Ernest L. Wilkinson and Alice L. Wilkinson v. The United States

304 F.2d 469, 157 Ct. Cl. 847, 9 A.F.T.R.2d (RIA) 1717, 1962 U.S. Ct. Cl. LEXIS 18

• Court: United States Court of Claims
• Decided: June 6, 1962
• Docket: 456-57
• Status: Published

Opinions

LARAMORE, Judge.

Taxpayers¹ seek to recover income tax alleged to have been wrongfully collected from them for the calendar year 1951. They aver that the Commissioner of Internal Revenue erroneously disallowed the major portion of plaintiffs’ claimed deduction for charitable contributions. The Commissioner . of Internal Revenue allowed a portion of the deduction but disallowed the remainder on the ground that the amount contributed exceeded the le-gaily permissible deduction of 15 per cen-tum of taxpayers' adjusted gross income.

In addition, the Commissioner of Internal Revenue asserts a counterclaim owing to plaintiffs’ failure to include in ordinary income the value of this charitable gift.

The facts, as determined by the commissioner of this court, are not objected to by either party. Hence, they are adopted by the court without exception. We shall refer to these facts, in the course of this opinion, as they relate to the issue being discussed.

There are three issues involved. The first issue is whether plaintiff is entitled to deduct 15 percent of his reported adjusted gross income for the year 1951 as a charitable contribution, or whether he is limited to 15 percent of the amount attributable to that year after spreading an amount earned as a legal fee over the period of years in which the fee was earned, as provided for under-26 U.S.C. (1939 I.R.C.) § 107(a) (1952 Ed.). The facts relevant to the above issue are these: Plaintiff was the principal attorney for the Confederated Bands of Ute Indians in several actions before this court. The litigation extended over 17 years and was concluded when this court, pursuant to a stipulated agreement by the parties that judgment should be entered for an agreed amount, awarded the Ute Indians four judgments totaling $31,-938,473.43. °.The attorneys’ fees amounted to $2,794,616.34, or eight and three-fourths percent of the judgments.

As a result of these fees, which plaintiff shared with others, Wilkinson reported gross income in 1951 of $1,266,-625.20. Since plaintiff had worked on these cases for more than 17 years, he elected to limit the tax attributable to the legal fee in the manner provided for under section 107(a) of the Internal Revenue Code of 1939.

That section, as effective in 1951, reads:

“§ 107. Compensation for services rendered for a period of thirty-six months or more and back pay — (a) Personal services.

“If at least 80 per centum of the total compensation for personal services covering a period of thirty-six calendar months or more (from the beginning to the completion of such services) is received or accrued in one taxable year by an individual or a partnership, the tax attributable to any part thereof which is included in the gross income of any individual shall not be greater than the aggregate of the taxes attributable to such part had it been included in the gross income of such individual ratably over that part of the period which precedes the date of such receipt or accrual.”

In effect, taxpayer limited his tax liability for the year 1951 by determining what his taxes would have, been had he been paid ratably over the 17-year period preceding the date of receipt. The defendant concedes that it was proper for taxpayer to limit his 1951 tax in this manner. However, in computing the net taxable income for 1951, plaintiff listed contributions to charity in the total amount of $203,243.48. Plaintiff claimed a deduction of $189,993.78, which sum was 15 percent of his reported adjusted gross income, the legal maximum then permitted as charitable deductions. In March 1954, the Commissioner of Internal Revenue determined and collected a deficiency in tax for 1951 on the ground the contributions were limited to 15 percent of the amount allocated to 1951 under the section 107(a) computation, rather than to 15 percent of the total 1951 adjusted gross income as reported by the taxpayer. Hence, $152,115.15 of $189,-993.78 deduction was disallowed and added to 1951 net income which resulted in an asserted tax deficiency of $79,842.-61.

Defendant agrees that under the provisions of 26 U.S.C. (I.R.C.1939) § 23(o) (1952 Ed.) plaintiff is entitled to an allowable deduction of 15 percent of his adjusted gross income for charitable contributions.

