Commissioner of Internal Revenue v. Blair

• Decision Date: 27 May 1936
• Docket Number: No. 5648.,5648.
• Citation: 83 F.2d 655
• Parties: COMMISSIONER OF INTERNAL REVENUE v. BLAIR.
• Court: U.S. Court of Appeals — Seventh Circuit

83 F.2d 655 (1936)

COMMISSIONER OF INTERNAL REVENUE v. BLAIR.

No. 5648.

Circuit Court of Appeals, Seventh Circuit.

April 11, 1936.

Rehearing Denied May 27, 1936.

Frank J. Wideman, Asst. Atty. Gen., and Sewall Key and L. W. Post, Sp. Assts. to Atty. Gen., for petitioner.

J. F. Dammann and Calvin F. Selfridge, both of Chicago, Ill. (Wilson & McIlvaine, of Chicago, Ill., of counsel), for respondent.

Before EVANS and ALSCHULER, Circuit Judges, and BALTZELL, District Judge.

EVANS, Circuit Judge.

The taxability of a beneficiary under a testamentary trust for income theretofore assigned by him to his children is before this court for the second time. We previously held 60 F.(2d) 340 it to be a spendthrift trust under the Illinois law and held the income for 1923 taxable to the assignor. The instant appeal involves identical facts, except that the tax years involved are 1924 to 1926 and 1929, and reference is therefore made to our previous opinion for a statement of facts.

After the opinion of this court was announced, the trustees under the testamentary trust instituted suit against assignees in the Superior Court of Illinois to determine the validity of the assignments so they might know whether they were validly paying the beneficiary's income to the assignees, instead of paying it to the beneficiary. The Superior Court held, following this court's view, that this was a spendthrift trust and no assignment of income could be validly made. On appeal the Illinois Appellate Court for the first district reversed (Blair v. Linn, 274 Ill.App. 23) the Superior Court's ruling and held the trust not to be of spendthrift character and held the assignments valid and directed the Superior Court to enter a decree accordingly. The Board of Tax Appeals in the instant suit felt compelled to follow the Illinois Appellate Court decision which was rendered after the Circuit Court of Appeals decision. From the Board's decision, the Commissioner appeals.

Under the assignments, taxpayer's children received income as follows: 1924, $30,000; 1925, $48,000; 1926, $57,000; and 1929, $57,000. The children have paid tax on these sums and, since the Commissioner's determination against respondent, have filed claims for refunds which will not be acted upon until after termination of the case.

It is petitioner's chief contention that in spite of the assignment the income is nevertheless taxable to respondent because he had assigned merely the right to future income and no present interest or estate in the corpus. This court on the previous appeal found it unnecessary to pass on that question. 60 F.(2d) 340.

Respondent maintains that the decree of the Illinois Superior Court (pursuant to the Appellate Court's mandate) is decisive of the property rights of the respective parties and also insists that an existing property right was duly assigned by Blair, the beneficiary, to his children.

Chapter 37, section 41, Smith-Hurd Ill. Ann.Stat., provides: "All opinions or decisions of said court upon a final hearing of any cause, shall be reduced to writing by the court, briefly giving therein the reasons for such opinion or decision, and be filed in the case in which rendered." This section amended, on April 25, 1935 (Smith-Hurd Ann.St. c. 37, § 41), the same section as previously existing by striking therefrom the proviso: "Provided, That such opinion shall not be of binding authority in any cause or proceeding, other than in that in which they may be filed."

Binding Effect of State Court Determination of Rights Under Trust. We are first called upon to determine whether the decree of the Superior Court of Illinois, entered pursuant to a direction from the Illinois Appellate Court, adjudging the trust not a spendthrift trust and holding valid the assignments of income therefrom, is binding upon this court in an income tax case, especially in view of the fact that on another occasion we held the trust to be a spendthrift trust. 60 F.(2d) 340.

We are of the opinion that the inferior state court's decree adjudging the rights between the parties must be followed by this court.

