Winslow v. Commissioner

SIDNEY W. WINSLOW, JR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Winslow v. Commissioner Docket No. 88605. United States Board of Tax Appeals 39 B.T.A. 373; 1939 BTA LEXIS 1042; February 9, 1939, Promulgated *1042 1. Annual installments of principal of life insurance received by the beneficiary after the death of the insured held exempt from income tax, Revenue Act of 1934, section 22(b)(1). 2. Amounts received by the beneficiary in addition to the principal installments of life insurance as distributions of earnings of the insurer held not exempt. C. Clifton Owens, Esq., for the petitioner. Paul E. Waring, Esq., for the respondent. STERNHAGEN *373 The Commissioner determined a deficiency of $1,403.64 in petitioner's income tax for 1934. Petitioner assails the inclusion in income of an annual installment and a distribution of earnings received *374 under a contract of insurance of which he was beneficiary. A second issue was settled by stipulation. FINDINGS OF FACT. Petitioner, a resident of Boston, Massachusetts, was the beneficiary under a policy of life insurance issued to his father by the Equitable Life Assurance Society on November 12, 1904. By the terms of this policy the Society agreed to pay to petitioner, the designated beneficiary, if he should survive the insured, $100,000 in 50 annual installments of $2,000 each. *1043 The consideration was an annual premium of $2,569.44. When issued, there was stamped on the policy's face the company's agreement. * * * neither to commute or cash any of the said instalments or make advance payments whatever thereon, nor to recognize any assignment or hypothecation of this contract or any part thereof, or interest therein, without the written concurrence of the Assured, except as required by law. The insured died on June 18, 1917, without having authorized or concurred in any changes in settlement, and the company has made no changes. It is stipulated: "Except for the terms and conditions contained in the policy, the amount that would have been payable immediately upon the death of the insured was $53,000." By interpretation of this stipulation, the Board finds as a fact that the commutation on the date of death of 50 annual installments of $2,000 each would be $53,000. 1 The policy was surrendered by petitioner and in place thereof the Society issued to him a bond, dated July 9, 1917, agreeing to pay him, his executors, administrators, *1044 or assigns $100,000 in 50 equal annual installments of $2,000. The bond provided: These Instalments are based upon an assumed rate of interest of 3% per annum. If a higher average annual rate shall be earned by the Society, the amount of the Instalments may be increased on any anniversary by an excess interest dividend as determined and apportioned by the Society. No assignment or hypothecation of the Instalments payable hereunder will be recognized by the Society. If the Beneficiary should die before all of the aforesaid Instalments have been paid, such unpaid Instalments may be commuted on the basis of 3% per annum compound interest and paid in a single sum. Under no other circumstances will the Society commute or anticipate instalments. Petitioner received the initial installment of $2,000 in 1917, and like installments, together with an additional amount of several hundred dollars, in each succeeding year. Prior to 1934 the aggregate amount so received by petitioner was $45,473.40. In 1934 petitioner received $2,581.40, of which the Commissioner included $2,353.32 in taxable income. *375 OPINION. STERNHAGEN: The amount of $45,473.40 received by petitioner*1045 from the insurer prior to the taxable year 1934 represents 17 annual installments of $2,000 each ($34,000) and dividends of $11,473.40. No part of this had been reported by petitioner as income in the years received. Now the Commissioner determines that the commuted value of the $100,000 to be paid in 50 annual installments of $2,000 each, agreed by the parties to be $53,000, is the amount exempt from tax; that this exemption has already been applied to $45,473.40, leaving $7,526.60 still subject to the exemption; that the exemption of this $7,526.60 must be spread ratably over the remaining 33 years of periodic payments; and that hence only the pro rata amount of $228.08 is the exempt portion of the $2,581.40 received in 1934, thus adding $2,353.32 to 1934 income to be taxed. Assailing this determination, the petitioner argues that the entire payment of $2,581.40 is tax-exempt; that at least $2,000 thereof is, and that even if the Commissioner's theory is correct, his computation is incorrect in that he uses all unreported income from installment payments of prior years to reduce the amount to be exempted on future installments, thereby seeking to correct past errors by present*1046 adjustments. Section 22(b)(1), Revenue Act of 1934, provides for the exemption from tax of: (1) LIFE INSURANCE. - Amounts received under a life insurance contract paid by reason of the death of the insured, whether in a single sum or otherwise (but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income). Such