de Canizares v. Commissioner

Jane J. de Canizares, Petitioner, v. Commissioner of Internal Revenue, Respondent de Canizares v. Commissioner Docket Nos. 64310, 64311 United States Tax Court 32 T.C. 345; 1959 U.S. Tax Ct. LEXIS 169; May 14, 1959, Filed *169 Decisions will be entered under Rule 50. 1. Held, that the payments of $ 8,000 which petitioner received in each of the taxable years 1951 to 1954, inclusive, were annuity payments which she received under a contract which she entered into with R. H. Johnson Company on October 27, 1943, by which she transferred to the company 117 shares of stock in the company which she had received as a bequest from her husband who died July 31, 1943. Petitioner is taxable on such annuity payments as provided under the statutes taxing annuity payments -- Internal Revenue Code of 1939 for the years 1951, 1952, and 1953, and Internal Revenue Code of 1954 for the year 1954. Held, further, that the consideration which petitioner paid for the annuity was the fair market value of the stock at the time she transferred it to the company and not what a commercial insurance company would have charged for a similar annuity contract which would have been in excess of what the petitioner paid for the annuity. Anna L. Raymond, 40 B.T.A. 244, affd. 114 F. 2d 140, distinguished. 2. The Commissioner, in his determination of the deficiency for*170 1951, added to the tax an addition for underestimation as provided under section 294(d)(2), 1939 Code. Held, the Commissioner is sustained and the amount of the addition will be recomputed under Rule 50. *171 Joseph W. Price 3d, Esq., for the petitioner. William C. Baskett, Esq., for the respondent. Black, Judge. BLACK *346 The Commissioner has determined deficiencies in petitioner's income tax and an addition to tax under section 294(d)(2), 1939 Code, as follows: Addition to Docket No. Year Deficiency tax, sec. 294(d)(2) 64310 [1951] $ 3,406.43 $ 204.38 [1952] 3,277.79 64311 [1953] 2,612.49 [1954] 2,388.11 The deficiencies are due to the addition of $ 8,000 by the Commissioner to the income reported by petitioner on her return for each of the taxable years. That adjustment is explained in the deficiency notice as follows: (a) It is held that $ 8,000.00 received by you in each of the years * * *, under the terms of an agreement entered into with R. H. Johnson Company in 1943, is includible in gross income in the respective years, under the provisions of sections 22(a) and/or 22(b)(2) of the Internal Revenue Code of 1939 * * * For the year 1954 the Commissioner states that the determination is made under sections 61 and 72 of the 1954 Code. The petitioner assigns errors as to the foregoing action of the Commissioner. FINDINGS OF FACT. Part*172 of the facts has been stipulated and the stipulation of facts is incorporated herein by reference. Petitioner, Jane J. de Canizares, hereinafter referred to as Jane or petitioner, resides at Wayne, Pennsylvania. During all the time *347 relevant herein she was on the cash basis and filed her income tax returns with the collector of internal revenue or with the district director of internal revenue at Philadelphia. Prior to June 16, 1938, Frederic A. de Canizares, hereinafter referred to as Frederic, the husband of Jane, was president of and owned 234 shares of the capital stock of R. H. Johnson Company, a Pennsylvania corporation, hereinafter referred to as the company, said shares being the total outstanding capital stock of the company. The actual operation of the company was in the hands of Arlington W. de Canizares (the nephew of Frederic), hereinafter referred to as Arlington, Michael Civitella, and Albert L. Brooke, Frederic working only on a part-time basis. Arlington was vice president of the company, Michael was general manager, and Albert was secretary and treasurer. All three of them had been with the company for a substantial period of time. Arlington became concerned*173 with respect to his position in the company. He was actively operating the business but, since all of the stock was owned by his uncle, he was fearful of what might happen to him in the future. In February 1938, Arlington and Frederic met in Florida for the purpose of working out a plan for the future ownership and management of the company. An agreement was reached at that time, which was later reduced to writing, and executed on June 16, 1938. The pertinent portions of this agreement are as follows: Whereas, the party of the first part [Frederic] is the President of R. H. Johnson Company, a Pennsylvania corporation, with Two hundred thirty-four (234) shares of Common Stock outstanding, all of which are owned outright by the party of the first part, and Whereas, the party of the second part [Arlington] is Vice-President and Treasurer of said Company and in active charge of the management of the said business, and Whereas, the said parties have agreed with each