Rosenthal v. Commissioner of Internal Revenue

• Decision Date: 24 June 1953
• Docket Number: Docket 22463.,No. 127,127
• Citation: 205 F.2d 505
• Parties: ROSENTHAL v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Second Circuit

205 F.2d 505 (1953)

ROSENTHAL v. COMMISSIONER OF INTERNAL REVENUE.

No. 127, Docket 22463.

United States Court of Appeals Second Circuit.

Argued March 11, 1953.

Decided June 24, 1953.

Henry Epstein, New York City (Hays, Wolf, Schwabacher, Sklar & Epstein, Edwin D. Hays, and Daniel P. Hays, all of New York City, on the brief), for petitioner.

Harry Marselli, Sp. Asst. to Atty. Gen. (H. Brian Holland, Asst. Atty. Gen., and Ellis N. Slack, Sp. Asst. to Atty. Gen., Washington, D.C., on the brief), for respondent.

Before AUGUSTUS N. HAND, CHASE, and CLARK, Circuit Judges.

CLARK, Circuit judge.

The taxpayer, Paul Rosenthal, petitions for review of a decision of Judge Disney in the Tax Court, reviewed by the entire court, 17 T.C. 1047, in so far as it determines a deficiency of $16,983.17 in his gift tax for 1946 and rejects his claim of overpayment of that tax in the amount of $160,212. In the same decision the court found a deficiency of $23,194.37 in Rosenthal's gift tax for 1944, but neither party has petitioned for review of this portion of the decision. At issue here is the taxability of certain obligations undertaken by Rosenthal toward his children in connection with his separation and subsequent divorce from his estranged wife. The basic facts were found by the court as stipulated by the parties and are not in dispute.

On July 26, 1944, Rosenthal entered into a separation agreement with his wife which contained a series of provisions for the education, care, support, and maintenance of their two children, Jill, then 20 years old, and Sue, aged 14. In these the taxpayer undertook: (1) To pay his wife for the benefit of the children $10,000 per annum for each daughter until she reaches the age of 21 or marries or until the wife dies; (2) To pay each child during her lifetime after she becomes 21 or marries, the sum of $8,000 annually until the death of the wife and $6,250 annually thereafter; and, if Rosenthal's mother dies during his lifetime, (3) To set up a trust for each child then living in the amount of $150,000, the income to be payable to the child for life, and upon her death the principal payable to her issue then living or, in default of issue, as the child may by will appoint, and (4) To pay to each of the children (or to the wife for the benefit of a minor child) an additional $3,000 annually until the death of the child or of the wife. The separation agreement also provided that, in the event of divorce, it should become a part of the decree or be considered "an agreement incident to such divorce"; its effectiveness, however, was not conditioned on the occurrence of a divorce. On September 18, 1944, taxpayer's wife did secure a Nevada divorce, and the July 26 agreement was expressly adopted by the court and made a part of its decree. The value of the taxpayer's obligations toward his children assumed in that agreement, as of both July 26 and September 18, 1944, was stipulated between the Commissioner and the taxpayer to be $499,340.98.

In 1945, Rosenthal sought to amend the separation agreement to translate so far as possible the annual payments due the children into one funded payment. The obligation to create trusts for them had already matured, since Rosenthal's mother died on November 19, 1944; and on May 14, 1945, the elder daughter, Jill, had reached the age of 21. Attorneys on both sides conducted the negotiations with the assistance of an accountant who calculated the value of taxpayer's existing obligation to make annual payments to both daughters, as of October 1, 1945, to be $357,000 under the Actuary's or Combined Experience Table of Mortality with interest at 4 per cent — the table then used by the Commissioner — or $453,000 under the Combined Annuity Mortality Table with interest at 3½ per cent, which the accountant regarded as "a more commercial table." Adding to these figures the obligation to create trusts at a face value of $300,000, the alternative computations of the worth of taxpayer's commitments become $657,000 or $753,000. The parties sought to retain the fair equivalent of these undertakings and ultimately reached agreement on what they considered a suitable modification on March 15, 1946. In lieu of the payments prescribed by the earlier agreement, the taxpayer was to establish on April 1, 1946, a trust for each daughter in the amount of $312,500, and to pay each during her lifetime $3,000 annually until the death of the wife and $1,500 annually thereafter. He also agreed to pay each child $5,021.33 as her "share of the income earned and allocable to the trusts provided for" in the original agreement. To differ from that agreement, these provisions were to become effective only upon appropriate amendment of the divorce decree, which was promptly ordered by the Nevada court on March 29, 1946. The total obligation assumed by the taxpayer under the new agreement was valued by the Commissioner at $729,737.67.

