RESOLVED that the sum of $30,000 be appropriated from the funds now on hand and be divided between Professor Chase, Professor Petty and Professor Washburne, in proportion to the sums due them for arrears of salary.

Dean Chase, who was familiar with all the facts and agreements concerning the indebtedness, caused to be inserted in the minutes of the meeting of the board of directors of August 13, 1918, the following:

It was explained to the Board by Dean Chase in regard to the resolution as to arrears of salary, that when these arrearages had occurred, these professors had hoped that if the property of the Law School ever had to be sold under foreclosure or otherwise, the value of the equity together with other sums payable to the Law School, would be sufficient to pay all such arrearages, but they agreed nevertheless that if such should not prove to be the case, they would waive their claims for any deficiency and would release and cancel the same.

The above mentioned sum of $30,000 was insufficient to pay Dean Chase (and the other two professors above mentioned), the full amounts due them, and the insertion in the minutes referred to above was made with full knowledge of this fact. Shortly thereafter the law school closed.

After the close of the war Dean Chase succeeded in making an advantageous contract providing for the lease of space by the law school, which was reopened and soon began to operate upon a remunerative basis.

At the date of the death of Dean Chase, January 8, 1924, the above mentioned indebtedness of the law school to him had been reduced to the amount of $28,870.61, which sum was subsequently paid to the executor of his estate.

The estate of George Chase duly returned for estate-tax purpose the funds mentioned in the preceding paragraph, being all amounts received by the executor on account of principal of said advances and the Federal estate tax thereafter assessed thereon was duly paid.

After the death of George Chase on January 8, 1924, Jabish Holmes, as president of the New York Law School, caused calculations to be made of the amount of interest on arrearages in salaries to enable the board to determine whether the law school would recognize a moral obligation to pay interest upon the arrearages of salary due George Chase at the date of his death, without regard to the statute of limitations.

During the lifetime of Dean Chase and up to his death on January 8, 1924, the subject of interest and never been spoken of by the board of directors as it was unable to say whether the law school would ever be able to pay the principal. This computation showed interest due to the date of death of approximately $57,000. On October 7, 1924, the law school made a payment of interest upon the arrearages of salary due Dean Chase in the amount of $5,288.77. This amount was paid to the executor of his estate, who immediately turned it over to the petitioner.

The discussion by the trustees of the payment of interest which resulted in a resolution of the board of directors of May 26, 1925, began only a short while prior to the adoption of that resolution and a number of months after the death of Dean Chase. The position of the board of directors was that while it felt that the law school was under no legal obligation to make payments of interest, and although no demand had ever been made by any of the professors for the payment of interest, it still felt that the law school was under a strong moral obligation to pay a sum equal to interest if the affairs of the law school warranted. This was in recognition of the appreciation of the law school of the actions of Professors Chase, Petty, and Washburne, who, through their generosity to the law school and by waiting without any expectation at the time the waivers were made of receiving the arrears and interest, had made a possible the continuation of the New York Law School and its ultimate establishment upon a firm financial basis.

On May 26, 1925, the board of directors of the law school adopted the following resolution:

ON MOTION the Treasurer was authorized to make payment on account of interest due the three Professors after retaining about $5,000 for contingent expenses.

Of the total amount of interest of $57,913.86 received by the petitioner in respect of the debt owed to Dean Chase by the New York Law School, the sum of $9,367.50 accrued prior to March 1, 1913, and the balance thereof, namely, $48,546.36, accrued on and after March 1, 1913.