other that for the best interests of said business and in fairness and justice, the stock control of said business shall be equally divided between the party of the first part and the party of the second part for himself*174 and certain of the officers and employees associated actively in the conduct of the business, and Whereas, in order to carry out the said understanding, the said parties have agreed between themselves that the said internal affairs of the Company shall be managed as hereinafter set forth in this Agreement, with the further understanding that details not covered by this Agreement shall be settled in accordance with the full intent and purpose of this Agreement that the management of the Company shall continue without interruption or dispute. * * * * FIRST: Party of the first part agrees to assign and set over on or before June 17, 1938, One hundred seventeen (117) shares (the one-half of the outstanding shares of the common stock of said Company) to the party of the second part IN TRUST nevertheless for the uses and purposes set forth in an agreement or DECLARATION OF TRUST to be executed by the party of the second part bearing even date with this agreement. In effect as affecting the rights of the *348 party of the first part inter alia the DECLARATION OF TRUST will provide that in the event of the death of the party of the second part before February 19, 1943, the said *175 One hundred seventeen (117) shares of stock will be re-transferred by the personal representatives of the party of the second part to the party of the first part free and clear of all trusts and limitations. This trust provision restricting the right of transfer until February 19, 1943, may be amended by mutual, but only by mutual agreement of the parties hereto. SECOND: Party of the first part for himself, his executors, administrators and assigns, agrees that upon his death, or sooner, if he so elects, the remaining One hundred seventeen (117) shares shall be conveyed to the party of the second part in trust, however, to carry out the provisions of payments as hereinafter provided in the article designated "Sixth" in this Agreement, and upon the fulfillment of the said conditions to have the same transferred to the said party of the second part free and clear of all trusts and limitations. It is understood that this further trust applying to these remaining One hundred seventeen (117) shares, will cover in its provisions the use and final distribution of these additional shares in conformity with all articles in the Declaration of Trust of Arlington W. Canizares dated June *176 17, 1938. * * * * SIXTH: Upon the execution of the above mentioned covenants and agreements and upon the transfer of the aforementioned stock still retained and standing in the name of the party of the first part by his personal representatives as soon after the death of the party of the first part as is practical and convenient, but in any event within one year subsequent to his death, the party of the second part on his behalf and on behalf of his associates now or hereafter to be connected with the Company and on behalf of his executors, administrators, or personal representatives, agrees to have paid by the said Company to Jane J. Canizares, wife of the party of the first part, the annual sum of Eight Thousand ($ 8,000.) Dollars, payable monthly so long as she shall live. In the event the said Jane J. Canizares pre-deceases her husband, it is agreed by the party of the second part that the said sum of Eight Thousand ($ 8,000.) Dollars annually shall be paid to Nancy Jane Canizares, daughter of the party of the first part, until a total sum of Fifty Thousand Dollars ($ 50,000.) is paid to said daughter. In the event Jane J. Canizares survives the party of the first part and*177 dies before a total sum of Fifty Thousand Dollars ($ 50,000) has been paid to her in manner as hereinabove provided, it is agreed that whatever balance less than Fifty Thousand Dollars ($ 50,000.) has been so paid shall then be paid at the same rate of Eight Thousand Dollars ($ 8,000.) annually to Nancy Jane Canizares until a total sum of not less than Fifty Thousand Dollars ($ 50,000.) with interest at the rate of six percent (6%) per annum on the unpaid balance, shall have been paid and accounted for. * * * * NINTH: On the books of R. H. Johnson Company, the Pennsylvania corporation, as aforesaid, appears a debit balance of Twenty-two Thousand Two Hundred Ninety-three Dollars and Fourteen Cents ($ 22,293.14) owing by R. H. Johnson and Company Incorporated, a Delaware Corporation. On the books of the Company as aforesaid also appears overdrafts of salaries amounting to Twenty-One Thousand Three Hundred Seventy-five Dollars and Four Cents ($ 21,375.04) owing by the party of the first part and One Thousand, Four Hundred Dollars ($ 1,400.00) owing by the party of the second part. It is agreed that