Sun First Nat. Bank of Orlando v. United States

• Decision Date: 17 October 1979
• Docket Number: No. 558-76.,558-76.
• Citation: 607 F.2d 1347
• Parties: SUN FIRST NATIONAL BANK OF ORLANDO, and Marcia Andersen Murphy, as Co-Trustees of the Jeanette Andersen Trust v. The UNITED STATES.
• Court: U.S. Claims Court

607 F.2d 1347

SUN FIRST NATIONAL BANK OF ORLANDO, and Marcia Andersen Murphy, as Co-Trustees of the Jeanette Andersen Trust v. The UNITED STATES.

No. 558-76.

United States Court of Claims.

October 17, 1979.

David W. Hedrick and John J. Reid, Orlando, Fla., for plaintiff. F. Cleveland Hedrick, Jr., Washington, D. C., attorney of record. Michael D. Savage, Hedrick & Lane, Washington, D. C., Eugene B. Cawood, and Giles, Hedrick & Robinson, Orlando, Fla., of counsel.

Bruce W. Reynolds, Washington, D. C., with whom was Asst. Atty. Gen. M. Carr Ferguson, Washington, D. C., for defendant. Theodore D. Peyser, Jr., and Maxine C. Champion, Washington, D. C., of counsel.

Before FRIEDMAN, Chief Judge, SKELTON, Senior Judge, and KASHIWA, Judge.

ON PLAINTIFFS' MOTION FOR SUMMARY JUDGMENT AND DEFENDANT'S CROSS-MOTION FOR SUMMARY JUDGMENT

On rehearing, the opinion of the court of November 15, 1978, is withdrawn, and the following opinion is substituted:

FRIEDMAN, Chief Judge.

This case, before us on cross-motions for summary judgment, presents a difficult question involving the federal income tax liability of a trust for capital gains it received after the death of the settlor who was the income beneficiary of the trust during her lifetime: whether the gains were "income in respect of a decedent" under section 691 of the Internal Revenue Code of 1954, so that the trust was entitled to a deduction for the estate taxes that were attributable to the gains. We answer that question affirmatively and grant the plaintiffs' motion for summary judgment.

I.

In March, 1941, Jeanette Andersen established an inter vivos trust. The trust income was to be paid to her for life and then to her daughter.¹ Upon the daughter's death, the corpus of the trust was to be distributed to the daughter's children. The principal asset she transferred to the trust was shares of Orlando Daily Newspapers, Inc., the publisher of two daily newspapers in Orlando, Florida, which her husband, Martin Andersen, had given her in 1936. Although the record does not show the value of the stock when Mrs. Andersen transferred it to the trust in 1941, it was valued at $11,000 in the gift tax returns filed in connection with Mr. Andersen's transfer of the stock to his wife in 1936. Estate of Andersen v. Commissioner, 32 T.C.M. (CCH) 1164 (1973).

Orlando Newspapers prospered, and in 1965, the trust sold its Orlando stock for more than $6,000,000. The sale price consisted of $1,557,441 in cash and 15 promissory notes payable annually from 1966 through 1980. Each of the first 14 notes was for $242,179.50, and the final note was for $1,453,077. The trustee treated the gain on the sale as income to the trust and reported it on the installment basis, pursuant to section 453 of the Code.

Because of the large increase in the value of the stock between the creation of the trust in 1941 and the sale in 1965, substantial capital gain was realized upon sale of the stock. The trustee treated this gain as income rather than as an addition to the corpus. He paid most of this income to Jeanette Andersen, as income beneficiary. In 1967, a Florida court, in reviewing an accounting Martin Andersen made upon his resignation as trustee, ruled that under Florida law this treatment of the gain was correct.² For federal tax purposes the trust reported the entire capital gain from the notes as income for the years 1966 through 1972, and the grantor reported amounts received as income from the trust.

Jeanette Andersen died in December 1968. In her federal estate tax return, her executrix did not include the value of the corpus of the trust. On audit, however, the Commissioner of Internal Revenue included the corpus on the ground that Jeanette Andersen's retention of a life interest in the property she had transferred to the trust made that property part of her estate under section 2036 of the Code. The Tax Court upheld that determination. Estate of Andersen, supra.³

The trust then filed claims for refund for the years 1969 through 1972. Its theory was that Jeanette Andersen was the constructive owner of the trust property during her lifetime; and that the gain on the sale of the notes that were paid after her death was income in respect of a decedent, so that the recipient of such income (the trust) was entitled under section 691 of the Code to a deduction covering the estate tax paid on that income. The Internal Revenue Service rejected the claim for refund on the ground that the gain on the notes was not income in respect of a decedent. This suit followed.