It would appear then that the legal issue is whether the taxpayer, in computing his 1951 income tax in accordance with the provisions of section 107(a), acquired a new adjusted gross income for deduction purposes. The Government contends that when the plaintiff computed his tax under the provisions of section 107(a) he then limited his deduction to 15 percent of the amount attributable to 1951. We do not agree with this contention. The 1939 Internal Revenue Code provides:

“Sec. 23. Deductions from gross income

In computing net income there shall be allowed as deductions:

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“(o) Charitable and other contributions

“In the case of an individual, contributions or gifts payment of which is made within the taxable year to or for the use of:

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to an amount which in all the above cases combined does not exceed 15 per centum of the taxpayer’s adjusted gross income. * * * ”

Clearly, taxpayer is permitted a deduction of 15 percent of his “adjusted gross income.’’ Adjusted gross income has a definite meaning in tax law, it is the amount remaining from gross income after allowing deductions limited to business expenses and losses from sales or exchanges of property.

Inasmuch as section 23(o) requires that plaintiff’s 1951 charitable deduction be limited to 15 percent of his 1951 adjusted gross income, for the Government to prevail it must establish that the effect of applying section 107(a) is to reduce plaintiff’s 1951 gross income and consequently his 1951 adjusted gross income. We do not construe section 107(a) as having this effect. Section 107 (a) states that it is applicable when at least 80 percent of the total specified compensation earned over a period of more than three years is included in the gross income of any individual for a particular .year. This negates any contention that gross income for the year of receipt is reduced if the tax paid on that amount is limited by the computation authorized under section 107(a). We are of the view that section 107(a) merely provides a method of limiting the tax due in the year of receipt of that compensation. It does not go back and reopen prior years’ taxes. Albert C. Redpath, 19 T.C. 470. The section merely provides that the tax for the year of receipt shall not be greater than the aggregate of taxes had the compensation been included in gross income ratably over the period the work was performed. The intention was to adjust only the tax. It did not purport to have anything to do with the computation of adjusted gross income. Since plaintiff’s adjusted gross income remained the same, and plaintiff is entitled to a deduction based on this amount, it follows that any deduction allowable must be taken in that year or not at all. 26 U.S.C. (I.R.C.1939) § 43 (1952 Ed.)

It should be noted that section 107(a) is a relief statute and should be interpreted to achieve the purpose Congress intended which was the avoidance of tax inequities which would result when a cash basis taxpayer receives in one year the fruits of several years’ labor. A narrow interpretation of this section would deny taxpayer the benefits of the relief intended.

The defendant relies on the case of Thayer v. Commissioner, 12 T.C. 795, in support of the theory that the aggregate tax due may be determined only by recomputing the taxes for each component year under the provisions of section 107(a). In that case the taxpayer received a legal fee in 1944 on which he was entitled to limit his tax under the provisions of section 107(a). The taxpayer was seeking a medical expense deduction to the extent it exceeded five percent of his adjusted gross income. Thus, the higher the adjusted gross income, the lower the permissible medical deduction. The Tax Court concluded that adjusted gross income for 1944 should include only that part of the fee allocable to that year. Admittedly, the result we have reached in the instant case is contrary to the result reached by the Tax Court.

To the extent that this opinion is in conflict with the Tax Court’s decision in the Thayer case, supra, we can only say that we disagree with that court’s interpretation of section 107(a).

We conclude that plaintiffs were entitled to a charitable deduction to the extent of 15 percent of their full adjusted gross income, which was not diminished by the limitation of their tax liability for the year pursuant to the provisions of section 107(a).

The second issue, raised by the defendant’s counterclaim, is whether the plaintiff is required to include in 1951 income the value of a contract right to receive income. This contract right was donated to charity and is the basis for the deduction discussed in the first issue.

In 1932, Captain Raymond T. Bonnin entered into two contracts to represent the Ute Indians. In 1935, Bonnin assigned his contracts to a New York law firm, retaining an interest as to contingent compensation while continuing to work on the claims. In 1937, the New York law firm dissolved, but Wilkinson, who was a member of that firm, continued to represent the Ute Indians. In 1938, plaintiff purchased from Bonnin 44.79 percent of Bonnin’s contingent fees for $12,092.17. At this time there was much uncertainty as to the extent of the Indian claims and even greater uncertainty as to whether the claims could ever be collected. However, in 1950, this court entered judgments in favor of the Ute Indians in the amount of $31,-938.473.43, and in 1951 this court awarded legal fees for services rendered to the Ute Indians in a total amount of $2,-794.616.43. Bonnin’s share of this fee was $427,245.53. Of this amount, 44.79 percent ($191,363.28) representing the amount purchased by plaintiff in 1938, and assigned by him by deeds of gift to charitable institutions in September of 1951, was distributed to said institutions. The plaintiff contends that the value of this gift is not attributable to income. The defendant asserts that it is.