these debit balances as they appear on the books of the Company shall be cancelled*178 and liability for the payment thereof by the Delaware Corporation and the parties hereto shall cease and terminate in whatsoever manner the certified public accountant and auditor for the Company shall determine. *349 On June 17, 1938, Arlington executed a declaration of trust which embodied the terms of the agreement of June 16, 1938, between him and Frederic. This declaration of trust is embodied in the stipulation of facts but it is believed unnecessary here to set out in detail the provisions of this declaration of trust. Concurrently with the execution of the agreement of June 16, 1938, Frederic transferred 117 shares of the stock of the company to Arlington which shares are still held by Arlington as trustee in accordance with the terms of said agreement. Frederic died testate on July 31, 1943, and by his will dated October 17, 1938, bequeathed and devised all of his assets to his widow, the petitioner herein, who was also designated executrix in the will. For the purpose of carrying out the provisions contained in the agreement of June 16, 1938, an agreement was entered into on October 27, 1943, between the company on the one part and Jane as executrix of the estate of*179 Frederic and individually. The pertinent provisions of this agreement are as follows: Whereas, Frederic A. Canizares during his lifetime was President of R. H. Johnson Company, and at the time of his death, the owner of One hundred seventeen (117) shares of the Common Stock of the said Company, and Whereas, he had, by Agreement made between him and Arlington W. Canizares, Vice-President of the said Company dated June 16, 1938, agreed, inter alia, that upon his death, the said One hundred seventeen (117) shares of the Common Stock of the said Company should be conveyed to Arlington W. Canizares, party of the second part, IN TRUST, to carry out certain provisions of payments as hereinafter set forth, and particularly as designated "Sixth" and "Ninth" in the said Agreement, and upon fulfillment of the said conditions, the said stock was to be transferred to the said Arlington W. Canizares, free and clear of all the trusts and limitations, and the Company was to cancel all indebtedness due it by both Frederic A. Canizares and A. W. Canizares. Whereas, it was agreed by Arlington W. Canizares on his behalf, and on behalf of the other associates of the said Company, to have the said Company*180 pay to Jane J. Canizares, party of the second part, certain sums of money, as set forth in said Agreement, and in the event of her death prior to the payment of a total sum of Fifty Thousand Dollars ($ 50,000.) the balance to be paid to her daughter, Nancy Jane Canizares (now Corbett) and Whereas, the Directors of the said Company, have, by Resolution, duly authorized the proper Officers to enter into an Agreement with Jane J. Canizares, Executrix of the Estate of Frederic A. Canizares, Deceased, and in her individual capacity to carry out the terms as set forth in the aforementioned Agreement, and Whereas, in carrying out the terms and intent of the Agreement as aforesaid, the said Jane J. Canizares, as Executrix of the Estate of Frederic A. Canizares, Deceased, has transferred the aforementioned One hundred seventeen (117) shares of stock to R. H. Johnson Company, which stock was standing in the name of Frederic A. Canizares at the time of his death. Now Know Ye, That in consideration of the premises, and the transfer of One hundred seventeen (117) shares of the Common Stock of the said R. H. Johnson Company to the said Company, * * * the Company also agrees to pay to Jane J. Canizares*181 the annual sum of Eight Thousand Dollars ($ 8,000.00), * * *. In the event that Jane J. Canizares dies before a total sum of Fifty Thousand Dollars *350 ($ 50,000.) has been paid to her in the manner as hereinabove provided, the party of the first part agrees that the balance of such sum of Fifty Thousand Dollars ($ 50,000.) remaining unpaid, shall then be paid at the same rate of Eight Thousand Dollars ($ 8,000.) annually, to Nancy Jane Canizares (now Corbett) until the total sum of not less than Fifty Thousand Dollars ($ 50,000.), with interest at the rate of six percent (6%) per annum on the unpaid balance, shall have been paid. Under no circumstances, however, in the event that Jane J. Canizares dies before receiving total payments amounting to Fifty Thousand Dollars ($ 50,000.) shall the Company pay a greater sum than Fifty Thousand Dollars ($ 50,000.), with interest as aforesaid on the unpaid balance, to Jane J. Canizares, and Nancy Jane Canizares (now Corbett). At the time of Frederic's death Jane was 67 years old and had a life expectancy of 10.48 years. Following Frederic's death a Federal estate tax return was filed for his estate which included the 117 shares of *182 stock of the company owned by him