De Reuter v. Commissioner

7 B.T.A. 600, 1927 BTA LEXIS 3142

• Court: United States Board of Tax Appeals
• Decided: July 8, 1927
• Docket: Docket Nos. 6243, 10644, 13220.
• Status: Published

Opinions

OPINION.

MilltkeN:

In view of the conclusion which we have reached, we find it necessary to discuss but one question and that is, whether the annuities received by the petitioners under the will of James Gordon Bennett constitute income which is taxable by reason of the provisions of the Revenue Act of 1921. The applicable provisions of that Act are:

Sec. 213. That for the purposes of this title (except as otherwise provided in section 233) the term “gross income”-—

(a) Includes gains, profits, and income derived from salaries, wages, or compensation for personal service (including in the case of the President of the United States, the judges of the Supreme and inferior courts of the United States, and all other officers and employees, whether elected or appointed, of the United States, Alaska, Hawaii, or any political subdivision thereof, or the District of Columbia, the compensation received as such), of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. The amount of all such items (except as provided in subdivision (e) of section 201) shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under subdivision (b) of section 212, any such amounts are to be properly accounted for as of a different period; but

(b) Does not include the following items, which shall be exempt from taxation under this title:

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(3) The value of property acquired by gift, bequest, devise, or descent (but the income from such property shall be included in gross income) * * *

Sec. 219. (a) That the tax imposed by sections 210 and 211 shall apply to the income of estates or of any kind of property held in trust, including—

(1) Income received by estates of deceased persons during the period of administration or settlement of the estate;

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(4) Income which is to be distributed to the beneficiaries periodically, whether or not at regular intervals, and the income collected by a guardian of an infant to be held or distributed as the court may direct.

* * * * * ' * *

(c) In cases under paragraphs (1), (2), or (3) of subdivision (a) or in any other case within subdivision (a) of this section, except paragraph (4) thereof the tax shall be imposed upon the net income of the estate or trust and shall be paid by the fiduciary, except that in determining the net income of the estate of any deceased person during the period of administration or settlement there may be deducted the amount of any income properly paid or credited to any legatee, heir, or other beneficiary. In such cases the estate or trust shall, for the purpose of the normal tax, be allowed the same credits as are allowed to single persons under section 216.

(cl) In cases under paragraph (4) of subdivision (a), and in the case of any income of an estate during the period of administration or settlement permitted by subdivision (c) to be deducted from the net income upon which tax is to be paid by the fiduciary, the tax shall not be paid by the fiduciary, but there shall be included in computing the net income of each beneficiary that part of the income of the estate or trust for its taxable year which, pursuant to the instrument or order governing the distribution, is distributable to such beneficiary, whether distributed or not, or, if his taxable year is different from that of the estate or trust, then there shall be included in computing his net income his distributive share of the income of the estate or trust for its taxable year ending within the taxable year of the beneficiary. * * *

The question presented is whether the annuity received by each of petitioners was a “bequest” which was exempt from income tax under section 213, or constituted distributive income which was taxable under section 219. This question depends upon the construction of the will of James Gordon Bennett. The seventh, eighth and tenth clauses of that will bequeathed to the respective petitioners “ an annuity.” No limit is placed 'upon the payment of these annuities. The only direction is that they be paid. The whole estate is charged with their payment. The only way in which any part of the estate can be freed from this charge is found in the thirtieth clause where the executors are given the power to convert property into money and where it is provided that the property “ so sold, conveyed, * * * or exchanged shall be free from all lien or charge of or by 'reason of any devise, bequest, or annuity given or made by this, my Will, or any Codicil thereto.” It is to be noted, however, that this very power of sale or conversion is given to the executors for, among other purposes, the payment of the annuities. So that while the property sold is free of the charge, it is clear that the proceeds remain subject to the payment of the annuities.

Respondent invites our attention to the following excerpt from the thirtieth clause:

I authorize and empower said executors or executor to retain and hold any personal property which may belong to me at the time of my death and to set aside and hold any part thereof to provide for the payment and satisfaction of any annuity given by me.

