Evans v. Dudley

• Decision Date: 20 September 1960
• Docket Number: Civ. A. No. 16602.
• Parties: T. M. EVANS and Josephine S. Evans, Plaintiffs, v. Alexander J. DUDLEY, individually and as Former District Director of Internal Revenue, Defendant, United States of America, Intervenor.
• Court: U.S. District Court — Eastern District of Pennsylvania

188 F. Supp. 9

T. M. EVANS and Josephine S. Evans, Plaintiffs, v. Alexander J. DUDLEY, individually and as Former District Director of Internal Revenue, Defendant, United States of America, Intervenor.

Civ. A. No. 16602.

United States District Court W. D. Pennsylvania.

September 20, 1960.

John A. McCann, Pittsburgh, Pa., and Kirkpatrick, Pomeroy, Lockhart & Johnson, Pittsburgh, Pa., for plaintiff.

Hubert I. Teitelbaum, U. S. Atty., Pittsburgh, Pa., for defendant.

GOURLEY, Chief Judge.

In this non-jury proceeding in which the taxpayer seeks the recovery of certain of his 1954 income taxes allegedly erroneously assessed and collected by the District Director, the United States has filed a counterclaim which poses the focal legal questions for this court's determination.

1. May the Commissioner of Internal Revenue disallow on audit a deduction for bond premium amortization as to bonds purchased in 1954 where express statutory authority exists for such deduction under 26 U.S.C.A. § 171 based upon the thesis that the taxpayer has received a deduction on said bonds under the charitable contribution provisions of the Internal Revenue Act.

2. In the event that it is concluded that the Commissioner's disallowance of the bond premium amortization deduction was improper, should the allowable bond premium be computed based on the general or special call prices?

For purposes of simplification I shall allude throughout this opinion, in the singular, to the taxpayer, T. M. Evans, in view of the fact that all transactions were admittedly conducted by him, although the complaint is brought by T. M. Evans and his wife, Josephine S. Evans, since the income tax return upon which suit is predicated was filed as a joint husband-wife return.

The taxpayer's complaint requested relief with respect to increasing allowance for fair market value of the equity in bonds to which he was entitled as a charitable contribution in his tax return for the year 1954, and with respect to the amount of a claimed casualty loss resulting from a hurricane to taxpayer's summer home located at Fishers Island, New York.

In view of the uncontested testimony as to the values of the securities deductible as a charitable contribution and stipulated agreement rendered during trial between the taxpayer and the government, as to the casualty loss experienced, the court entered final orders on these issues and accordingly they require no further consideration.

I shall, therefore, direct myself entirely to the issues raised by the governments' counterclaim as to the correctness of the bond premium amortization deduction.

On October 15, 1954, taxpayer bought $1,300,000 face amount of public utility bonds at a premium. On October 18, 1954, he bought an additional $700,000 face amount of similar bonds, all bonds were issued prior to January 22, 1951. The total cost to the taxpayer of the bonds so purchased, including commissions and other charges was $2,227,930.96. Being public utility bonds they were so called callable bonds, being subject to redemption at any time upon thirty days' notice at a lower price than the purchase price known as the call price. The premium paid on acquiring the bonds, i. e., the amount paid for the bonds in excess of their call prices, was $182,420.

All of these public utility bonds were purchased through the First Boston Corporation, a national brokerage house having an office in Pittsburgh, Pennsylvania. The taxpayer had previously dealt with them to a substantial extent in connection with his extensive market operations. In order to pay for the public utility bonds the taxpayer advanced $118,000 of his own money and borrowed $2,109,930.96 from Mellon National Bank and Trust Company.

The taxpayer on November 19, 1954, donated $1,250,000 face amount of these bonds, $700,000 to Yale University and $550,000 to the T. M. Evans Foundation. (Substantial gifts to both of these charities were made by taxpayer both prior to and subsequent to the above transactions.) In March and May of 1955, taxpayer donated the remaining $750,000 of these bonds to the T. M. Evans Foundation.

Under the terms of his deeds of gift of the bonds, Yale University and the T. M. Evans Foundation, respectively, at the time of the gifts accepted the bonds and agreed to assume and pay the outstanding indebtedness relating to the bonds which the taxpayer had incurred in purchasing them.

Taxpayer, in his federal income tax return for the year 1954 took a deduction under 26 U.S.C.A. § 171 of the Internal Revenue Code of 1954, in the amount of $170,500 by way of amortization of the premium paid on the acquisition of the bonds. The amount was calculated as being the difference between the prices paid and the call prices at the earliest call dates. In addition taxpayer claimed a deduction for the charitable contribution of his equity in the face amount of the bonds.

In short, taxpayer was able to secure what amounted to a double deduction under the Revenue Law, first by invoking the amortization provision of the Act, and second by taking a deduction under the charitable contribution provisions of the Act.

It is not in dispute that taxpayer had engaged in security transactions on a large scale both prior and subsequent to this transaction, nor was anything unusual, irregular, or not in accordance with established practice. The taxpayer admittedly states that based upon information which he gleaned from financial publications and upon consultation with counsel he purchased the utility bonds with the view of taking advantage of tax benefits available under the amortization provisions of the Revenue Act as well as the deduction to which he would be entitled in making a charitable contribution, together with a full recognition of the risk of loss or benefit from any decline or advance in the market value which might accrue.

I.

The government contends that the taxpayer should not be entitled to bond premium amortization under 26 U.S.C.A. § 171 where he secures the equivalent of the benefit as a charitable contribution. The government categorically admits that the taxpayer had he not made a charitable contribution of the bonds, would have been entitled to obtain the bond premium amortization. Thus, had the taxpayer contributed to the charitable purposes in cash or other securities, the utility bonds would have been a proper subject for amortization.

In short, the government advances the proposition that an otherwise allowable deduction should not be permitted if the taxpayer, on entering into a transaction, is motivated by the tax advantage to be gained rather than by a commercial or industrial purpose. In this connection they rely upon Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596.

The cases which have applied the rules enunciated by this authority essentially were transactions which constituted a sham or use to evade tax responsibility. The purchase of bonds by the taxpayer, unlike the transactions relied upon by the government, was a real and legitimate purchase, in the open market at arms length with outstanding financial institutions resulting in an appreciable change in the taxpayer's financial position.

Thus, in each of the cases where the Tax Court concluded that a commercial or industrial purpose was lacking, it was concluded that the prices were artificial or that they resulted from transactions involving clients of the same promoters or finders and thereby having the indicia of unreality, John Fox 17 TCM 1006; Maysteel Products, Inc., 33 T.C. ___; Fabreeka Products Co., 34 T.C. 30; Jack L. Sherman, 34 T.C. ___; Sadie S. Friedman, 34 T.C. ___.

The purchase of bonds by the taxpayer, unlike the transactions relied upon by the government, was a real and legitimate purchase in the open market at arms length with outstanding financial institutions, resulting in an appreciable change in the taxpayer's financial position.

This Circuit has recognized that motive of tax avoidance, in itself, may not be considered in determining the incidence of taxation, Weller v. Commissioner, 3 Cir., 270 F.2d 294. It appears self-evident that this court is without power to conclude as a matter of law that the provisions of 26 U.S.C.A. § 171 do not have application to any security which might fall within the terms and provision thereof, merely where the taxpayer uses that security for any other purpose for which he is entitled to a deduction under any other provisions of the Internal Revenue Code.

The government inferentially is suggesting that this court is empowered to legislate on what appears to be a loophole in the law permitting a double deduction. Such power rests with Congress and not the courts. It is not my province to add...