Opinion
Docket No. 6394.
1946-06-4
EMILY B. HARRISON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
William F. Scheid, Jr., Esq., and J. Marvin Haynes, Esq., for the petitioner. Robert H. Kinderman, Esq., for the respondent.
Petitioner was a beneficiary of currently distributable income of a testamentary trust. In 1940, pursuant to orphan's court adjudication of that year, petitioner received as income beneficiary a share of a down payment on the purchase price of trust real estate forfeited as liquidated damages. The forfeiture occurred in 1937 and the down payment was carried on the trust books as corpus until 1940. In the latter year it was decreed by the orphans' court to be income of the trust and distributable as such. Petitioner received her share of such distribution in that year. Held, that the distribution so received is taxable to petitioner in 1940. William F. Scheid, Jr., Esq., and J. Marvin Haynes, Esq., for the petitioner. Robert H. Kinderman, Esq., for the respondent.
By this proceeding petitioner challenges the respondent's determination of a deficiency in her income tax for the calendar year 1940 in the amount of $436.32. The question presented is whether an amount distributed in 1940, pursuant to an adjudication of the Orphans' Court of Delaware County, Pennsylvania, to petitioner as income beneficiary for life of a trust, is taxable to her in that year. The case was submitted on a stipulation of facts, with exhibits attached and one additional joint exhibit.
FINDINGS OF FACT.
The facts as stipulated and as contained in the documentary exhibits are so found. Petitioner's father, George McFadden, a resident of Philadelphia, Pennsylvania, died testate on January 5, 1931. He will be referred to hereinafter as decedent. By his will he created a trust and conveyed to it his entire estate, with the exception of certain personal effects. Among the assets of the trust was decedent's home estate, Bloomfield, and it was provided that decedent's surviving wife should be permitted to reside therein and to use the furnishings and equipment thereof without any charge or rental during her lifetime or until she should remarry. Also, the trustees were directed to pay her out of the income of the trust $120,000 yearly during her lifetime or until she should remarry. In the event of remarriage she must be paid annually out of such income $10,000 during her life. The trustees under the will were directed to pay the taxes and other public charges on such estate and the cost of maintenance of the buildings, residence, and grounds thereof (not in excess of $20,000 annually) out of the income of the trust. The balance of the income from the trust estate was to be paid monthly as nearly as possible to decedent's two sons and his two daughters during their respective lives, in the proportions of one-third to each of the two sons and one-sixth each to petitioner and her sister, Caroline B. Ewing.
Decedent's surviving wife remarried sometime prior to 1937 and moved from Bloomfield. Subsequent to her moving therefrom the trustees rented Bloomfield for only one year to Neuman for $6,000 and in 1937 entered into an agreement with Neuman to sell him the property for the agreed price of $300,000. A down payment of $10,000 was made by the purchaser. The purchaser failed to consummate the purchase and thereby, in the year 1937, forfeited such payment. Pursuant to the agreement the $10,000 was retained by the trustees as liquidated damages. From 1937 to 1940 the trustees regarded this fund as principal of the trust. It was so carried on the trust books. No return thereof as income was made either by the trust or the beneficiaries.
The estate known as Bloomfield was appraised at the time of decedent's death for inheritance tax purposes at $500,000, and the furnishings and equipment, which included valuable art objects, were appraised at slightly more than $75,000. Bloomfield, except as hereinabove indicated, was nonproductive of income and, with its equipment, was subject to annually accruing taxes, the expenses of caretaking, maintenance, and various forms of insurance, all of which were paid out of the income of the trust estate, and only that portion of such income which remained after payment of the accruing charges enumerated was paid to the beneficiaries of the trust in the proportions hereinabove indicated. Such disposition of the trust income was acquiesced in by all the parties in interest until 1940.
A fiduciary account of the trust was stated as of January 1, 1940, to which exceptions were taken by petitioners's sister, Caroline B. Ewing (hereinafter referred to as Caroline). Caroline had a status as beneficiary under the trust identical with that of petitioner. Because of the exceptions, the trustees instituted a proceeding in the Orphans' Court of Delaware County, Pennsylvania, for instructions as to the administration of the trust estate. In this proceeding Caroline appeared as exceptant. No other beneficiary joined formally in such appearance. In its decree the orphans' court stated that the ‘account is confronted by * * * exceptions which raise two questions.‘
The first exception raised the question of whether the fund of $10,000 forfeited to the trustees as liquidated damages upon the failure of the purchaser of Bloomfield to consummate the purchase thereof was principal or income. The exceptant claimed that it was income and distributable as such. This exception was sustained by the court. In its decree the court said in part:
The auditing judge would not feel like interfering with that in which the parties themselves have acquiesced, but the future situation respecting the young people is such that the Court feels moved to make a decree respecting the future conduct of this trusteeship as now appears the best possible in their aid:
First. In what manner is the forfeited-liquidated-damages fund to be treated, with regard to income or principal?
