National Metropolitan Bank of Washington v. United States

Whitaker, Judge, delivered the opinion of the court: This is a suit to recover income taxes alleged to have been erroneously exacted. There is no dispute as to the facts. Christina Buchholz was the owner of the Occidental Hotel at Nos. 1411 and 1413 Pennsylvania Avenue Northwest, Washington, D. C., which she had acquired under the will of her husband Gustav Buch-holz, who died in June 192'5. In August of that year Christina Buchholz entered into a written agreement with her son, Frederick, plaintiffs’ decedent, transferring to him the goodwill and all the other assets of the Occidental Hotel, in consideration of his agreement to devote his best efforts to' the conduct of the business, to discharge all the obligations of the lease which the Occidental Hotel had on 1411 Pennsylvania Avenue NW., to pay all debts and taxes incident to said business, to maintain suitable insurance, and to make suitable repairs, and, in addition, to pay all debts of the — 39 — estate of Gustav Buchholz, all taxes thereon, all expenses of administration, and all legacies provided for in Gustav Buchholz’s will, and in further consideration of the right in Christina Buchholz to occupy, rent free, apartment “7-F” in 1411 Pennsylvania Avenue, and to pay to her as compensation for acting as housekeeper of the Hotel Occidental the sum of $200.00 a month. As the profits of the hotel business accumulated they were credited on the hotel’s books to Frederick W. Buchholz’s personal drawing account. From year to year he withdrew such portion of these profits for his own personal use as he desired. Between January 1, 1944, and November 22, 1944, the date of his death, he withdrew from the profits of the business a total of $65,174.23, but at the time of his death there remained a balance in his account on the books of the hotel of $36,346.64. His executors included this balance in his income for the period and paid income taxes on it. Later they decided it should not have been included and they filed a claim for refund of the additional taxes resulting from its inclusion. This claim was denied and this suit was brought. The agreement between plaintiffs’ decedent and his mother provided for the following, in the event of the death of Frederick W. Buchholz during his mother’s lifetime: It is further agreed by the parties hereto that if during the lifetime of the party of the first part [Christina Buchholz], the party of the second part [Frederick Buchholz] shall die, or for any other reason cease to carry on the aforesaid business, except upon the written consent of the party of the first part, the said business, and all rights and interests whatsoever therein of the party of the second part, and all and singular the assets, of whatsoever character, connected therewith, shall forthwith revert to and become the property of the party of the first part, and all right, title and interest whatsoever of the party of the second part therein shall absolutely cease and determine * * *. Under this clause of the contract Christina Buchholz took over all the assets of the business on her son’s death, including the balance remaining in his drawing account. The parties agree that she is entitled to this balance in his drawing account under this provision of the contract, and it was stated — 40 — in oral argument that the United States District Court for the District of Columbia had so decreed. An appeal was taken to the Court of Appeals and the majority of that court affirmed in a per curiam opinion. National Metropolitan Bank of Washington v. Doherty, 160 F. 2d 580. The opinion read : The District Court granted appellee’s motion to dismiss appellant’s complaint on the ground that it failed to state a claim on which relief could be granted. The question turned on the interpretation of a contract. A majority of this court are of opinion that the District Court’s interpretation is correct. The judgment is therefore affirmed. We are of the opinion that under this interpretation of the agreement between plaintiffs’ deceased and his mother, this balance in his account was not income to him and should not have been included in his gross income for the taxable period. There can be no doubt that Frederick W. Buchholz had the right to withdraw this balance from the business at any time for his own personal use, but the contract has been interpreted to mean that if he had not actually done so prior to his death, his estate was not entitled to it, but upon his death it became the property of his mother. We would have experienced some difficulty in determining whether or not the estate of Frederick Buchholz was entitled to these profits under the contract, but this difficulty has been removed by the decree of the District Court, affirmed on appeal. If this balance did not become a part of his estate, but went to his mother at his death, not by inheritance, but by virtue of the contract, then it was not his income, but was his mother’s