Watkins v. Commissioner

FLORENCE H. WATKINS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Watkins v. Commissioner Docket No. 100640. United States Board of Tax Appeals 43 B.T.A. 900; 1941 BTA LEXIS 1431; March 13, 1941, Promulgated *1431 1. The taxpayer is the life beneficiary of a trust part of the corpus of which was preferred stock of a certain Massachusetts corporation calling for the payment of 6 percent annually and no more. The trust was created and administered in Massachusetts. Taxpayer is entitled to receive the net income of the trust and upon her death the corpus is to be paid over to others. In December 1935 the corporation resolved to pay and paid a $6 dividend on all preferred stock, in addition to the dividend already paid that year, specifying it to be the dividend to accrue for the succeeding year. The trustee received the dividend but did not pay over any of the amount to the taxpayer until 1936. In December 1936 a dividend was again paid to the trustee (being the dividend to accrue for the year 1937). The trustee paid the amount received over to the taxpayer in 1937. Held, the taxpayer is taxable on the amount of such dividends in the years in which they were actually distributed to her by the trustee. 2. In December 1937 the corporation called in the preferred stock in the hands of the trustee and gave in exchange its note bearing interest at 4 1/2 percent per annum, commencing*1432 January 1, 1938, but payable for a full year in advance on December 31 of each year, beginning December 31, 1937. An interest payment was made to the trustee that day and paid by him to the taxpayer in 1938. Held, the interest payment is taxable to petitioner in the year 1937, regardless of the fact that she did not receive it until 1938. John W. Windhorst, Esq., for the petitioner. Lucien W. Shaw, Esq., for the respondent. KERN *901 The issues here involved concern income taxes asserted against petitioner for the calendar years 1935, 1936, and 1937 in the sums of $6,119.63, $6,032.58, and $2,629.03, respectively. In addition thereto, petitioner claims a refund for the year 1937 in the amount of $10.31. The question presented is whether dividends and interest received by a trust prior to the years for which they were normally payable are distributable, and, therefore, taxable to the life beneficiary of the trust in the year of their receipt by the trustees. FINDINGS OF FACT. All the facts involved herein have been either admitted by the parties in their pleadings or have been stipulated by counsel, and we find them to be as admitted*1433 and stipulated. The following is a resume of all of those facts which we consider pertinent to a clear understanding of this case. On April 23, 1928, in the State of Massachusetts, a trust agreement was drawn up by Paul Watkins wherein he, as settlor, named Florence H. Watkins, his wife, the petitioner herein, as a beneficiary. Upon the settlor's death, if his wife should survive him along with issue of the settlor, the trustees were directed to pay over to the petitioner such portions of the net income of the trust as she might request, and to accumulate the rest, adding the same to capital during her lifetime, and upon her death to pay over the corpus as she might by her last will appoint, or, in default of appointment, to the issue then living of the settlor. On December 24, 1931, Paul Watkins died. The petitioner and four children were alive and of full legal age and capacity during all of the years here involved. Pursuant to discretion vested in the trustees, they established four separate funds and made separate income tax returns on these funds during the years here involved. However, no question as to the validity or effect of this action is involved in this proceeding. *1434 The rights of the petitioner in each of these funds is identical, and, consequently, we shall in the future speak of them collectively. *902 After the death of the settlor, the bulk of the assets held by the executors consisted of a substantial block of the common stock of the J. R. Watkins Co. On August 25, 1934, the Paul Watkins Estate, Inc., a Delaware corporation, was organized and on September 11, 1934, the assets remaining in the hands of the executors were transferred to the Paul Watkins Estate, Inc. This last mentioned organization thereupon issued three classes of stock to the executors and to certain legatees under the will of Paul Watkins. Common and preferred stock was issued by the Paul Watkins Estate, Inc., on September 11, 1934, and subsequently was transferred to various trusts and persons, but during all the time the wife and children of the deceased, or trusts created for their benefit, were the owners of substantially all the stock. The Paul Watkins Estate, Inc., during the three years here involved was a personal holding company within the meaning of section 