Chism's Estate v. CIR

• Decision Date: 22 October 1963
• Docket Number: No. 18203.,18203.
• Citation: 322 F.2d 956
• Parties: ESTATE of E. W. CHISM, Deceased, Clara Chism, Executrix, and Clara Chism, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

322 F.2d 956 (1963) ESTATE of E. W. CHISM, Deceased, Clara Chism, Executrix, and Clara Chism, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 18203.

United States Court of Appeals Ninth Circuit.

July 30, 1963.

Rehearing Denied October 22, 1963.

Kent & Brookes, Valentine Brookes, Paul E. Anderson, and Richard A. Wilson, San Francisco, Cal., for petitioners.

Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, David O. Walter and Ralph A. Muoio, Attys., Dept. of Justice, Washington, D. C., for respondent.

Before ORR, HAMLEY and BROWNING, Circuit Judges.

HAMLEY, Circuit Judge.

This is a proceeding to review a decision of the Tax Court redetermining deficiencies in the income taxes of E. W. Chism and his wife, Clara Chism, for the years 1952 through 1956. Clara Chism appears in her own right and as executrix of the estate of her deceased husband who died on December 27, 1956.

During the years in question the Chisms and their daughter, Alice Jane Frazer, owned all of the stock of Chism Ice Cream Company, a Nevada corporation. E. W. Chism, who was president of the company, owned 71,500 shares. Mrs. Chism, who was corporate secretary, owned 67,500 shares, and their daughter, who was vice-president, owned 51,000 shares. During these years Chism drew an annual salary of $24,000 and the daughter an annual salary of $5,000. Mrs. Chism received no salary.

Also during those years, and for several years before, Chism and his wife withdrew substantial additional amounts from the corporation. These withdrawals were recorded on the books of the company in an account entitled "E. W. Chism — Note Receivable."¹ They were never evidenced by promissory notes or other written instruments, no interest was ever paid or charged on the outstanding balance, and no collateral security was ever given for them. Mrs. Chism and the general manager of the company testified that these withdrawals were loans and were to be repaid. In years prior to 1952 some repayments were made, the last being made in 1951, in the amount of $1,720.17.

On occasion the company had made loans to other employees for the purpose of assisting them to meet personal emergencies, and in these instances, the company did not require the execution of a note or the posting of collateral, nor did it charge interest. Balance sheets evidencing the existence of the withdrawals by the Chisms as constituting a loan to stockholders was included with each of the corporate income tax returns filed by the company during the years in question and prior thereto. In addition, these balance sheets were used by the company in securing bank financing.

Treating these withdrawals in excess of salary as loans from the company, the Chisms did not report them as gross income in their joint income tax returns for the years 1952 through 1956.

On March 6, 1959, the Commissioner of Internal Revenue issued to the Chisms his deficiency notice covering those years. The Commissioner determined that all such withdrawals from the company in excess of salary constituted a distribution of informal dividends to Chism and his wife. Based on this determination the Commissioner fixed the aggregate income tax deficiency for the years 1952 through 1956 at $15,683.00, distributed between the years as shown in the margin.²

A timely petition to redetermine the deficiency for these years was filed with the Tax Court. It was alleged in the petition that the Commissioner had erred in three respects: (1) in treating the Chisms' withdrawals in excess of salary as dividends instead of loans; (2) in failing to treat the withdrawals, alternatively, as tax-exempt health insurance plan payments; and (3) in assessing a deficiency for the taxable year 1952 for the additional reason that assessment for that year is barred by the statute of limitations. In addition, petitioners asked for a refund of all taxes paid for the years in question on the ground that all of Chism's salary on which taxes had been paid was paid pursuant to a health insurance plan.

In its unreported findings of fact and opinion the Tax Court rejected all of petitioners' contentions, upheld the deficiency determination, and disallowed the claim for overpayment of taxes. On this review petitioners renew the contentions which they advanced without success in the Tax Court. With regard to the claim for refunds, recovery of the taxes paid for the years 1952 and 1953 only is sought.

Petitioners advance several reasons why the Tax Court erred in finding and concluding that the withdrawals made by the Chisms from the company in the years 1952 through 1956 were taxable dividends rather than loans. The first of these is that a Nevada probate court had previously adjudicated that the withdrawals gave rise to an enforceable claim by the corporation which it was entitled to collect from the estate of E. W. Chism, and that the Tax Court is bound by that adjudication.