income, accruing to her as one who had an interest in the business. Whether or not his mother, or her estate, should pay taxes on it is not before us, but we are convinced that under the contract, as it has been interpreted, it was not Frederick Buchholz’s income. As the contract has been interpreted, Frederick’s right to the profits of the business was contingent on his withdrawal of those profits prior to his death. If he died before he had withdrawn them, the profits went, not to his estate, but to his mother. Before his death, he was undoubtedly entitled — 41 — to the profits; but death intervened, whereupon the profits went to his mother. If they were his mother’s profits, they could not have been his. Plaintiffs also contend that if this be considered to have been income to decedent, then he is entitled to have this income diminished by the amount of it because he had to give it back. Defendant says this is not true because it continued to be his income until he died and, therefore, he did not have to give it back within the taxable period. We do not face this question because we do not think it was his income anyway; but we are of the opinion that his estate should not have to pay income taxes on it, since his estate never received the benefit of it, it having gone under the contract, not to his estate, but to his mother. Plaintiffs also claim a loss of the amount decedent paid for the transfer of the business to him. The consideration for the transfer was his agreement to pay all debts of the estate of his father, Gustav Buchholz, all taxes thereon, all legacies in his father’s will, and the expenses of the administration of his estate. The total amount paid by him for these purposes amounted to $12,010.97. His executors claim this amount as a loss in the taxable period in which he died. The contract between him and his mother, under which the hotel business was transferred to him, provided that the business should become his absolutely if his mother died during his lifetime and he was still operating the business; but if he died first, the business was to revert to his mother. Had he outlived his mother, his original investment would have been unimpaired by his death; but, having predeceased his mother, it was wiped out on his death, leaving nothing to go to his estate. When he died, then, he lost his original investment. Since this was a loss “incurred in trade or business,” his estate is entitled to deduct it under section 23 (e) (1) of the Internal Revenue Code (26 U. S. C. (1946 Ed.) sec. 23). This is in harmony with the opinion of the Tax Court in Gannon v. Commissioner, 16 T. C. 1134. In that proceeding there was involved the right of Gannon to deduct the amount he had paid into the law firm of Baker, Botts, Parker and Garwood of Houston, Texas, for a 6.2 percent interest in — 42 — that firm. His contract with the firm provided that he was to forfeit the amount he had paid for his interest in case he withdrew from the firm during his lifetime. He did withdraw and claimed the amount paid as a loss incurred in trade or business. The Tax Court held that he was entitled to it. The Commissioner of Internal Bevenue acquiesced in the holding. 1951-52 C. B. 2. This holding was reiterated in Palmer Hutcheson v. Commissioner, 17 T. C. 14. It is said, however, that he could not have sustained a loss because there, was more cash in the business at the time he took it over than the amount he paid out in discharge of his agreement to pay the debts, taxes and expenses of administration of the estate of Gustav Buchholz. There was a balance of $24,330.48 to the credit of the Occidental Hotel in the Merchant’s Bank and Trust Company of Washington, D. C., which was double what he paid out in discharge of his obligations under the contract with his mother. However, we do not think that Frederick Buchholz had the right at the time he took over the business to withdraw this balance for his own personal use. It is true that the cash on hand was transferred to him by his mother, together with all the other assets of the hotel business; but it was an asset to be used in the conduct of the business, just as the tables, chairs, dishes, etc., were to be used. It was working capital and could no more have been withdrawn by Buchholz for his own personal use than he could have sold the furniture and equipment of the business and put the proceeds of the sale in his pocket. All that Buchholz was ever entitled to was the profits of the business, and it was only the profits that were credited to his account. (Commissioner’s finding 7, to which no exception was taken.) He had no right to waste the assets of the business, and impair the reversionary interest of his mother. His obligation was to use the assets turned over to him in the conduct of the business. He agreed “to devote his best efforts to the conduct of said business.” Had he withdrawn all the cash in the bank and had no money left to meet his payroll and to buy food and supplies, he would have fallen