351 of the Revenue Acts of 1934 and 1936 and of Title I-A of the Revenue Act of 1936 as amended*1435 by section 1 of the Revenue Act of 1937. The trustees of the four trust funds in question accepted from the executors of the estate of Paul Watkins, deceased, 6,450 shares of the preferred stock, series B, issued by Paul Watkins Estate, Inc. This stock entitled the owner to receive dividends at the fixed annual rate of 6 percent of the par value thereof and no more. On or about July 5, 1935, in accordance with the terms of the trust agreement, the petitioner filed the following request and direction in writing with the trustees: Until further notice you will consider this an order to pay to me for deposit in my account with your company the income that arises from the Paul Watkins Trust Fund, monthly. This request and direction thereafter remained in full force and effect, without change, during all the taxable years involved in this proceeding. On December 26, 1934, a dividend was declared on the common and preferred stock of the Paul Watkins Estate, Inc., and the following day this dividend was received by the stockholders. On December 21, 1935, another dividend was declared on both common and preferred stock, the dividend payment being received by the stockholders*1436 on December 22, 1935. On December 27, 1935, at a meeting of the board of directors of the corporation, the secretary reported, inter alia, according to the minutes: * * * the net income of the corporation for the year 1935 to the date of the meeting was the sum of $138,041.52, and that it was not expected that the corporation would have any further income for the year 1935. The Secretary further explained that the dividend on the Preferred B Stock of this corporation to and including December 31, 1935, had been paid and that the dividend this *903 year paid upon the Preferred B stock of the corporation for the three months' period from September 30 to December 31, 1935, together with the dividend paid upon the Common Stock of this corporation on December 21, 1935, aggregated $25,000. The Secretary thereupon explained that, according to the articles of Incorporation of the corporation, dividends upon the Common Stock for any year were restricted to the difference between $100,000 and the Preferred Stock dividend for such year; that a dividend upon the Preferred Stock for the entire year 1936 would amount to $47,764.50, and that the maximum dividend, therefore, permissible*1437 to the Common Stock for the year 1936 would be in the sum of $52,235.50. The Secretary stated that the cash of the corporation on hand, after making payment of all expenses of the corporation, amounted to $48,181.82, and that if the Preferred Stock dividend for the full year 1936 were to be paid in cash there would remain in the treasury of the corporation the sum of $417.32, and further stated that the corporation held 600 shares of the capital stock of The Chase National Bank of the City of New York, 60 shares of Amerex Holding Corporation, and 640 shares of The National City Bank, and that the market value thereof, together with the cash on hand, was less than the dividend which, under the Articles of Incorporation, could be paid to the common stockholders, to-wit, the sum of $52,235.50. Immediately after receiving this report the directors adopted the following resolution: BE IT RESOLVED That a dividend is hereby declared upon each share of the Preferred B Stock of the corporation outstanding in the amount of $6.00 per share, being the dividend to accrue upon said stock for the entire calendar year 1936, said dividend to be payable December 28, 1935, to the stockholders of*1438 record at the close of business on the same date. BE IT FURTHER RESOLVED That there is hereby declared to the common stockholders of the corporation a dividend in kind consisting of the 600 shares of the stock of The Chase National Bank of the City of New York, the 60 shares of Amerex Holding Corporation, and the 640 shares of the stock of National City Bank of the City of New York owned by this corporation, said stocks to be distributed ratably to the common stockholders on December 28, 1935, to the common stockholders of record on said date. Pursuant to the foregoing resolution the dividend on preferred series B stock was received by the trustees on December 28, 1935, in the amount of $38,700. All of this sum was included in gross income by the trustees in their income tax returns for the calendar year 1935, and no part of it was deducted in those returns under section 162 of the Revenue Act of 1934, or paid in 1935 by the trustees to the petitioner or included by the petitioner in the gross income disclosed by her 1935 income tax return. Respondent treated this $38,700 as income distributable by the trustees in 1935 to the petitioner and added it to the gross income disclosed*1439 