Anderson v. Commissioner of Internal Revenue

• Decision Date: 09 January 1948
• Docket Number: No. 9084,9085.,9084
• Citation: 164 F.2d 870
• Parties: ANDERSON v. COMMISSIONER OF INTERNAL REVENUE (two cases).
• Court: U.S. Court of Appeals — Seventh Circuit

164 F.2d 870 (1947)

ANDERSON v. COMMISSIONER OF INTERNAL REVENUE (two cases).

Nos. 9084, 9085.

Circuit Court of Appeals, Seventh Circuit.

December 17, 1947.

Rehearing Denied January 9, 1948.

William H. Dillon, John O. Snook, Bruce S. Parkhill, and Allin H. Pierce, all of Chicago, Ill., for petitioners.

Sewall Key, Acting Asst. Atty. Gen., George A. Stinson, Harry Baum, and Robert N. Anderson, Sp. Assts. to Atty. Gen., and J. P. Wenchel and B. D. Daniels, both of Washington, D. C., for respondent.

Before SPARKS and KERNER, Circuit Judges, and LINDLEY, District Judge.

SPARKS, Circuit Judge.

These cases involve income tax liability for the years 1939 and 1940. They were consolidated below and here for hearing and decision. The Tax Court held that the taxpayers remained the substantial owners of the shares of stock transferred of record to members of their families, and that therefore the income from such shares was includible in the taxpayers' gross incomes as defined in section 22(a) of the Internal Revenue Code, 26 U.S.C.A.Int.Rev. Code, § 22(a). These petitions seek a review and reconsideration of those rulings pursuant to sections 1141 and 1142 of that Code.

The following facts are substantially supported by the evidence. Petitioners are brothers. In 1937, they were the respective owners of 388 and 360 of the 750 outstanding shares of stock of Robert R. Anderson Company which had been organized by their father and owned and operated by him for many years. In 1937, Herbert was married and had a son 14 years of age. Ralph had three children, aged respectively 14, 8 and 7 years, by his first wife. He remarried in 1939.

On December 1, 1937, taxpayers caused some of their shares to be transferred on the corporate books to members of their respective families. Herbert's wife and child thereby became record owners of a total of 68 shares, while Ralph's children became the record owners of 85 shares. The new certificates were placed in a safe of the company in the care of its secretary, Christiansen, with the knowledge and consent of the donees, who were apprised of the transfers. Ten days thereafter a dividend of $25 per share was declared on the stock, and on the same day taxpayers borrowed the dividends from the transferees and executed in exchange, 6% demand notes, which were also kept in the office of the company. Christiansen placed the certificates in envelopes bearing the names of the donees.

On April 1, 1938, taxpayers caused more of their shares in such company to be transferred to said respective parties on such corporate books, and such certificates were placed with the others last mentioned. As a result thereof the record ownership of Herbert's wife and child was increased to a total of 140 shares, while the record ownership of Ralph's children was increased to a total of 175 shares. A few days later another dividend of $25 per share was declared, which taxpayers again borrowed from the transferees in exchange for 6% demand notes. These were likewise placed in the company's safe.

On April 15, 1939, taxpayers caused additional shares of this company to be transferred in the same manner as before and the new certificates were placed in the company's safe with the others. Thereby the record ownership of Herbert and wife and child was increased to a total of 228 shares, while the record ownership of Ralph's children and second wife was increased to a total of 307 shares. Two weeks later a dividend of $50 per share was declared, and taxpayers again borrowed the dividends from the transferees and again executed 6% demand notes which were placed in the company's safe. No interest was paid on any of the notes given for the borrowed dividends.

On December 31, 1941, taxpayers each executed new 6% demand notes on the amount of interest then due. Each taxpayer devoted the dividends he borrowed to his own business or personal use, and not to the support or maintenance of his wife or children. Some of the dividend checks were endorsed by taxpayers or by Christiansen in the names of the payees.

After the transfers taxpayers continued to manage and direct the affairs of the corporation in the same manner as before. No formal stockholders' meetings were held after the transfers until November 9, 1940.

In 1940, taxpayers decided to convert the business from a corporation to a partnership. With the consent of all the members of the family, it was arranged that taxpayers and their wives would acquire the stock standing in the names of the children in such proportions that each would own one-fourth of the stock, in exchange for notes to the children.

Accordingly, on November 19, 1940, transfers were made on the corporate books placing the entire outstanding stock in the names of taxpayers and their wives in equal amounts of 187½ shares each. Thereupon, the taxpayers and their wives executed 6% demand notes to the children in amounts based on the book value of the shares. These were likewise placed in the company's safe. It was understood that when the sons reached the age of 25, or finished school, they could use the notes or proceeds to purchase an interest in the partnership, while the daughter would receive one-half of the amount of her note when she reached the age of 25, or married, and the other half when she was 30. A partial liquidation distribution was made before the end of 1940, and the liquidation was completed in 1941. On December 31, 1941, additional notes were given to the children in the amounts of unpaid interest, and these were placed in the company's safe with the others. At the same time taxpayers took credits against the principal of the notes for income tax payments and investments made on behalf of the children, these credits being acknowledged in most instances by proper endorsement on the notes.

In 1941 taxpayers decided to create trusts for the children, the corpora to consist of the various notes which had been executed and were still in the company's safe. The parties thereupon caused a trust agreement to be prepared, naming their brother-in-law as trustee, and instructed Christiansen to destroy the old notes and substitute new ones payable to the trustee. The new notes were prepared, but the old ones were never destroyed. This trust agreement was executed January 2, 1942, but when the trustee later inquired about the payment of interest on the new notes he was informed by taxpayers that the trust agreement was void and would be cancelled on the advice of taxpayers' attorney. The trust agreement was thereupon marked "void" and returned to taxpayers with the new notes.

No gift tax returns were filed for 1937 and 1938 because each gift was valued by taxpayers at less than the $5,000 gift tax exemption allowable for those years. In 1939 the value of each gift was over $4,000 but less than $5,000, but no gift tax return was filed for that year because taxpayers were unaware of the reduction of the allowable exemption from $5,000 to $4,000.

The dividends on the transferred shares were reported as the income of the wives and children. The taxes were paid on their behalf by taxpayers. The Commissioner determined that the transfers were without federal income tax effect, and included in taxpayers' gross incomes for 1939 the dividends paid in that year on the transferred shares, resulting in the 1939 deficiencies in controversy. The Commissioner likewise disregarded the transfers in determining the capital gain realized by taxpayers upon the 1940 liquidation distribution, and included in their gross incomes for that year the gain attributable to the number of...