Grunbaum v. Commissioner

OTTO S. GRUNBAUM, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Grunbaum v. Commissioner Docket Nos. 99318, 99319. United States Board of Tax Appeals 44 B.T.A. 810; 1941 BTA LEXIS 1271; June 25, 1941, Promulgated *1271 Petitioner has continuously resided in the State of Washington for the last 46 years. Prior to October 7, 1919, he was unmarried. On the latter date he married and that marital relation has existed at all times since. On and prior to April 30, 1919, petitioner owned 125 shares of the 250 shares of outstanding stock of a corporation. On the latter date a contract was executed whereby petitioner purchased from the owners the remaining 125 shares of such corporation stock for the agreed price of $100,000, payable $10,000 down and the balance in monthly installments of $5,000 each. Certificates for the purchased stock were issued to and in the name of petitioner, who thereupon endorsed them in blank and placed them in the custody of an escrow agent under an agreement that upon the full payment of the purchase price the certificates were to be surrendered to petitioner, but that if there should be default as to any installment payment petitioner's rights in the stock and all payments thereon should be forfeited and the certificates delivered to the sellers. In the latter event the sellers were to be immediately reelected to the same positions as directors and officers of the corporation*1272 they held at the time of the purchase by petitioner. Upon the execution of the contract of purchase, the sellers resigned as directors and officers of the corporation and petitioner assumed complete control and management thereof through exercise of full proprietary interest in the entire stock of the corporation. Petitioner paid $30,000 of the purchase price of the stock prior to his marriage. After marriage he paid thereon $50,000 from dividends received from the corporation and $20,000 from sources not disclosed, and the certificates of stock were surrendered to petitioner, who continued to hold them through the taxable years 1936 and 1937. Held, that the dividends received on such stock in the taxable years were the separate property of petitioner and properly includable as income in computing his tax liability. George E. H. Goodner, Esq., for the petitioner. B. H. Neblett, Esq., for the respondent. HILL *811 Respondent determined deficiencies in petitioner's income tax for the years 1936 and 1937 in the respective amounts of $3,024.01 and $1,688.35. The issue before the Board is whether or not dividends received on stock standing*1273 in petitioner's name were taxable to him as income from separate or from community property. FINDINGS OF FACT. Petitioner is an individual, residing in Seattle, Washington, and has lived there continuously during the last 46 years. His income tax returns for the years 1936 and 1937 were filed with the collector of internal revenue for the district of Washington. Petitioner is engaged in the retail furniture business. The business is incorporated under the name of "Grunbaum Bros. Furniture Company, Inc." and is hereinafter referred to as the company. Petitioner has been president of the company since 1920. Prior to that time he was secretary of the company. On and prior to April 30, 1919, petitioner was the owner of 125 of the 250 shares of stock of the company then outstanding. Andrew J. Woodhouse and his wife owned the remaining shares and they with petitioner were the three directors and officers of the company. On April 30, 1919, petitioner entered into an agreement with Woodhouse for the purchase, for a total consideration of $100,000, of the 125 shares of stock held by Woodhouse and his wige. The agreement provided in material part as follows: 1. That the*1274 party of the first part has sold and transferred to the party of the second part one hundred and fifteen (115) shares of stock in said corporation and has caused to be transferred to said second party ten shares (10) of said stock belonging to his said wife, making a total of One Hundred Twenty-five (125) shares at the agreed sale price of One Hundred Thousand Dollars ($100,000), to be paid by party of the second part as herein provided, * * * The remainder of the paragraph quoted above in part provided that upon the execution of the agreement petitioner should pay Woodhouse the sum of $10,000 in cash and real estate, leaving a balance of $90,000 to be paid in monthly installments of $5,000 each, beginning July 1, 1919. The agreement further provided: 2. Said One Hundred Twenty-five (125) shares of stock is to be immediately transferred to the second party (petitioner) herein and new certificates - one for 115 shares and one for 10 share - are to be issued to the second party herein and to be immediately endorsed in blank and put in escrow in the Seaboard National Bank under the terms of an escrow agreement, a copy of which is hereto attached marked "Exhibit A" and hereby made*1275 a part hereof, and the parties hereto especially agree to the terms of said escrow agreement making time whether mentioned therein or herein the essence thereof and hereof, and it is understood and agreed between the parties hereto that if the *812 second party shall default in any of the payments and the first party shall then take the stock under said escrow agreement that an election of officers shall then and forthwith be held, at which said election the first party and his said wife shall be chosen as trustees of said corporation and the second party is to eliminate all other parties as trustees or stockholders in said corporation except only the second party, to the end that the first party and his wife will be reinstated in said corporation and