O'Brien v. Commissioner , 22 T.C. 661 ( 1954 )

Louise Webber O'Brien, Petitioner, v. Commissioner of Internal Revenue, Respondent

O'Brien v. Commissioner

Docket No. 37346

United States Tax Court

22 T.C. 661; 1954 U.S. Tax Ct. LEXIS 164;

June 28, 1954, Filed. June 28, 1954, Filed

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Decision will be entered under Rule 50.

Taxpayer was the executrix and residuary legatee of the will of her husband. One of the assets of his estate was a block of shares in a holding company which owned the stock of certain national banks. When the banks failed, the executrix took a deduction for worthlessness of the shares owned by the estate on her fiduciary return for 1933. The shareholders of the holding company were deemed liable for the assessment on the bank stock. The executrix paid the estate's proportionate part of such assessment and deducted such amount on her fiduciary return for 1935. The estate received a "Settlement Fund Certificate" which indicated the amount of the assessment paid by the estate and undertook to repay in a specified manner, out of the assets of the principal bank which were to be liquidated, that portion of the assessment allocable to that bank with interest thereon at 5 per cent. In 1944, after taxpayer had rendered her final accounting as executrix and distributed the residue of the estate to herself, she received a final payment on the Settlement Fund Certificate, part of which was designated as "principal" and part as "interest." Only partial tax benefits had been received in the 1933 and 1935 returns by reason of worthlessness and the assessment; and the amount of principal received in 1944 was considerably less than the portions of the 1933 and 1935 deductions for which no tax benefits had been derived. Held: 1. The receipt of principal by taxpayer was tax free. Estate of Fred T. Murphy, 242">22 T. C. 242; Tuttle v. United States, 101 F. Supp. 532 (Ct. Cl.). 2. The amount designated as interest was in fact interest and taxable as such. Tuttle v. United States, supra.

Oscar L. Tyree, Esq., for the petitioner.

Paul E. Waring, Esq., for the respondent.

Raum, Judge.

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RAUM

The Commissioner determined deficiencies in income tax for 1944 and 1945. The deficiency for 1945 and certain adjustments for 1944 are not contested. The question presented is whether certain payments in the aggregate amount of $ 26,144.77 received by petitioner in 1944 constitute taxable income in whole or in part. The Commissioner determined that the entire amount represented taxable income, and explained his adjustments as follows:

(a) & (b) In the taxable year 1944, you received the sum of $ 26,144.77 representing recovery of assessment paid by the Estate of Roscoe B. Jackson upon stock of the Guardian Detroit Union Group, Inc., plus interest. On your return filed for the year 1944, you reported such amount as received. However, taxable as ordinary income to the extent of $ 5,648.03. It is held that this income is taxable to you within the purview of Section 22 (a) of the Internal Revenue Code, as follows:

		Reported
	Amount to	on	Additional
	be reported	return	income
Interest income	$ 8,554.25	-0-	$ 8,554.25
Ordinary income	17,590.52	$ 5,648.03	11,942.49

Although petitioner had reported $ 5,648.03 of the total amount as income, she now contends that no part of the $ 26,144.77 constitutes taxable income, and makes the following assignment of error:

(a) The respondent erred in including in petitioner's taxable income for the calendar year 1944 the amount of $ 8,554.25 as "Interest income," the amount of $ 11,942.49 as "Recovery income," and in failing to exclude from petitioner's income for said year the amount of $ 5,648.03, which was erroneously reported on the petitioner's return filed, all resulting from recoveries by the Estate of Roscoe B. Jackson, deceased, with respect to losses incurred by said Estate by reason of the ownership by said Estate of stock in the Guardian Detroit Union Group, Inc. As a result, respondent has overstated petitioner's taxable income for the calender year 1944 by the total amount of $ 26,144.77.

FINDINGS OF FACT.

The stipulation of facts is hereby adopted and incorporated herein in full by reference.

Petitioner Louise Webber O'Brien, an individual residing in Grosse Point Farms, Michigan, filed her income tax return for the calendar year 1944 with the collector of internal revenue for the district of Michigan at Detroit, Michigan.