a provision (except that "in installments" was used in lieu of "or otherwise"), was enacted as section 22(b)(1), Revenue Acts of 1932 and 1928, and section 213, Revenue Act of 1926. Section 213, Revenue Act of 1924, and previous acts exempted: (1) The proceeds of life insurance policies paid upon the death of the insured. The change in the 1926 Act was intended: * * * to prevent any interpretation which would deny the exemption in the case of installment payments, * * * and the parenthetical clause was added: * * * In order to prevent an exemption of earnings where the amount payable under the policy is placed in trust upon the death of the insured and the earnings thereon paid * * *. [Conference Report, H.R. 1, 69th Cong., 1st sess., p. 33.] The phrase "or otherwise" *1047 in the 1934 Act supplanted "or in installments" in the 1932 Act to make it clear: * * * that the proceeds of a life-insurance policy payable by reason of the death of the insured in the form of an annuity are not includible in gross income. [Finance Committee Report No. 558, 73d Cong., 2d sess., p. 23.] *376 Congress has thus clearly manifested an intention to exempt amounts received by the beneficiary of a policy, "paid by reason of the death of the insured" in installments or in annuities, and has departed from language which might be construed to exempt only the amount "paid upon the death of the insured", or at that time. Both the plain wording of the section and its legislative history show that the $2,000 installments were intended to be fully exempted from tax, for they were received by reason of the death of the insured and were expressly receivable as installments. The Commissioner so construed the exemption under early acts in several rulings. 2 After the Board's decision of Edith M. Kinnear,20 B.T.A. 718, in 1930, the rule was changed. Respondent now relies on the Kinnear case as support for the change of administrative rule and*1048 for the determination here. Kinnear was the beneficiary of a policy on her father's life, which, as originally written, entitled her to $25,000 upon proof of the insured's death. But by request of the insured the policy had been endorsed to provide that: * * * settlement of the full proceeds of this policy shall be made with Edith M. Kinnear, the beneficiary, in accordance with the provisions of Option A, payable monthly, without privilege of revocation or surrender. Option A provided that upon the insured's death the company should hold the proceeds of the policy until the death of the beneficiary and pay 3 percent annual interest thereon. By another provision the payments were to be increased, as they were here, by annual dividends of the company. Kinnear argued under the 1926 Act that the statute: * * * does not contemplate a situation where the insured by direction prior to his death has instructed the insurance company to retain the principal amount*1049 of the policy and pay to the beneficiary only the interest and dividends, without privilege of revocation or surrender on the part of the beneficiary. The Board rejected the argument. It reviewed the above cited Committee reports, addressed itself to the taxable status of interest and dividends on policy proceeds which the insured had required the company to hold, and found no reason in the beneficiary's lack of power to alter the arrangement for a failure to apply strictly the language of the parenthetical clause. This case is authority only for the taxation of interest and dividends on an amount which might have been paid in a lump sum at the time of death but which because of the insured's unalterable directions was held by the company. The Commissioner, however, used it as warrant for a change in his former rulings, and in G.C.M. 13796, XIII-2 C.B. 41 (Oct. 2, 1934), cited it in holding that the successive statutes: * * * exclude from gross income only the principal sum of the capital value of a life insurance policy as of the time of the insured's death, and do *377 not exclude any amounts which are added to such principal sum (when it is paid in*1050 installments) by reason of the running of time. * * * He thought it logical: * * * that Congress intended to exclude from gross income only the proceeds of life insurance policies which are reportable for estate tax purposes. * * * and reasoned that: * * * "proceeds" when allowed to remain with the insurance company earn additional amounts which * * *. * * * accrue by reason of the running of time or by reason of the fact that final settlement is postponed to a date beyond the date of death. * * * Whether such an arrangement with the company was made by the beneficiary or by the insured was regarded as immaterial. Since the Kinnear decision considered only interest and dividends on the face amount of the policy which was retained by the company, it falls short of supporting the treatment in G.C.M. 13796 of insurance proceeds received by reason of the insured's death. The gist of G.C.M. 13796 was incorporated in Regulations 86, article 22(b)(1)-1: * * * The amount exempted is the amount payable had the insured or the