occupy the same positions that they do this date, and the second party occupy the same position he does this date, both as to stock and trustees. The 125 shares of stock of the company owned by Woodhouse and his wife were transferred to petitioner, who endorsed the shares in blank and deposited them in escrow with the Seaboard National Bank of Seattle on April 30, 1919. The deposit in escrow was governed by an agreement by*1276 which petitioner and Woodhouse instructed the bank: * * * that when and if the undersigned, Otto S. Grunbaum, shall pay to you the sum of Ninety Thousand ($90,000) Dollars at or before the times mentioned in said agreement, you are then to hand over the two certificates above named to Mr. Grunbaum or his written order, and if the undersigned, Mr. Grunbaum, shall default in any of the payments to be made in the amounts and at the times to be made as in said attached agreement provided and shall remain in default for a period of ten days then and in that instance you are to deliver over to the undersigned, Mr. Woodhouse, or his order the two certificates of stock hereinabove mentioned and without notice to Mr. Grunbaum. It is especially agreed that time wherever mentioned herein is the essence hereof. Prior to October 7, 1919, petitioner was unmarried. On that date he married Adelaide Grunbaum and since then such marital relation has continued. At the time of petitioner's marriage he owned at least 113 shares of the 125 shares of the company's stock owned by him prior to the purchase of the Woodhouse shares. At the time of his marriage petitioner's only assets were his stock*1277 in the company and personal effects. Prior to October 7, 1919, in addition to the $10,000 paid upon execution of the contract, four monthly payments of $5,000 each were made in accordance with the contract of April 30, 1919. The remainder of the purchase price was paid monthly pursuant to the agreement, and upon payment of the last installment on December 10, 1920, the stock in escrow was delivered to petitioner. Upon the execution of the contract and pursuant thereto Woodhouse and his wife resigned as directors and officers of the company. Thereupon other directors and officers were elected and the management and control of the company passed to petitioner. The company paid dividends to petitioner on its 250 shares of stock in the years 1919 and 1920 in the following amounts: [1919] Amount [1920] Amount May 31 $5,000 Jan. 31 $5,000 July 31 5,000 Feb. 28 5,000 Aug. 30 5,000 Mar. 31 5,000 Sept. 30 5,000 May 30 5,000 Oct. 31 5,000 June 30 5,000 Nov. 30 5,000 July 31 5,000 Dec. 31 5,000 Aug. 31 5,000 Total 35,000 Total 35,000 *813 It is conceded by petitioner on brief that the dividends so paid were*1278 applied as payments on the stock purchased from Woodhouse. Petitioner paid $30,000 on such purchase price before his marriage and $70,000 after his marriage. Of the $70,000 so paid, $50,000 came from dividends on the 250 shares of the company's stock and the remaining $20,000 thereof came from sources not disclosed. Petitioner received as salary in 1919 and 1920 $6,680 and $7,266.57, respectively, and his wife received as salary during those years $805 and $950, respectively. In 1921 the Attorney General of the United States issued an opinion to the effect that husbands and wives who were residents of the State of Washington were permitted to file tax returns on the community property basis. From the date of their marriage until the opinion of the Attorney General regarding returns of community property was promulgated, petitioner and his wife filed income tax returns on a noncommunity property basis. After learning of the Attorney General's opinion, petitioner and his wife filed amended returns on a community property basis dating back to the time of thrir marriage. Petitioner's amended income tax returns for the years 1919 and 1920, which were on the community property*1279 basis, reported dividends from the stock of the company in the sum of $35,000 for each year as petitioner's separate property. Thereafter petitioner and his wife in their income tax returns reported all of their income as community property. As a basis therefor petitioner presented testimony for the purpose of showing an oral agreement between himself and wife at or about the time of their marriage by which the separate property of each was converted into community property. We find that there was no such sgreement. At a special meeting of the shareholders of the company held December 24, 1923, the following resolution was presented and adopted: RESOLVED, That the capital stock of the Grunbaum Bros. Furniture Company, Inc., be increased from $25,000.00 consisting of 250 shares of the par value of $100.00 each, to $400,000.00 consisting of 4,000 shares also of the par value of $100.00 each, such increase of $375,000.00 representing a stock dividend of *814 $330,000.00 chargeable against, or payable out of, the net earnings of the corporation, and $45,000.00 which has been subscribed for and paid. AND BE IT FURTHER RESOLVED, That Article II of the Article of Incorporation*1280 of Grunbaum Bros. Furniture Company, Inc., be amended to read as follows: "The capital stock of this corporation shall be $400,000.00, divided into 4,000 shares of the par value of $100.00 each." Pursuant to the resolution of the shareholders of the company adopted December 24, 1923, the company declared a stock dividend so that each share of stock outstanding was multiplied 14.2 times. The 250 original shares plus the stock dividends totaled 3,550 shares. The remaining 450 shares of stock authorized were sold by the company. Petitioner purchased 434 of the 450 shares of stock sold. On January 1, 1936, and throughout