Petitioner is the widow of Roscoe B. Jackson, who died testate on March 19, 1929, a resident of Detroit, Wayne County, Michigan. His will was duly probated in the Probate Court, Wayne County, Michigan, and under the terms thereof his widow, petitioner herein, was designated executrix and sole residuary legatee. Petitioner duly qualified as executrix on April 15, 1929, and entered upon the duties of administering the estate.

On March 4, 1930, an "Inventory and Appraisal of the Assets of the Estate of Roscoe B. Jackson, Deceased" was filed in the Probate Court in which there was reported the ownership of 525 "units" of Guardian Detroit Union Group, Inc. (hereinafter sometimes referred to as Guardian Group), at $ 500 per unit, or a total value of $ 262,500, as of the date of death of decedent. These units were reported in the Federal estate tax return of decedent at the same value; but in the final determination of estate tax liability they were included in the estate at a value of $ 288,750. These units were later split into 3,464 units.

During the year 1933, the 3,464 units of stock in the Guardian Detroit Union Group became worthless and the sum of $ 153,051 ¹ was claimed as a deduction from gross income on the fiduciary income tax return filed by the estate of decedent for the year 1933, resulting in the offset of otherwise taxable income totaling $ 11,129.94.

Guardian Group held the stock of certain banking corporations, including the Guardian National Bank of Commerce of Detroit (hereinafter sometimes referred to as Guardian Bank) and five other Michigan national banks located respectively in Grand Rapids, Jackson, Lansing, Niles, and Ionia (hereinafter sometimes referred to as the out-state banks).

In 1933, the Guardian Bank suspended its banking operations and was declared insolvent by the Comptroller of the Currency. A receiver was appointed and a stock assessment was levied upon the shareholders of the bank. The receiver took the position that the shareholders of the Guardian Group were liable for this assessment and started suit in the United States District Court for the Eastern District of Michigan, Southern Division, to enforce this liability. The out-state banks referred to above also became insolvent in 1933, and the receivers appointed for them similarly asserted stock assessment liabilities against the shareholders of the Guardian Group.

During the pendency of the foregoing litigation, a committee was formed to represent the depositors of the Guardian Bank. The committee prepared a plan for liquidation of the bank and settlement of asserted stockholder liability with respect to shares of stock held by Guardian Group in the Guardian Bank as well as in the out-state banks. The plan was approved by the Comptroller of the Currency and made public October 25, 1934.

Briefly summarized, the plan provided for a settlement of all asserted liability for assessment upon shares held in Guardian Group by reason of that corporation, in turn, holding shares in Guardian Bank and the five out-state banks. The plan further provided for the acquisition of the asset of Guardian Bank and the liquidation of such assets in a manner which would permit part recovery of the losses suffered by the creditors and stockholders. Settlement of asserted stockholder liability was to be accomplished by raising a Settlement Fund sufficient to pay off the amount of such asserted liability, tentatively agreed as $ 5,040,000, which Settlement Fund would be paid over to the receivers of the six national banks in proportion to the respective capital of such banks, and the liability for any asserted stockholder assessment with respect to said national banks would be released. The plan further provided for the formation of a new corporation to be known as Guardian Depositors Corporation (hereinafter sometimes referred to as Depositors Corporation), which corporation was to acquire the assets of Guardian Bank. At the time the plan was proposed, creditors of Guardian Bank had received dividends from the receiver of that bank equal to 68 per cent of their allowed claims, and certain of the larger depositors consented to the use of their share of the last dividend, amounting to 8 per cent, in such way that all depositors having claims of $ 1,000, or less, could be paid in full. Under the plan the larger depositors in Guardian Bank would assign to the new Depositors Corporation the unpaid balance of their claims to be used by Depositors Corporation in purchasing the remaining assets of Guardian Bank for the purpose of liquidating such assets. The assets acquired were to be liquidated, first, for the benefit of those creditors of Guardian Bank assigning their claims, until such claims were fully paid with interest; second, repayment of the capital of the new corporation to those who furnished the same; third, for the reimbursement of those who paid into the Settlement Fund the amount of their stockholder liability to the extent that such amount was paid to the receiver of Guardian Bank to discharge asserted stockholder liability; and finally, for distribution of the remainder among the stockholders of Guardian Bank.

