First National Bank of Kansas City v. CIR

• Decision Date: 08 November 1962
• Docket Number: No. 16975.,16975.
• Citation: 309 F.2d 587
• Parties: The FIRST NATIONAL BANK OF KANSAS CITY and Arthur Mag, Executors of the Estate of Michael H. Katz, Deceased, and the First National Bank of Kansas City and Arthur Mag, Executors of the Estate of Rose B. Katz, Deceased, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Eighth Circuit

309 F.2d 587 (1962)

The FIRST NATIONAL BANK OF KANSAS CITY and Arthur Mag, Executors of the Estate of Michael H. Katz, Deceased, and the First National Bank of Kansas City and Arthur Mag, Executors of the Estate of Rose B. Katz, Deceased, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 16975.

United States Court of Appeals Eighth Circuit.

November 8, 1962.

George E. Gibson, of Stinson, Mag, Thomson, McEvers & Fizzell, Kansas City, Mo., G. Lee Burns, Ernest M. Fleischer, Stinson, Mag, Thomson, McEvers & Fizzell, Kansas City, Mo., on the brief, for petitioners.

Richard J. Heiman, Attorney, Tax Div., Dept. of Justice, Washington, D. C., Louis F. Oberdorfer, Asst. Atty. Gen., Washington, D. C., and Lee A. Jackson, Joseph Kovner and Arthur E. Strout, on the brief, for appellee.

Before VOGEL and VAN OOSTERHOUT, Circuit Judges, and VAN PELT, District Judge.

VOGEL, Circuit Judge.

This is a petition for review of a decision of the Tax Court whereby there was held to be a deficiency of $22,687.64 in the income tax of Michael H. Katz and Rose B. Katz (both since deceased) for the taxable year of 1956.

Michael and Rose Katz were husband and wife residing in Kansas City, Missouri. They used the cash receipts and disbursements method of accounting and filing their income tax returns. Michael Katz was never a dealer in annuities, life insurance policies or securities.

In 1934 Michael Katz (hereinafter referred to as taxpayer or petitioner) purchased from the Equitable Life Assurance Society of the United States a Retirement Annuity Policy No. 9,564,624 for a single premium of $50,000. Taxpayer designated his wife and children as the beneficiaries of the policy, and elected a refund annuity beginning at age 70, one of the optional modes of settlement provided by the policy. Under such an election, the taxpayer would have received the monthly amount of $787.84 beginning on September 8, 1956. In addition to the provisions allowing for monthly annuities, the policy also provided for surrender of the policy any time before the due date of the first monthly annuity payment. The policy contained a schedule which showed the exact amount of the cash surrender value at the end of each policy year.

In addition the policy provided for the payment to policyholders of any divisible surplus. Such a payment could be received either as a dividend or apportioned to the policy and left to accumulate interest. Two such dividends were paid in 1935 ($104.50) and 1936 ($85.00) and the taxpayer chose to leave them with the company.

The policy was assignable with the assignee thereof having the same rights as his assignor. On August 23, 1956 (16 days before the due date of the first annuity payment) the taxpayer exercised his right of assignment by transferring the policy to the Mercantile Bank and Trust Company of Kansas City, Missouri. He received $97,200 for the policy. The cash surrender value on that date was $97,250 and the 1935 and 1936 dividends and interest thereon were valued at $352.01, or a total value of $97,602.01. The bank purchased the policy as an investment and by surrender of the policy on September 8, 1956, did realize a profit of $402.01.

The contention of the petitioner is that the $47,200 gain realized upon the sale of the policy was a capital gain and not ordinary income as contended by the government and held by the Tax Court.

There is little doubt that there was a "bona fide" and not a "sham" sale of the policy, and though there may have been a tax purpose involved therein, this by itself does not prevent the transfer from receiving capital gains treatment. See C. I. R. v. Phillips, 4 Cir., 1959, 275 F.2d 33, 35; Arnfeld v. United States, 1958, 163 F.Supp. 865, 867-868, 143 Ct.Cl. 277, certiorari denied, 369 U.S. 943, 79 S.Ct. 722, 3 L.Ed.2d 676. Additionally, there is little question but what the insurance policy itself constituted a capital asset. The Tax Court so held. This determination, however, does not resolve the case, for as said in Hort v. Commissioner, 1941, 313 U.S. 28, 31, 61 S.Ct. 757, 758, 85 L.Ed. 1168:

"* * * Simply because the lease was `property\' the amount received for its cancellation was not a return of capital, quite apart from the fact that `property\' and `capital\' are not necessarily synonymous in the Revenue Act of 1932 or in common usage. Where, as in this case, the disputed amount was essentially a substitute for rental payments which § 22(a) expressly characterizes as gross income, it must be regarded as ordinary income, and it is immaterial that for some purposes the contract creating the right to such payments may be treated as `property\' or `capital.\'" (Emphasis supplied.)

