Lay v. Commissioner

ESTATE OF CHARLES H. LAY, OIL CITY TRUST COMPANY, EXECUTOR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Lay v. Commissioner Docket No. 92163. United States Board of Tax Appeals 40 B.T.A. 522; 1939 BTA LEXIS 839; September 7, 1939, Promulgated *839 Decedent, several years prior to his death, loaned certain securities to his son for use as additional collateral to that pledged by his son to secure the latter's indebtedness to a bank on two promissory notes. There was an agreement that decedent was to have a claim over against the son in the event that any of his collateral had to be used to pay the son's debts. At decedent's death, the notes had not been paid and there had been no foreclosure on the collateral. In the estate tax return, the executor included the securities loaned by decedent to his son at their full market value at the date of the death of decedent and deducted as a claim against the estate the amount of the indebtedness evidenced by the son's notes, less the fair market value of the collateral posted by the son. The Commissioner disallowed any part of the deduction. Held, petitioner is not entitled to any deduction by reason of the alleged claim, the facts showing that subsequent to decedent's death the son was assigned $15,000, specific bequests of the estate, which he in turn assigned as additional collateral to the bank to secure the indebtedness and this $15,000, plus the son's interest as residuary*840 legatee, plus the son's collateral already posted at the bank, will be more than ample to pay the indebtedness and the estate of decedent will never be called upon to pay any part of the indebtedness. R. J. Cleary, Esq., for the petitioner. Paul E. Waring, Esq., for the respondent. BLACK *522 The Commissioner has determined a deficiency of $4,529.17 in the Federal estate tax liability of the estate of Charles H. Lay. The petition assigns two errors, as follows: (1) The Commissioner of Internal Revenue erred in disallowing as a deduction from the gross estate item 25 of Schedule I, Debts of Decedent, in the amount of $42,372.04. * * * (2) The Commissioner of Internal Revenue did not allow as a deduction from the gross estate of decedent any amount on account of attorneys' fees and other expenses incurred and to be incurred in the determination of the estate tax liability of petitioner's decedent. * * * On issue (2) it was stipulated at the hearing by counsel for the parties that upon filing with the Board proofs by the executor of payments of attorneys' fees, the Government will allow the deduction. We interpret this stipulation to*841 mean that the question of what, if any, deduction petitioner will be allowed for attorneys' fees paid out by the estate will be settled under Rule 50 and we shall so treat the stipulation. This leaves only issue (1) for decision. *523 FINDINGS OF FACT. The decedent, Charles H. Lay, a resident of Oil City, Pennsylvania, died testate on April 19, 1935. The executor of his estate, the petitioner herein, is the Oil City Trust Co. of Oil City, Pennsylvania. During 1930 and 1931 the decedent pledged with the Oil City Trust Co. certain securities as collateral on loans which decedent's son, Russell C. Lay, then had outstanding at that institution. On the date of decedent's death, Russell's loans at the Oil City Trust Co. aggregated $59,015.10; the fair market value of the decedent's securities which were pledged as collateral on these loans was $43,222.22; and the fair market value of certain securities belonging to Russell which were also pledged as collateral on these loans was $16,743.06. On or about April 16, 1936, petitioner filed with the office of the collector of internal revenue for the twenty-third district of Pennsylvania an estate tax return on behalf of*842 the decedent's estate. Under schedule B of this return petitioner reported as a part of decedent's gross estate, at a value of $43,222.22, the decedent's securities which were pledged as collateral on Russell's loans; and under schedule I thereof, petitioner deducted as a debt of decedent the amount of $42,372.04, which amount represented the difference between the aggregate loans of $59,015.10 and the fair market value of the pledged securities belonging to Russell, determined at that time to be $16,643.06 instead of $16,743.06. The return as filed disclosed a total tax due of $3,438.63, which amount the executor paid. The respondent disallowed the claimed deduction of $42,372.04, and determined the deficiency herein of $4,529.17, $3,813.47 of which, together with interest of $429.63, was paid by the petitioner on or about March 3, 1938. Cash aggregating $59,015.10 actually passed to Russell from the Oil City Trust Co. at the time the loans were made. At the time the decedent pledged the securities in question on the loans made to Russell, it was understood and agreed between decedent and Russell that the securities still belonged to decedent and that in the event the Oil*843 City Trust Co. foreclosed on any of the securities belonging to the decedent, the decedent was to have a claim against Russell for the value of the securities so taken over in satisfaction of Russell's obligations. At the dates of the hearing herein, November 10 and 11, 1938, Russell's obligations which were outstanding at the Oil City Trust Co. on April 19, 1935, in the aggregate amount of $59,015.10, were unpaid. *524 On August 5, 1935, Russell secured from his wife and two daughters assignments to himself of the specific bequests of $5,000 made to each of those three individuals under the decedent's will, and on August 14, 1935, Russell assigned, transferred, and set over the three assignments aggregating $15,000 to the Oil City Trust Co. as additional collateral on Russell's obligations at that institution. The fair market value of these specific bequests at all times pertinent hereto was $5,000 each or $15,000 for the three specific bequests in question. Between the date of decedent's death and November 7, 1938, Russell had borrowed an additional $2,749.90, which brought the total amount of Russell's notes at the Oil City Trust Co. up to $61,765. About the*844 year 1916 Russell started in the transfer and storage business as an individual proprietor and as such he operated under the trade name of Carnahan Transfer & Storage. For the calendar years 1935, 1936, and 1937 and for the period ended October 31, 1938, this business was operated at net losses of $5,858.32, $2,184.31, $1,772.15, and $5,783.77, respectively. Russell's total assets (personal property at fair market value and real estate at book value), but not including the value of his interest as residuary legatee of the estate of decedent, and liabilities, including those of the Carnahan Transfer & Storage business and the notes outstanding at the Oil City Trust Co., on the dates shown were as follows: Date Total assets Total liabilities Apr. 19, 1935 $75,888.49 $75,963.65 Apr. 30, 1935 75,888.49 75,963.65 Dec. 31, 1935 82,308.74 75,963.65 Dec. 31, 1936 $82,337.99 $80,105.13 Dec. 31, 1937 75,462.99 80,921.17 Oct. 31, 1938 77,557.74 96,206.57 The real estate of Russell and the Carnahan Transfer & Storage business, included at book value in the above statement of assets, had an actual value considerably less than book value. On October 20, 1938, the*845 executor of the estate of the decedent, Charles H. Lay, filed the first and final account of the decedent's estate, showing facts as follows: Inventory and appraisement of the goods, chattels and credits of Charles H. Lay on the date of his death, including the securities pledged with the Oil City Trust Co. $105,178.81 Net corpus gains since death 17,000.19 Total income of estate since death 17,790.30 Total 139,969.30 Amounts expended by executor 29,386.20 Balance in hands of executor 110,583.10 *525 Out of the $110,583.10, the executor has paid specific bequests totaling $34,650, and has distributed to Russell as residuary legatee $11,564.61, $7,937.61 of which was for interest on Russell's notes at the Oil City Trust Co., thus leaving a balance of $64,368.49 in the hands of the executor, which includes the securities that are still up as collateral on Russell's loans. The only specific bequests made by decedent's will which remain unpaid are the $5,000 each to Russell's wife and two daughters, which, as already stated, are up as collateral with the Oil City Trust Co. The estate has ample assets with which to pay these specific bequests. The*846 Commissioner, in disallowing petitioner's claimed deduction of $42,372.04 in question, stated in his deficiency notice, among other things, as follows: From a careful consideration of the facts it appears that the decedent acted merely as an accommodation party in the transaction represented by said item. The decedent's motive was to establish his son in business in which the decedent himself apparently had no interest whatever. Furthermore, it does not appear that the item represents a personal obligation of the decedent existing at the time of his death, the liability for which was incurred or contracted bona fide and for an adequate and full consideration in money or money's worth within the meaning of section 303(a)(1) of the Revenue Act of 1926, as amended. The decedent's action in establishing and helping his son in the business did not augment his estate or grant him a right or privilege he did not possess before. See . Furthermore, the Carnahan Transfer and Storage Company appears to be a going concern and the son doubtless will eventually be able to satisfy the amount due on the note claimed in this estate as*847 a deduction. OPINION. BLACK: Did the respondent err in disallowing as a claim against the estate of the decedent the item of $42,372.04 deducted by petitioner under schedule I of the estate tax return? The applicable statute, section 303(a)(1) of the Revenue Act of 1926, as amended by section 805 of the Revenue Act of 1932 and section 403(a) of the Revenue Act of 1934, provides: SEC. 303. For the purpose of the tax the value of the net estate shall be determined - (a) In the case of a citizen or resident of the United States, by deducting from the value of the gross estate - (1) Such amounts - * * * (C) for claims against the estate, (D) for unpaid mortgages upon, or any indebtedness in respect to, property where the value of decedent's interest therein, undiminished by such mortgage or indebtedness, is included in the value of the gross estate, and * * * as are allowed by the laws of the jurisdiction, whether within or without the United States, under which the estate is being administered * * *. The deduction herein allowed in the case of claims against the estate, unpaid mortgages, or any indebtedness shall, when founded upon a promise or agreement, *526 *848 be limited to the extent that they were contracted bona fide and for an adequate and full consideration in money or money's worth. * * * While decedent, Charles H. Lay, was not personally liable upon the notes due by his son, Russell C. Lay, to the Oil City Trust Co., nevertheless, he had during his lifetime loaned some of his securities to Russell to be used as collateral security to secure the payment of Russell's notes to the bank. Certainly to the extent that this collateral will be subjected to the payment of Russell's debts there is a deductible claim under section 303(a)(1), but the amount of petitioner's claim must be reduced by other considerations which we shall discuss later. At the time of decedent's death these securities which were the property of decedent and were up as collateral to secure his son's indebtedness had a fair market value of $43,222.22 and were included at that value as a part of decedent's gross estate. The petitioner does not claim as a deduction the full market value of the securities, but claims a somewhat less amount, to wit, $42,372.04. This latter amount represents the figure which remains after the fair market value of the collateral put*849 up prior to decedent's death by Russell, the maker of the notes, is deducted from the indebtedness