Commissioner of Internal Revenue v. Pierce

• Decision Date: 27 December 1944
• Docket Number: No. 37.,37.
• Parties: COMMISSIONER OF INTERNAL REVENUE v. PIERCE PIERCE v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Second Circuit

146 F.2d 388 (1944)

COMMISSIONER OF INTERNAL REVENUE v. PIERCE

PIERCE v. COMMISSIONER OF INTERNAL REVENUE.

No. 37.

Circuit Court of Appeals, Second Circuit.

December 27, 1944.

George J. Laikin, of Washington, D. C., Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and Helen R. Carloss, Sp. Assts. to the Atty. Gen., for Commissioner.

Edwin S. Cohen and Norris Darrell, both of New York City, (Sullivan & Cromwell, of New York City, of counsel), for taxpayer.

Before L. HAND, AUGUSTUS N. HAND, and FRANK, Circuit Judges.

L. HAND, Circuit Judge.

Both the Commissioner and the taxpayer appeal from an order of the Tax Court, which expunged in part, and affirmed in part, a deficiency assessment for income taxes against the taxpayer for the year 1940. (The taxpayer has not pressed her appeal before us, and we understand it to be abandoned.) The taxpayer's husband died on March 18, 1940, leaving a life insurance policy in the sum of $100,000, in which he had named her as the beneficiary. The policy first contained an unconditional promise to pay to the taxpayer on the death of her husband, "the sum of $100,000," and later provided as follows: "The Insured shall have the right with the privilege of revocation and change, to elect in lieu of payment in one sum either Option `A', `B' or `C', or that the amount payable be distributed under two or more of said Options. The Beneficiary * * * when this Policy becomes payable, shall have the same right and privilege if no such election effected by the Insured shall then be in force." The taxpayer's husband did not during his life elect any of the options, but after his death, in accordance with the language just quoted, the taxpayer elected to take under "Option `C'," which gave her the right to have the net proceeds of the policy paid "in either 10, 15, 20 or 25 stipulated installments of an amount corresponding in the Table below to the age of the Beneficiary at the death of the Insured, provided that if the Beneficiary shall survive to receive the number of installments selected, similar installments shall be continued during the lifetime of the Beneficiary." She chose to be paid in ten installments: i. e., 120 monthly installments spread over 10 years. At her age each payment came to $597, and they were to continue as long as she lived. To these installments the insurer added such monthly dividends as were declared upon the policy — these being the subject of the taxpayer's appeal. For the year 1940 she received ten installments, aggregating $6,294, together with nine monthly dividends for $36 each. She did not return any of these as income, relying upon § 22(b) (1) of the Internal Revenue Code, 26 U.S.C.A. Int.Rev.Code, § 22(b) (1), which excludes from gross income and exempts from taxes the following: "Life insurance. Amounts received under a life insurance contract paid by reason of the death of the insured, whether in a single sum or otherwise (but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income)." The Commissioner assessed a deficiency against her of $2,009.51, which he computed as follows. He divided the principal of the policy — $100,000 — by the figure 19.45 — that being the taxpayer's expectancy in 1940 — this gave a quotient of $5,141.39, of which he took five-sixths — there being only ten monthly payments in the year 1940. The result was $4,284.49, and this he treated as the proper amortization payment of the capital sum of $100,000; the difference — $6,294 minus $4,284.49 — he treated as income and taxed accordingly. Upon review by all the judges of the Tax Court, it was held, two judges dissenting, that the taxpayer was right; the deficiency was expunged, except as to the nine dividends already mentioned; and from this order the Commissioner appealed.

Four Circuit Courts of Appeals have held that § 22(b) (1) does not mean to separate such installments as are here in question into principal and interest and to include the interest in gross income; but that it exempts the whole installment. Commissioner v. Winslow, 1 Cir., 113 F.2d 418, 133 A.L.R. 405; Commissioner v. Bartlett, 2 Cir., 113 F.2d 766; Commissioner v. Buck, 2 Cir., 120 F.2d 775; Allis v. La Budde, 7 Cir., 128 F.2d 838; Kaufman v. United States, 4 Cir., 131 F.2d 854. The parenthesis applies to cases where the capital sum is retained for a season undiminished, and only the interest is paid to the beneficiary (United States v. Heilbroner, 2 Cir., 100 F.2d 379); and in economic theory there is no difference between such interest, and the interest concealed in an installment; for, when an insurer pays the beneficiary in a series of installments, it always does add something as interest upon those installments which for the time being it retains. Nevertheless, although for this reason the distinction is to some extent formal, the courts have thought that they saw adequate ground for it in the language used; and the Commissioner, after many unsuccessful efforts, has finally yielded and amended his regulations accordingly (Regulations 103, § 19.22(b) (1)-1). We are, therefore to take it as datum that, it the insured had during his life elected to take under "Option `C'," the Tax Court would have been right. The Commissioner insists, however, that his earlier position is still valid when, as here, it was the beneficiary, not the insured, who made the choice. The argument is that, since she had the option of choosing between the principal and one of the options, it is as though she had actually received the principal and had reinvested it with the insurer, instead of upon some other security. Were that done, the resulting payments would have to be broken down into earnings and amortization installments, and, qua earnings, would be taxable.

It cannot be seriously argued that, literally at any rate, the installments are not "paid by reason of the death of the insured"; they are all conditional upon that event, and they begin to be payable at once thereafter. Pro tanto, they are precisely like any other life insurance, all of which is payable "by reason of the death of the insured." We recognize, however, that that is not a final answer; for, granting that the insured's death is a condition precedent, it is not the only condition precedent to the payments in question, as it is when the insured himself makes the choice. If the words should be read: "only by reason of the death of the insured," the meaning would be as the Commissioner maintains; and our decision turns upon whether that is their right interpretation.

The policy offered the beneficiary a choice between rights already in existence, with whose creations she had had nothing whatever to do; they came to her ready made by the insured. To say that her position was the same as though, having the principal in hand, she had exchanged it with the insurer for the option, is untrue in fact and unwarranted in law. Perhaps, if the policy had not contained the options, the beneficiary might still have been able to buy "Option `C'" from the insurer by a direct bargain; but nothing in the record supports that assumption, and we have no right to make it. Life insurance is a technical subject, and it would be hazardous to say that it made no difference in the beneficiary's powers in dealing with the insurer that the policy contained the options. But even if it did make no difference, it is a fiction to treat the situation as though she had made such a bargain; it is as untrue as it would be to say that if the policy permitted her to be paid in dollars or pounds, and she took pounds, she had bought the pounds from the insurer with the dollars. It is as untrue as it would be to say that, if a testator gives a legatee the choice of money or a chattel and he takes the chattel, he has bought it of the executor. In such situations the beneficiary makes no bargain whatever with the decedent's representative; all that happens is that, not having the power to take both benefits, and being therefore put to a choice, he takes one of those already provided. Nothing...