Since the Tax Court made its own evaluation of the circumstances attending the withdrawals, it obviously did not consider itself conclusively bound by the state court adjudication. Its reasons for not considering itself bound are not so clear. However, from the Tax Court's opinion, it appears that it relied upon the nonadversary character of the probate proceeding; and, possibly, that it considered the proceeding collusive.

Consequently, the thrust of the arguments presented here is directed toward the nature of the Nevada probate proceeding. Petitioners and the Commissioner agree that if the adjudication was collusively obtained, solely for the purpose of affecting petitioners' federal income tax liability, then it is not binding here. They also agree that the state court proceeding was not contested in the sense that one party said "yes" while another said "no." Their disagreement centers around whether the adjudication was in fact collusively obtained, and whether an adversary contest in the state court proceeding is essential to the state adjudication's conclusiveness for federal tax purposes.

Both petitioners and the Commissioner seem to agree in the assumption that a state court adjudication could, under certain factual circumstances, be fully determinative of whether, for federal tax purposes, the withdrawals were loans or dividends. If that assumption is an unwarranted one, then we need not decide whether the state adjudication was collusively obtained, or whether in order to be binding here it must have involved a contest. That is to say, if the Government is not concluded on principles of res judicata and if Congress has not made the answer to the "loans or dividends?" question wholly dependent upon state law, then we need not and should not attempt to answer those questions. Our efforts to do so would only beget confusion. Gallagher v. Smith, 3 Cir., 223 F.2d 218, 222; I Paul, Federal Estate & Gift Taxation § 1.11 at pages 75-77.

The Nevada probate proceeding in issue concerned only the E. W. Chism estate and Chism Ice Cream Company. Neither the Government nor any of its agencies was a party to it. No determination of law or fact made therein can be res judicata against the United States.

Accordingly, the Government is concluded by the state adjudication only if the tax imposed by the Internal Revenue Code is solely upon income as determined by state law, "the federal law having imposed no qualification upon or criterion for the taxability thereof." Gallagher v. Smith, 3 Cir., 223 F.2d at 222. Or to apply the principle of Burnet v. Harmel, 287 U.S. 103, 110, 53 S.Ct. 74, 77 L.Ed. 199, the state adjudication can be conclusive only if the federal taxing act, by express language or necessary implication, makes its own operation dependent upon state law.

The taxing statute with which we are here concerned provides only that gross income includes dividends. Section 22 (a), Internal Revenue Code of 1939; section 61(a) (7), Internal Revenue Code of 1954. It contains no express language making its operation dependent upon state law.

Nor does state law, by necessary implication, control as to whether withdrawals by shareholders from closely held corporations are loans or dividends. Whether a withdrawal is a loan is a factual question "to be determined upon consideration of all the circumstances present in a particular case, and depends upon the existence of an intent at the time the withdrawal is made that it should be paid back." Clark v. C. I. R., 9 Cir., 266 F.2d 698, 710-711. The significant fact is the intent of Chism when he took the money, whether he took it for permanent use in lieu of dividends or whether he was then only borrowing. Wiese v. C. I. R., 8 Cir., 93 F.2d 921, 923.

The Nevada probate court adjudication established that the Chisms had a legal obligation to repay the withdrawals that had been made. But it is not the existence of a legal obligation to repay that is controlling. It is petitioners' intent to honor, and the intent of their collective alter ego, the corporation, to enforce that obligation which determines the nature of the withdrawals. Cf. W. F. Young, Inc. v. C. I. R., 1 Cir., 120 F.2d 159, 164. The Tax Court did not err in refusing to be bound by the state court adjudication. Notwithstanding that it may have been taken for improper reasons, its action in reappraising the evidence in the light of a standard peculiar to federal tax law was entirely proper.

Petitioners also urge that the Tax Court erred in determining that the withdrawals were dividends because that determination is inconsistent with a determination made in a related case.

One of the findings of fact that the Tax Court made in concluding that the withdrawals were dividends rather than loans was that despite a considerable increase in its earned surplus between 1937 and 1956, Chism Ice Cream Company had never, with one small exception, declared or paid formal dividends.³ This finding, say petitioners, is the only "fact of any substance" in support of the Tax C...