represented by the notes. Petitioner concedes that the amount of the collateral put up with the bank by Russell must first be deducted from the indebtedness due the bank and then it contends that the balance, not exceeding the fair market value of the collateral put up by decedent, is deductible from decedent's gross estate - this, of course, assuming that the estate's claim over against Russell was valueless because of his insolvency. We think that as a general rule, without anything more, petitioner's contention would be sound. But it has been held that the amount of a claim for liability of a decedent as surety or endorser which is deductible from the estate is not in all cases what it would have figured on paper at decedent's death. Subsequent events which serve to increase or decrease the amount which the estate has to actually expend in settlement of the liability may be taken into consideration. ; *850 ; . The evidence in this proceeding shows that although the creditor, the Oil City Trust Co., had the right to subject to the payment of its notes against Russell the entire collateral put up by decedent to secure the payment of his son's notes, there was an agreement between decedent and his son that decedent should have a claim over against his son for any amount that decedent's collateral should be used to pay the son's debts. Because of this agreement, petitioner concedes *527 that the indebtedness of $59,015.10 must be reduced by $16,743.06, the value of the collateral pledged by Russell. We think it must be reduced still further in the manner hereinafter set out. The evidence shows that decedent made special bequests of $5,000 each to Russell's wife and two daughters. These special bequests have been assigned by the owners thereof to Russell and he in turn has assigned them to the bank as additional collateral. The facts show that the estate is thoroughly solvent and that these three specific bequests of $5,000 each will undoubtedly be paid. *851 If, and when they are paid, they will reduce Russell's indebtedness to the bank in the amount of $15,000 and the collateral belonging to decedent will be relieved to that extent. This fact is made clear by the testimony of petitioner's witness, A. E. Mackintosh, vice president of the Oil City Trust Co., whose testimony included the following with reference to the effect of the assignment to the bank of the three specific bequests of $5,000 each: Q. Who will receive the $5,000 as set forth in those assignments on the ultimate liquidation of this estate? A. The Oil City Trust Company. Q. And what will happen to that $15,000 according to your own schedule here for distribution of assets? A. It would reduce the amount of the notes. We may point out that when petitioner, as executor of the estate, finally makes payment of this $15,000 to the Oil City Trust Co. it will not be paying it as a debtor but will be distributing it as a fiduciary to the assignee of those entitled to receive it under the terms of the will. When this $15,000 is paid to the Oil City Trust Co. it will reduce Russell's liability on the notes to that extent. Thus we have to reduce the $59,015.10*852 indebtedness which existed at the time of decedent's death by $16,743.06, the value of Russell's collateral on that date, a concession which petitioner makes, and, in accordance with our holding, by the $15,000 which will be paid in settlement of the three specific bequests just mentioned. This will leave $27,272.04 of the indebtedness unpaid, which under ordinary circumstances the collateral belonging to the estate of decedent would have to pay and the amount would be deductible under section 303(a)(1). There is another consideration, however, that has to be taken into account in determining whether or not under the facts as found the estate will be entitled to have this remaining $27,272.04 allowed as a deduction, which is that Russell is the residuary legatee of decedent's estate. The facts show that the value of the assets belonging to the estate at the time of the hearing in this proceeding is $64,368.49, all liquid securities. The estate owes no indebtedness except to the extent that its collateral up with the Oil City Trust Co. may be subjected to the payment of Russell's notes. *528 As we have already stated, $15,000 of this $64,368.49 remaining assets of decedent's*853 estate will be used to pay the specific bequests which the Oil City Trust Co. now holds as additional collateral to secure the payment of Russell's notes and when so used it will reduce Russell's notes by that amount. That will leave the estate with $49,368.49 liquid assets, including the assets on deposit with Oil City Trust Co. as collateral. These assets will belong to Russell, as residuary legatee, subject only to the claim of the Oil City Trust Co., there being no other indebtedness of the estate. The value of those remaining assets, $49,368.49, will be considerably greater than the amount of the claim which will still remain unsatisfied after the collateral belonging to Russell and the three specific bequests of $5,000 each are used to reduce the indebtedness. This $49,368.49 residuary part of the estate will, as we have just stated, belong to Russell and, when eventually used to pay the remaining $27,272.04 indebtedness of the Oil City Trust Co. against Russell, it will be a case of using Russell's property to pay Russell's debts and we fail to see where, under these circumstances, the estate of Charles H. Lay is entitled to any deduction at all because of the alleged claim*854 against it. Of course, if when decedent died there had been indebtedness to the Oil City Trust Co. for money borrowed by decedent, the claim would have been deductible in full. Doubtless, the Commissioner would not contend otherwise, but where an estate is liable only as a surety or an endorser, it can not take any deduction because of such liability where the principal has ample assets to pay the indebtedness. Cf. ;. On this issue we hold for the respondent. Decision will be entered under Rule 50.