Estate of Horvath v. Comm'r of Internal Revenue

• Decision Date: 18 January 1973
• Docket Number: Docket No. 2854-69.
• Citation: 59 T.C. 551
• Parties: ESTATE OF AKOS ANTHONY HORVATH, KLARI A. ERDOSS, EXECUTRIX, PETITIONER V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

59 T.C. 551

ESTATE OF AKOS ANTHONY HORVATH, KLARI A. ERDOSS, EXECUTRIX, PETITIONER V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 2854-69.

United States Tax Court

Filed January 18, 1973.

Milton Brandon, for the petitioner.

Agatha L. Vorsanger, for the respondent.

Pursuant to sec. 2053(a)(3), petitioner deducted $422,958.91 from decedent's gross estate. According to respondent's statutory notice of deficiency, the deduction was disallowed because ‘the statute of limitations can be pleaded to bar collection.’ The pleadings herein were directed solely to this question. At trial respondent stated that the underlying validity of the debt was also in question. Held: Respondent's new theory was not evident from the pleadings and required different proof. Petitioner was surprised and the presentation of her case was substantially prejudiced. Therefore, the underlying validity of the debt is not before this Court. Held, further, respondent's new theory constitutes a new ‘issue’ rather than a new ‘reason.’ Held, further, the statute of limitation did not bar collection of this debt since decedent had executed a valid acknowledgment under New York law. Held, further, the penalty imposed by sec. 6651(a) is without consequence because there was no estate tax liability.

STERRETT, Judge:

Respondent determined a deficiency in petitioner's Federal estate tax return in the amount of $66,112.02 and a delinquency penalty under section 6651(a), I.R.C. 1954,¹ in the amount of $13,222.40. The issues for our determination are:

(1) Whether an issue as to the validity of a debt of the decedent, Akos Anthony Horvath, is before this Court, where the statutory notice and pleadings were framed in terms of whether the applicable State statute of limitations barred the collection of such debt.

(2) Whether the statute of limitations barred collection of a debt owed by the decedent to Massachusetts Mohair Plush Co. under the laws of New York.

(3) Whether a delinquency penalty under the provisions of section 6651(a) is applicable.

FINDINGS OF FACT

Decedent Akos Anthony Horvath died testate on April 29, 1964. Petitioner Klari A. Erdoss, the daughter of the decedent, was duly appointed executrix of the decedent's last will and testament by the Surrogate's Court of New York County, New York.

An estate tax return was due no later than 15 months after the date of decedent's death, or July 29, 1965. On May 19, 1966, an estate tax return, Form 706, was filed on behalf of the decedent with the district director of internal revenue, New York, N.Y. The petitioner resided at the time of the filing of the petition herein at Bronxville, N.Y.

Decedent was the father of three children: the petitioner herein, Ernest Horvath (hereinafter referred to as Ernest), and George A. Horvath (hereinafter referred to as George). At the time of his death, the decedent was 89 years of age. Ernest was 61 years old and George was 55.

Massachusetts Mohair Plush Co., Inc. (hereinafter referred to as the company), was a closely held corporation with its business office located in New York City. Its principal business was the manufacture of decorative and industrial fabrics.

The company's 1,500 shares of common stock were held equally by the petitioner, Ernest, and George. The decedent owned 2,500 shares of authorized and issued 6-percent cumulative, $100 par value, class A preferred stock. Thirteen thousand, three hundred shares (13,300) of class B preferred stock were issued to Shippan Enterprises, Inc., a wholly owned subsidiary, but were eliminated through consolidation.

Ernest served as president of the company, George wassecretary-treasurer, and the decedent was chairman of the board of directors. All three were salaried employees of the company. Management of the company was informal in that the board of directors never met as such. The decedent, father to the other officers, exercised final authority on most decisions concerning business operations. He played an active role in the company until just prior to his death. Petitioner did not take an active role in the management of the company, nor did she receive a salary.

The decedent, Ernest, and George commonly made withdrawals from the company. These were usually evidenced by demand notes or on open account. A certified financial statement of the company for the period ended April 30, 1964, reflected these withdrawals as assets under the heading ‘Notes and Loans Receivable— Officers and Others . . . . . $1,385,623.’

In response to a request for verification of receivables from accountants conducting an audit of the company, decedent executed the following written statement:

FEBRUARY 12, 1963

WASSERMAN & TATEN

501 Fifth Avenue

New York, N.Y.