Pursuant to the plan, the depositors committee solicited subscriptions from stockholders of the Guardian Group equivalent to $ 8.06623 per share of stock owned, in compromise and discharge of their entire liability for assessment as stockholders of the Guardian Bank and the out-state banks. Under date of November 12, 1934, Louise Webber Jackson, executrix of the estate of Roscoe B. Jackson, deceased, signed a consent to the plan agreeing to the assessment of the aforementioned amount per share of Guardian Group stock owned by the estate. Under date of February 2, 1935, the estate paid to the Guardian depositors committee the amount of $ 27,919.84, computed as the amount of the assessment due at $ 8.06 per share for 3,464 units owned by the estate.

The aforementioned plan was approved by court order effective April 29, 1935, and Guardian Depositors Corporation was duly organized.

By letter dated October 7, 1935, the estate of Roscoe B. Jackson, deceased, was advised that, pursuant to the aforementioned plan, the remaining assets of Guardian Bank had been acquired and taken over by Depositors Corporation, and that the asserted stockholder liability had been settled by payment from the Settlement Fund to the receiver of Guardian Bank of the sum of $ 4,000,000, and that a similar asserted liability in connection with the five out-state national banks had been settled by payment to the receivers thereof of amounts aggregating $ 1,040,000. Enclosed with the letter was Settlement Fund Certificate No. 1084 issued under date of September 9, 1935, by the trustees of stock of Depositors Corporation pursuant to the aforementioned plan to "Estate of Roscoe B. Jackson, Louise Webber Jackson, Executrix." The certificate provided in part as follows:

From the Settlement Fund described in said Plan for Liquidation, the sum of $ 4,000,000 has been paid to the Receiver of the Guardian National Bank of Commerce of Detroit to discharge all liability to assessment on account of the shares of said Bank. Under said Plan it is proposed that the amount thus paid ($ 4,000,000) together with interest thereon should be repaid to those contributing to the Settlement Fund, as described in said Plan.

The undersigned TRUSTEES hereby certify that on account of the payment of: $ 27,919.84 * * *

TWENTY-SEVEN THOUSAND NINE HUNDRED NINTEEN & 84/100 Dollars, into said Settlement Fund, Estate of Roscoe B. Jackson, Louise Webber Jackson, Executrix, the registered holder of this Certificate is entitled to share in all distributions made to contributors to said Settlement Fund in the proportion which the amount of his net contribution thereto shall bear to the total amount contributed and paid into said Settlement Fund, together with interest on the amount to which he shall be from time to time entitled, at the rate of 5 per cent per annum from June 1st, 1935. * * *

As a result of the payment by the estate of $ 27,919.84 in satisfaction of the asserted liability for ownership of stock in Guardian Group, this amount was deducted on the fiduciary return of the estate of Roscoe B. Jackson, deceased, for the calendar year 1935 and resulted in the offset of otherwise taxable income of the estate in the amount of $ 6,378.10. This payment of $ 27,919.84 made by the estate of Roscoe B. Jackson, deceased, was in satisfaction only of the asserted liability as a result of ownership by Guardian Group of stock in the aforementioned six national banks.