at the time of his death. Upon the audit of such estate tax return, the Internal Revenue Service valued the said 117 shares of the company by multiplying the $ 8,000 annual payment provided for Jane by 7.21699, being the factor set forth in the Treasury regulations representing net worth of $ 1 payable each year during the life of a person age 67. This resulted in a value for the 117 shares of $ 57,735.92. The final Federal estate tax in Frederic's estate was paid on the basis of this value. The single premium cost of an annuity, based upon what a regular commercial insurance company would have charged to a woman 67 years of age on July 31, 1943, providing an income of $ 8,000 annually for life with the first payment to be made as of date of purchase and continuing annually during her lifetime, would have been $ 121,841. The fair market value of the 117 shares of stock in the company which petitioner transferred to the company on October 27, 1943, was $ 57,735.92 at the time of the transfer. At the time the agreement of October 27, 1943, was entered into, the company was solvent; it has enjoyed substantial earnings since such time and has paid *183 the $ 8,000 a year to Jane as such payments fell due. The company has not deducted for Federal income tax purposes any of the $ 8,000 payments to petitioner. The $ 8,000 payments are charged by the company to an account on its books known as "Treasury stock." The company paid petitioner $ 3,333.33 in 1943, and $ 8,000 per year in equal monthly installments each year from 1944 to 1954, inclusive. As of December 31, 1950, the sum of such payments to petitioner totaled $ 59,333.33, none of which was reported by petitioner in her income tax returns for the years 1943 to 1950, inclusive. The $ 8,000 received by petitioner from the company in each of the years 1951, 1952, 1953, and 1954 was not included in petitioner's gross income reported for such years. *351 OPINION. The Commissioner has included in petitioner's gross income for each of the years 1951 to 1954, inclusive, the sum of $ 8,000 which she received in each of those taxable years from the company under the terms of an agreement which she entered into with the company on October 27, 1943. The petitioner contests this determination of the Commissioner and states the issues in her brief as follows: (1) whether the amounts*184 received by petitioner during each of the years involved from R. H. Johnson Co. were excludible from gross income as being in the nature of a gift or bequest and (2) if such payments are held to be taxable to petitioner as an annuity, whether a portion of such payment may be excluded from petitioner's gross income during each of the years in accordance with the rules relating to the taxation of annuities. As to division 1 of petitioner's statement of the issues, we think she cannot be sustained. Petitioner was the sole beneficiary under the will of Frederic and what she received from him with respect to the 117 shares of stock in the company was the 117 shares of stock itself. It seems clear that at the time of Frederic's death he was the owner of 117 shares of the company's stock. The value of these shares was included in Frederic's gross estate and nobody contends that to do so was error. Thus, it is clear that what petitioner received as a bequest from Frederic was 117 shares of the company's stock. Plainly, the receipt of the 117 shares of stock by petitioner as a bequest from Frederic would not be taxable income to her. The Commissioner makes no such contention. But what*185 happened was that after Frederic's death petitioner, in her individual capacity and as executrix of her husband's estate, transferred to the company the 117 shares of the company's stock which had been bequeathed to her in consideration of the company's agreement to pay her an annuity of $ 8,000 each year for the remainder of her life. It is this $ 8,000 which petitioner received in each of the taxable years that the Commissioner seeks to tax for 1951, 1952, and 1953 under sections 22(a) and/or 22(b)(2), 1939 Code, and for 1954 under sections 61 and 72, 1954 Code. It seems to us that whether and to what extent petitioner is taxable on the $ 8,000 is to be determined by a consideration of the provisions of section 22(b)(2), 1939 Code, 1 and similar provisions in the 1954 Code. *186 *352 It seems to be too plain for argument that the $ 8,000 annual payment for life which petitioner was to receive under the agreement with the company, as consideration for the transfer of the 117 shares of stock to the company, was an annuity. The only question for decision here, it seems to us, is what was the cost to petitioner of the annuity of $ 8,000 which she was to receive. Under the terms of section 22(b)(2), whatever the cost was to petitioner she was under the legal obligation to return for taxation in each taxable year after the annuity began, 3 per cent