Sun First Nat. Bank of Orlando v. United States

• Decision Date: 15 November 1978
• Docket Number: No. 558-76.,558-76.
• Citation: 587 F.2d 1073
• 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

587 F.2d 1073

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.

November 15, 1978.

David W. Hedrick, Orlando, Fla., attorney of record, and John J. Reid, Orlando, Fla., for plaintiffs. 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., 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

FRIEDMAN, Chief Judge:

This case, before us on cross-motions for summary judgment, presents two questions involving the federal income tax liability of a trust for capital gains it realized after the death of the settlor who was the income beneficiary of the trust during her lifetime: (1) 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 property upon which the gains were realized; (2) if the gains were not income in respect of a decedent, whether under section 1014(a) and (b)(9) of the Code, the trust was entitled to a stepped-up basis for the property, thereby reducing the gain subject to tax. We answer both questions negatively and grant the defendant's 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 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 over $6,000,000. The trust received $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 reported the gain on the sale 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, the trust realized substantial capital gain upon each note as it was paid. The trustee treated these gains as income to the trust rather than as an addition to the corpus. He paid most of this income to Jeanette Andersen. In 1967 a Florida court, in reviewing an accounting Martin Andersen made upon resigning as trustee, ruled that under Florida law this treatment of the gain was correct. For federal tax purposes the trust reported the entire capital gain from the notes as income for the years 1966 through 1972.

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.²

The trust then filed claims for refund for the years 1969 through 1972. Its theory was that because the corpus of the trust was includable in Jeanette Andersen's estate, she 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.³ 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.⁴

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 revealed in their legislative history, which we described 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; those amounts were treated solely as part of the gross estate and thus subject to estate but not income taxes. Nichols v. United States, 64 Ct.Cl. 241 (1927), cert. denied, 277 U.S. 584, 48 S.Ct. 432, 72 L.Ed. 999 (1928). 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 1934.⁵ This provision required the inclusion as income in the final return of every decedent all income "accrued up to the date of his death" that was not income for any prior period.

This requirement resulted in the inclusion in the decedent's final return of 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.⁶ Helvering v. Enright, 312 U.S. 636, 61 S.Ct. 777, 85 L.Ed. 1093 (1941), exacerbated the situation by expanding the meaning of "accrued" for purposes of section 42 beyond prior accounting concepts of accrual; the provision was to be "construed in furtherance of the intent of Congress to cover into income the assets of decedents, earned during their life and unreported as income, which on a cash return, would appear in the estate returns." 312 U.S. at 644-645, 61 S.Ct. at 782.

Section 126 of the Internal Revenue Code of 1939, added in 1942,⁷ 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." Such income was not included in the decedent's final income tax return, but was to be reported by the person receiving that income in the year of receipt. Those provisions were carried over into section 691 of the 1954 Code with only minor changes that are not significant to the disposition of the issue before us.

Congress did not define "income in respect of a decedent," and the definition of that term in the Treasury Regulation does not aid us here.⁸ There is nothing in the history of section 126, however, to indicate that the new provision was intended to change the substantive content of the prior law which, as Enright stated, was designed "to cover into income the assets of decedents, earned during their life and unreported as income." Estate of Davison, supra, 292 F.2d at 941, 155 Ct.Cl. at 299; Commissioner of Internal Revenue v. Linde, 213 F.2d 1, 5-6 (9th Cir.), cert. denied, 348 U.S. 871, 75 S.Ct. 107, 99 L.Ed. 686 (1954). Congress understood "income in respect of a decedent" as comprising those 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 of Internal Revenue, 415 F.2d 531, 534-535 (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 C.B. 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 the income after death.

B. Under these principles the gain the trust realized when the notes were paid was not income in respect of a decedent. Although Jeanette Andersen had the right to all the income of the trust during her lifetime, that right terminated upon her death in December 1968. The income here involved — the gain on the notes that were paid between 1969 and 1972 — was not her property but the property of her daughter, to whom the trust income was payable after her death. The gain upon the payment of those notes was not income that the decedent had earned or accrued prior to her death, the receipt of which was postponed until after her death. Instead it was...