223 F.2d 218 (3rd Cir. 1955), 11305, Gallagher v. Smith

Docket Nº:11305.
Citation:223 F.2d 218
Party Name:Immaculata GALLAGHER, also known as Lottie Gallagher, Appellant, v. Francis R. SMITH, Former Collector of Internal Revenue for the First District of Pennsylvania, and United States of America.
Case Date:June 03, 1955
Court:United States Courts of Appeals, Court of Appeals for the Third Circuit

Page 218

223 F.2d 218 (3rd Cir. 1955)

Immaculata GALLAGHER, also known as Lottie Gallagher, Appellant,


Francis R. SMITH, Former Collector of Internal Revenue for the First District of Pennsylvania, and United States of America.

No. 11305.

United States Court of Appeals, Third Circuit.

June 3, 1955

Argued Nov. 1, 1954, Reargued Feb. 21, 1955.

Page 219

Herman J. Obert, Philadelphia, Pa., for appellant.

Carolyn R. Just, Washington, D.C. (H. Brian Holland, Asst. Atty. Gen., Ellis N. Slack, Carolyn R. Just, Sp. Assts. to Atty. Gen., W. Wilson White, U.S. Atty., on the brief), for appellee.

Before BIGGS, Chief Judge, and MARIS, GOODRICH, McLAUGHLIN, KALODNER, STALEY and HASTIE, Circuit Judges.

MARIS, Circuit Judge.

The issue presented on this appeal is whether all or only one-thirteenth of the net income of a trust fund created by the will of the plaintiff's deceased husband is taxable, for income tax purposes, against her. The dispute arises out of the following facts:

The testator, Edward A. Gallagher, a resident of Philadelphia, Pennsylvania, died on March 19, 1942, survived by his widow, who is the plaintiff, and thirteen children. By the terms of his will he created a trust during the lifetime of his widow or until her remarriage. In the event of her death or remarriage the estate was to be distributed among twelve

Page 220

of his children, one son, Edward Gallagher, Jr., being expressly excluded from participation. The will, in pertinent part, provides as follows:

'One: I hereby devise, give and bequeath all of my estate, real and personal of whatsoever nature and wheresoever situated to my wife Immaculata, also called Lottie, and my attorney Louis Marion, Esquire as Trustees in Trust nevertheless to and for the following uses and purposes:

'A. To hold, invest, re-invest and to receive the income therefrom and distribute the same to my wife Immaculata also called Lottie, for her benefit, maintenance and support and that of all my children living with her at the time during the term or period of her natural life or as long as she shall remain unmarried.

'B. Upon the death of my wife or if, as and when she remarries the balance of my estate, assets and property, with any accumulated income therefrom then in the possession and control of my said trustees shall be distributed in equal shares among my children and issue of all deceased children as may be living at the time fixed for the said distribution equally per stirpes except my son Edward Gallagher, Jr. who shall not in any way, manner or form be entitled to or share in my estate whatsoever.

'C. If at the time of such distribution to my children any of them shall be minors, then I hereby direct, appoint and designate my son Arthur and my daughter Rita to act as Guardians of the estate of said minors without their being required to furnish any bond or security for their faithful performance as such guardians, and with full power and authority given to them to hold, invest re-invest and distribute the income and principal thereof for the maintenance, welfare and support of such minor children in such sums and amounts as to them shall seem fit and proper.

'Four: I do further declare that all and any assets, income, property or estate herein devised and bequeathed to my said Trustees shall be during the period of the said Trust and until distribution and payment thereof is made to my children, in accordance with the terms thereof free and clear of any or all debts, contracts, transfers, hypothecations and anticipations of my wife or children and also free and clear of any and all debts, levies, attachments, executions and sequestrations in any proceedings against them.'

At the time of the testator's death he owned an 85% interest in the partnership of E. A. Gallagher & Sons, which consisted of the testator and his son, Arthur A. Gallagher. By the terms of Paragraph Two of the will the testator authorized his trustees to continue his interest in the business and conferred upon them every power he might have possessed in respect thereto if living. Pursuant to this authorization the trustees and the surviving partner continued the business and the trustees received 85% of the net income therefrom. The entire net trust income for the taxable period from March 20, 1942 to December 31, 1942 was reported in the individual federal income tax return of the plaintiff. For the years 1943 through 1948 the plaintiff and twelve of testator's children (being all of his children except Edward, Jr.) each reported a one-thirteenth part of the income of the trust estate upon their individual income tax returns.

