Harris v. United States

• Decision Date: 21 January 1966
• Docket Number: No. 999.,999.
• Parties: Robert E. HARRIS and Dorothy H. Harris, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Southern District of West Virginia

249 F. Supp. 380

Robert E. HARRIS and Dorothy H. Harris, Plaintiffs, v. UNITED STATES of America, Defendant.

No. 999.

United States District Court S. D. West Virginia, Huntington Division.

January 21, 1966.

W. E. Parsons, Huntington, W. Va., William G. Wilson, Logan, W. Va., for plaintiffs.

Richard M. Roberts, Acting Asst. Atty. Gen., Russell L. Davis, Dept. of Justice, Washington, D. C., Milton J. Ferguson, U. S. Atty., George D. Beter, Asst. U. S. Atty., Huntington, W. Va., for defendant.

CHRISTIE, District Judge:

This is an action brought by plaintiffs, under 28 U.S.C.A. § 1346(a) (1), to recover cover federal income taxes in the sum of $3,221.30, paid under protest for the years 1954, 1955 and 1956. The parties by mutual agreement have submitted the case to the Court, sitting without a jury, for determination of the issues involved.

A stipulation of facts was entered into and agreed upon by the respective parties. It is shown in its entirety in an appendix to this opinion.

Based on this stipulation of facts, the exhibits and depositions of record, we must hold, for the reasons shown, that the Internal Revenue Service was correct in treating plaintiffs' returns in 1954, 1955 and 1956 as unreported dividends and assessing the deficiency complained of.

The resolution of two basic issues, we think, quite clearly determines the outcome of this case. They are (1) whether or not the income credited to the beneficiaries' accounts in 1948, 1949 and 1950 was income "currently distributable," for purposes of Internal Revenue Code Section 662, making it then taxable to the beneficiaries, and (2) whether payments to Harris, Inc., by the executors were contributions to capital, thus making the payments received by plaintiffs during the years 1954, 1955 and 1956 distributions taxable as dividends defined in Section 316 of the Internal Revenue Code of 1954, or whether these payments made to the corporation were loans, thus making the repayment of such loans taxable only on the portion which represented interest.

I

The handling of the estate and trust as set forth in the will of B. C. Harris required the executors to pay all of his just debts including Federal Estate and State Inheritance Taxes before any distribution of his estate was made, and in the event that at the time of his death there were insufficient liquid assets to pay all of his just debts, including Federal Estate Tax, State Inheritance Tax, and other taxes, the executors were directed to sell or encumber so much of the real estate as was necessary for that purpose. From the deposition of Mrs. Harris, a plaintiff and an executrix under the will, it was evident that the estate at the time of Mr. Harris' death did not have enough cash to pay the aforementioned taxes. Mrs. Harris explained that since real estate values were rising at that time, the executors and beneficiaries had agreed that the net income belonging to the trust would be credited to the beneficiaries, but would be used for the payment of the Federal Estate and West Virginia Inheritance Taxes. By such plan, the executors and beneficiaries would benefit twofold: (1) Gain an obvious tax advantage by crediting the beneficiaries with the net income so as to reduce the net income of the estate taxable as an entity, and (2) avert the necessity of selling the valuable real estate of the estate. It is plain, however, from a reading of the will and the pertinent provisions of the Internal Revenue Code¹ that the effect of these manipulations were in fact tax evasive rather than a prudent attempt to minimize taxes. As previously mentioned, the will specifically provided that there was to be no distribution of income until the taxes and other indebtedness had been paid. It is well established that executors' power and authority are defined and limited by the will and their assumption of duties as executors requires that their conduct be consonant with the directions of the will and not in conflict therewith. 21 Am.Jur., Executors and Administrators, Sections 3 and 208 (1939); Harrison v. Miller, 124 W. Va. 550, 21 S.E.2d 674 (1942); 8 M.J., Executors and Administrators, Section 60 (1949). Thus, the executors under the will lacked authority, in both law and fact, to credit the $207.714.58 to the beneficiaries' accounts before the taxes were paid. Plaintiffs contend, however, that Igoe v. Commissioner of Internal Revenue, 19 T.C. 913 (1953), is controlling here. From a careful reading of that case it is quite distinguishable. There, the will of Andrew J. Igoe provided that after the payment of all the debts and testamentary expenses, the estate was to be split among several beneficiaries. There, as here, the issue was whether net income of the estate was properly credited to the beneficiaries so as to come within the appropriate sections of the Code. The Court held that such income was properly credited. The all-important distinguishing factor, however, was that the assets of the estate of Andrew J. Igoe were more than adequate to provide for the payment of all obligations of the estate including debts, taxes, and administrative expenses, without use of the 1941 net income involved in those proceedings and it was so noted by the Court.