A somewhat analogous case is that of Freuler v. Helvering, 291 U.S. 35, 54 S.Ct. 308, 312, 78 L.Ed. 634. There, the Court was passing upon the taxability of income distributed to the beneficiaries, which income represented depreciation of the corpus of the trust. The state court (California Probate Court), in an independent suit, held that the trustee should have reserved the amount which represented the depreciation. The Court, in that case, was construing section 219, Act of 1921 (42 Stat. 246), which provides:

"* * * the tax shall not be paid by the fiduciary, but there shall be included in computing the net income of each beneficiary that part of the income of the estate or trust for its taxable year which, pursuant to the instrument or order governing the distribution, is distributable to such beneficiary, whether distributed or not * * *."

The Court held the California Probate Court decree to be binding. It said:

"We think the order of the state court was the order governing the distribution within the meaning of the Act. Moreover, the decision of that court, until reversed or overruled, establishes the law of California respecting distribution of the trust estate. It is none the less a declaration of the law of the state because not based on a statute, or earlier decisions. The rights of the beneficiaries are property rights and the court has adjudicated them. What the law as announced by that court adjudges distributable is, we think, to be so considered in applying section 219 of the Revenue Act of 1921. * * *

"The decree was a judgment which fixed the rights of the remaindermen and the obligations of the life tenants."

The court also said:

"The word `order' in the statute must be given some meaning as applied to trust income which is to be distributed periodically; and we think it clear that the section intended that the order of the court having jurisdiction of the trust should be determinative as to what is distributable income for the purpose of division of the tax between the trust and the beneficiary."

The court does not discuss the fact that the decree was that of an inferior tribunal. It was passing upon a different subsection of the Act, one having a specific provision commanding recognition of an "order" governing distribution. The statute did not specify the rank of the court which made the order.

Although there are these distinctions between the Freuler Case and the instant one, we accept it as authority for holding that a final decree of a state court, supreme or inferior, entered in a specific matter such as the interpretation of rights under a testamentary trust, is binding upon a Federal court in determining the character of a trust, the income from which is the subject of a Federal tax.

The logic supporting the adoption of such a rule is the same as that which furnishes the basis of res judicata. We are adopting the ruling of a court having jurisdiction of the subject matter and of the person. The orderly administration of justice and final settlement of property rights will be promoted by so doing. It is true that this court has previously reached a contrary conclusion — that the trust was a spendthrift one — but our decision was before the Illinois court had declared itself in reference to a matter to which its jurisdiction extended. Moreover, the previous proceeding in this court was one to which the beneficiaries were not a party, whereas they were the parties to the state court proceeding.

This conclusion is not inconsistent with that announced in Graham v. White-Phillips Co., 296 U.S. 27, 56 S.Ct. 21, 22, 80 L.Ed. ___, 102 A.L.R. 24 (same case in this court, 74 F.(2d) 417), wherein the Supreme Court held that an Illinois Appellate Court decision was not binding upon this court in the construction of the Uniform Negotiable Instruments Law. The Court there pointed out that the Illinois appellate decisions were not in accord on that question; that a statute provided that their opinions "shall not be of binding authority in any cause or proceeding other than in that in which they may be filed." This proviso, as above pointed out, has since been repealed. The effect of such repeal is undetermined. As the section now stands, it merely provides for the reducing of opinions to writing upon final hearing.

It may well be argued that the repeal of the provision making the decision binding only in the cause in which it is filed extended the scope and effect of the decisions of the Illinois Appellate Courts. That would be our view of its effect. But, it is for the Illinois courts to finally determine the effect of this repeal statute, and when those courts have spoken we will willingly adopt their construction.

We rest our conclusion not upon the effect of the repeal of the state statute, but upon the judicial determination of rights by a court of competent jurisdiction authorized to hear and determine the rights of the parties under this testamentary trust. The final decision of such a court, which is not appealed from, is binding upon the Federal court for the purpose of determining the character of the trust which in turn may be determinative of a Federal income tax assessment.^*

The correctness of our conclusion is not entirely free from doubt. We would be better satisfied if the suit in the state court had been more adversary in its nature. There is that which suggests a friendly suit to avoid taxes, to which there was no opposition or adverse party. All who joined in the litigation were desirous of obtaining the same end — the avoidance of a large part of the Federal income tax through division of the income by the beneficiary among his children. The Government was not a party to that suit. The suit was prosecuted only until a favorable decision was reached and then no appeal was taken. The first court ruled adversely to the...