On December 2, 1947 the plaintiff executed a paper entitled 'Confirmation of Release and Disclaimer' by which she confirmed her release, disclaimer and renunciation of all past, present and future interest as beneficiary of the trust or under the intestate laws of Pennsylvania in excess of one-thirteenth of the distributable trust income. On June 10, 1948, the first account of the trustees

Page 221

was called for audit before the Orphans' Court of Philadelphia County, Pennsylvania. The account had been filed in order that its confirmation might provide a basis for the discharge of Louis Marion as a co-trustee under the will. Notice of the filing of the trustees' account and of the date of the audit was sent to the Internal Revenue Agent in charge at Philadelphia. On June 29, 1948 the Orphans' Court filed its adjudication confirming the account and awarding the balance of income for distribution in equal shares to the taxpayer 'and testator's twelve children entitled under his will.'

Assessments for deficiencies of income tax for the years 1943 through 1948 were made by the Commissioner of Internal Revenue against the plaintiff on his October, 1950 assessment list pursuant to a notice of deficiencies sent June 20, 1950. On November 14, 1950 the plaintiff paid under protest $600.00 on account of the deficiency assessment for each of the six years, a total of $3, 600.00, and instituted the present action in the District Court for the Eastern District of Pennsylvania to recover this amount as an overpayment. She asserted that the Commissioner had assessed the deficiencies against her on the alleged ground that all of the distributable trust income was taxable to her and that the assessment was illegal because, as she contends, she was entitled by law to only a one-thirteenth share thereof which she had received and properly reported as taxable income. She also asserted that in any event she had released and disclaimed any greater interest in the trust estate. Furthermore she contended that her interest under the will had been adjudicated to be only a one-thirteenth share by the Orphans' Court of Philadelphia County which alone had jurisdiction of the estate and that its adjudication is conclusive.

The United States intervened as a party defendant in the present suit. It filed an answer and a counterclaim in which it asserted the deficiency assessments which the Commissioner of Internal Revenue had made against the plaintiff for the years 1943 through 1948. The assessments totaled $413, 927.96; interest thereon totaled $76, 820.42. A credit of $16, 305.95 was given plaintiff for payments previously made, including the payment of $3, 600.00 for which the plaintiff had brought this suit, leaving a balance of $474, 422.43 for which the counterclaim was filed. Both parties moved for summary judgment. The plaintiff also moved for judgment on the pleadings.

The district court found that the plaintiff was entitled under the will to receive the entire net income of the trust estate, that her confirmation of release and disclaimer of interest in excess of a one-thirteenth share did not affect her tax liability because under the law of Pennsylvania the plaintiff, being a beneficiary under a spendthrift trust, could revoke the release and receive future income, and that the adjudication of the Orphans' Court of Philiadelphia County was not binding on the district court because the proceedings were of a nonadversary nature. The motion of the defendants was accordingly granted, the complaint was dismissed, and judgment was entered against the plaintiff on the counterclaim in the amount, including interest, of $550, 034.57. 119 F.Supp. 360.

The decision of the present case turns upon whether the adjudication by the Orphans' Court is to be given conclusive effect, taxwise, as to the interests of the plaintiff and the twelve children in the net income of the trust estate. Before considering this question some preliminary observations need to be made. The books are full of federal tax cases in which state court decisions have been refused controlling effect upon the ground that they were not res judicata in the federal tax case or because they were regarded as nonadversary or as in fact consent decrees or because they were obtained by collusion. But, as Mr. Paul points out in an excellent discussion of the subject, 1 there are at least three types

Page 222

of tax cases involved with respect to which the effect of state decisions may be quite different.

One group of federal tax cases refuses to give state decisions conclusive effect in situations where Congress has imposed a federal criterion with respect to the taxability of income or property or the allowability of claimed deductions. For example, in ascertaining whether claims asserted against an estate 'were contracted bona fide and for an adequate and full consideration in money or money's worth' 2 or where business expenses are sought to be deducted by a taxpayer as 'ordinary and necessary' 3 the Tax Court is not bound by a state court decision with respect to whether the federal test of deductibility...

To continue reading