The following is a summary of the amounts claimed as deductions from gross income and the amount of income offset by such deductions by the estate of Roscoe B. Jackson, deceased, as a result of the claimed worthlessness of stock owned in Guardian Group and the assessment made with respect thereto relating to ownership by Guardian Group of stock in national banks:

	Deductions	Income
	claimed	offset
Stock loss -- Estate's 1933 fiduciary return	$ 153,051.00	$ 11,129.94
National banks assessment Estate's 1935 fiduciary
return	27,919.84	6,378.00
Total	$ 180,970.84	$ 17,507.94

Under the plan for liquidation of Guardian Bank and liquidation of the asserted stockholder liability, it was provided that in the event more than the amount required to effect settlement was subscribed to the Settlement Fund, the excess would be adjusted among those paying the largest percentage of their total contribution so as to equalize the payments to the Settlement Fund. Accordingly, on the following dates the estate of Roscoe B. Jackson, deceased, received the amounts indicated from Guardian Depositors Corporation through the Guardian depositors committee as its share of so-called equalization dividends relating to the contribution to the Settlement Fund evidenced by Settlement Fund Certificate No. 1084:

Date	Amount
Dec. 28, 1939	$ 1,662.72
Dec. 27, 1940	692.80
	$ 2,355.52

As a result of these equalization dividends, the net contribution of the estate of Roscoe B. Jackson, deceased, to the Settlement Fund with respect to the stock of the six national banks was $ 25,564.32. The $ 2,355.52 equalization dividends were reported as nontaxable income on the estate's 1939 and 1940 fiduciary income tax returns.

On February 10, 1942, the estate of Roscoe B. Jackson, deceased, received a so-called first liquidating dividend of $ 2,556.43 from Guardian Depositors Corporation representing a recovery of 10 per cent of the amount of the net contribution referred to in the paragraph above. The letter from Depositors Corporation transmitting the check for $ 2,556.43 stated that Depositors Corporation had paid the balance due depositors and other creditors in accordance with the plan on February 2, 1942, and had disbursed a sufficient amount to the trustees to provide distribution of a liquidating dividend to the Settlement Fund Certificate holders of 10 per cent of the principal amount of the net contribution to such Settlement Fund. This $ 2,556.43 payment to the estate of Roscoe B. Jackson, deceased, was reported on the 1942 fiduciary income tax return of said estate as nontaxable income.

Under date of January 8, 1943, petitioner filed her final account as executrix of the estate of Roscoe B. Jackson, deceased, covering the period from June 30, 1933, to December 31, 1942. Petitioner had previously filed a first account as executrix covering the period from March 19, 1929, to June 30, 1933. The Probate Court by order dated February 2, 1943, approved the final account of petitioner, as executrix, assigned the residue of the estate to petitioner, and she was discharged as executrix. Although the Settlement Fund Certificate is not listed in the residue of the estate assigned to and received by petitioner, said certificate was within her physical possession or control at the time the estate was closed and at all times subsequent thereto until the certificate was transmitted to Guardian Depositors Corporation for cancellation in the manner hereinafter shown. The equalization dividends of $ 2,355.52 and the $ 2,556.43 liquidating dividend, totaling $ 4,911.95 identified above were included in "Total Receipts" in the final account of the executrix of the estate of Roscoe B. Jackson, deceased, covering the period June 30, 1933, to December 31, 1942. Subsequent to February 15, 1943, the date of the execution of the "Receipt for Residue" by petitioner, the petitioner, as executrix of the estate of Roscoe B. Jackson, deceased, did not maintain a bank account for the estate. The petitioner did not make an application to the Probate Court subsequent to February 15, 1943, for the adjudication or distribution to her of Settlement Fund Certificate No. 1084 nor the proceeds received with respect thereto from Guardian Depositors Corporation.

On February 15, 1943, Louise Webber Jackson O'Brien signed a "Receipt for Residue" of the estate of Roscoe B. Jackson which stated:

I, LOUISE WEBBER JACKSON O'BRIEN, sole residuary devisee and legatee of the estate of said deceased, hereby acknowledge receipt of the residue of said estate as shown by the final account of the executrix of the will of said deceased heretofore herein allowed as stated, and said residue having been transferred and delivered to me, I do hereby release said estate of and from any and all further claims.

Thereafter petitioner, as sole residuary legatee, was the owner of the Settlement Fund Certificate at issue in this proceeding.

By letter dated March 10, 1944, Guardian Depositors Corporation transmitted its check No. 1540, drawn on the Manufacturers National Bank of Detroit in the amount of $ 15,338.59, payable to the order of:

Estate of Roscoe B. Jackson,

Louise Webber Jackson, Executrix,

c/o J. L. Hudson Co.,

Detroit, Michigan.