The amount of interest actually received by the petitioner, as shown on the notice of deficiency annexed to the petition, was as follows:

Oct. 7, 1924	$5,288.77
During 1925	12,000.00
During 1926	40,565.15
Total	57,853.92

In the audit of the petitioner's income-tax returns for 1924, 1925, and 1926 the respondent added to the net income reported $5,288.77, $12,000, and $40,565.15, respectively, in determining the deficiencies. The advances made by Dean Chase to the New York Law School, payments of principal, and the computation of interest are shown by the following statement:

		Period				Interest,
From -	To -	Year	Month	Day	Principal	6 per cent
Sept. 30, 1907	Sept. 30, 1908	1	0	0	$3,750.00	$225.00
Sept. 30, 1908	Sept. 30, 1909	1	0	0	15,000.00	900.00
Sept. 30, 1909	Sept. 30, 1910	1	0	0	22,500.00	1,350.00
Sept. 30, 1910	Sept. 30, 1911	1	0	0	37,000.00	2,220.00
Sept. 30, 1911	Sept. 30, 1912	1	0	0	51,000.00	3,060.00
Sept. 30, 1912	Sept. 30, 1913	1	0	0	64,500.00	3,870.00
Sept. 30, 1913	Sept. 30, 1914	1	0	0	71,300.00	4,278.00
Sept. 30, 1914	Sept. 30, 1915	1	0	0	78,800.00	4,728.00
Sept. 30, 1915	Sept. 30, 1916	1	0	0	85,800.00	5,148.00
Sept. 30, 1916	Sept. 30, 1917	1	0	0	92,900.00	5,574.00
Sept. 30, 1917	Sept. 30, 1918	1	0	0	93,400.00	5,137.00
Aug. 30, 1918	Payment				21,154.90
Do	Sept. 30, 1918	0	1	0	72,245.10	361.23
Sept. 30, 1918	Salary
Do	Feb. 17, 1920	1	4	17	72,245.10	5,984.28
Feb. 17, 1920	Payment				5,641.30
Do	Sept. 13, 1920	0	6	26	66,603.80	2,286.71
Sept. 13, 1920	Payment				2,115.49
Do	July 25, 1922	1	10	12	64,488.31	7,222.69
July 25, 1922	Payment				807.41
Do	Jan. 4, 1923	0	5	9	63,680.90	1,687.54
Jan. 4, 1923	Payment				11,520.04
Do	Dec. 11, 1923	0	11	7	52,160.86	2,929.72
Dec. 11, 1923	Payment				23,290.25
Do	Mar. 12, 1924	0	3	1	28,870.61	437.88
Mar. 12, 1924	Payment				10,577.55
Do	June 24, 1924	0	3	12	18,293.06	310.98
June 24, 1924	Payment				9,000.00
Do	Sept. 30, 1924	0	3	6	9,293.06	148.69
Sept. 30, 1924	Payment				3,693.06
Do	Nov. 28, 1924	0	1	28	5,600.00	54.14
Nov. 28, 1924	Final payment				5,600.00
	Total interest					57,913.86
Oct. 7, 1924	Payment on a/c interest					5,288.77
	Balance due on interest					52,625.09

OPINION.

SMITH: The question presented is whether the petitioner is liable to income tax upon amounts received by her representing interest upon arrearage of salary owed to George Chase, her brother, who died January 8, 1924. The petitioner claims that the amounts received represented gratuities to her by the New York Law School and that such gratuities were not taxable income. The respondent, on the other hand, contends that the amounts received were interest upon an obligation owed to her brother, which interest she received as residuary legatee.

In any event we are of the opinion that the respondent is in error in including the total amount of the interest payments as taxable income of the petitioner. If it be assumed that the New York Law School was obligated to pay interest upon the arrearages of salary to George Chase, the interest which had accrued up to the date of his death constituted a part of his gross estate subject to estate tax and the receipt thereof by the petitioner was not taxable income. . But we are of the opinion that the petitioner is not liable to income tax in respect of any portion of the amounts received from the New York Law School. The facts adduced show conclusively that the payment in question was a gift by the New York Law School. Not only did no consideration move from Jessie Chase to the New York Law School, but none moved from George Chase, himself. Had the payment been made directly to the latter it would still be a gift. ; affd., . The debt owed by the New York Law School to Dean Chase was not a fixed obligation payable at a definite time or at all events. It was only payable if and when, and provided the debtor ultimately obtained funds with which to make payment. The debt was not due unless and until funds were earned with which to repay it. There was no agreement or demand to pay interest expressed or implied. Even if the waivers by Dean Chase expressed in the meeting of the board of directors on August 13, 1918, were completely disregarded, no interest accrued as a matter of law in the instant transaction. Interest does not run on indefinite, conditional or unmatured obligations, or, even on such definite ones as money payable on demand, unless there is an express agreement to pay interest. ; .