GENTLEMEN:

This is to certify that as of September 29, 1962, I was indebted to Massachusetts Mohair Plush Company, Inc. on a non-interest bearing note for $310,510.80 and on open account for $110,498.11.

Very truly yours,

(S) Akos A. Horvath AKOS A. HORVATH

In this last will and testament executed on December 13, 1962, and admitted to probate on May 15, 1964, decedent included the following clause:

THIRTEENTH:

I hereby direct and authorize my Executors, as soon after my death as may be possible, to tender all of the preferred stock of Massachusetts Mohair Plush Co., Inc. (hereinafter referred to as ‘Corporation’), which I may own at my death (it should be approximately $250,000 face value) to Corporation in exchange for satisfaction of such indebtedness I may have to said Corporation, as may appear on its books and records (it should be approximately $400,000) at the time of my death.

If Corporation is not willing to accept such tender, then I direct my Executors to enforce the rights of the preferred stock so as to obtain maximum value therefor before arranging to pay my indebtedness to Corporation.

Between 1963 and 1964 the company was short of ready cash and was not able to pay many of its debts, including the Federal withholding tax then due. By 1969 the company was bankrupt.

Petitioner included among the debts of the decedent on his estate tax return the sum of $422,958.91 as ‘Non-interest bearing loans from Massachusetts Mohair Plush Co., Inc.’ This amount entered into the computation of decedent's taxable estate.

In his statutory notice of deficiency sent pursuant to section 6212, respondent disallowed this deduction by stating: ‘Schedule K, item 1, in the amount of $422,958.91 is disallowed since the statute of limitations on this debt can be pleaded to bar collection.’

The petition herein addressed itself solely to finding error in respondent's determination that the statute of limitations had run on decedent's debt. Respondent's answer affirmed or denied each allegation of the petition, but raised no affirmative defenses.

In his opening statement to this Court, respondent stated that he questioned the underlying validity of decedent's indebtedness to the company and alternatively would rely on the statute of limitations to bar collection. During the course of the trial petitioner objected to the introduction of the validity theory on the basis of surprise.

OPINION

The first issue we must decide is whether respondent may question the validity of decedent's underlying indebtedness to the company.

In his notice of deficiency, respondent disallowed a deduction taken by the petitioner pursuant to section 2053(a)(3) in the following language: ‘Schedule K, item 1, in the amount of $422,958.91 is disallowed since the statute of limitations on this debt can be pleaded to bar collection.’

The petition herein was addressed solely to claiming error in respondent's determination that the statute of limitations had run on decedent's debt. The answer merely affirmed or denied the allegations without raising any affirmative defenses. The pleadings were without amendment.

Petitioner's opening statement to this Court was entirely consistent with the pleadings herein. However, respondent stated in his opening statement that he did not intend to limit his reliance solely to the statute of limitations, but also wished to attack the underlying validity of the debt. Petitioner claimed surprise, arguing that the issue had been narrowed sufficiently to forego any discussion of the validity of the debt. Further she argued that in order properly to decide this issue, substantially new and different facts would have to be brought forward, and to require petitioner to do so at the hearing would be unjust and prejudicial to her case.

Respondent asserts that attacking the validity of the debt simply constitutes another reason for upholding the original determination of a deficiency.

It is well settled that the respondent's determination may be affirmed for reasons other than those assigned in his notice of deficiency. Estate of Peter Finder, 37 T.C. 411 (1961); Standard Oil Co., 43 B.T.A. 973 (1941), affd. 129 F.2d 363 (C.A. 7, 1942). However, it is equally clear that the Court must determine whether there has been surprise and substantial disadvantage to the petitioner in the presentation of his case because of the manner in which the statutory notice and pleadings were drawn when compared to the issues raised at the trial. Mills v. Commissioner, 399 F.2d 744, 748 (C.A. 4, 1968), affirming a Memorandum Opinion of this Court; Richard Rubin, 56 T.C. 1155 (1971), affirmed per curiam 460 F.2d 1216 (C.A. 2, 1972); Nat Harrison Associates, Inc., 42 T.C. 601, 617 (1964). In this Court's opinion, it is appropriate to determine whether surprise and disadvantage are present prior to making the often esoteric finding that a particular theory advanced by the respondent has characteristics more like new ‘reasons' than new ‘issues' or ‘matters.'² This is so because once surprise and substantial detriment are found, the theory, whether a new reason or new issue, need not be heard by this Court. Cf. Commissioner v. Chelsea Products, 197 F.2d 620, 624 (C.A. 3, 1952), affirming 16...