Liquidated damages are not principal, if the damage accrues and is collected after the death of the decedent. Whether future developments might change its status or not remains, of course, for the future to disclose. This property was sold for Three Hundred Thousand Dollars. Of that sum, Two Hundred-Ninety Thousand dollars remain unpaid. If at any time in the future this property brings a sum in excess of Three Hundred Thousand dollars, then the liquidated damages derived out of forfeiture of the hand money would be increment, if not income, and certainly not principal. If the property should be sold for less than Three Hundred Thousand dollars, it is just possible that a proper allocation of this Ten Thousand dollars would require the sum to be treated as principal. Until that eventuality arises, no one knows; but in the meantime the necessities of the interested parties will not await the resolution of this problem, and under what the auditing judge conceives to be the authority of Levy's Estate, 333 Pa. 440, the Court directs that the sum of Ten Thousand dollars so received be transferred from principal to income, and distribution thereof made in accordance with the terms of the will and the provisions of this decree with respect to the other income in this estate.
The other exception requested ‘the court to reallocate a certain portion of the expense of maintaining this property (Bloomfield) to the principal or corpus of the estate, either as a direct assessment or as a partial marshalling of the assets, until the building can be sold and the account then made to conform to the decedent's will.‘ Caroline complained ‘that the diminution of her income by reason of the outlay for maintenance of Bloomfield rendered the sum she receives insufficient for her support in the station in life to which her father introduced her.‘
In its decree entered April 1, 1940, the court directed the item of $10,000 representing liquidated damages to be transferred from principal to income in the trust accounts and distributed as such to the life beneficiaries. It further directed that one-sixth of the expense of maintaining Bloomfield be allocated for a limited time between one-sixth of the trust corpus and Caroline's one-sixth share of the income in the proportions of three-fourths and one-fourth, respectively. A like allocation of one-sixth of such expense was directed between an additional one-sixth of the corpus and petitioner's one-sixth share of the trust income.
Pursuant to the decree, the trustees made the directed transfer of the $10,000 liquidated damages from principal to income and in 1940 distributed to petitioner as her one-sixth share, less $500 expenses incurred in connection with the receipt thereof, or $1,166.67. Petitioner's individual income and defense tax return for the calendar year 1940 was prepared on the cash basis and was filed with the collector of internal revenue at Newark, New Jersey. As reported therein, petitioner's income did not include the $1,166.67. In recomputing petitioner's tax liability, respondent did so include it and the deficiency resulted therefrom.
OPINION.
HILL, Judge:
The only question presented here is whether a portion of a forfeited down payment for the purchase of real estate forming part of the corpus of a trust is taxable income to petitioner in 1940, the year of its distribution to her as an income beneficiary. Petitioner contends that under the Revenue Act of 1936 the down payment was income to the trust in 1937, the year of forfeiture, and under sections 161 and 162 of that act, was taxable either to the trust or to herself in that year and is, therefore, not taxable to her in 1940. Respondent's position is that petitioner's right to a portion of the $10,000 first matured in 1940 and, since she received it then, sections 22(a) and 42 of the Internal Revenue Code require that she be taxed on it in 1940.
We think it clear that, standing alone, the forfeiture of purchase price payments which are properly retained as liquidated damages for failure to consummate a purchase agreement is income to the payee in the year of such forfeiture. Doyle v. Commissioner, 110 Fed.(2d) 157, and Virginia Iron, Coal & Coke Co. v. Commissioner, 99 Fed.(2d) 919.
The statement of the above factual situation fits the instant case in so far as the fact of forfeiture and the facts giving rise to it are concerned. If we should stop with such statement of facts and rest our holding thereon alone, we would hold that the forfeited payment in the instant case was income which was distributable and taxable to petitioner in 1937 and, hence, not taxable to her in 1940. However, additional facts are present in the proceeding before us. When the cash payment of $10,000 of the purchase price for Bloomfield was received, it was not income to the trust. At that time, it was regarded by the trustees as principal and was so entered on the trust account. Notwithstanding the payment was forfeited later in 1937, the trustees continued to regard it as principal and accordingly refused to pay it out or distribute it as income. Since the income of the trust was distributable currently, there was no incentive taxwise for the trustees to account for the fund in question as principal instead of income, for the reason that the trust could avoid taxation thereon in either event. The trustees held the fund in the corpus of the trust under a claim of right and duty to do so until a proceeding instituted in the orphans' court in 1940 it was judicially determined by that court that the fund was income and not principal. Accordingly, the orphans' court by decree directed the trustees to transfer the fund to income and distribute it as such. The decree was entered in 1940 and the fund in question was distributed in that year to petitioner and the other trust beneficiaries. It is obvious, in view of the conditions obtaining as above detailed, that petitioner could receive a distributable share of the fund as income only after the orphans' court had judicially determined it to be income and directed its distribution as such.
We will not review the rationale employed by the orphans' court in approaching its decision to direct the fund in question to be transferred from principal to income and so to be distributed to the beneficiaries, further than to observe that it appears therefrom that the court regarded the question before it as being directed largely to its discretion under the authority of Levy's Estate, 333 Pa. 440, and as one not free from difficulty. it appears also that the decision of the orphans' court was influenced at least in part by ‘the necessities of the interested parties.‘
It is unquestionable that until such decree was entered the fund in question did not become available to petitioner and the other trust beneficiaries as distributable income. North American Oil Consolidated v. Burnet, 286 U.S. 417, 423. Petitioner was, therefore, under no duty to report her share of such income for tax purposes until the obstacle of the legal controversy which prevented her from receiving it was removed. Freuler v. Helvering, 291 U.S. 35, 42. She did not so report it. The income represented by such distributable share became available to petitioner upon the entry of the decree in question in 1940. She is, therefore, taxable thereon in that year.
Reviewed by the Court.
Decision will be entered for the respondent.