the years 1936 and 1937, 3,372.92 shares of the company's stock were held in petitioner's name and 46.2 shares were in the name of petitioner's wife. Of the shares held in petitioner's name, 1,096.4 shares were derived from the 113 shares owned by petitioner at the date of his marriage and were his separate property; 1,775 shares were derived from the 125 shares purchased from Woodhouse. Of these latter shares at least 80 percent of the purchase money came from petitioner's separate property and 20 percent from a source not disclosed by the record. Such latter*1281 shares were also petitioner's separate property. The remainder of the 3,372.92 shares of stock held in the name of petitioner, to wit, 501.52, was acquired subsequent to his marriage and was the community property of petitioner and his wife. The 46.2 shares held by petitioner's wife were derived from the 113 shares held by petitioner at the time of his marriage. They were gifts to her by petitioner and were her separate property. The company paid a dividend of $9 a share in 1936 and $6.50 a share in 1937. Petitioner and his wife received the dividends at those rates on stock standing in their names, the total number of such shares being 3,419.12. On December 23, 1937, petitioner and his wife executed an instrument entitled "Declaration Converting Separate Property Into Community Property." This agreement contained the following provisions: * * * for and in consideration of the love and affection we each bear toward the other, and further in consideration of the mutual helpfulness we have been one to the other in the past, and for and in consideration of the co-mingling of our joint efforts and earnings and properties heretofore, do hereby mutually agree one with the other*1282 that every piece, parcel, lot and tract of land, whether situated in the city of Seattle, King County, State of Washington, or elsewhere, and each and every part of the personal property of whatsoever kind, name and nature and wheresoever situated, shall be by us and all persons whomsoever, deemed, esteemed, regarded, treated and known as community property. In this agreement so made one with the other, the date of acquiring, the manner of acquiring and all statements by either of us heretofore *815 made respecting alleged separate property of whatsoever kind, name or nature and wheresoever situated, or affecting any property, is to be regarded and esteemed as of no effect, the full intent and purpose of this instrument is to be construed by the courts, our heirs, executors and assigns and by all other persons whomsoever, as a voluntary conveyance and unitedly to the community of all our earthly possessions in such form and manner that the same shall from this date be the property of the community of ourselves as husband and wife. This instrument was executed after petitioner received notice that respondent considered the shares in the company to be petitioner's separate*1283 property rather than community property. Petitioner and his wife have one child, a daughter, Luba Grunbaum. On December 4, 1935, 320 shares of the company's stock were transferred from petitioner to a trust for Luba Grunbaum. Petitioner and his wife filed separate income tax returns for the years 1936 and 1937, each reporting one-half the dividends both received on the company's stock. On his original return for 1936 petitioner reported dividends from the company's stock in the sum of $33,652.08, but stated that they were community income. He reported one-half thereof as his income and computed his tax accordingly. On or about April 29, 1937, petitioner filed amended returns for himself and wife for the year 1936, in which he excluded $2,880 from gross income representing dividends paid on 320 shares of stock of the company which had been transferred by petitioner to the Luba Grunbaum trust in 1935. The amended returns reported as community income dividends on 3,419.12 shares of stock of the company at $9 a share, a total of $30,772.08. Petitioner filed claims for refund for himself and his wife for $302.40 each, plus interest on amounts overpaid on 1936 income tax returns. *1284 In his income tax return for 1937 petitioner reported as community income dividends from 3,419.12 shares of stock of the company at $6.50 a share, a total of $22,224.28. He reported one-half thereof as his income and computed his tax accordingly. In determining deficiencies in petitioner's income tax for the years 1936 and 1937 respondent treated as petitioner's separate property 1,775 shares of stock of the company which were derived from 125 original shares purchased from Woodhouse and wife under the agreement of April 30, 1919. Respondent also treated as petitioner's separate property the 1,096.4 shares derived from the 113 shares of stock of the company held by petitioner at the date of his marriage on October 7, 1919. Respondent added one-half of 501.52 shares owned by the community to the total of the shares which respondent had included as separate property of petitioner and determined that petitioner was taxable on dividends received in the years 1936 and 1937 from 3,122.16 shares of stock of the company. *816 OPINION. HILL: The issue before us is whether or not dividends on stock owned by petitioner before his marriage and stock acquired by contract entered*1285 into before his marriage are includable in petitioner's gross income as income from separate property. Petitioner contends that he and his wife orally agreed at the time of their marriage that all separate property of each of them should be community property. He asserts that this agreement was reaffirmed throughout their marriage and was finally put in written form in 1937. He urges two alternative