CIR v. Makransky

• Decision Date: 03 July 1963
• Docket Number: No. 13785-13793.,13785-13793.
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner in No. 13,785, v. Robert MAKRANSKY, Executor of the Estate of Harry Makransky, and Helen Makransky. COMMISSIONER OF INTERNAL REVENUE, Petitioner in Nos. 13,786, 13,787, v. Emanuel MOSS and Sylvia Moss. COMMISSIONER OF INTERNAL REVENUE, Petitioner in Nos. 13,788, 13,789, v. Hilda B. SCHNEIDER. TRUST Under Deed of Joseph BINENSTOCK (Deceased), Girard Trust Corn Exchange Bank, Theodora B. Jacobs, Sylvia B. Moss, Hilda B. Schneider (formerly Hilda B. Raines), Helen B. Makransky, John Tait and Albert Barnes Zink, Trustees, Petitioners in Nos. 13,790, 13,791 v. COMMISSIONER OF INTERNAL REVENUE, Respondent. COMMISSIONER OF INTERNAL REVENUE, Petitioner in Nos. 13,792, 13,793, v. Allen C. JACOBS and Theodora B. Jacobs.
• Court: U.S. Court of Appeals — Third Circuit

321 F.2d 598 (1963)

COMMISSIONER OF INTERNAL REVENUE, Petitioner in No. 13,785, v. Robert MAKRANSKY, Executor of the Estate of Harry Makransky, and Helen Makransky.

COMMISSIONER OF INTERNAL REVENUE, Petitioner in Nos. 13,786, 13,787, v. Emanuel MOSS and Sylvia Moss.

COMMISSIONER OF INTERNAL REVENUE, Petitioner in Nos. 13,788, 13,789, v. Hilda B. SCHNEIDER.

TRUST Under Deed of Joseph BINENSTOCK (Deceased), Girard Trust Corn Exchange Bank, Theodora B. Jacobs, Sylvia B. Moss, Hilda B. Schneider (formerly Hilda B. Raines), Helen B. Makransky, John Tait and Albert Barnes Zink, Trustees, Petitioners in Nos. 13,790, 13,791 v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

COMMISSIONER OF INTERNAL REVENUE, Petitioner in Nos. 13,792, 13,793, v. Allen C. JACOBS and Theodora B. Jacobs.

Nos. 13785-13793.

United States Court of Appeals Third Circuit.

Argued January 7, 1963.

Decided July 3, 1963.

Albert Barnes Zink, Philadelphia, Pa., for Binenstock's trust and others (George F. Shinehouse, Jr., Philadelphia, Pa., on the brief).

Bernard Wolfman, Philadelphia, Pa., for respondents Helen Makransky and Robert Makransky, Exr. of Estate of Harry Makransky (Jerome Kurtz, Wolf, Block, Schorr & Solis-Cohen, Philadelphia, Pa., on the brief).

Herman Krekstein, Philadelphia, Pa., on the brief for respondents Emanuel and Sylvia Moss and Hilda B. Schneider.

John B. Jones, Jr., Dept. of Justice, Washington, D. C., for Commissioner of Internal Revenue (Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Harry Baum, Harold M. Seidel, Attys., Dept. of Justice, Washington, D. C., on the brief).

Before KALODNER, HASTIE and GANEY, Circuit Judges.

HASTIE, Circuit Judge.

The Tax Court has imposed income tax liability upon a trust for certain distributions of corporate earnings of J. A. Dougherty & Sons, Inc., ("Dougherty, Inc."), while refusing to treat these disbursements as yielding taxable income to the beneficiaries of the trust or the settlor. 36 T.C. 446. The trustees have filed petitions for review on behalf of the trust and the Commissioner has filed protective cross-petitions from the decisions that the beneficiaries are not taxable.

The trust was created gratuitously in 1947 by an indenture of the settlor, Joseph Binenstock. The beneficiaries are his children, and the corpus is all of the issued and outstanding stock of Dougherty, Inc., an incorporated business theretofore owned entirely by Binenstock. The indenture expressly provides that the trust shall be irrevocable.

When this trust was created, there was pending against Binenstock a lawsuit by the Commonwealth of Pennsylvania for a large sum of money. The creation of the trust and transfer to it of the Dougherty, Inc., stock rendered Binenstock insolvent. He continued to be insolvent in 1950, when the Commonwealth prevailed in the lawsuit, recovering a judgment of almost $865,000 against him.

Immediately thereafter, the Commonwealth threatened to sue under the Pennsylvania Uniform Fraudulent Conveyance Act, 39 P.S. §§ 351-363, to set the trust aside and appropriate the Dougherty stock to the satisfaction of its judgment against Binenstock. In these circumstances the interested parties sought to achieve a settlement under which the Commonwealth would receive, in installments over a three-year period, $756,000 in full satisfaction of its judgment. Since Binenstock had no assets or resources which would yield so large a sum, it became necessary to involve the trust and Dougherty, Inc., in the settlement arrangement. It was proposed that the trustees agree to keep the assets of the trust intact pending full payment of the $756,000 and that the trustees further agree not to resist an action to set the trust aside if the $756,000 should not be paid. It was also proposed that Dougherty, Inc., lend Binenstock $756,000 in installments, with appropriate arrangements to assure the payment of this money to the Commonwealth.