From 1944 through the first quarter of 1946, the taxpayer made all the direct payments called for by the original agreement, but did not actually set up the trusts upon the death of his mother. Taking the position that a gift tax became due only as non-exempt payments were made, he did not report any gifts to the children in 1944, since they were then both minors whom he was under an obligation to support; in 1945, however, he reported the payments made to Jill after she became 21. The payment — in the amount of $2,750 — made to Jill for the first three months of 1946 under the old agreement was likewise reported. In addition, the taxpayer reported in his 1946 return payments made during that year under the new agreement amounting to $637,292.66.¹ A gift tax of $160,212 was paid on the $640,042.66 total of 1946 payments.

The Commissioner determined that the taxpayer should have included in his taxable gifts for 1946 the actuarial value in that year of the future annual payments to be made to both daughters under the revised agreement. In his notice of deficiency, the Commissioner valued the payments due Jill at $45,215.91, and those due Sue at $45,979.10. Accordingly, he added $91,195.01 to the taxable gifts and deducted therefrom $1,500² for the 1946 payments to Jill already reported. A deficiency of $39,848.36 was consequently assessed.

Seeking redetermination of this assessment in the Tax Court, the taxpayer contended not only that there was no additional tax due for 1946, but that he was entitled to refund of the $160,212 in taxes already paid, since none of the 1946 payments were properly taxable in that year. Two separate arguments were made in support of this claim. First, taxpayer contended that the 1946 agreement giving rise to these payments was made for an adequate and full consideration, namely, surrender of the children's rights under the 1944 agreement. Second, he argued that, since the 1946 agreement became effective only upon amendment of the divorce decree, payments thereunder were in discharge of a decretal obligation, and hence not taxable gifts. In addition to vigorously disputing both these contentions, the Commissioner countered on the first with the argument that, if the gifts made to the children were not taxable in 1946, a gift tax should have been paid on them in 1944 when the original agreement was executed. Since the taxpayer's 1944 gift tax return was also before the Tax Court in connection with the tax due on payments to his wife under the same 1944 agreement, the Commissioner maintained that adoption of taxpayer's first contention should result simply in a corresponding increase in his 1944 gift tax deficiency.

The Tax Court, however, deemed it unnecessary to examine this theory, for it rejected the taxpayer's two principal arguments in a comprehensive opinion by Disney, J., reviewed by the court. But it did agree with the taxpayer on the subsidiary point that the present worth in 1946 of the payments to be made to the younger daughter, Sue, during her minority, to the extent of $10,000 per annum, should not be included as taxable gifts, since these were in discharge of taxpayer's obligation to support his minor child. The 1946 gift tax deficiency was therefore reduced to $16,983.17, and this is the decision for which review is sought here by the taxpayer. The remaining part of the decision, for which neither party has sought review, is not immediately relevant here, since it determined a deficiency of $23,194.37 in the taxpayer's 1944 gift tax on the payments to his wife in that year.

The two principal contentions pressed by the taxpayer in the Tax Court also form the mainstay of his argument here; certain additional subsidiary claims not raised below will be discussed later. We may consider at the outset his interesting argument that his 1946 undertakings to make payments to or for the benefit of his children were wholly immunized from gift taxation because effective only upon incorporation into the divorce decree. For this proposition he relies chiefly on Harris v. C. I. R., 340 U.S. 106, 71 S.Ct. 181, 95 L.Ed 111, which held a settlement of marital property rights between husband and wife, operative by its terms only on entry of a divorce decree, to be exempt from gift taxes. The basis for this decision was the Court's holding that the settlement was founded not on a voluntary promise or agreement, but on the command of the divorce court, instructed by state law to decree a just and equitable disposition of the parties' property. Hence the arrangement was deemed in effect to be for "an adequate and full consideration in money or money's worth," I. R.C. § 1002, 26 U.S.C. § 1002, the Court analogizing it to a transaction "in the ordinary course of business" which, under Treas. Reg. 108, § 86.8, satisfies the statutory requirement of a consideration to support the tax exemption. See also C. I. R. v. Converse, 2 Cir., 163 F.2d 131, 174 A.L. R. 199.

The rationale of both the Harris and Converse decisions rests basically...