In the case Estate of C. R. Hubbard, 41 B.T.A. 628 (1940), what we consider an analogous situation to the case at bar, the Court interpreted "properly credited" as contemplated by Sections 661 and 662 of the Code. There the will of the decedent provided that it was the duty of the executors to pay all administrative expenses and the inheritance taxes payable to the State of West Virginia and then to distribute to the beneficiaries the residue of the estate in accordance with the directions of the will. The executors, however, took up with the heirs and legatees the advisability of paying the state inheritance taxes from the income of the estate instead of obtaining money for their payment from the sale of income-producing securities. This procedure was followed and accordingly the money that was credited to the heirs or legatees was used for the payment of the taxes. The Court, in holding that the income was not properly credited, stated,

"The credit which was made to the beneficiaries' shares was not made with any expectation that the amount would ever be paid over to the beneficiaries. At the time the credit was made it was known that the money would be needed and would be used for the payment of West Virginia inheritance taxes. The executors are charged with the duty of paying those taxes before the estate is distributed. * * * In this situation we do not think that the income of the estate was `properly' credited to the beneficiaries * * *."

Therefore, where a credit is made on the executor's books, but where the income is actually used for the payment of inheritance taxes, we must hold, in light of the Hubbard decision, that here, as a matter of law, the income is taxable to the estate and not properly credited to the beneficiaries. In Commissioner of Internal Revenue v. Stearns, 65 F.2d 371 (2d Cir. 1933), the Court stated that a mere entry on the books of the fiduciary will not serve unless made in such circumstances that it cannot be recalled. Plaintiffs claim here that it is established that the income was so credited as to be beyond the point of recall. The circumstances in this case, however, do not bear out this claim. It is evident that the intention of the parties involved was for the co-executors to use this credited income for the payment of estate and inheritance taxes. The deposition of Mrs. Harris, executrix and beneficiary, leads us to no other conclusion, portions of which are as follows:

"Q. May I ask you another question now, Mrs. Harris? I notice that the estate of your husband did not sell its assets to pay the estate tax liability.

"A. There wasn't anything sold.

"Q. Why wasn't that sold?

"A. Well, for the same reason I said. It was real estate and at that time real estate was just becoming a little bit more valuable, going up, and I didn't feel like it was necessary to sacrifice it when we had our inheritance cash that we could put to that use. If we hadn't had, I would have gone to the bank and borrowed money rather than sacrifice the property.

* * * * * * *

"Q. Why is it that the estate did not make cash distributions or property distributions of these earnings to the three beneficiaries?

"A. Well, the boys had a living of their own and they set up an allowance, a widow's allowance, for me to live on until the estate was settled * * *.

* * * * * * *

"Q. Why didn't they distribute the earnings in cash or in property to the three beneficiaries? Was it to hold the property together?

"A. Mr. Harris directed that the property be put into — to form Harris, Inc., to separate the two businesses. It was his request that we form these two corporations."

Thus, we can only hold that any income that was credited by the executors did not actually belong to the beneficiaries, but rather was controlled and used by the executors for the payment of taxes so as to hold the property together. Even assuming that a portion of such income was credited to the beneficiaries beyond recall, the fact that the executors lacked authority to make any distribution of income in the first place, as previously mentioned, would nullify its legal effect.

II

Having decided that the alleged distribution of income was not properly credited to the beneficiaries, the resolution of this second issue becomes academic.

Plaintiffs have assumed throughout: (1) That a loan was made to the executors by the beneficiaries of the distributable income, and (2) that such loan incurred by the executors was assumed by Harris, Inc., as a debt. Based on these assumptions, they insist that the loans assumed by Harris, Inc., did not constitute contributions to capital and, therefore, payments made to the beneficiaries by Harris, Inc., were in payment of this loan and not dividend...