Giving this provision its broadest construction, it is apparent that there is nothing therein to the effect that any annuity is payable out of the income of the personalty so to be set apart. If such fund, if created, should fail, it is our opinion that the remaining corpus of the estate would remain liable for the satisfaction of the annuities. In those cases where it was the clear intention of a testator that an annuity should be paid out of income or out of a particular fund, such intention must be given full effect. See Delaney v. Van Aulen, 84 N. Y. 16, and Irwin v. Wollpert, 128 Ill. 527; 21 N. E. 501. On the other hand, where an annuity is given without limitation and the will merely indicates that the annuity may be paid out of income, the corpus is liable when the income becomes insufficient. Thus, it was said by Judge Denio in Pierrpont v. Edwards, 25 N. Y. 128—

The only Question which I think it necessary to consider, in this case, is whether the bequest of the annuity of $7,000 a year, to the testator’s wife, was specific, in the sense that if it could not be paid out of the fund indicated — namely, the income of the trust estate — it was to fail, or to abate, in proportion that the indicated fund should prove deficient; or on the other hand, whether it was intended by the testator that it should be paid; at all events the income of his property given to the trustees being pointed out by way, it is called, of demonstration. I am of opinion that the last mentioned construction is the one which we are bound to place upon the instrument, * * * The leading principle of the cases is that when the testator bequeaths a sum of money, or which is the same thing, a life annuity, in such a manner as to show a separate and independent intention that the money shall be paid to the legatee at all events, that intention will not be permitted to be overruled merely by a direction in the will that the money is to be raised in a particular way or out of a particular fund. (Sir James Wigram in Dickin v. Edwards, 4 Hare. 273.)

Reading the will of James Gordon Bennett as a whole, it at once becomes apparent that the annuities which it bequeaths are charges upon its whole estate, income, personalty and realty. The James Cordon Bennett Memorial Home is a residuary legatee and devisee, and gets only what may be left after the annuity charges are paid.

That the annuities provided by the will are in fact bequests, seems clear. See Pierrpont v. Edwards, supra; Clark v. Clark, 147 N. Y. 639; 42 N. E. 275; Canal Bank v. Hudson, 111 U. S. 66; 3 C. J. 202.

Are these annuities bequests of income within the meaning of section 219, or are they bequests as that term is used in section 213?

Long before the Sixteenth Amendment to the Constitution became effective, a broad distinction had been drawn between a bequest of a pure annuity and a bequest of income. Thus, it is said in section 2 of Chapter XIII of Itemsen on the Preparation and Contest of Wills (1907) :

An annuity is substantially different from a gift of the income or use of property. An annuity is a fixed amount directed to be paid absolutely and generally without contingency. An income embraces only the net profits after deducting all necessary expenses and charges, and consequently is uncertain in amount.

Annual taxes on principal are deducted from a use or income but not from annuities. * * *

Where the testator sets aside a fund to provide for the payment of an annuity, his will should clearly indicate whether he intends the annuity to be a charge on the corpus or payable only out of the income. Thus, under “ a clear gift of an annuity, a direction to set a fund apart to secure it, which is to fall into the residue upon the death of the annuitant,” the corpus is still liable to make good arrears. “ But if there is a direction to set apart a sum of money in order to i>ay an annuity out of the dividend with a gift over, the annuitant is not entitled to come upon the corpus, and it is a simple case of tenant for life and remaindermen,” So if it is clear that the annuity is to be paid only out of the income each year, or that the corpus is to be looked upon as an entirety after the annuitant’s death, the corjius will not be liable for arrears. In the absence of an expressed intent to the contrary, the testator’s personal estate is primarily liable for the payment of an annuity. In some states it is provided by statute that, if the funds or property out of which annuities are payable fails, resort may be had to the general assets, as in case of a general legacy. Some testators provide for the purchase of annuities; some create a trust for their payment; others simply direct their payment out of the estate.

