Hill's Estate v. Maloney

• Decision Date: 16 November 1944
• Docket Number: No. C-1762,C-2496.,C-1762
• Citation: 58 F. Supp. 164
• Parties: HILL'S ESTATE et al. v. MALONEY, Collector of Internal Revenue (two cases).
• Court: U.S. District Court — District of New Jersey

58 F. Supp. 164

HILL'S ESTATE et al. v. MALONEY, Collector of Internal Revenue (two cases).

Nos. C-1762, C-2496.

District Court, D. New Jersey.

November 16, 1944.

William A. Moore, of Trenton, N. J., and Sanford D. Beecher and William H. Huplits, Jr., both of Philadelphia, Pa., for plaintiffs.

Thorn Lord, U. S. Atty., of Trenton, N. J., by Charles D. Hyman, Asst. U. S. Atty., of Atlantic City, N. J., and Lester L. Gibson, Sp. Asst. to Atty. Gen., for defendant.

FORMAN, District Judge.

The estate of C. V. Hill and its executors, J. Stuart Hill and C. V. Hill, Jr., claim refunds of federal income tax paid by the late C. V. Hill during his lifetime for the calendar years 1935 and 1936, in two separate actions brought against the Collector of Internal Revenue. Both actions were tried together before this Court and have the same bases in fact. The amounts involved differ because one action represents a claim of refund for the year 1935 and the other for the year 1936.

C. V. Hill, a resident of Trenton, New Jersey, now deceased, was born on October 10, 1863. During his lifetime he regularly reported his income for federal income tax purposes on a cash basis. He paid such tax in the amount of $9,513.04 for the year 1935 and in the amount of $10,487.43 for the year 1936. Plaintiffs received a notice of a deficiency of income tax for these years under date of May 29, 1939, in the amounts of $384.14 and $2,014.47, respectively. These deficiencies were paid by plaintiffs. Claims for refund of tax for 1935 and 1936 were disallowed by the Commissioner of Internal Revenue on September 12, 1939, and November 19, 1940, respectively.

On August 31, 1935, C. V. Hill agreed with a syndicate composed of five individuals to sell 900 shares of the common stock of C. V. Hill & Co., Inc., upon condition that the determination of the fair sale value of the stock be submitted to a neutral and independent appraiser agreeable to both parties. Upon a written submission of such value by the appraiser, the syndicate was to have the option of purchasing the entire amount of stock for cash upon the basis of the value determined by the appraiser within thirty days thereafter. The syndicate consisted of J. Stuart Hill and C. V. Hill, Jr., sons of C. V. Hill, and three others, all five of whom were employees of the company.

On December 9, 1935, the syndicate was formally organized by virtue of an agreement entered into by these five persons, whereby the sons of C. V. Hill were designated the syndicate managers. It was proposed therein that 450 shares of stock should be purchased, allocable to the syndicate members as follows:

                   J. Stuart Hill           175 shares
                   C. V. Hill, Jr.          175 shares
                   J. Tinley Knotts          45 shares
                   Earl J. Kressler          40 shares
                   Frank D. MacMaster        15 shares
                

In addition to setting forth the terms upon which the members entered the agreement and their obligations thereunder, it provided that the purpose of the formation of the syndicate was to acquire the said stock for which it would be bound to pay the same benefits to C. V. Hill as he would derive from the investment in a non-refundable annuity contract for life of an amount which would be the equivalent of the value of the stock. No mention was made of the balance of 450 shares, but it is known that they were purchased as shown below and it is assumed that they were allocated to the syndicate members in similar proportion.

Under a contract dated December 11, 1935, C. V. Hill sold to the syndicate 450 shares of the stock with a ninety-day option to purchase the remaining 450 shares. The contract set forth that a determination of the fair sale value of the 900 shares had been made by a disinterested, neutral and independent appraiser and that his determination was agreeable to both parties. It stated that the value of the stock was determined to be $360,000, or $400 per share, and that amount was the consideration which was to be paid to C. V. Hill in the same manner as if he had invested that sum in a non-refundable life annuity contract. C. V. Hill, under this contract, was to receive the sum of $27,000 in cash and $1,514.70 per month for the balance of his life commencing January 31, 1936, and upon the exercise of the option by the syndicate he was to receive an additional $18,000 as a down payment and an annual payment of $20,444.40 for life commencing January 31, 1937. The option was exercised by the syndicate and a contract was entered into between the parties on January 6, 1936, for the purchase by the syndicate of the balance of the stock amounting to 450 shares upon the terms set forth in the December 11, 1935 contract.