In the Ledyard case, at pages 74-75, the New York Court of Appeals, in pointing out that interest is not implied until a loan is unequivocally payable, said:

* * * The important practical inquiry, therefore, in each case in which interest is in question is, what is the date at which this legal duty to pay as an absolute present duty arose? * * * Money payable on demand does not draw interest until after demand, and so, money deposited with a depositary, does not draw interest until after demand. * * * If there had been any understanding that he was to have interest, would there not have been some mention of a matter of such importance, or would not the interest have been credited against the moneys had? * * *

Similarly, in the Totten case, it was said:

* * * In the absence of an agreement for a loan with interest the statute of this state does not apply and require interest. It only provides for the payment of interest after the account becomes due. * * * It is a fair inference from the evidence that this loan was not intended to be paid until Harry could sell the property, and therefore it would not become due until the proper time had arrived for the sale of the property. The property has not been sold, and there was no demand for the payment of the loan before the beginning of this litigation.

In the instant case not only was the payment of interest never even contemplated, much less agreed upon, but there was an express and formal waiver of the debt itself. Furthermore, Jabish Holmes, the president of the New York Law School, affirmed in an affidavit admitted in evidence in the stipulation as being the equivalent of the sworn testimony of the affiant:

Therefore, as a gratuity and rather as a gift in appreciation for their conduct, the trustees decided that inasmuch as we had the money and were able to do so, that it would show great lack of appreciation of our moral obligations if we did not give to these people, as a gift, a sum equal to this interest, and consequently the trustees continued the payment thereof until the full amount was paid.

Finally, there remains the vital point that the payment was made to Jessie Chase, the petitioner, rather than to the creditor or his estate. Jessie Chase had no privity or business relationship with the law school in any way. If anything could be needed to establish the voluntary nature of the transaction, it is this conclusive fact. Jessie Chase parted with no manner of consideration and the law school was under no obligation to her, legal or moral.

The case at bar is distinguishable at a glance from those rulings and decisions that have held bonuses and the like paid to employees in the regular course of business to be taxable income. Even there the trend of modern authority is to apply the common law rules of construction of gifts, to corporate transactions where additional payments are made to employees in recognition of valuable services performed. ;; reversed by the Circuit Court of Appeals, . If in those cases a payment to a person then under employment and in consideration of his services could be held to be a gift, surely an amount paid to a third person where the debt was waived and where the idea of interest payable upon that debt had never entered anyone's head, must likewise be held to be a gift. In , the president of a commercial corporation who received a salary of $6,000 a year was voted a bonus of $50,000 in recognition of his able management and the successful operation of the company. The court fell back upon the long-accepted definition of a gift as a transfer "without any consideration or compensation therefor, 28 C.J. 620." The court took the view that:

If the agreement had remained executory, no court would enforce it; if the corporation was insolvent at the time, no court would refuse to set the transaction aside at the suit of a creditor or a trustee in bankruptcy, and, if the corporation had attempted to deduct the amount of the payment from its gross income for tax purposes, we have little doubt that the government could successfully contest its right to do so. It is said that the corporation paid no income tax for the year in question, but if that be true, it would in nowise change the nature of the transaction.

In another recent decision the Board has applied these principles to the payment of interest by a corporation to a stockholder on loans by the latter to the former. . The facts in that case, as far as they went, were surprisingly similar to those in the instant proceeding.

Upon the entire record we are of the opinion that the payments by the New York Law School to the petitioner involved herein constituted gifts and are not liable to income tax.

Judgment will be entered under Rule 50.