by her return for 1935. Respondent also added $40, which adjustment is not contested by petitioner. No part of this $38,700 was paid to the petitioner during 1935, but all of this sum was paid to her by the trustees during 1936. In its personal holding company income tax return for the year 1935, the corporation received a credit of $38,700 for dividends paid, and thereby reduced its tax liability for that year. *904 On December 26, 1936, the secretary of the corporation made a report somewhat similar to that of December 1935. He pointed out to the directors that if they did not pay some dividends in 1936 they would have to pay a high undistributed profits tax. Again a resolution was passed. The resolution, in essence, said that a dividend in the amount of 50 cents per share for each month in 1937 be declared on December 26, 1936, on the preferred stock, to the preferred stockholders of record at the close of business on December 26, 1936. Also declared at the same time was a dividend of $60,000 on the common stock to the common stockholders as of December 26, 1936. A stock dividend was also declared on the common stock. The trustees, pursuant to the resolution, *1440 received on December 27, 1936, a dividend on their preferred stock in the total amount of $38,700. All of this sum was included in gross income by the trustees for the calendar year 1936, and no part of it was deducted in said returns under section 162 of the Revenue Act of 1936, or paid in 1936 by the trustees to the petitioner or included by petitioner in the gross income disclosed by her 1936 income tax return. Respondent treated the amount as income distributable to petitioner during 1936, and, therefore, taxable to her as income in that year in the amount of $34,666.11 (entire dividend less certain taxes paid thereon by the trustees). The $34,666.11 was paid by the trustee to the petitioner during the year 1937. The corporation in its 1936 return took a credit for dividends paid and thereby reduced its liability for taxes. On December 31, 1937, the Paul Watkins Estate, Inc., purchased and retired the 6,450 shares of its preferred stock, series B, then owned and held by the trustees. In exchange for the stock, the corporation executed and delivered on December 31, 1937, to the trustees, a note in the face amount of $161,250, bearing interest at the rate of 4 1/2 percent*1441 per annum, commencing on January 1, 1938, but specifically payable for a full calendar year in advance on the 31st day of December in each year, beginning with the year 1937. That same day the corporate directors adopted a resolution as follows: BE IT FURTHER RESOLVED, That the officers of this corporation are forthwith directed to execute said notes and to make delivery thereof upon surrender of the certificates representing said $645,000 par value of Preferred B stock of this corporation and this date to make payment of the interest due upon said notes for the period ending December 31, 1938, said payment to be made to the extent of $19,425 in cash and by the issuance and delivery to said trustees of 96 shares of the 4% noncumulative preferred stock of The J. R. Watkins Company owned by this corporation * * *. Pursuant to the resolution a note was signed by the corporation. The following paragraph is an excerpt from that note: On or before December 31, 1943, or in event of the prior death of Florence H. Watkins, of Winona, Minnesota, then at the date of her death, for value received, the undersigned promises to pay to the order of Boston Safe Deposit & Trust *905 *1442 Company, Joseph R. Watkins, William B. Watkins, Florence H. Watkins, Trustees under indenture dated 4-23-28 made by Paul Watkins for the benefit of Florence H. Watkins and her issue - Number , One Hundred Sixty-one Thousand Two Hundred Fifty Dollars ($161,250), with interest from January 1, 1938, until paid at the rate of Four and one-half per cent (4 1/2%) per annum, such interest to be payable for a full calendar year in advance on the 31st day of December in each year beginning with the year 1937. Principal and interest are payable at the office of First National Bank and Trust Company of Minneapolis, Minneapolis, Minnesota. The interest authorized to be paid in cash and stock by the foregoing resolution was paid on December 31, 1937, by the corporation, and received on that date by the trustees. This interest in the amount of $29,025 ($19,425 cash and stock valued at $9,600), was included in gross income by the trustees in their income tax returns for the year 1937 and was not deducted by them under the provisions of section 162 of the Revenue Act of 1936, or paid in 1937 by the trustees to the petitioner or included by petitioner in the gross income disclosed by her income*1443 tax return for 1937. Respondent treated this $29,025 as income distributable to petitioner in 1937, and, after