McLoughlin v. Commissioner of Internal Revenue, 255.

CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)
Citation89 F.2d 699
Docket NumberNo. 255.,255.
Decision Date03 May 1937

Lord, Day & Lord, of New York City (Bernhard Knollenberg, Jesse Hoyt, and Joseph W. Wyatt, both of New York City, of counsel), for petitioner Edward McLoughlin.

James W. Morris, U. S. Asst. Atty. Gen., and Sewall Key and Berryman Green, Sp. Assts. to Atty. Gen., for respondent.

John J. Bennett, Jr., N. Y. Atty. Gen., Henry Epstein, Sol. Gen., of Albany, N. Y., and John F. X. McGohey, Colin McLennan, and John C. Crary, Asst. Attys. Gen., amici curiæ.

Before L. HAND, SWAN, and AUGUSTUS N. HAND, Circuit Judges.

AUGUSTUS N. HAND, Circuit Judge.

This is a petition by a taxpayer employed in the Insurance Department of the State of New York at an annual salary of $5,125 to review an order of the Board of Tax Appeals holding his salary for 1932 income subject to taxation under the Revenue Act of that year. In 1930 the taxpayer was appointed by the Superintendent of Insurance to act as legal counsel in the Liquidation Bureau of the Insurance Department and worked daily in that capacity from 9 a. m. to 5 p. m. Outside of these office hours he did a certain amount of legal work for personal clients which, in 1923, yielded $1,410 less $570 office expenses.

The Liquidation Bureau was created in 1909 and in 1932 was in charge of a Special Deputy Superintendent of Insurance who was a civil service employee with a salary paid by the state. During the year 1932 the Bureau had from 100 to 400 employees, including three Assistant Special Deputy Superintendents, attorneys working on legal matters, bookkeepers, stenographers, adjusters, and accountants.

Under the New York Insurance Law (Consol.Laws N.Y. c. 28) § 400 et seq., the Superintendent of Insurance may apply to the court for an order taking over the assets of insurance companies for the purpose of liquidating, rehabilitating, or conserving their business. When such an order is made all of the work necessary for liquidation, rehabilitation, or conservation is performed by the Bureau. When an order for liquidation of a company is made, its charter is dissolved and no new business is transacted but the assets are liquidated, the claims of creditors adjudicated, and dividends are declared to those persons entitled to share in the assets of a defunct insurance company. When a company is rehabilitated by the Bureau, its property is returned to it so that it may resume business under its own management.

The business of the Bureau during 1932 was liquidation to which the taxpayer devoted 90 per cent. of his time during that year. The remaining 10 per cent. was devoted to legal problems of the Bureau as a whole, such as drafting a new article 11 of the Insurance Law relating to "Rehabilitation, Liquidation, Conservation and Dissolution of Delinquent Insurers."

Among the facts stipulated before the Board of Tax Appeals were the following:

"8. In the year 1932 the Department of Insurance had a general bank account with the Bank of New York & Trust Company at 48 Wall Street, New York City. The expenses of the Bureau, including all salaries, were paid by checks drawn on this bank. This account was referred to as the `Wash Account,' as simultaneously with the drawing of checks for salaries, etc., other checks were drawn on the bank accounts of the companies in liquidation and deposited with the Bank of New York & Trust Company to equalize the amount drawn out therefrom to meet the salaries and other overhead expenses of the Bureau. In drawing checks against the various companies in liquidation to meet petitioner's compensation and the other expenses of the Bureau, checks would be drawn by an Assistant Special Deputy of Insurance (as representative of the Superintendent of Insurance) on the bank accounts in which the deposits of the various companies were maintained. Each company coming under the jurisdiction of the Bureau kept its separate bank account, and the Superintendent of Insurance (having charge of all the assets of such company) was in a position to draw checks on the account.