The proposals affecting the corporate assets which constituted the trust corpus were submitted by the trustees to the Orphans' Court for approval. Binenstock and the beneficiaries filed waivers of objection. The court approved the proposed diversion of assets of the trust, acting on a report of a master finding that the proposed agreement and corporate loan were in the best interest of the trust and its beneficiaries because of the danger that otherwise the Commonwealth would have the trust set aside. In making this recommendation the master noted Binenstock's insolvency and stated that the transaction would deplete the trust estate.

The Commonwealth, the trustees and Binenstock then entered into the proposed settlement agreement. Dougherty, Inc., undertook to lend Binenstock $756,000 in installments as needed to pay the Commonwealth, with Binenstock surrendering to the corporation as security all of his substantial assets, aggregating $130,000 in value.

The taxable years 1952 to 1956, inclusive, are involved in this proceeding. Binenstock died in 1952. During the taxable years the corporation paid to Binenstock, and after his death to his personal representative, most of the money required to satisfy the Commonwealth's claim, and these disbursements were so used. The sums thus distributed by Dougherty, Inc., over a period of several years were less than the available earnings of the corporation. It is the tax status of these distributions of corporate funds, minus the value of the collateral posted by Binenstock, with which this case is concerned.

The Tax Court treated these distributions as corporate dividends taxable to the trust as sole stockholder. Challenging this conclusion, the appellants first urge that the Tax Court erred in refusing to recognize the $756,000 as being in substance what it was in form, a loan from the corporation to Binenstock.

While in many cases various factors must be weighed in determining for income tax purposes the true character of a purported loan, there is one essential without which a transaction cannot be recognized as a loan. The parties must have entered into the transaction with the intention that the money advanced be repaid. Spheeris v. Commissioner, 7th Cir. 1960, 284 F.2d 928, cert. denied, 1961, 366 U.S. 944, 81 S.Ct. 1673, 6 L. Ed.2d 855; Clark v. Commissioner, 9th Cir. 1959, 266 F.2d 698; Regensburg v. Commissioner, 2d Cir. 1944, 144 F.2d 41, cert. denied, 323 U.S. 783, 65 S.Ct. 272, 89 L.Ed. 625; Saigh, 1961, 36 T.C. 395, 419-22; 1 Mertens, Federal Income Taxation, 1962 ed., § 9.21, cases cited in note 41.

In this case it does not appear and, indeed, it is incredible that anyone anticipated that the difference between the sums distributed by the corporation and the value of the collateral deposited by Binenstock should ever be repaid. While the Orphans' Court was asked to approve this transaction in the form of a loan, and did so, that court acted pursuant to a master's report which made it clear that the difference between the sum to be distributed and the amount of the collateral to be supplied by Binenstock would represent a depletion of the assets of the corporation and that such a loss was acceptable only because, as between the destruction of the trust and this depletion of its assets, the latter was, in the master's words, "much the lesser of the two evils".¹

Moreover, all of the parties were aware that Binenstock was insolvent, advancing in years² and without present or prospective means of repaying any large sum of money to the corporation. His only income was a small salary and he was assigning as collateral all of his assets which might otherwise have become sources of additional income.

The corporation's undertaking and its action with reference to advances after Binenstock's death were also significant. In promising to supply money over a period of years for the settlement of the Commonwealth's claim, the corporation agreed that these payments were not to be interrupted or terminated in the event of Binenstock's death. Binenstock did die about a year after this agreement. Thereafter, the company advanced over $200,000 to his estate for payments to the Commonwealth in accordance with the original undertaking. When these payments were made there was not even an insolvent Binenstock to whom the corporation could look for repayment.

In the light of this total picture the Tax Court rightly described Binenstock and his estate as mere conduits through which the corporation made payments to the Commonwealth in settlement of its claim. The casting of such a transaction in the form of a loan to Binenstock cannot prevent its characterization for tax purposes in accordance with the conduct of the parties and their manifest understanding.

This brings us to a consideration of the Tax Court's affirmative conclusion that the distributions of corporate funds to satisfy the Commonwealth's claim were taxable as informal corporate dividends. The Internal Revenue Code defines "dividend" in language requiring the satisfaction of four criteria: There must be (1) a "distribution" of property (2) "made by a corporation" (3) "to its shareholders" (4) "out of its earnings and profits". Int.Rev.Code of 1954, § 316 (a); Int.Rev.Code of 1939, § 115(a), ch. 2, 53 Stat. 46, as amended. It should be observed that these criteria do not include a requirement that the distribution be made pursuant to a formal declaration of a dividend. Informal withdrawals and distributions, although characterized by the parties as other than dividends, must be taxed as dividends if the statutory criteria are met. Clark v. Commissioner, supra; Regensburg v. Commissioner, supra; Allen v. Commissioner, 1st Cir. 1941, 117 F.2d 364; Wiese v. Commissioner, 8th Cir.1938, 93 F.2d 921, cert. denied, 304 U.S. 562, 58 S.Ct. 944, 82 L. Ed. 1529; Christopher v. Burnet, 1931, 60 App.D.C. 365, 55 F.2d 527. Three of the listed criteria need not detain us. The first creates no problem once it is determined that the disbursement of corporate funds was...