Commissioner of Internal Revenue v. Hopkinson

• Decision Date: 06 March 1942
• Docket Number: No. 37.,37.
• Citation: 126 F.2d 406
• Parties: COMMISSIONER OF INTERNAL REVENUE v. HOPKINSON.
• Court: U.S. Court of Appeals — Second Circuit

126 F.2d 406 (1942)

COMMISSIONER OF INTERNAL REVENUE v. HOPKINSON.

No. 37.

Circuit Court of Appeals, Second Circuit.

March 6, 1942.

COPYRIGHT MATERIAL OMITTED

Samuel O. Clark, Jr., Asst. Atty. Gen. and Sewall Key and A. F. Prescott, Sp. Assts. to the Atty. Gen., for petitioner.

Herman Goldman, of New York City (Milton J. Levitt, of New York City, of counsel), for respondent.

Before L. HAND, CHASE, and FRANK, Circuit Judges.

CHASE, Circuit Judge.

The Commissioner determined deficiencies in the income taxes of the respondent for each of the calendar years 1934 and 1935 by treating as ordinary income certain payments made to her as the beneficiary of a trust which she had reported as capital gains. The Board upheld the taxpayer and the Commissioner filed a petition to review its decision. The issues in this respect are the same for both years. There is an additional issue for 1935. In that year the trustee paid $7500.00, out of the income of the trust which would otherwise have been distributable to the respondent, for legal services. She did not report that as part of her gross income. The Commissioner included it in determining the deficiency for that year but the Board reversed.

It found the facts as follows:

"Prior to May 12, 1930, Ernest Hopkinson, the husband of petitioner, was the owner of certain inventions pertaining to the manufacture of tires and tire fabrics. He had received United States and foreign letters patent on some of these and had filed applications for both domestic and foreign letters patent as to others. On May 12, 1930, Hopkinson entered into a written agreement with United States Rubber Co. which recited that he was the `seller' and the company was the `purchaser' of certain patents and inventions and also mentioned a desire to terminate a prior license agreement between Hopkinson and the company. The agreement reads in part as follows:

"The Seller has granted, bargained, sold, conveyed, transferred, assigned, set over and delivered and by these presents does grant, bargain, sell, convey, transfer, assign, set over and deliver unto Meyer Rubber Company, a New Jersey corporation and a subsidiary of the Purchaser, the following:

"There then follows a list of the patents and patent applications covered by the agreement and the Seller agrees that he will execute on behalf of the said subsidiary or any assignee of same or successor assignee, all necessary or proper instruments and will do all other or further acts which may be required by the Purchaser or said subsidiary or assignee or successor assignee for the full and complete transfer of all the right, title and interest of the Seller in said Letters Patent and the inventions subject thereof to said subsidiary or assignee or successor assignee.

"The Rubber Co., as `consideration for the sale of all the present inventions and improvements referred to', agreed to pay Hopkinson certain amounts in respect of each tire casing manufactured by it or its subsidiaries, a fraction of any royalties received by the Rubber Co. from licensees, and other amounts representing portions of proceeds of sales of weftless fabrics, in so far as the tires and fabrics were made under the Hopkinson patents. In case the Rubber Co. should desire to sell any of the patents or in the event of Hopkinson's death, the Rubber Co. could resolve all further payments, due on the patents under the contract, with lump sum payments to be arrived at either by agreement or by appraisers appointed by the parties. Pursuant to this agreement, Hopkinson executed formal assignments of his patents and patent applications to the Rubber Co., and the assignments were thereafter duly recorded. Hopkinson was not in the business of selling patents on or prior to May 12, 1930.

"Prior to July 17, 1932, Hopkinson received, pursuant to the agreement, amounts in excess of the cost or other basis to him of the inventions, patents, and patent applications covered by the agreement. He did not report any profit derived by him under the agreement on the installment basis.

"On July 19, 1932, Hopkinson, without consideration and as a gift, executed an indenture of trust whereby he transferred to himself as trustee the above mentioned agreement with the Rubber Co. The beneficiary of the trust was Bessie B. Hopkinson, the petitioner. The indenture gave Hopkinson, as trustee, power to ask for and receive all royalties and payments due under the agreement and to take any legal steps necessary or proper for the complete enjoyment of the assigned contract and the protection and enforcement of the trustee's rights thereunder. In addition, with respect to the assigned contract, the trustee was to have the right to exercise all rights, powers, and privileges which it would have been lawful for the settlor to exercise during the term of the trust had the contract not been assigned. The payments received by the trustee pursuant to the assigned contract were, under the trust, to be distributed to petitioner upon receipt by the trust, except that lump sum payments were to be invested and the income therefrom paid over to petitioner quarterly. The trustee was authorized to employ counsel and to pay their compensation out of trust income. The trust was to be irrevocable and was to terminate at the end of three years, or upon the death prior to that time of either the settlor or petitioner.

"The trust indenture was modified without consideration on December 30, 1932, by a written agreement between Hopkinson and petitioner. The principal material changes were to provide that the royalties and other payments should be paid over to petitioner during her life and that upon her death all rights under the contract with the Rubber Co. should pass to the lawful surviving issue of the settlor and the trust should terminate. If any such child were under age at petitioner's death, the trust continued as to him until he should reach the age of 21, with interim discretionary payments of income for his support and maintenance. Russell Hopkinson was to become successor trustee if Ernest Hopkinson should die prior to the termination of the trust. In all other respects the original trust indenture remained operative.

"Ernest Hopkinson died a resident of the County and State of New York on May 3, 1933. Following his death, Russell Hopkinson became trustee under the indenture of trust as modified.

"On August 9, 1934, Russell Hopkinson, as trustee, and the Rubber Co. entered into an agreement dated as of January 1, 1934, modifying the original agreement of May 12, 1930, between Ernest Hopkinson and the Rubber Co. The modification provided for payments of various sums in settlements of disputes between the parties and for other amounts based on moneys received by the Rubber Co. from its licensees.

"During 1934, the trustee received $158,850.97 from the Rubber Co. pursuant to the contract as modified, and during 1935, $92,371.14.

"The fiduciary returns for 1934 and 1935 of Russell Hopkinson as trustee treated as taxable income only a portion of the above mentioned amounts. The portion of the amount which was received with respect to each of the letters patent and patent applications which was included as taxable income was determined in accordance with the provisions of section 117 of the Revenue Act of 1934, 26 U.S.C.A.Int.Rev. Acts, page 707, on the theory that the patents and patent applications were capital assets and were held by the taxpayer for the length of time elapsing between the dates of the applications for the various patents and the date of the sale thereof, namely, May 12, 1930. The respective holding periods are not in issue, and it is stipulated that the various patents and patent applications were held for the periods shown in the stipulation of facts.

"In computing the net income of the trust for the year 1935, the trustee deducted from the gross income thereof reported on the return the sum of $7,500, representing legal expenses. This sum was paid out by the trustee during 1935 from trust income. The legal services consisted of tax advice, advice as to the modification of the agreement with the Rubber Co., and counsel as to the assignment of petitioner's beneficial interest to her children.

"In both years petitioner reported in her individual returns the net income reported by the trustee in his fiduciary returns."

When the Commissioner first determined the deficiencies he did so partly on the ground that the contract was not for the sale of capital assets but merely for the payment of royalties. He did not rely upon this contention before the Board but wishes to do so now. We think that is permissible under Hormel v. Helvering, 312 U.S. 552, 61 S.Ct. 719, 85 L.Ed. 1037, as the respondent has been put to no disadvantage by way of surprise; has filed,...