deducting certain taxes paid by the trustees, respondent determined that the amount of income received by the trustees during 1937 which was distributable to petitioner in 1937 was $22,021.66. This amount was paid by the trustees to the petitioner during the year 1938. The petitioner and the trustees prepared and filed Federal income tax returns for the years here involved on the cash receipts and disbursements basis. OPINION. KERN: As has been stated already, the issues in this controversy concern the prepaid dividends on the preferred stock and the prepayment of the interest on the note which was issued in place of the preferred stock certificates. The dividends due on the stock in the years 1936 and 1937 were paid to the trustees in the years 1935 and 1936, respectively, but were not distributed by them to the life beneficiary of the trust until 1936 and 1937. The interest on the note for the year 1938 was paid to the trustees in 1937 but was not distributed to the life beneficiary until 1938. The question presented is whether such items of income to the trustees*1444 are "to be distributed currently" within the meaning of section 162(b) of the Revenue Acts of 1934 and 1936, set out in the margin, 1 and, therefore, to be included in the taxable income *906 of the life beneficiary in the years in which they were received by the trustees, although not actually distributed until subsequent years. The decisive consideration is whether the amounts received by the trustees were paid to them as current income or whether they should be considered*1445 advances of income for succeeding years. Rental income, for instance, paid in advance to a trustee may not be distributed currently to the life beneficiary but must be held by the trustee and distributed periodically to the persons entitled thereto in each period when the rent would normally be paid. ; . On the other hand, a so-called "annual consideration payment" in the nature of a bonus to assure continued tenure after the expiration of a current lease is not treated as advance rental, but as current income distributable in the year of receipt. ; affd., . Likewise, ordinary dividends are distributable in full to the life beneficiary living at the time of declaration and are not apportionable between such beneficiary and the remainderman. ; . We must determine, first, under which of the foregoing rules the dividends fall. The dividends paid in December of 1935 and 1936 were, in a sense, ordinary dividends. They were not ordinary, however, in the*1446 sense of having been earned at the time of declaration and payment. The stock upon which they were paid was preferred stock paying 6 percent annual dividends and no more. For both 1935 and 1936 the full 6 percent had been paid and the stockholder was entitled to no more. When an extra payment was made in December of each year it was in the nature of an advance payment, analogous to the advance payment in , rather than a payment for current use of property as in the Malcom case, supra.Whether the trustees properly treated the dividends as income in the year of receipt is not before us for decision. As to the beneficiary, we are of the opinion that, in view of the dividends being advance payments, she was not entitled to them in the year of payment and they were, therefore, not currently distributable. The situation with respect to the interest paid in December 1937 is different from that as to the dividends. From the terms of the note on which the interest was paid it is clear that no interest on the principal was ever intended to be paid to the remainderman. The note recites that the interest is to continue until the*1447 principal is paid. The latter event was to take place "on or before December 31, 1943, or in the event of the prior death of Florence H. Watkins", the petitioner. Clearly all interest payments were for her sole benefit. And, since the remaindermen had no right to them, even contingently, we must conclude that the interest payment made on December *907 31, 1937, was currently distributable to the petitioner. Regardless of the fact that it was not distributed to petitioner until 1938, the entire amount is income taxable to the petitioner in the year 1937, since it was distributable to her in that year. Petitioner has conceded that an adjustment made by the respondent in the amount of $40, which was added to her gross income for the year 1935 is correct, and, consequently, this amount is no longer in issue. As to the refund for the year 1937 in the amount of $10.31, there has been no explanation or proof offered by the petitioner on this issue and, therefore, we disallow the claimed refund. Decision will be entered under Rule 50. Footnotes 1. SEC. 162. NET INCOME. The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that - * * * (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. * * * ↩