This payment was referred to as a second liquidating dividend representing a recovery of 60 per cent of the amount of the net contribution to the Settlement Fund totaling $ 25,564.32. This check was endorsed "Estate of Roscoe B. Jackson, Louise Webber Jackson, Executrix," and was deposited in her personal account in the Manufacturers National Bank of Detroit. This amount was not reported as taxable income by the estate of Roscoe B. Jackson, deceased; however, it was reported by petitioner in her 1944 individual income tax return in the manner hereinafter shown.

A letter dated July 12, 1944, from Guardian Depositors Corporation addressed to the estate of Roscoe B. Jackson, deceased, related to the payment of the final distribution to the holders of Settlement Fund Certificates advising that the final distribution in the following amount would be made on July 31, 1944, upon surrender of the Settlement Fund Certificate No. 1084:

Principal	$ 2,251.93
Interest	8,554.25
Total	$ 10,806.18

The amount designated "Principal" represented a distribution of about 8.808 per cent to each of the holders of the Settlement Fund Certificates of their net contribution to the fund. The portion of the payment designated "Interest" represented the Settlement Fund Certificate holder's proportionate share of the 5 per cent per annum interest from June 1, 1935, to July 31, 1944, on the $ 4,000,000 paid to the receiver of Guardian Bank.

After receipt of the letter dated July 12, 1944, from Depositors Corporation, under date of October 9, 1944, petitioner endorsed in blank on the reverse side of Settlement Fund Certificate No. 1084 the transfer of said certificate in the following manner:

Estate of Roscoe B. Jackson

Louise Webber Jackson

Executrix

The certificate was returned to Depositors Corporation and on or about October 18, 1944, Depositors Corporation's check No. 1519 dated July 31, 1944, in the amount of $ 10,806.18 was received payable to the order of:

Estate of Roscoe B. Jackson

Louise Webber Jackson, Executrix

c/o J. L. Hudson Co.

Detroit 26, Mich.

This check was endorsed in the following manner and deposited in petitioner's personal account:

Estate of Roscoe B. Jackson

Louise Webber Jackson

Executrix

The amount of this payment was not reported as taxable by the estate of Roscoe B. Jackson, deceased; however, it was reported as taxable income by petitioner, individually, in her 1944 income tax return to the extent shown below.

On her individual income tax return for the calendar year 1944, petitioner reported in the following manner the aggregate of $ 26,144.77 ($ 15,338.59 plus $ 10,806.18) received by her in that year from Depositors Corporation:

Refund of Guardian Bank stock assessment		$ 26,144.77
Deducted on the 1935 return of the estate of Roscoe
B. Jackson	$ 27,919.84
Tax benefit from the deduction in 1935	7,423.10
Amount on which no tax benefit was obtained		20,496.74
Portion taxable		$ 5,648.03

The amount shown as income offset of $ 7,423.10 should have been $ 6,378.10, since the estate of Roscoe B. Jackson, deceased, on its income tax return for the calendar year 1935 was entitled to an exemption of $ 1,000 and a dividends received credit of $ 45, neither of which amounts was correctly reflected in the computation shown on petitioner's return for the calendar year 1944.

OPINION.

During 1944 petitioner received an aggregate of $ 26,144.77 from Guardian Depositors Corporation in connection with the Settlement Fund Certificate to which she had succeeded as the sole residuary legatee of the estate of her deceased husband. Of that amount, $ 8,554.25 was denominated as "interest"; the remaining $ 17,590.52 represents so-called principal. The question for decision is whether the $ 26,144.77, or any of its components, represents taxable income, reportable by petitioner. We shall deal separately with the items of principal and interest.

