Hall v. Commissioner , 17 T.C. 20 ( 1951 )

Estate of Frank Hall, Deceased, Irving Trust Company, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent

Hall v. Commissioner

Docket No. 22725

United States Tax Court

17 T.C. 20; 1951 U.S. Tax Ct. LEXIS 126;

July 17, 1951, Promulgated

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Decision will be entered for the respondent.

Deduction -- Nonbusiness Expense -- Premiums Paid on Insurance. -- The petitioner held insurance on the life of a debtor of petitioner's estate to secure payment of the debt principal. The debtor was not obligated to reimburse petitioner for its payments of premiums. Petitioner paid the premiums out of the principal of the trust. Under the facts, held, that (1) the estate was not engaged in a business, and the insurance premium expense is not deductible under section 23 (a) (1) (A); and that (2) the payment of insurance premiums is not a nonbusiness expense under section 23 (a) (2) and is not deductible.

Charles P. Connell, Esq., for the petitioner.

Stephen P. Cadden, Esq., for the respondent.

Harron, Judge. Disney, J ., dissents. Murdock, J., dissenting. Johnson and Tietjens, JJ., agree with this dissent.

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HARRON

The respondent has determined a deficiency in the income tax liability of the estate of Frank Hall, deceased, for the year 1945 in the amount of $ 637.81. The petitioner denies liability for the entire deficiency and, in addition, claims that it is entitled to refund of $ 383.55 for overpayment of tax.

During the year 1945, the petitioner, as executor and trustee of the estate of Frank Hall, deceased, had a claim for a debt owing to the estate. It held, as partial collateral to secure payment of the principal of the debt, policies of insurance on the life of the debtor. The debtor was not obligated to pay the premiums on the insurance. The petitioner paid the premiums on the policies during 1945 in the total amount of $ 4,916.25. The only question is whether the expense of the insurance premiums is deductible under either section 23 (a) (2) or section 23 (a) (1) (A) of the Code.

The petitioner filed the estate's income tax return with the collector for the second district of New York.

FINDINGS OF FACT.

The petitioner is the executor and trustee of the estate of Frank Hall, deceased, who died testate in New York City on July 31, 1939. During his lifetime, Hall loaned Charles V. Snedeker $ 234,000 at 6 per cent interest to enable him to buy a membership in the New York Stock Exchange. Snedeker purchased the Exchange membership for $ 234,000. When Hall died, the entire indebtedness was still owing. Hall had been declared an incompetent person. The guardianship committee obtained a judgment in April 1939, before Hall died, against Snedeker for defaults in interest payments. The judgment against Snedeker was for $ 53,198.97.

In May 1941, Snedeker was not in good standing under the Stock Exchange rules and could not use his membership because of the judgment against him and because his Exchange dues were unpaid. Snedeker wanted to work out his difficulties so that he could regain active use of his Exchange membership and pay off his debt to Hall's estate. Snedeker was a beneficiary of the estate of Charles Gulden, deceased, who died in 1916. He had a remainder interest in the Gulden estate which had value if he survived his mother, Emma Gulden Snedeker. She was living in 1941. Also, his Stock Exchange membership had value. It could be sold. Snedeker also had three insurance policies on his own life in the total face amount of $ 100,000. The foregoing were Snedeker's chief assets. None of Snedeker's assets were liquid or readily marketable.

The petitioner and Snedeker, on May 19, 1941, executed a lengthy compromise settlement agreement, which was subsequently approved by the Surrogate's Court on May 26, 1941. Under this agreement Snedeker's indebtedness to Hall's estate was reduced to $ 150,000, payable 10 years thereafter, on May 19, 1951; Snedeker was obligated to pay 3 per cent interest, $ 4,500 anually, from the time he regained active use of his Exchange membership until the obligation became due in 1951. No annual payments to curtail the principal amount of the indebtedness were required unless Snedeker realized "excessive income" which was defined in the agreement to mean annual income above Snedeker's family living expenses, taxes, interest on the Hall estate debt, and money due the Stock Exchange for various purposes. If any "excessive income" was realized by Snedeker in any year, 50 per cent thereof was to be paid to petitioner and was to be applied by it to reduce the principal amount of the debt.

