Mott v. United States, 390-69.
| Decision Date | 14 July 1972 |
| Docket Number | No. 390-69.,390-69. |
| Parties | Frank E. MOTT and Mary R. Williams, Executors of the Last Will and Testament of Walter C. Teagle v. The UNITED STATES. |
| Court | U.S. Claims Court |
Edward A. Vrooman, New York City, for plaintiffs. Harry F. Weyher, New York City, attorney of record.
Allan C. Lewis, Washington, D.C., with whom was Asst. Atty. Gen. Scott P. Crampton for defendant. Philip R. Miller and Joseph Kovner, Washington, D.C., of counsel.
Before COWEN, Chief Judge, DURFEE, Senior Judge, and DAVIS, SKELTON, NICHOLS, KASHIWA and KUNZIG, Judges.
ON PLAINTIFFS' MOTION AND DEFENDANT'S CROSS-MOTION FOR SUMMARY JUDGMENT
This tax case, apparently one of first impression, comes before the court on the parties' cross-motions for summary judgment. The issue is whether an estate is entitled to a deduction from its gross income, pursuant to Section 661(a)(2) of the Internal Revenue Code of 1954,1 when it makes a distribution of corpus of an estate to a qualified charitable beneficiary pursuant to a general pecuniary bequest. We have concluded that the claimed deduction is not available.
The pertinent facts, which have been stipulated, are as follows: Walter C. Teagle died on January 9, 1962, leaving a gross estate in excess of $36,000,000. Under the terms of his will, two-thirds of the estate, after payment of debts, expenses, and specific bequests, was left to the Teagle Foundation, a tax-exempt charitable corporation. The residue of the estate, including all income earned during its administration, was left in trust for the benefit of Jane W. Teagle, an alternate life beneficiary, with specified remainders over.
The years involved in this suit are the estate's taxable years ending July 31, 1963, 1964, and 1965. During this period, the executors of the estate made the following payments out of the corpus of the estate in partial satisfaction of the bequest to the Teagle Foundation:
1963________________ $13,165,575.75
1964________________ 405,379.02
1965________________ 375,000.00
The executors also made several distributions of income to Jane during the administration period before the trust came into operation, including during the years involved here, a $100,000 payment in 1963.
In computing Mr. Teagle's taxable estate, the executors were allowed an estate tax deduction of $14,107,420.90 for the charitable bequest to the Teagle Foundation. They now assert that they are also entitled to a deduction, in computing the estate's taxable income for the years involved here, for the payments described above which they made in satisfaction of the charitable bequest. Briefly stated, they contend that such a deduction is permitted by the plain terms of Section 661(a)(2), which provides in pertinent part that:
In any taxable year there shall be allowed as a deduction in computing the taxable income of an estate * * * any * * * amounts properly paid * * * for such taxable year * * *.
The Government, while conceding that a literal reading of Section 661(a)(2) would permit plaintiffs to prevail, maintains that that section cannot properly be interpreted without reference to its purpose, and that when the provision is read in the context of the entire statutory scheme of Subchapter J of Chapter 1 of the Code, it is clear that the distribution to the charitable organization in this case cannot qualify for the deduction permitted by Section 661(a)(2).
