United States v. National City Bank of New York

• Decision Date: 27 November 1937
• Citation: 21 F. Supp. 791
• Parties: UNITED STATES v. NATIONAL CITY BANK OF NEW YORK et al.
• Court: U.S. District Court — Southern District of New York

21 F. Supp. 791

UNITED STATES v. NATIONAL CITY BANK OF NEW YORK et al.

District Court, S. D. New York.

July 22, 1937.

Supplemental Opinion November 27, 1937.

Lamar Hardy, U. S. Atty., of New York City (Irvin C. Rutter, Asst. U. S. Atty., of New York City, of counsel), for the United States.

Taylor, Blanc, Capron & Marsh, of New York City (Russell L. Bradford and George H. Craven, both of New York City, of counsel), for National City Bank of New York.

F. L. Crocker and Dunnington, Bartholow & Miller, all of New York City, for defendant Gertrude Vanderbilt Whitney.

PATTERSON, District Judge.

The suit is one in equity by the United States against National City Bank and Gertrude Vanderbilt Whitney to collect income tax. The case comes up on motion by the defendants to dismiss the amended bill for insufficiency on its face, also on counter motion by the plaintiff to strike the answers for insufficiency. The suit was commenced on March 14, 1931.

The facts shown by the amended bill are these: Cornelius Vanderbilt died in 1899. By his will he devised real estate at Fifth avenue and Fifty-Seventh street to his wife, Alice G. Vanderbilt, for life, with contingent remainders in fee simple. The contingent remainders were: On the wife's death to such of two named sons as his wife should appoint by will, in default of appointment to the elder of the two named sons living at the wife's death, and in case neither of the sons should be then living to his eldest daughter then living, with further remainders over to grandchildren living at the wife's death or to the residuary estate in case neither of said sons nor any daughter should survive the wife.

In 1925 the widow as life tenant brought a proceeding in the New York Supreme Court for a judicial sale of the real estate. The New York Real Property Law, §§ 67-71, Consol.Laws, c. 50, under which the proceeding was brought, provides that in cases where real estate has been devised for life with remainders to persons who are unascertainable during the life tenancy, the court may order a sale of the real estate if it is satisfied that a sale is for the best interests of all concerned and if there is consent by all parties prospectively interested who are not under disability; the sale is to be made by a referee; the proceeds of sale are to be paid to a trust company or individual appointed by the court "who shall thereby become trustee or trustees for such life tenant and remaindermen," charged with investing the proceeds, paying the net income to the life tenant for life, and finally distributing the principal to the remaindermen.

In due course the court ordered a sale, and the referee appointed made an agreement to sell the real estate for $7,100,000. The prospective purchaser paid $500,000 of the purchase price to the referee, who turned that sum over to National City Bank on January 15, 1926; that bank having already been appointed trustee of the proceeds of sale by the court. The purchaser later defaulted and the $500,000 was declared forfeited. Further proceedings and negotiations resulted in the sale and conveyance of the real estate by the referee to a new purchaser for $6,600,000, and the net proceeds of this sale, $6,429,142.47, were turned over to National City Bank as trustee; $500,000 on December 20, 1926, and the balance on February 1, 1927.

The value of the real estate on March 1, 1913, was $3,641,304, a sum greater than the value in 1899, when the testator died.

The life tenant died on April 22, 1934. Both of the sons named in the remainders having predeceased her, the property passed by the terms of the will to the eldest daughter living at the life tenant's death, Gertrude Vanderbilt Whitney. National City Bank accordingly in due course turned over the capital of the fund to the extent of about $5,000,000 to Gertrude Vanderbilt Whitney, reserving about $1,000,000 for possible taxes.