contentions. He contends that even if we find that there was no oral agreement which converted separate property into community property, the 125 shares of stock subject to the escrow agreement were acquired after marriage and dividends from those shares and their increment are community income. Petitioner's second alternative contention is that, if we find that there was no oral agreement and hold that the stock in escrow was not acquired after marriage, then at least $20,000 of the purchase price of the Woodhouse stock was paid from community funds and one-fifth of those shares became community property. Respondent contends that the contract between petitioner and Woodhouse marked the acquisition of such stock by petitioner as his separate property. Respondent argues that the*1286 evidence is insufficient to establish an oral agreement between petitioner and his wife converting their separate property into community property. The applicable provisions of law are Remington's Revised Statutes of Washington, sections 6890 and 6892. 1 *1287 We are of the opinion that petitioner has not presented sufficient evidence to establish the existence of an oral agreement between himself and his wife. The only evidence regarding the alleged oral agreement was the testimony of petitioner and his wife. This evidence is counterbalanced by the fact that petitioner reported as his separate property dividends from the company's stock in both his original and amended income tax returns for the years 1919 and 1920. Petitioner testified that neither he nor his wife had ever mentioned the agreement to any one before the controversy giving rise *817 to this proceeding. The instrument entitled "Declaration Converting Separate Property Into Community Property", executed by petitioner and his wife on December 23, 1937, neither refers to a preexisting oral agreement nor suggests the existence of one. The title of the instrument, together with the phrase "shall from this date be the property of the community of ourselves as husband and wife", to our mind, completely negatives the testimony in regard to the alleged oral agreement. It is necessary, therefore, that we consider petitioner's alternative contentions. Petitioner argues*1288 that he did not acquire the 125 shares of the company's stock from Woodhouse until the stock was released from escrow in 1920. He points to the provision of the escrow agreement under which the bank was instructed to deliver certificates of stock to Woodhouse in the event of default by petitioner and contends that he had no property in the stock until he had fulfilled his obligations under the contract. We do not agree with this contention. Petitioner, prior to his marriage, acquired the stock from Woodhouse by purchase, subject to forfeiture of the stock and all payments thereon in case of default in making payment of the purchase price. There was no default and such payments were completed more than a year after petitioner's marriage and thereupon the certificates of stock issued in his name were surrendered to him by the escrow agent. Immediately upon the execution of the contract of purchase the stock ownership of Woodhouse and wife ceased and he and his wife accordingly resigned as directors and officers of the company and surrendered the full management and control therof to petitioner. The latter thereupon, in the exercise of full proprietary rights in the entire stock*1289 of the company, had the company declare and pay to him monthly dividends on all of its outstanding stock in amounts equal to the monthly installments due on the price of the stock purchased. These dividends were applied on such purchase price to the extent of $70,000. The evidence and concessions by petitioner show that at least $80,000 of the purchase money was paid from the separate funds of petitioner. The evidence does not disclose the source or character of the funds with which the remaining $20,000 of the purchase price was paid. We have previously considered the question of whether or not rights under a contract which after marriage materialize into legal title are separate or community property in the State of Washington. . In that case we stated: It is quite obvious that the petitioner had much more than, as he contends, a mere option to buy the stock. He had a right to have the dividends which might be declared on such stock applied by the stockholders toward the purchase of the stock for himself. While not owning legal title to the tree, in other words, he was to be given its fruits; the right to enjoy the fruits being, *1290 of course, one *818 of the most important incidents of ownership. * * * We are of the opinion that petitioner's contract right on January 1, 1924, which later brought him title to the company's shares, was one of real substance and clearly "property" within the meaning of the Washington statutes. And we are of the opinion that petitioner's "property" was acquired before March 4, 1924, when he married. It has been said: As between husband and wife, when a right, legal or equitable, is acquired whether before or during marriage, all things of value into which the initial right develops by the performance of conditions, the running of time or the like, or into which it is converted by an assignment, or if the initial right rests in obligation, all that which is obtained through the performance, discharge, satisfaction, enforcement or assignment of the obligation, are deemed in law to have been acquired as of the date of the acquisition of the initial right, and take the character, as separate or common, of that right. (McKay Sec. 517, p. 352.) * * * * * * There is no doubt on the authorities that this rule obtains in Washington. *1291 The date of