Before reaching the merits of this case, we think it is important to summarize briefly some of the basic principles of Subchapter J which relate to distributions by estates. Since the enactment of the Revenue Act of 1913,2 the value of "property acquired by gift, bequest, devise or inheritance"3 has been excluded from gross income. The exclusion is not absolute, however, since income from such property, including income realized by an estate during its administration,4 is subject to tax.5 Similarly, a bequest of income from property is not within the statutory exclusion.6 It has therefore become necessary to develop a system of rules which would determine the proper amounts of estate income subject to tax and, more importantly for purposes of this case, a system which would determine who should bear the burden of that tax. In making this latter determination, Congress has adopted the "conduit principle" of taxing estates (and trusts as well), through which an estate is treated as a taxable entity and is taxed, in general, on income which it realizes but which it does not distribute, or is not deemed to have distributed, to its beneficiaries. Where income is distributed to a beneficiary, or is deemed to be so distributed, that income would not be taxable to the estate but instead would be taxable to the beneficiary, a result which is accomplished by permitting the estate a deduction for the amount of the distribution and by requiring the beneficiary to include that amount in his gross income. In this manner, the conduit principle serves to effectuate a Congressional policy to tax estate income once, and only once, by allocating the tax between estate and beneficiary.7
Under the present rules of Subchapter J, the allocation described above is accomplished through the combined operation of the concept of "distributable net income," or "D. N. I.," and the statutory distribution rules applicable to estates and complex trusts, which are set out in Sections 661-63. With regard to distributable net income, we limit our discussion here to only a few salient aspects of that concept, since we previously examined it in detail in Manufacturers Hanover Trust Co. v. United States, 312 F.2d 785, 160 Ct.Cl. 582, cert. denied, 375 U.S. 880, 84 S.Ct. 150, 11 L.Ed.2d 111 (1963). What is important to note here is that D. N. I., which is essentially the estate's taxable income (with some modifications), serves generally as a ceiling on the combined tax liability of the estate and beneficiary, and limits the amount taxable to the beneficiary and deductible by the estate.
In addition, we should also note that D. N. I. is expressed in terms of taxable income, and that in computing taxable income Section 642(c), in general, allows an estate (or trust) an unlimited charitable deduction for amounts of "gross income" which, pursuant to the governing instrument, is paid, permanently set aside, or to be used for charitable purposes. Thus, a charitable distribution which is deductible under Section 642(c) has the effect of reducing the maximum aggregate amount taxable to the estate and beneficiary because it reduces D.N.I.8
The distribution rules of Sections 661-63 provide the mechanism for allocating D. N. I. between estate and beneficiary. Since frequently an estate makes distributions to more than one beneficiary during a particular taxable year, and since some beneficiaries have greater rights to income than do others, the distribution rules provide for priorities of taxability by establishing what is known as the "tier system." Through this system, D. N. I. is allocated under Section 662(a)(1) first to beneficiaries who have rights to current income, based upon a conclusive presumption that "any distribution is considered a distribution of the trust or estate's current income to the extent of its taxable income for the year."9 By presuming that such distributions are income, Subchapter J eliminates the need for "tracing" the source of distributions, as was necessary under prior law, to determine what portion, if any, constitutes amounts of current income.10
After allocating D. N. I. among the "first-tier" beneficiaries described above, any D. N. I. remaining would be allocated among "second-tier" beneficiaries according to Section 662(a)(2). Theoretically, all distributions except first-tier distributions fall within the second tier, which is defined as "all other amounts properly paid, credited, or required to be distributed to such beneficiary for the taxable year." The term "amounts," which is central to the controversy here, is broad enough to encompass non-first-tier distributions from either principal or income, whether of money or specific property. Again, this eliminates the necessity for tracing, since the statute assumes that second-tier distributions diminish whatever D. N. I. remains after allocations to first-tier distributees.
By defining second-tier distributions as any "amounts," the sweep of Section 662(a)(2) is so broad that, if left unqualified, bequests excluded under Section 102(a) could become taxable to beneficiaries under Section 662. To preserve the exemption for bequests, Section 663(a)(1) excludes from the operation of the distribution rules any amount which is not payable solely out of income and "which, under the terms of the governing instrument, is properly paid or credited as a gift or bequest of a specific sum of money or of specific property and which is paid or credited all at once or in not more than 3 installments." If a distribution meets these requirements it will be considered a bequest excluded under Section 102(a). If it fails to meet them, it will be considered a bequest of income from property under Section 102(b)(2),11 and will be taxed according to the distribution rules. Of course, the amount taxable under the distribution rules is circumscribed by the estate's D. N. I., so that amounts distributed in excess of D. N. I. would still be considered as a bequest excluded under Section 102(a), whether or not the distribution meets the specific requirements of Section 663(a)(1).12
A second modification to the distribution rules which is pertinent to this case is contained in Section 663(a)(2). It provides that "amounts" do not include "any amount paid or permanently set aside or otherwise qualifying for the charitable deduction provided in section 642(c) * * *." The purpose of this provision, as explained by the committee reports, is that "since the estate or trust is allowed a deduction...
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