beneficiary not elected to exercise an option to receive the proceeds of the policy or any part thereof at a later date*1051 or dates. If the policy provides no option for payment upon the death of the insured, or provides only for payments in installments, there is exempted only the amount which the insurance company would have paid immediately after the death of the insured had the policy not provided for payment at a later date or dates. * * * * * * (b) * * * If the proceeds are payable in installments for a fixed number of years, * * * the amount that would have been payable by the insurance company immediately upon the death of the insured (if payment at a later date had not been provided for) is to be divided by the total number of installments payable over the fixed number of years for which payment is to be made, and the quotient represents the portion of each installment to be excluded from gross income. The amount of each installment in excess of such excluded portion is to be included in gross income. * * * Under this regulation the commuted value of proceeds, as of the date of the insured's death, is the maximum exemption no matter how or when payable or why. Respondent defends this article by quoting from the Kinnear opinion that a beneficiary is taxable on earnings from a policy: *1052 * * * where the amount payable * * * has been placed in trust by the insured under an agreement that the earnings thereon shall be paid to the beneficiary. * * * But the $2,000 installments were not earnings on an amount payable. Respondent cites United States v. Heilbroner, 100 Fed.(2d) 379, affirming 22 Fed.Supp. 368, which is substantially similar to Kinnear,*378 supra. Heilbroner was the beneficiary of insurance policies on the life of her husband, who died after directing the company to hold the face amounts for payment to children on his wife's death and to pay the wife interest and dividends annually apportioned to the policies by the issuing companies during her lifetime. In holding such interest and dividends taxable, the court treated them as: * * * sums paid by the companies for the retention and use of the face amounts of the various policies without impairment of the obligations ultimately to pay the principal amounts of the several policies to the remaindermen. The arrangement was thought to be similar to the establishment of a trust for the payment of interest on principal to a beneficiary. It*1053 was thought: * * * reasonable to suppose that Congress intended to exclude from gross income only the proceeds of policies which are reportable for estate tax purposes. * * * This interpretation * * * prevents an insured from eliminating from taxation income arising from the proceeds of a life insurance policy by making it payable to the beneficiary for a period during which the payment of the principal sum is suspended. * * * * * * The amounts to be held under an agreement to pay interest are the proceeds of the policies at whatever time receivable after the death of the insured. This rationale establishes that the income from the retained face amount of a policy is taxable and conversely implies that the face value remains the "proceeds" no matter when paid. In our opinion, the wording of the statute, that amounts received in installments by the beneficiary and paid by reason of the death of the insured, covers each $2,000 installment, and each in therefore exempt from tax in its entirety when paid. This holding is harmonious with decisions that from the standpoint of the payer periodic payments of a principal amount in installments give no deduction of a part thereof*1054 as if it were interest. Daniel Brothers Co. v. Commissioner, 28 Fed.(2d) 761; Henrietta Mills, Inc. v. Commissioner, 52 Fed.(2d) 931; Corbett Investment Co. v. Helvering, 75 Fed.(2d) 525; MacDonald v. Commissioner, 76 Fed.(2d) 513; Penn Mutual Life Insurance Co. v. Commissioner, 92 Fed.(2d) 962. There is, however, no support for the petitioner's argument that the additional amount of $581.40 received by petitioner in 1934 is likewise exempt. This was a distribution out of the earnings of the corporation appropriately called in the bond an "excess interest dividend." While it was paid by virtue of the corporation's contractual obligation, it was a gain to petitioner currently derived from the principal invested. In its essential nature it resembles the earnings *379 held taxable in Heilbroner and Kinnear, supra.This "excess interest dividend" was not received solely "by reason of the death of the insured", as was the $2,000; it was paid also by reason of the withholding of the future installments of the principal amount and their profitable investment*1055 by the corporation. Thus they are not squarely within the statutory exemption and are like any other income from an investment. Decision will be entered under Rule 50. Footnotes 1. This interpretation is in accordance with the apparent understanding of both counsel, as shown in their briefs. ↩ 2. O.D. 433, 2 C.B. 91; L.O. 995, 2 C.B. 90; O.D. 612, 3 C.B. 120; O.D. 767, 4 C.B. 231; O.D. 1010, 5 C.B. 100; G.C.M. 10843, XI-2 C.B. 22↩.