acquisition of property determines its character as separate or community property, (Washington); and cases therein cited. And the date of acquisition taken is that when the equitable interest arises and not when the legal title is transferred, ; (Washington); (Washington); (Washington). The same rule appears to be general, as stated by McKay, § 533, supra, and to obtain also in Nevada, ; and in California, . Cf. 5 R.C.L. 834. In the case of , the Supreme Court of Washington stated: It is the rule in this state that the status of property, whether real or personal, becomes fixed as of the date of its purchase or acquisition, and that the status, when once fixed, retains its character until changed by agreement of the parties or operation of law. Property acquired*1292 through contractual obligation, as between husband and wife and all others claiming under them, has its origin and is acquired as of the date when the obligation becomes binding, and not as of the time when the money is paid or the thing is delivered or conveyed. The fruit of the obligation is legally acquired as of the date when the obligation becomes binding. On these authorities we hold that petitioner acquired the Woodhouse stock at the time of the execution of the contract of purchase thereof, to wit, April 30, 1919, and that it became thereby his separate property. Petitioner presents as an alternative contention that upon the basis of the facts as we have found them at least 20 percent of the purchase price of the Woodhouse stock was paid with community funds and that therefore such stock to the extent of 20 percent thereof was the community property of petitioner and his wife. This contention is apparently based on the fact that under the laws of Washington property acquired by a spouse during the marital relation is presumed prima facie to have been acquired with community *819 funds and is therefore presumed prima facie to be community property. This*1293 presumption can not be availed of by petitioner for the reason that the stock in question was not acquired by petitioner during the existence of the marital relationship. It was acquired before his marriage. Under the laws of Washington there is no presumption that payment during the existence of the marital relation on the purchase price of property acquired before marriage is made with community funds. To establish such fact direct and positive evidence is required. "Moreover, the right of the spouses in their separate property is as sacred as is the right in their community property, and, when it is once made to appear that property was once of a separate character, it will be presumed that it maintains that character until some direct and positive evidence to the contrary is made to appear." ; , cited with approval in . Since the stock purchased from Woodhouse became petitioner's separate property at the time of its purchase on April 30, 1919, and was his separate property at the time of his marriage, the petitioner, in order to support his*1294 contention that the stock or any percentage thereof became community property after his marriage, had the burden of showing by evidence that the purchase price of the stock or a part thereof was paid from community funds. There is no such evidence in the record. We hold, therefore, that the stock purchased by petitioner from Woodhouse and the shares of stock subsequently derived therefrom as the result of a stock dividend distributed by the company to petitioner were his separate property during the taxable years 1936 and 1937. The number of shares of such stock was 1,775. We hold further that the 113 shares of the company's stock owned by petitioner at the time of his marriage, other than that purchased from Woodhouse, and the stock derived therefrom as the result of a stock dividend distributed by the company to petitioner, were the separate property of petitioner in such taxable years. The number of shares of such stock was 1,096.4. We hold further that 501.52 shares of the company's stock held in the name of petitioner were the community property of petitioner and his wife in the taxable years and that petitioner owned a community onehalf interest therein. It follows that*1295 the dividends distributed by the company in the taxable years 1936 and 1937 on 2,871.4 shares of the company's stock were income to petitioner as his separate property and that one-half of such dividends distributed on 501.52 shares represented community income to petitioner, all of which is properly includable in petitioner's income in computing his tax liability for the years in question. This is in accordance with respondent's determination. Decision will be entered for respondent. Footnotes 1. SEC. 6890. Separate property of husband. Property and pecuniary rights owned by the husband before marriage, and that acquired by him afterward by gift, bequest, devise or descent, with the rents, issues, and profits thereof, shall not be subject to the debts or contracts of his wife, and he may manage, lease, sell, convey, encumber, or devise, by will, such property without the wife joining in such management, alienation, or encumbrance, as fully and to the same effect as though he were unmarried. [Section 6891 contains similar provisions with respect to the wife.] SEC. 6892. Community property defined - Husband's control of personalty. Property, not acquired or owned as prescribed in the next two preceding sections, acquired after marriage by either husband or wife, or both, is community property. The husband shall have the management and control of community personal property, with a like power of disposition as he has of his separate personal property, except he shall not devise by will more than one-half thereof. ↩