"9. Petitioner's compensation for 1932 was prorated to the companies in proportion to the time devoted by him in connection with the respective companies on the legal affairs of which he was engaged. Petitioner's time devoted to the affairs of one particular company, would be charged against such company. Petitioner's time devoted to the general legal problems of the Department, would be prorated among the various companies under a formula designed to charge general administration expenses of the Department to the companies in liquidation in proportion to the aggregate compensation of those engaged in the specific liquidation of the respective companies.

"10. Petitioner's compensation during 1932 was paid bi-monthly but was computed on an annual basis. Petitioner was paid by check, a form of the check used being annexed hereto as Exhibit `C.' Petitioner did not receive any additional compensation from the Insurance Department by way of special fees or otherwise in addition to his fixed compensation. His yearly compensation was determined by the Superintendent and the compensation did not vary in accordance with the volume of legal matters handled by him during the year. Petitioner's entire compensation for 1932 was paid from funds of insurance companies being liquidated by the Superintendent of Insurance.

"11. In the budget of the Superintendent of Insurance there appeared an item called the Reserve Fund, for the use of the Superintendent in liquidating insurance companies whose assets were not sufficient to pay the costs of liquidation. In the budgets submitted for the fiscal years ending June 30, 1931, 1932 and 1933, the amount of the Reserve Fund was $5,000.00. It does not appear that any of the compensation paid to the petitioner during the year 1932 was derived from this fund."

The salary the taxpayer received for his work in the Liquidation Bureau was held taxable by the Commissioner of Internal Revenue. The action of the Commissioner was sustained by the Board of Tax Appeals on the ground that the taxpayer was not "an employee of the state engaged in carrying on an essential governmental function and that in any event the fact of his compensation being from private funds and not from those of the state precludes the allowance of exemption from Federal income tax."

The question presented for our decision is whether the taxpayer's compensation as counsel for the Liquidation Bureau and received through such Bureau is subject to federal income tax.

Section 22 of the Revenue Act of 1932, 26 U.S.C.A. § 22 and note, provides that:

"(a) General definition. `Gross income' includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid."

Treasury Regulations 77 contained the following provisions:

"Art. 643. Compensation of State officers and employees. — Compensation paid to its officers and employees by a State or political subdivision thereof for services rendered in connection with the exercise of an essential governmental function of the State or political subdivision, including fees received by notaries public commissioned by States, is not taxable. Compensation received for services rendered to a State or political subdivision thereof is included in gross income unless (a) the person receives such compensation as an officer or employee of a State or political subdivision, and (b) the services are rendered in connection with the exercise of an essential governmental function. The commissions of receivers appointed by State courts are taxable."

It is unnecessary for us to deal with the question as to whether the taxpayer when acting as counsel for the Liquidating Bureau was engaged by the state in the exercise of essential governmental powers. It may well be that his activities were essential, like those of a receiver. Jacoby v. Bond & Mortgage Guarantee Co. (C.C. A.) 72 F.(2d) 420, 423. Irrespective of any such relation to the state, there can be no exemption from federal taxation where, as here, taxation would result in no burden upon the governmental power of the state. That the existence of a burden is the test was the view adopted by the Supreme Court in sustaining the validity of a transfer tax by a state upon United States bonds in Plummer v. Coler, 178 U. S. 115, 20 S.Ct. 829, 44 L.Ed. 998, and in upholding a federal tax upon an estate which included state municipal bonds in Greiner v. Lewellyn, 258 U.S. 384, 42 S. Ct. 324, 66 L.Ed. 676. See, also, Snyder v. Bettman, 190 U.S. 249, 253, 254, 23 S.Ct. 803, 47 L.Ed. 1035; United States v. Perkins, 163 U.S. 625, 16 S.Ct. 1073, 41 L. Ed. 287; and Fox Film Corp. v. Doyal, 286 U.S. 123, 128, 52 S.Ct. 546, 76 L.Ed. 1010. By the same reasoning it was held that profits realized by an investor from a sale...

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