In Peck v. Kinney (C. C. A.), 143 Fed. 76, it is said:

There is this distinction between income and an annuity. The former embraces only the net profits after deducting all necessary expenses and charges; the latter is a fixed amount directed to be paid absolutely and without contingency. Ex parte McComb, 4 Bradf. Sur. (N. Y.) 151, 152. “An annuity is defined as ‘a stated sum, payable annually’ (Pearson v. Chace, 10 R. I. 455), or as ‘ a yearly payment of a certain sum of money granted to another in fee, for life, or for years.’ Kearney v Cruikshank, 117 N. Y. 95, 22 N. E. 580; Bartlett v. Slater, 53 Conn. 102, 22 Atl. 678, 55 Am. Rep. 73.” Goodyear Shoe Machinery Co. v. Dancel, 119 Fed. 692, 56 C. C. A. 300. It is a grant of a certain sum of money payable at the expiration of fixed, consecutive periods, for a definite term or for life. Lumley’s Law of Annuities, 1.

The court then quotes from the oft-cited case of Booth v. Ammerman, 4 Bradf. 129. From the last case we make the following excerpt:

An annuity is a stated sum per annum, payable annually unless otherwise directed. It is not income or profits, nor indeterminate in amount varying according to tlie income or profits, though a certain fund may be provided, out of which it is to be payable. * * * The income or interest of a certain fund is not an annuity, but simply profits of certain property, to be earned, which may vary more or less.

To the same effect see Dulaney's Administrator v. Dulaney, 105 Va. 429; 54 S. E. 40, and Overton v. Lea, 108 Tenn. 505; 68 S. W. 250.

From the above, three things become apparent: (1) That each annuity herein involved is in fact a bequest; (2) that these annuities do not constitute bequests of income; and (3) that each annuity is a charge upon the whole estate.

Since no income, nor any share of income, has been bequeathed to any one of the petitioners, it can not be held that such petitioner was entitled to a “ distributive share of the income of the estate or trust,” which is taxable under section 219. We can not see that the fact that the number of years during which a legacy is payable is determinable by the life of the beneficiary makes that income which otherwise is not income.

Respondent contends that these proceedings are governed by Irwin v. Gavit, 268 U. S. 161, and Heiner v. Beatty, 17 Fed. (2d) 743. In our opinion, these cases are not in point. In the Gavit case, there was a bequest of a certain share of income arising from a certain trust fund. In these proceedings, we have no bequests of income, but a bequest of a sum certain, payable at all events each year so long as the legatee lives. In the Beatty case the testator, Carnegie, did bequeath an annuity but he made the annuity payable (in the case the executors did not purchase it from an insurance company) out of the income of a trust fund. The Circuit Court of Appeals reversed the decree of two judges of the lower court (10 Fed. (2d) 390) holding the annuity exempt from income tax, but in so doing-placed their decision squarely on the ground that the bequest was one of income from a trust. Thus the appellate court said:

The first part of the Carnegie will with which we are concerned is the Fifth Article. It reads as follows:

Fifth: I give to each of the persons hereinafter in this Fifth Article named an annuity of the annual amount in this Fifth Article set after his or her name, to be paid semhumually during the annuitant’s life, that is to say, to * * * Mr. Beatty Art-Dept wife succeeding five thousand dollars.

If the will had stopped there, it is possible the testator’s provision for John W. Beatty would have been a bequest, payable in semi-annual installments directly from the estate, and all payments made to him year by year would have been exempt from taxation under paragraph 3 of subdivision (b) of section 213 of the cited act (Clomp. St. §6336 l/8ff). However, the will did not stop there, but, going on, it provided in the very next article, by words whose significance we have emphasized by italics, as follows:

Sixth: I direct my executor and trustee either to set apart, hold m trust, invest and keep inpested, in separate funds, one for each annuitant, sufficient sums to produce by the clear net interest and income thereof respectively, the several annuities provided in the Fifth Article of this will, * * * and to pay the said several annuities from the interest and income of the respective funds in semi-annual payments, or to purchase such annuities in life insurance companies. * * *

By the Eighth Article the testator authorized his executor and trustee (who is one corporate person), “in its discretion, to retain for investment of the principal of any of the trusts, herein provided for, any of the securities left by me.” And, finally, by the same article he authorized the executor and trustee to sell any of the securities coming into its hands and reinvest the proceeds.