As collateral security for payment of the debt, Snedeker assigned to petitioner all his interest in the Gulden estate, the insurance policies aggregating $ 100,000, face amount, and he agreed that all of the net proceeds from the sale of his Stock Exchange membership should be paid to petitioner. In 1945, the highest and lowest prices for which New York Stock Exchange memberships were sold were $ 95,000 and $ 49,000. In 1945, the value of the Emma Gulden Snedeker trust was $ 80,000.

The insurance policies were completely assigned to petitioner. Under the agreement, the petitioner agreed to pay the insurance premiums on the policies which amount to about $ 3,500 per year. Snedeker's debt to Hall's estate was not to be increased by the amounts of the insurance premiums which petitioner paid. Snedeker was not obligated to reimburse the petitioner for all of the insurance premiums which it paid, but, as is shown hereinafter, he might pay some amounts to the petitioner which would serve to reimburse it for part of its expenditures for insurance premiums. Such reimbursement for part of the premiums was conditional. If Snedeker failed to pay the 3 per cent annual interest on the debt or defaulted in other respects under the agreement, the petitioner could let the insurance lapse and could surrender the policies to the insurors for their then cash surrender values. If the petitioner should surrender the policies to the insurors for their cash surrender values, such proceeds would become the petitioner's for its own account, as executor and trustee of the estate, and the proceeds from the cash surrender values would not be applied to reduce the principal amount of the debt.

If Snedeker pays the principal amount of the debt, he will be entitled to recover the insurance policies from petitioner provided he acts within 30 days and provided he pays petitioner the cash equivalent of the then cash surrender values of the policies. Or, if Snedeker makes payments on the principal amount of the debt, reducing it to less than $ 100,000, he will be entitled to recover a proportionate amount of the insurance upon the same conditions as above stated. If the petitioner receives from Snedeker the cash equivalent of the cash surrender values of the insurance policies under any of the circumstances set forth in the agreement, the petitioner shall retain such payments for its own account and shall not apply such sums to reduce the principal amount of the debt.

The only instance when the proceeds of the insurance policies may be applied to reduce the principal amount of the debt is upon the death of Snedeker.

The reason for the above arrangement, whereby the proceeds realized by the petitioner in the amounts of the cash surrender values of the insurance policies could be retained by the petitioner for its own account, was that the petitioner over a 10-year period will pay insurance premiums aggregating $ 35,000; and since Snedeker is not obligated under the agreement to reimburse the petitioner for any of the expenditures for the insurance premiums, any sums realized by petitioner from the policies, either out of proceeds received as the cash surrender values from the insurors if the policies are surrendered before their maturity or from cash payments by Snedeker in the amounts of the cash surrender values of the policies at such time as he may recover them from the petitioner, will partially reimburse the petitioner for its expenditures for insurance premiums during the term of the agreement.

Snedeker's mother died in December 1944. In 1945, legal proceedings were instituted in the matter of Gulden's estate to determine Snedeker's interest in his mother's trust in the estate. The three children of Snedeker claimed that they had a three-fourths interest in a trust. Snedeker was the only child surviving Emma Gulden Snedeker. This litigation was concluded on September 15, 1947. The Surrogate's Court held that Snedeker held the entire interest in his mother's trust, and the claim of his three children was rejected.

The Gulden estate owns 97 parcels of realty in New York City, some of which is located in the business section near Canal Street. Descendants of Gulden, including Snedeker, hold undivided interests in the property. Partition of any one of the undivided interests, including Snedeker's, would be difficult and would require court proceedings. Although the petitioner has a right, under its agreement with Snedeker, after the death of his mother, to proceed against the Gulden estate to acquire Snedeker's interest in that estate, which he assigned to the petitioner, the petitioner has not elected to exercise this right. Beginning in 1948, the Gulden estate distributed income on Snedeker's interest, which was paid to the petitioner and was credited in reduction of the principal amount of Snedeker's debt to Hall's estate.

Snedeker has paid the 3 per cent interest payments of $ 4,500 to the petitioner which have become due, but he made no payments in curtailment of principal, and at the end of 1945 the principal amount of the debt was $ 150,000. However, after 1947 the distributions of income to the petitioner by Gulden's estate reduced the principal amount of the debt, and at the end of 1949 it amounted to about $ 133,000.