of the cost of the annuity and the balance of the $ 8,000 was to be excluded until she entirely recovers her cost of the annuity. Thereafter, the entire $ 8,000 is taxable as ordinary income. That seems to be the clear meaning of section 22(b)(2) printed in the margin and is the interpretation which the Treasury has given the statute in Rev. Rul. 239, 1953-2 C.B. 53. In that ruling it was held that the "consideration paid" for an annuity contract executed by an individual in exchange for real property is the fair market value of the real property at the time of the transfer. *187 The annuity payments received under the contract constitute ordinary income to the extent of 3 per cent of the fair market value of the real property at the time of the transfer until the aggregate of that portion of the payments which is not taxable under section 22(b) (2) of the Code equals the fair market value of the property transferred. After such time the payments are taxable in full as ordinary income. In the instant case, what was the "consideration paid" by petitioner for the $ 8,000 annuity which is being paid to her by the company? Petitioner contends that it was the cost of a comparable annuity which would have been written by a commercial insurance company, payable to one having a life expectancy equal to that of petitioner at the time of the contract of October 27, 1943, between petitioner and the company. In pursuance of this contention, petitioner introduced evidence at the hearing to the effect that the single-premium cost of an annuity, based upon what a regular commercial insurance company would have charged to a woman 67 years of age on July 31, 1943, providing an income of $ 8,000 annually for life with the first payment to be made as of date of purchase *188 and continuing annually during her lifetime, would have been $ 121,841. But assuming, as petitioner contends, that the cost of an annuity similar to that which petitioner is receiving would have cost $ 121,841 from a commercial *353 insurance company, it is clear to us that petitioner's annuity of $ 8,000 had no such cost to her as $ 121,841. The cost to her, under the authorities which we have examined, was the fair market value of the 117 shares of stock which she transferred to the company by the agreement of October 27, 1943. That fair market value was $ 57,735.92, which was the figure determined for estate tax purposes at the time of the death of Frederic, July 31, 1943. We have no other evidence as to the fair market value of the 117 shares of stock at the time of its transfer by petitioner to the company on October 27, 1943, in consideration of the annuity than the value which was used for estate tax purposes. Petitioner, in arguing that the cost to her of the annuity was what a regular insurance company would have charged for a similar annuity regardless of the fair market value of the property which she transferred to the company, relies upon Anna L. Raymond, 40 B.T.A. 244,*189 affd. 114 F. 2d 140. We think petitioner's reliance on that case is misplaced. That case held that where the consideration paid by a taxpayer to charitable institutions for annuities was in excess of cost of the annuities and so was in part a gift, cost based on insurance company estimates as to cost of similar annuities was the fair cost to be used for the purpose of determining what part of annuity payments received by the taxpayer was subject to income tax under section 22(b)(2), 1939 Code. In the instant case, there is no contention that the 117 shares of stock which petitioner transferred to the company in consideration of the annuity had a fair market value in excess of the cost of a similar annuity written by a commercial insurance company. In fact, it seems entirely clear that the fair market value of the 117 shares of stock was much less than a commercial insurance company would have charged for a similar annuity contract. That being true, we think it must be held that the cost to petitioner of the annuity contract here in question was the fair market value of the stock at the time of transfer, which we have held under the evidence was*190 $ 57,735.92. Under section 22(b)(2) it is 3 per cent of this $ 57,735.92 which is taxable to petitioner in each taxable year as ordinary income until the amount which is excluded under the provisions of the statute equals petitioner's cost of the annuity, $ 57,735.92. Thereafter, all of the $ 8,000 is taxable. Certainly, we know of no case, and we have been cited to none, which holds that a taxpayer who has purchased an annuity from a noncommercial source at a price less than a commercial insurance company would have charged for a similar annuity would have a right to use as his basis of cost for the annuity the higher cost which the commercial insurance company would have charged. We deny petitioner's contention that she has the right to use as her basis of cost