Exchange Security Bank v. United States, Civ. A. No. 66-684-S

• Court: United States District Courts. 11th Circuit. United States District Court of Northern District of Alabama
• Citation: 345 F. Supp. 486
• Docket Number: 68-389-S.,Civ. A. No. 66-684-S
• Parties: EXCHANGE SECURITY BANK et al., Plaintiffs, v. UNITED STATES of America, Defendant. Ellen Gregg INGALLS et al., Plaintiffs, v. UNITED STATES of America, Defendant.
• Decision Date: 07 June 1972

345 F. Supp. 486

EXCHANGE SECURITY BANK et al., Plaintiffs, v. UNITED STATES of America, Defendant.

Ellen Gregg INGALLS et al., Plaintiffs, v. UNITED STATES of America, Defendant.

Civ. A. Nos. 66-684-S, 68-389-S.

United States District Court, N. D. Alabama, S. D.

June 7, 1972.

Robert McDavid Smith, Allen D. Rushton-Lange, Simpson, Robinson & Somerville, Birmingham, Ala., for plaintiffs.

Jack D. Warren, Tax Div. Dept. of Justice, Washington, D. C., Henry I. Frohsin, Birmingham, Ala., for defendant.

MEMORANDUM OF OPINION

POINTER, District Judge.

These actions, consolidated for trial, have been brought under 28 U.S.C. § 1346(a) (1) for the refund of income taxes collected on the 1960 incomes of Ellen Gregg Ingalls (CA 66-684) and of the Estate of Robert I. Ingalls Sr., deceased (CA 68-389).¹ According to the assessments Mrs. Ingalls and her late husband's estate realized income in 1960 to the extent of $44,942.14 and $188,532.83, respectively, from the cancellation in that year by Ingalls Iron Works Company of debts owed by them to the company. The cancellation is said to have arisen as an incident of an agreement which settled part of a bitter intra-family dispute which had been going on for more than a decade, even the settlement of which spawned its own court battles.² With good reason no effort is made to claim a gratuitous forgiveness under Helvering v. American Dental Co., 318 U.S. 322, 63 S.Ct. 577, 87 L.Ed. 785 (1943) or insolvency on the part of the debtors per Mertens, Law of Federal Income Taxation, § 11.22.

The family conflict erupted in 1948 when Mr. Ingalls Sr. opposed the marital plans of his son, Robert I. Ingalls Jr. Mr. Ingalls Sr., the founder and chief executive officer of Ingalls Iron Works Company, controlled its affairs; although, due to outright gifts and the establishment of family trusts, he no longer had a majority of the stock in his own name. Mr. Ingalls Jr. was, as President and Vice Chairman, second in command of the company, as well as its largest individual stockholder. When the son went forward with the marriage, he soon found himself neither an officer nor a director of the company. Mr. Ingalls Sr. died in 1951, and by 1953 the son had managed to become the chief corporate executive, although his position was hardly secure in view of the some thirty separate lawsuits which were filed in the state and federal courts by one or another of the interested parties and companies. The focal point was a case in the state court in which Mrs. Ingalls was contesting, and her son was supporting, the company's belated exercise of an option to redeem the 2,287 shares of stock owned by Mr. Ingalls Sr. at the time of his death, shares which otherwise would have gone into testamentary trusts over which Mrs. Ingalls had significant powers.

While the son was in control, the company instituted in this court two "collection" suits: one seeking to recover from the Estate of Mr. Ingalls Sr. a principal indebtedness of $188,532.83 (of which $120,000 was evidenced by his promissory note and the balance reflected in an open account on the company's books); and the other seeking to collect from Mrs. Ingalls $52,165.93³ allegedly due from her by account stated. As is not unusual with closely held family corporations, the company over the years had paid various personal bills and tax liabilities of Mr. and Mrs. Ingalls Sr., reflecting the same as accounts receivable, with credits being made against the accounts principally from company dividends and from their personal "outside" income being collected by the company as their agent.

The Estate formally denied any indebtedness, and counterclaimed for some $541,000 in unpaid dividends on the 2,287 shares of stock which were the subject of the redemption dispute. Mrs. Ingalls denied any indebtedness on her own part, specifically denying any "account stated," and counterclaimed for $141,051.17. According to her counterclaim, the company had erroneously charged her account with $193,217.10 in taxes paid by it to state and federal agencies. These taxes, she said, should have been charged to Mr. Ingalls' account by virtue of an agreement made years earlier between the two of them whereby, in consideration for using her income to pay household expenses, he agreed to pay her tax liabilities. It is apparent that the formal denials of indebtedness were designed in large part to put the company to potentially insurmountable evidentiary problems.⁴

The case against Mrs. Ingalls was tried in 1957 (on the theory of an account stated), resulting in a verdict and judgment favorable to the company for the amount claimed by it plus interest. 152 F.Supp. 523 (N.D.Ala.1957). The Fifth Circuit reversed, concluding that Mrs. Ingalls' response to an auditor's inquiry was insufficient to convert what had been an open account into an account stated. 258 F.2d 750 (5th Cir. 1958). After the remand the complaint was amended to add counts charging an open account, and Mrs. Ingalls parried by adding the defense of the Alabama three-year statute of limitations.