The petitioner has paid all of the insurance premiums on the insurance on Snedeker's life out of principal of Hall's estate. No insurance premiums have been paid out of income of the estate. The Surrogate's Court gave its approval of petitioner's charging the insurance premiums to the principal of the estate on May 26, 1941, after those having interests in Hall's estate gave their consent. The petitioner requested permission to charge this expense to the principal of the estate because, in 1941, one of the income beneficiaries of Hall's estate was an elderly woman, 71 years old, and the reduction of the income of the estate by the expense of the insurance premiums would have reduced the amount of income distributable to the aged income beneficiary and caused her hardship.

In 1945, the petitioner did not distribute income of the estate to the above beneficiary, or to any other beneficiary. The net income of Hall's estate for 1945, after deductions totaling $ 4,985.28, which included $ 4,916.25 which was paid by the petitioner for insurance premiums on the Snedeker insurance, was $ 1,927.54.

As of December 31, 1944, the cash surrender values of the insurance policies totaled $ 8,264.33, and at the end of 1945, the cash surrender values totaled $ 10,432.69.

The respondent has disallowed the deduction of $ 4,916.25 claimed as an expense of the estate. In the statement attached to the notice of deficiency, the respondent stated that he had determined that the above insurance premium expense was not deductible under either section 23 (a) (1) (A) or section 23 (a) (2) of the Code. Section 24 (a) (4) of the Code is not mentioned.

Ultimate Findings of Fact.

1. The duties of the petitioner in 1945, as executor and trustee of Hall's estate, consisted of collecting interest, paying insurance premiums, paying expenses of the estate, keeping the records of the estate, and preparing and filing income tax returns. The petitioner, as executor and trustee of Hall's estate, was not engaged in the conduct of a business on behalf of those who were beneficiaries of the estate and the testamentary trust.

2. The expense paid by the petitioner for insurance premiums on policies of insurance which were collateral to secure discharge of the principal of a debt owing to petitioner's estate was paid to keep the insurance alive and available for application in discharge of the debt, and such expense was not paid for the collection of income or for the maintenance or conservation of property held for the production of income.

OPINION.

The petitioner contends that the payments of premiums for the insurance on the life of Snedeker are deductible either under section 23 (a) (1) (A) of the Code, as business expense, or under section 23 (a) (2), as nonbusiness expense. The respondent contends that the insurance premium expense is not deductible under either section.

It is held that the executor and trustee of Hall's estate was not engaged in the conduct of a business on behalf of the beneficiaries of the estate. United States v. Pyne, 313 U.S. 127">313 U.S. 127 (1941);Higgins v. Commissioner (C. A. 2, 1940), 111 F. 2d 795, affd. 312 U.S. 212">312 U.S. 212; City Bank Farmers Trust Co. v. Commissioner (Estate of Duke) (C. A. 2, 1940), 112 F. 2d 457, affd. 313 U.S. 121">313 U.S. 121 (1941); Estate of Hyman Y. Josephs, 12 T. C. 1069. The evidence presented to us does not show that the petitioner was any more than "a casual administrator." See, also, T. D. 5196, 1942 C. B.-2, pp. 96, 97, 98. The expense of the insurance premiums is not deductible as a business expense under section 23 (a) (1) (A).

There remains the question whether the insurance premium expenses are deductible as nonbusiness expense under section 23 (a) (2). The following facts are important under this issue: The debt of Snedeker for $ 150,000 was an asset of Hall's estate. The debt produced $ 4,500 income annually, 3 per cent of the debt. The interest was a personal obligation of Snedeker which he paid out of his own funds. When the petitioner realized anything from other collateral given to secure the debt, such as payments by the Gulden estate in 1949 and 1950, for example, such payments were applied to reduce the principal amount of the debt. The proceeds of the policies of insurance, if they mature upon the death of Snedeker prior to discharge of the debt, can be applied in full or partial discharge of the principal amount of the debt. The insurance policies are security for the payment of the principal amount of the debt. The insurance policies do not yield income to the estate. Any annual "dividends" under the insurance policies are retained by the insuror and are applied to the annual premiums, according to our understanding. It follows that the expense of the insurance premiums is not an expense which is paid or incurred for the production or collection of income for the estate of Hall. ¹