Recapitulating, these provisions created, somewhat inartificially, yet, we think with no lack of certainty, out and out trusts. They provided a capital sum for each annuitant, directed that it be “ set apart ” and “ held in trust ” for him and that from the interest and income therefrom accruing payment of a definite sum to be made to him semi-annually. Having all the earmarks of formal trusts, the executor and trustee, believing itself charged therewith, exercised the election given it to create capital trust funds by withdrawing from the body of the estate sufficient securities to produce the amounts to be paid annually to the more than forty annuitants. For John W. Beatty it took, “ set apart” and “held in trust” one $100,000 United States Steel Corporation Registered 50 year 5 per cent Gold Bond and two $5,000 bonds of the same issue, and of the interest received therefrom it paid him $5,000 a year. This is what was done. But the testator directed, in the alternative and at the trustee’s election, another way by which the trustee could provide for the payment of the annuities, namely; by taking a part of the principal of the estate and with it buy annuities. Thus, in both ways the testator willed that parts of the corpus of his estate be appropriated as capital sums from which income in amounts sufficient to pay the annuities could be obtained. In neither way- — -indeed, nowhere in the will — did he provide for payment of annuities from the principal of his estate. In other words, the testator, through alternative ways, specifically indicated and fully provided the sources of income to be paid the annuitants. What the will intended the annuitant here to receive and what actually he did receive was the income derived from a source which we think is sufficiently definite to fall within the statute’s denomination of “ income derived from any source whatever.”

We look in vain for a provision in the Bennett will similar to that in the Carnegie will. We find no bequest of income.

Respondent cites Cummings' Executor v. Cummings, 146 Mass. 501; 16 N. E. 401, to the effect that annuities such as those before us are payable primarily from income. The same would be true of any legacy, for no court would permit an executor to sell property to pay a legacy if he had income available. So also such a legacy is payable out of personalty rather than realty. All these are matters of administration with which annuities have no concern.

Next, it is contended that since the annuities were paid in the taxable years involved, from income, the annuities constitute income. It may be noted that during the first two years after Bennett’s death all the annuities herein involved wore paid out of the corpus of the estate. The same, for all we know, may be done later. It is because certain testators have thought that they had ample means to pay annuities and their expectations have failed, that the cases which we have cited, have arisen. The fact that income is used to pay an obligation does not necessarily make what was income to the payor, income to the payee. The payment by one from his salary of borrowed money without interest, does not make the money so paid income to the recipient. Neither would the payment of a simple legacy from income of an estate, make the legacy taxable as income.

Respondent calls our attention to the language of Mr Justice Holmes in Irwin v. Gavit, supra, where he states that if the income therein involved was not taxable, Congress “ has missed so much of the general purpose that it expresses at the start.” We have not before us the question of the extent to which the income of the estate of James Gordon Bennett is taxable, and express no opinion on that question. All we have before us is whether these annuities constitute taxable income in the hands of the beneficiaries. But even if our decision should result in this income becoming nontaxable at all events, we can only say that this results from the provisions of the law. The Supreme Court, construing the same act that was construed in the Gavit case, held in Smietanka v. First Trust & Savings Bank, 257 U. S. 602, that income received by a trustee to be accumulated for unborn and unascertained beneficiaries, was not taxable.

We are aware that the British courts have held that annuities similar to those here involved, are subject to the British income tax, but in Merchants’ Loan & Trust Co. v. Smietanka, 255 U. S. 509, it was said:

The British income tax decisions are interpretations of statutes so wholly different in their wording from the acts of Congress which we are considering that they are quite without value in arriving at the construction of the laws here involved.

We have for application, sections 213 and 219 of the Revenue Act of 1921. It is only by a strained construction that we can by any possible means arrive at the conclusion that these annuities are taxable under section 219, to the petitioners, as distributive income. On the other hand, section 213 grants an exemption in cases of bequests. There is no doubt that each of these annuities is a bequest and there is no doubt that none of them is made payable by the will of James Gordon Bennett, out of income. To hold that the mere fact that in the taxable years involved, the annuities were paid out of income and therefore were distributive income to the recipients, would give a construction to the taxing statute far beyond the meaning of the words used. When we are compelled to choose between clear words of exemption and a strained construction of a taxing provision, we accept that which is clear rather than that which involves doubt.

Judgment mil be entered on 15 days’ notice, under Rule 50.