On the foregoing facts the plaintiff charges that there was a gain in 1926 of $500,000, being the amount of the forfeited deposit on the abortive sale, and that there was a gain in 1927 of $2,787,838.47, being the difference between the value of the real estate on March 1, 1913, and the net proceeds of the completed sale; that such gains were income taxable in those years against the referee or against the life tenant as trustee or fiduciary of the real estate or against National City Bank as trustee, fiduciary, or transferee of the proceeds of sale; that no one has ever reported the gains for tax or paid any tax on them. The first cause of action in the amended bill is for $116,365, the tax at normal and surtax rates on the alleged $500,000 gain in 1926. The second cause of action is for $688,324.61; the tax at normal and surtax rates on the alleged $2,787,838.47 gain in 1927. The prayer for relief is that the payments received by National City Bank be impressed with a trust in favor of the plaintiff as a creditor of the referee or of the life tenant; that National City Bank account to the plaintiff for enough money to pay the tax; that the funds later turned over to Gertrude Vanderbilt Whitney be impressed with a trust in the plaintiff's favor as a creditor of National City Bank, in an amount sufficient to discharge the plaintiff's claim for tax; and that the plaintiff's lien for tax be enforced against the funds.

So much for the amended bill. The defendants by their answers admit practically all the allegations in the amended bill, other than the conclusions of law as to gains and taxes claimed to be owing. The answers contain two affirmative defenses. The one is that limitations have run against imposition of tax; the other is that in any event the tax on the gains should be no more than 12½ per cent. of such gains as capital net gains; it being shown that by written notice of July 31, 1935, the defendants put themselves on record as electing that any taxes found to be due be computed as taxes on capital net gains.

First, on the sufficiency of the amended bill. In brief, it shows a case where a testator in 1899 devised real estate to a person for life, with various contingent remainders in fee simple to persons unascertainable during the life tenancy, and where the real estate was sold in 1927 by order of court pursuant to statutory authority, while the life tenant was still alive, with the result that the proceeds of sale passed to a trustee charged with the duty of paying the net income from the fund to the life tenant during her life and holding the capital for the remaindermen designated in the will. The sale having brought more than the value of the real estate on March 1, 1913, which value was greater than the value at the decedent's death, is the trustee thus receiving the proceeds of sale liable under the Revenue Act 1926, 44 Stat. 9, for income tax on the excess of proceeds over the value of March 1, 1913?

By the will the successive estates in the real property were a legal life estate in the widow and contingent remainders in others, including Gertrude Vanderbilt Whitney. There was no trust covering the real property. Upon the sale the proceeds that were received took the place of the real property. Instead of the widow holding the proceeds as legal life tenant, however, the proceeds passed to a trustee whose function it was to pay to the widow the net income for life and on her death to pay over the fund to the remainderman then entitled under the terms of the will. The trust during the widow's life was a requirement under the statute whereby the sale was effected; a requirement put in for the better protection of the remainders. So the widow became equitable life tenant of the proceeds where formerly she had been legal life tenant of the property sold. There was no change in the structure of the remainders. They had been contingent remainders at law, and after the sale they were still contingent remainders at law of the same quality. There was of course the fact that the property to which the remainders attached was personalty in lieu of realty.

So far as concerned the respective rights of life tenant and remainderman, the proceeds of sale, including gain, were capital and nothing else. The New York statute, by means of which the realty was sold, provided in express terms that the proceeds of sale be held for the remainderman, and this would have been the result even without specific provision. Matter of Kernochan, 104 N.Y. 618, 11 N.E. 149. But it does not follow that a gain realized out of the sale, capital between life tenant and remainderman, did not constitute taxable income so far as concerned the right of the United States to collect income tax. Merchants' Loan & Trust Co. v. Smietanka, 255 U.S. 509, 41 S.Ct. 386, 65 L.Ed. 751, 15 A.L.R. 1305.

In such a situation I am of opinion that under the Revenue Act of 1926 a taxable gain measured by the excess of the proceeds of sale over the value of the realty on March 1, 1913, was realized in 1927, and that the obligation of paying the tax on such gain was laid on National City Bank as fiduciary.

By section 212 of the act, 44 Stat. 23, net income in the case of an individual means gross income as defined in section 213, 44 Stat. 23, less deductions allowable under other sections. By section 213, gross income includes gains, profits, and income derived from "sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property." We come then to section 219, 44 Stat. 32, dealing with "estates and trusts," and providing in part as follows:

"Sec. 219. (a) The tax imposed by Parts I and II of this title shall apply to the income of estates or of any kind of property held in trust, including —

"(1) Income accumulated in trust for the benefit of unborn or unascertained persons or persons with contingent interests, and income accumulated or held for future distribution under the terms of the will or trust;

"(2) Income which is to be distributed...