The next question is whether the insurance premium expense was paid for the management, or conservation, or maintenance of property held for the production of income. We think that the insurance premium expense does not come within the second part of section 23 (a) (2), because the insurance policies on Snedeker's life were security for the collection of the debt, the collection of which was for the benefit of those who had interests in the corpus, or principal, of the estate. If Snedeker should die, the proceeds of the insurance upon his death will be collected by the petitioner to discharge the debt to the extent of $ 100,000. The function of the assigned insurance policies is to serve as an instrument in the collection of an asset of the estate. The insurance premiums were paid to keep the insurance alive. The cost of the premiums is, therefore, an expense which is directly related to the collection and extinguishment of the debt. Under the regulations of the Commissioner, as amended on December 8, 1942, such expense does not come within section 23 (a) (2) and is not deductible. See 1942 C. B.-2, pp. 96, 99; T. D. 5196, amending section 19.23 (a)-15 of Regulations 103; and section 29.23 (a)-15 of Regulations 111. This regulation is reasonable and properly construes the statute, in our opinion. Cf. Bingham's Trust v. Commissioner, 325 U.S. 365">325 U.S. 365. It is obvious, beyond the need of observation, that any amount of the principal of the debt which is recovered is not reportable as income of the estate. See Edmunds v. United States (E. D. Mo., 1947) 71 F. Supp. 29">71 F. Supp. 29. Cf. National Engraving Co., 3 T.C. 178">3 T. C. 178.

Since the expenditures for insurance premiums, under the facts of this case, are directly related to the preservation of collateral security for the payment of the debt of Snedeker, which security, if collected upon Snedeker's death, will be applied in discharge of the debt, the expediture, in our opinion, is akin to a capital expense. This view finds support in the Surrogate's order approving payment of the insurance premium expense out of principal of the trust. Cf. City Bank Farmers Trust Co. v. Commissioner, supra, pp. 458, 459. Section 23 (a) (2) was not intended to extend deductibility of certain expenses to capital expense, which is not deductible under other provisions of the Code. See James C. Coughlin, 3 T. C. 420, 422; Warren Leslie, Sr., 6 T.C. 488">6 T. C. 488.

It is held that the insurance premium expense is not a nonbusiness expense within the scope of section 23 (a) (2) and is not deductible.

It should be pointed out that the insurance expense is recoverable, in part at least, if any of the policies of insurance should be returned to Snedeker, out of the payment he is obliged to make to the petitioner of a sum equal to the then cash surrender value of a policy. The premium expense which the petitioner does not recover will be a cost of collecting the debt, a capital expense.

The petitioner relies on John Cadwalader, Jr., 15 B. T. A. 1; Dominion National Bank, 26 B. T. A. 421; and First National Bank & Trust Co. of Tulsa v. Jones, 143 F.2d 652">143 F. 2d 652. The Cadwalader case, involving a loss deduction, is not in point. The issue presented by the pleadings does not involve a question of loss. The Dominion National Bank case is distinguishable, also. The taxpayer there was a corporation which was engaged in the conduct of a business. Deduction of the expense of insurance premiums was allowed as an ordinary and necessary business expense. Since the petitioner was not engaged in the conduct of business and is not entitled to the claimed deduction under section 23 (a) (1) (A), the above cited case is not in point. For the same reason, First National Bank & Trust Co. of Tulsa v. Jones, supra, is not in point. Other authorities cited by the petitioner have been considered, but they do not provide authority in support of petitioner's claim.

Decision will be entered for the respondent.

MURDOCK

Murdock, J., dissenting: Section 23 (a) (2) allows a deduction for the ordinary and necessary expenses paid during the taxable year for the management, conservation, or maintenance of property held for the production of income. The petitioner had property in the form of money owed to it by Snedeker on which money Snedeker was required to pay interest. That was property held for the production of income. A policy of insurance on the debtor's life was assigned to the petitioner as collateral security for the debt. The petitioner paid the premiums on those policies during the taxable year. Such payments were ordinary and necessary expenses paid during the taxable year for the management, conservation, or maintenance of property held for the production of income. The situation is not different in principle from fire insurance premiums paid on a policy covering a house owned by the estate on which it is entitled to receive rent from a tenant. Such premiums have always been regarded as ordinary and necessary expenses paid for the management, conservation, or maintenance of such property.

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Footnotes

• 1. SEC. 23. DEDUCTIONS FROM GROSS INCOME

  (a) Expenses. --

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  (2) Non-trade or non-business expenses. -- In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.↩