far short of devoting his best efforts to the conduct of the business. Since he could withdraw only the — 43 — profits of the business for his personal use, it is immaterial that there was more money in the bank than he paid for the business. The defendant sets out on page 70 of its brief section 43 of the Internal Revenue Code, as amended by section 134 (b) of the Revenue Act of 1942 (56 Stat. 798, 830), the last sentence of which reads: In the case of the death of a taxpayer whose net income is computed upon the basis of the accrual method of accounting, amounts (except amounts includible in computing a partner’s net income under section 182) accrued as deductions and credits only by reason of the death of the taxpayer shall not be allowed in computing net income for the period in which falls the date of the taxpayer’s death. This is inapplicable to the question before us. It means that if a deduction would not have accrued until after the taxpayer’s death, had he not died, his death will not cause it to accrue in the period just before his death so that it may be deducted in that period. It does not mean that a recognized deduction occasioned by death cannot be deducted. The report of the Senate Finance Committee on the Eeve-nue Act of 1942, on pages 100 and 101, reads: * * * These subsections further provide that amounts (other than amounts includible by a partner under section 182 in computing net income) which would be includible in the income of, or allowable as deductions and credits to, a decedent who keeps his books on the basis of the accrual method of accounting solely by reason of his death shall not be included in computing his income for the taxable period in which falls the date of his death. The purpose of this provision is to insure that with respect to the determination of the decedent’s income for his last taxable period the death of the decedent will not effect any change in the accounting practice by which the decedent determined his income during his life. Thus, upon the dissolution of a partnership because of the death of a partner the income of the partnership for the year ending with the dissolution, computed only according to the practice of the partnership in properly keeping its books, is included in the income of the deceased partner. For example, if a law partnership, keeping its books on the accrual basis, is entitled to certain contingent fees which are only accrued — 44 — upon the completion of the cases involved, such partnership will compute its tax for the year ending with the dissolution without accruing, on account of the death of the partner at such time, any such contingent fees in uncompleted cases. The report of the House Committee reads, on page 84: * * * These subsections further provide that amounts (other than amounts includible by a partner under section 182 in computing net income) which would be includible in the income of, or allowable as deductions and credits to, a decedent who keeps his books on the basis of the accrual method of accounting solely by reason of his death shall not be included in computing his income for the taxable period in which falls the date of his death. The purpose of this provision is to insure that with respect to the determination of the decedent’s income for his last taxable period the death of the decedent will not effect any change in the accounting practice by which the decedent determined his income during his life. Thus, upon the dissolution of a partnership because of the death of a partner, the income of the partnership for the year ending with the dissolution, computed only according to the practice of the partnership in properly keeping its books, is included in the income of the deceased partner. This section has no application to our question. Nor is section 24 (b) (1) (A) of the Internal Revenue Code applicable. This disallows “losses from sales or exchanges of property” “between members of a family.” What this statute means is that if I sell to a member of my family a piece of property at less than I paid for it, I cannot deduct the difference as a loss. The loss here was not a loss from a sale or exchange of property; it was a loss occasioned by death. Dealings between close members of a family often are not arms-length transactions. Frequently the property may be sold for more or less than it is worth; and, hence, it is no true measure of a loss, or evidence of a loss at all. The statute was designed to take care of such a situation. Here the loss did not result from a sale, but from the death of the owner of the property. Section 24 (b) (1) (A) is not applicable. — 45 — The plaintiffs are entitled to recover on both items. Entry of judgment will be withheld until the incoming of a stipulation by the parties, or, in the absence o fa stipulation, until the incoming of a report by a Commissioner of the court, showing the amount due plaintiffs computed in accordance with this opinion. It is so ordered. Howell, Judge; and Littleton, Judge, concur.