II.

A. Section 691(a) of the Code generally provides that "income in respect of a decedent" that is not part of the decedent's taxable income in the year of his death is taxable to the recipient of such income in the year of receipt if certain specified conditions are met.⁴ Section 691(c) of the Code provides that the recipient of income in respect of a decedent is entitled to a deduction reflecting estate taxes paid by the decedent's estate on any items constituting such income.⁵

In most cases that have arisen under these provisions the government has contended that particular items were income in respect of a decedent and therefore taxable to their recipients, and the recipients have denied that the items were in that category. The present case is the converse situation. Here the recipient (the trust) of the income (the gain on the notes) contends that the gain is income in respect of a decedent so that it may obtain a deduction for the estate taxes paid on the notes, and the government denies that the gain on the notes was income in respect of the decedent.

The purpose of these statutory provisions is explained in part in our summary of their legislative history in Estate of Davison v. United States, 292 F.2d 937, 155 Ct.Cl. 290, cert. denied, 368 U.S. 939, 82 S.Ct. 380, 7 L.Ed.2d 337 (1961). The income-in-respect-of-a-decedent provision first appeared in the 1939 Code. Prior to 1934, neither a cash basis taxpayer nor his estate was subject to federal income taxes on income he had earned and accrued but not received prior to his death. Congressional dissatisfaction with the discrimination between accrual and cash basis taxpayers and the concomitant loss of revenue from cash basis taxpayers resulted in section 42 of the Revenue Act of 1934.⁶ This provision required the decedent to include in his final return income that otherwise would have been reported over several years, and thus subjected such income to higher marginal rates of taxation than if the decedent had lived to receive the income.⁷

Section 126 of the Internal Revenue Code of 1939, added in 1942,⁸ eliminated the inequitable pyramiding effect of the accrual-at-death income concept of the prior law by incorporating in the Code the concept of "income in respect of a decedent." Congress understood that term to include items of income that, at the time of death, the decedent had earned or accrued but not yet received. Grill v. United States, 303 F.2d 922, 927, 157 Ct.Cl. 804, 813 (1962); Keck v. Commissioner, 415 F.2d 531, 534-35 (6th Cir. 1969); Trust Co. of Georgia v. Ross, 392 F.2d 694, 696 (5th Cir. 1967), cert. denied, 393 U.S. 830, 89 S.Ct. 97, 21 L.Ed.2d 101 (1968); Estate of Sidles v. Commissioner, 65 T.C. 873, 880 (1976), aff'd mem., 553 F.2d 102 (8th Cir. 1977), acq. 1976-2 Cum.Bull. 2. The purpose of section 126 was to shift the income tax liability for income that the decedent had earned or accrued but not received before death from the decedent to the person who received payment after death.

The shifting of income tax liability to the income recipient would have resulted in a significant difference between the tax treatment of income (1) received after the decedent's death and (2) received by the decedent prior to death and passed through the estate. In the latter situation, the income subject to tax under section 2036 of the Code would be the net amount after income taxes. By shifting income tax liability to the income recipient, section 126 created the likelihood of double taxation. This would result because the gross income the decedent had accrued but not yet received would be included in the estate, and an estate tax would be levied on that amount. The recipient of that income then would pay a tax on the entire income. Thus, the gross amount of income would be subjected to both an estate tax and an income tax. In effect, an income tax would be imposed without any adjustment to reflect the estate taxes already paid upon the income.

Section 691(c) of the Code provides some relief from this double taxation and reduces the disparity in treatment between income received by the decedent and income received directly by his successor. It does this by allowing the income recipient a deduction for estate taxes paid by the estate that are attributable to income received "by reason of the death of decedent." Ferguson, Income and Deductions in Respect of Decedents and Related Problems, 25 Tax L.Rev. 5, 146-48 (1969).

B. This case also involves the grantor trust provisions of subpart E of subchapter J of the Code, I.R.C. §§ 671-78. Those provisions enumerate several circumstances in which the general rule that a trust is to be taxed as a separate entity is "departed from on the theory that to apply the rule would improperly permit the grantor or other person who has substantial ownership of the trust property or income to escape tax on income which should rightfully be taxed to him." 6 Mertens § 37.01; Treas. Reg. §§ 1.671-2(a) and (d), 1.671-3. In effect, the grantor is treated for federal income tax purposes as the owner of the trust property because he has retained a substantial beneficial interest in, or substantial control over, the property.

A grantor is treated under subpart E as the owner of the trust corpus to the extent of his retained interest in the trust. I.R.C. § 671.⁹ Section 677 of the Code provides that a trust shall be treated under ...