for the annuity which she receives under the contract, *354 $ 121,841 which was the cost which a commercial insurance company would have charged for a similar annuity. Respondent, on his part, makes a contention which we also think is unsound. He contends that in years prior to the years here involved petitioner had excluded from gross income within the meaning of section 22(b)(2) payments totaling $ 59,333.33, which*191 amount exceeds the $ 57,735.92 which petitioner paid for the annuity contract. Therefore, argues respondent, the $ 8,000 payment received by petitioner in each of the years 1951 to 1954, inclusive, is taxable as ordinary income. Respondent relies for this contention upon the following stipulated facts: "As of December 31, 1950, the sum of such payments to petitioner totalled $ 59,333.33, none of which was reported by petitioner in her income tax returns for the years 1943 to 1950, inclusive." We do not have before us for adjudication petitioner's income tax liabilities for the years 1943 to 1950, inclusive. Regardless of what petitioner included and what she excluded with respect to her $ 8,000 annuity in those years, it does not govern her tax liability in the years we have before us. It is the statute itself which says: Amounts received as an annuity under an annuity or endowment contract shall be included in gross income; except that there shall be excluded from gross income the excess of the amount received in the taxable year over an amount equal to 3 per centum of the aggregate premiums or consideration paid for such annuity (whether or not paid during such year), until*192 the aggregate amount excluded from gross income under this chapter or prior income tax laws in respect of such annuity equals the aggregate premiums or consideration paid for such annuity. * * * In adding up the amount of exclusions petitioner is entitled to take before the entire $ 8,000 is taxable to her as ordinary income, the addition must be made upon what the statute prescribes a taxpayer may exclude and not what the taxpayer may have actually excluded in prior years. We think such is the effect of the Treasury's own ruling, Rev. Rul. 239, supra, to which we have already referred. This rule should govern the computation of the amounts taxable to petitioner in the taxable years we have before us for the years 1951, 1952, and 1953, under Rule 50. For the taxable year 1954 the applicable statutes are sections 61 and 72 of the 1954 Code. They provide for a somewhat different treatment for the taxation of annuities as is provided by section 22(b)(2) of the 1939 Code. In a recomputation under Rule 50 for the year 1954 the provisions of the 1954 Code for the taxation of annuities should be applied. In the Commissioner's determination*193 for the year 1951 he added $ 204.38 under the provisions of section 294(d)(2), 1939 Code. In the petition, error is assigned to this determination of the Commissioner on the ground that petitioner's underestimation of her tax for 1951 was due to reasonable cause. However, at the hearing of this proceeding *355 no evidence was offered by petitioner to establish reasonable cause. We think it is also proper to point out in this connection that the question of reasonable cause is immaterial in a consideration of the applicability of the addition to tax under section 294(d)(2). See H. R. Smith, 20 T.C. 663 (1953), and Kaltreider v. Commissioner, 255 F. 2d 833 (C.A. 3, 1958). Therefore, we sustain the Commissioner's determination that there should be an addition to the tax for 1951 under section 294(d)(2). The amount thereof will be determined under Rule 50. Decisions will be entered under Rule 50. Footnotes 1. SEC. 22. GROSS INCOME. (b) Exclusions From Gross Income -- The following items shall not be included in gross income and shall be exempt from taxation under this chapter: * * * * (2) Annuities, etc. -- (A) In General. -- Amounts received (other than amounts paid by reason of the death of the insured and interest payments on such amounts and other than amounts received as annuities) under a life insurance or endowment contract, but if such amounts (when added to amounts received before the taxable year under such contract) exceed the aggregate premiums or consideration paid (whether or not paid during the taxable year) then the excess shall be included in gross income. Amounts received as an annuity under an annuity or endowment contract shall be included in gross income; except that there shall be excluded from gross income the excess of the amount received in the taxable year over an amount equal to 3 per centum of the aggregate premiums or consideration paid for such annuity (whether or not paid during such year), until the aggregate amount excluded from gross income under this chapter or prior income tax laws in respect of such annuity equals the aggregate premiums or consideration paid for such annuity. * * *↩