1. As to principal of $ 17,590.52. If the administration of the estate had not been completed by 1944, and if the amounts aggregating $ 17,590.52 had been received by the estate in 1944, it is plain that such receipts would not have constituted taxable income to the estate. In Tuttle v. United States, 101 F. Supp. 532">101 F. Supp. 532 (Ct. Cl.), dealing with similar payments received by another stockholder of Guardian Group, it was held that the stockholder was permitted to recover, tax-free, receipts from the Settlement Fund in an amount equal to the excess of his original cost plus assessment over the amount of tax benefit enjoyed as a result of worthlessness and the assessment.

We have already indicated agreement with the decision in the Tuttle case, Estate of Fred T. Murphy, 22 T.C. 242">22 T. C. 242, and in accordance with both the Tuttle and Murphy cases, the amount in question, $ 17,590.52, would not have been taxable in the hands of the estate. This application of the tax benefit rule, as recognized in the Tuttle opinion (101 F. Supp. at p. 535) is not limited by the provisions of section 22 (b) (12) of the Internal Revenue Code. Indeed, in Birmingham Terminal Co., 1011">17 T. C. 1011, the tax benefit rule was held applicable in a situation not covered by section 22 (b) (12), and it was there said (p. 1014):

To be sure, section 22 (b) (12) of the Internal Revenue Code, which was intended to achieve a like result in certain circumstances, is literally not applicable here, but it was made plain in Dobson v. Commissioner, 320 U.S. at 505-506, that the addition of these provisions of the Code did not preclude the application of a similar rule in other comparable cases.

When the estate was closed, petitioner succeeded to the rights of the estate with respect to the Guardian Group stock and the Settlement Fund Certificate. The basis of any assets of the decedent in the hands of either the estate or petitioner, as residuary legatee, was their value at the time of decedent's death, section 113 (a) (5), Internal Revenue Code; and as was pointed out in Estate of Fred T. Murphy, 22 T. C. at p. 258, where an investment is made by a fiduciary under a will, "the cost or other basis to the fiduciary is to be taken" as the basis. Cf. Regs. 111, sec. 29.113 (a) (5)-1 (d). Accordingly, since the assessment paid by the estate is to be regarded as an additional capital cost of the stock ( Tuttle v. United States, 101 F. Supp. at p. 535; Estate of Fred T. Murphy, 22 T. C. 242, 256), the new basis which resulted therefrom subsequently became the basis in the hands of petitioner, who merely stepped into the shoes of the estate to this extent. And payments thereafter received by petitioner with respect to that stock must be measured against that basis and must have the same quality as income or nontaxable receipts as they would have had in the hands of the estate. The decision in the Murphy case, particularly with respect to the shares owned by Frederick M. Alger, Sr., goes far towards pointing the way to the result that we reach herein. We hold that $ 17,590.52 of the total amount received by petitioner in 1944, representing principal, did not constitute taxable income.

2. As to interest of $ 8,554.25. In the final payment received by petitioner in 1944, $ 8,554.25 thereof was specifically designated as interest. This was in accord with the explicit terms of the Settlement Fund Certificate, which called for the payment of interest with respect to that portion of the contribution to the Settlement Fund paid to the receiver of the Guardian Bank. Interest was stated to be at the rate of 5 per cent per annum and it was to run from June 1, 1935. The taxability of such interest was considered in the Tuttle case, where it was said (101 F. Supp. at pp. 535-536):

In the 1944 payments on the settlement fund certificates was a payment of $ 4,988.34, which was designated as interest on his contribution to the settlement fund. The liquidation agreement provided for the payment of 5 percent interest on the contributions, if funds were available for its payment. The payment was computed as interest, and we see no reason why it was not interest. It was, therefore, taxable as ordinary income.

We think that conclusion is correct, and we follow it here. Cf. also Ollie Beverly Rose, 8 T. C. 854, 858-860.

Decision will be entered under Rule 50.

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Footnotes

• 1. Actually the loss was understated, since under section 113 (a) (5)↩ of the Revenue Act of 1932 and the regulations, the basis basis was fair market value at date of decedent's death, which value was $ 288,750. Nevertheless, as will appear hereafter, this amount of understatement of the loss on the fiduciary return is immaterial to the issue herein involved.