The retrial was scheduled for the March 1959 docket. Among the lawsuits then still pending were the company's case in this court against the Estate of Mr. Ingalls Sr. (which cause had apparently lain dormant) and the case in the state court challenging the stock redemption (which was back in the trial court after an interlocutory appeal to the Alabama Supreme Court).

While waiting for the case against Mrs. Ingalls to be reached on the trial docket the parties commenced negotiations looking to a broader resolution of their multi-faceted dispute. An accord was reached, the terms of which were entered of record by this court on March 10, 1959. The terms of the settlement, briefly summarized, were as follows:

The stock redemption of Mr. Ingalls' 2,287 shares was set aside, such shares being recognized as part of his Estate and in turn divided between the two trusts established under his will. One of the trusts was a "marital" trust for the benefit of Mrs. Ingalls during her lifetime, coupled with a general testamentary power of appointment, which she agreed to exercise in favor of her two granddaughters.⁵ It was agreed that the shares placed in the other trust (for the benefit of a family foundation) were to be subject, at Mrs. Ingalls' death, to an option to purchase for a stipulated price, the granddaughters having a priority over the company regarding such option. The Estate's claim for back dividends was waived except to the extent of $175,000, which was to be paid to its attorneys as fees. The company's suits on the accounts were to be dismissed with prejudice, as were the counterclaims therein. Mrs. Ingalls was to be returned to the Board of Directors and to be elected to a corporate office at a compensation of at least $10,000 per year.

Shortly thereafter the company sought to renege on the settlement, contending that those representing it lacked authority to make such an agreement and that certain of the obligations undertaken by the other parties to the settlement were beyond their legal power. The company's contentions were rejected by this court in August 1959 (see 177 F. Supp. 151) and by the Fifth Circuit in August 1960 (see 280 F.2d 423). In September 1960 the company's Board of Directors adopted a resolution accepting, and directing immediate compliance with, the settlement, and in the same month final docket entries disposing of the company's "collection" suits were entered in this court.⁶ In May 1961 entries were made on the company's books charging off against retained earnings, as of December 31, 1960, the two accounts.

The government has taken the position in its assessments and in these actions that Mrs. Ingalls and the Estate of Mr. Ingalls realized income⁷ by the cancellation in 1960 of debts owed by them to the company in the amounts of $44,942.14 and $188,532.83, respectively. I.R.C. § 61(a) (12). Plaintiffs' suits for refunds are premised upon contentions which deny the debts, deny their cancellation, assert the lack of any enrichment thereby, and assert that in any event a year other than 1960 would be the correct period for inclusion. The burden is on the plaintiffs to prove one of their contentions; they are not excused from that responsibility by showing the difficulty or impossibility of that task. Burnet v. Houston, 283 U.S. 223, 51 S.Ct. 413, 75 L.Ed. 991 (1931); Allen v. Comm'r of Internal Revenue, 117 F.2d 364 (1st Cir. 1941).

This case presents a question not clearly answered by reported tax cases: Under what circumstances does D realize cancellation of indebtedness income when he settles a disputed collection suit brought against him by P for less than the amount P claims is owing? It is sometimes said that the compromise of a disputed debt does not give rise to income to the debtor. See, e. g., Mertens, Law of Federal Income Taxation, § 11.19. And certainly the dismissal by a plaintiff without any payment of a spurious collection suit for a debt which never existed or was never a legal obligation of the defendant should not create income. See United States v. Hall, 307 F.2d 238 (10th Cir. 1962); Autenreith v. Comm'r of Internal Revenue, 115 F.2d 856 (3rd Cir. 1950). Nor should the result be different if, to save the time and expense of defending the suit or to avoid the hazards inherent in almost all litigation, D is willing to make some payment to P. That there is no income in such situations may be understood either on the basis that no "debt" is being cancelled or that the nominal debtor in reality is not enriched thereby. Cf. United States v. Kirby Lumber Co., 284 U.S. 1, 52 S.Ct. 4, 76 L.Ed. 131 (1931).

On the other hand D may actually owe the debt; and yet P, confronted with a denial of liability, may be willing to settle, saving the time and expense of litigation, by accepting a much smaller payment than that actually owing. Where there are serious problems of proof or...