C. V. Hill, being 72 years of age at the time of these agreements, had a life expectancy based on mortality tables of approximately 8 years. He died on February 4, 1939, at which time he had received under the contracts the total sum of $162,377.10.

Prior to the execution of the aforesaid agreements, C. V. Hill was president and a director of C. V. Hill & Co., Inc., and his sons, J. Stuart Hill and C. V. Hill, Jr., were general manager and sales manager, respectively. Immediately upon the execution of the agreement dated December 11, 1935, C. V. Hill resigned as president and as a director of the company and thereafter the syndicate members elected themselves directors. J. Stuart Hill and C. V. Hill, Jr., were named as president and vice president, respectively. C. V. Hill no longer participated in the management of the company. The shares of stock acquired by the syndicate together with shares owned by them individually enabled the syndicate to enjoy a majority interest in the company. Upon taking over the business, the syndicate increased the salaries of its members and voted themselves large bonuses. Comparative figures for the years 1934 to 1936, inclusive, of the incomes received by each of the sons, who owned the greater part of the stock and were the dominant members of the syndicate, follow:

                            1934        1935        1936
                Salary   $ 6,075.00  $ 7,425.00  $24,250.00
                Bonus      4,000.00   16,000.00   40,000.00
                         __________  __________  __________
                Total    $10,075.00  $23,425.00  $64,250.00
                

C. V. Hill reported his 1935 income as if he had sold 450 shares of stock for cash or its equivalent. He treated the transfer as a closed and completed transaction for the sale of 450 shares of stock for $180,000, reporting a total capital gain of $157,500 on this item. This figure resulted from his use of the par value of the stock, $50 per share, as a cost basis to him, making his total cost the sum of $22,500. His 1936 income tax return was similarly computed on this basis and therefore in each of these years he included $157,500 in capital gain and paid the tax thereon. An audit of these returns by the defendant terminated in an adjustment of the cost basis of the stock to C. V. Hill from $50 per share to $43 per share, which was the basis for the deficiencies subsequently paid by the plaintiffs herein. A portion of the 1936 deficiency arose by reason of the alleged failure of C. V. Hill to include as income the sum of $4,590, which defendant claimed represented taxable annuity income as provided for by the Revenue Act of 1936. 26 U.S.C.A.Int.Rev. Code, § 22(b) (2).

Before instituting this suit, plaintiffs filed claims for refund of tax for the years 1935 and 1936 upon the theory that gain was only realized on the transaction upon actual receipt of payments as made from time to time. These claims were rejected by defendant who at that time took the position that the transfers of the stock were sales for cash or its equivalent and properly treated as such, i.e., closed transactions as if for cash. On their theory, plaintiffs compute C. V. Hill's income tax for the year 1935 to be approximately $118.92,¹ after reflecting, among other things, the actual receipt by him of $27,000, the down payment on his contract of December 11, 1935, received during that year, and his income tax for the year 1936 to be approximately $698.28,¹ based upon the actual receipt by C. V. Hill during that year of $36,176.40.

Therefore, plaintiffs seek in this action the recovery of $9,778.26 and $11,803.62, representing refunds of tax for the years 1935 and 1936, respectively.

Defendant now takes the position in his amended answer that the sale of the 900 shares of stock was not a bona fide sale of stock, but a gift of the same to the syndicate, with a reservation of the income therefrom for life. Under this theory defendant argues that C. V. Hill reserved to himself a life interest in the stock and therefore the transaction was not taxable as a closed transaction of a sale of stock for cash or its equivalent, but that the payments received in 1935 and 1936 should have been treated as ordinary income and so taxable. Defendant computed the correct liability of C. V. Hill for tax in 1935 as $3,959.53 and in 1936 as $7,050.14, and he conceded overpayment of tax in the amounts of $5,937.65 and $5,451.76 for those years, respectively. Pursuant to his altered position, defendant continues to include in his computation of C. V. Hill's gross income for the year 1936, the sum of $4,590 as taxable annuity income, which he argues he is entitled to do under Sec. 22 (b) (2) of the Revenue Act of 1936, supra. The price of the stock under the contract of December 11, 1935, was $180,000. That contract provided for a down payment of $27,000. The balance of $153,000 represented the cost of the annuity to C. V. Hill. Upon the latter amount defendant calculated 3% or $4,590.

In support of his contention that the transfer of the stock was not a bona fide sale but rather a gift of the stock to the syndicate with a reservation of the income therefrom for life, defendant argues that C. V. Hill and the syndicate anticipated that the earnings of C. V. Hill & Co., Inc., available for distribution, and the dividends on the...