See also C. I. R. v. Phillips, 4 Cir., 1959, 275 F.2d 33.

The major issue is, therefore, not whether the policy was a capital asset, but whether the gain realized thereon represented an appreciation of the capital asset itself, or rather represented income produced by such asset. For our purposes, the distinction seems well defined in Fisher v. Commissioner of Internal Revenue, 6 Cir., 1954, 209 F.2d 513, at page 514 where the court stated:

"We think the fundamental error into which the taxpayer has fallen is that he fails to distinguish, in respect to gains, between the status taxwise of an investor and a lender, or between seller and purchaser. It does not follow that because a transaction may be capital in its nature as to one it is necessarily capital as to the other. One who buys securities that are in default and later sells them at a profit realizes capital gain. One who receives income for the use of money or property or the performance of personal services is taxable upon such income. These propositions are, of course, elementary."

See also Commissioner v. P. G. Lake, Inc., 1958, 356 U.S. 260, 265-267, 78 S.Ct. 691, 2 L.Ed.2d 743; Tunnell v. United States, 3 Cir., 1958, 259 F.2d 916, 919; United States v. Snow, 9 Cir., 1955, 223 F.2d 103, 108-109, certiorari denied, 350 U.S. 831, 76 S.Ct. 64, 100 L.Ed. 741.¹ Here, it is quite plain that the $47,200 does not represent an appreciation in the value of the capital asset itself but is the total income earned by such asset during the period the insurance company held and used the $50,000 initial premium. Actually, there is no argument that such gain would have been treated as ordinary income if held to maturity and then surrendered for its face value. 26 U.S. C.A. § 72(e) (1) expressly characterizes such as gross income. See also Chapin v. McGowan, 2 Cir., 1959, 271 F.2d 856, 858; Blum v. Higgins, 2 Cir., 1945, 150 F.2d 471, 474, 160 A.L.R. 1093; Avery v. Commissioner of Internal Revenue, 9 Cir., 1940, 111 F.2d 19; Arnfeld v. United States, supra.

Having decided that the gain realized on an annuity policy was ordinary income and not appreciated value of the capital asset, does the fact that the policy was transferred to a third party 16 days before maturity alter the character of the gain for tax purposes? The courts have uniformly held that it does not. In C. I. R. v. Phillips, 4 Cir., 1960, 275 F.2d 33, at pages 35-36, the court stated:

"* * * We believe, however, that we are required to adopt the view that since the amounts receivable upon maturity or surrender of the endowment policy unquestionably would have been taxable as ordinary income, the taxpayer may not convert such income into capital gain by a bona fide sale of the contract which is the means of producing such ordinary income. The cash value of the policy was equivalent to the reserve value which, in turn, was computed on the basis of three percent compound interest. The sale of the policy was, as said by Mr. Justice Douglas in Lake, `essentially a substitute for what would otherwise be received at a future time as ordinary income\'.

Manifestly, the consideration paid by taxpayer\'s partners was `not for an increase in the value of income-producing property.\'" (Emphasis supplied.)

The 5th Circuit made the following statement upon the contention that a "transfer" is the only prerequisite for capital gains treatment, United States v. Harrison, 5 Cir., 1962, 304 F.2d 835, 837-838:

"The taxpayers hitch their wagon to a literalistic construction of the statutory term, `in exchange therefor\'. Under Section 1222(3) (of the 1954 Code, 26 U.S.C. § 1222(3)) a long-term capital gain is defined as the `gain from the sale or exchange of a capital asset held for more than 6 months, if and to the extent such gain is taken into account in computing gross income.\' To qualify as a capital gain income must be received not merely in an `exchange\' but `in exchange for a capital asset.\' The fact that a gain is received in an `exchange\' is a prerequisite to capital gains treatment, but it does not by itself insure such treatment. When the right to receive ordinary income is sold, the proceeds from that exchange do not qualify for capital gains treatment." (Emphasis supplied.)

See also Commissioner v. P. G. Lake, Inc., 1958, 356 U.S. 260, 265-267, 78 S. Ct. 691, 2 L.Ed.2d 743; Hort v. Commissioner, 1941, 313 U.S. 28, 31, 61 S.Ct. 757, 85 L.Ed. 1168; United States v. Snow, supra; and Fisher v. Commissioner of Internal Revenue, 6 Cir., 1954, 209 F.2d 513, 514. It is manifestly clear that one cannot transform into capital gain what would have otherwise constituted ordinary income through the simple expedient of a sale or transfer.

Petitioner attempts to make much of the fact that the transfer herein was of the whole property, no right being retained by him. He also contends that the policy was a unitary and not a separable property. By such a contention he attempts to distinguish Commissioner v. P. G. Lake, Inc., supra; Hort v. Commissioner, supra; and Helvering v. Horst, 1940, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75, in which only the right to income and not the supporting property was transferred. In Arnfeld v. United States, supra, which was also an annuity case, the...