The defendant’s counterclaim is predicated on the contention that plaintiff made an assignment of anticipated income. In support of its position, the defendant relies on several landmark decisions which tax the anticipatory assignment of income as ordinary income to the assignor. Helvering v. Eubank, 311 U.S. 122, 61 S.Ct. 149, 85 L.Ed. 81; Helvering v. Horst, 311 U.S. 112, 61 S.Ct. 144, 86 L.Ed. 75; Harrison v. Schaffner, 312 U.S. 579, 61 S.Ct. 759, 85 L.Ed. 1055; Lucas v. Earl, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731. We have no dispute with the principles expounded in these decisions, but we feel that defendant’s reliance on these principles in the instant action is misplaced. The cited cases on anticipatory assignments of income have arisen primarily in the context of gratuitous, intrafamily assignments, rather than as here from arm’s-length bargaining transactions. Here the income to be earned was attributable to Bonnin rather than plaintiff. Taxpayer, in a bona fide sale, purchased the right to receive this income if and when it became due. Hence, we are not concerned with the problem of income splitting to avoid taxation or of assigning income while retaining control of the corpus. Thus, cases cited in this area are inapposite because we first must determine whether the right assigned was income or property. If it is income, then the position taken by the defendant is correct and it must prevail. However, if the right assigned, is property, within the framework of the statutes, then the taxpayer must prevail. In an arjtt’s-length transaction the assignor of a. personal services contract right is taxed on the consideration received, and the as-signee is taxed on any amount ultimately collected under the assignment in excess of his cost. Cotlow v. Commissioner, 2 Cir., 228 F.2d 186. Since,-absent the gift to charity, taxpayer would be taxed on this excess upon receipt either as •ordinary income or capital gain, we are concerned here with determining which treatment is applicable. If taxpayer’s economic gain is “property” it qualifies for the favorable tax consequences on gifts of “property" provided for under the Treasury regulations.² In our opinion, save for the fact our problem involves a charitable deduction, other courts would reach the same conclusion by approaching the issue on the basis that the transaction did not involve a sale or exchange. P. N. Fahey, 16 T.C. 105; Hale v. Helvering, 66 App.D.C. 242, 85 F.2d 819. However, it is our opinion that the issue is best resolved by a definitive approach to the term “capital asset,”³ since the concept of capital gains and losses is applicable only with regard to a capital asset. 26 U.S.C. (I.R.C.1939) §§ 117(2, 3, 4), and (5) (1952 Ed.).

In effect, plaintiff contends that he became the assignee of a property right when he purchased the right to receive future income under the contract, and that this property right can be donated to charity and be subjected to favorable tax consequences. This position, of course, assumes that the gift was actually “property” within the definition of the regulations, which, in turn, has been construed by the courts to be limited to property treated as capital assets. The definition of a capital asset must be narrowly applied and its exclusions interpreted broadly. This is necessary to effectuate the basic congressional purpose. Corn Products Refining Co. v. Commissioner, 350 U.S. 46, 76 S.Ct. 20, 100 L. Ed. 29. It is true the Treasury regulations treat favorably gifts of “property” to charity. It is also true that contract rights are generically deemed property rights. Whether they are “property” for tax purposes, however, may be another matter. As this court stated in Arnfeld v. United States, 143 Ct.Cl. 277, 287, 163 F.Supp. 865, cert. den. 359 U.S. 943, 79 S.Ct. 722, 3 L.Ed.2d 676, “the concept of ‘property’ is not necessarily controlling in matters of taxation.” The concept of property, for capital gains tax purposes, is limited to those assets treated as capital assets. Therefore, plaintiff must show that the property donated was a capital asset as contemplated within the meaning of the Internal Revenue Code. To make this determination, we must look at the nature of the income that would have resulted had there been no assignment. If Bonnin had retained the contract, he would have received income for personal services. The question then is whether the assignment of the right to receive the income intervenes to alter the inherent characteristics of the income such as to remove it from the realm of ordinary income when it is ultimately received. We conclude that it does not. Courts many times have had occasion to pass on the question of whether future income may be converted into capital gain. The decisions amply support the position that what was income to the assignor remains income when it is received by the as-signee. Arnfeld v. United States, supra; Cotlow v. Commissioner, supra.

The rationale supporting our decision is that if the fee were paid to Bonnin it would be taxable to him as ordinary income and that no transaction could change the character of the fee. Were we to hold otherwise, we can visualize countless opportunities for individuals performing personal services to exploit this method of limiting their tax responsibilities. For example, two lawyers, each working on a contingent fee contract, might sell to the other the right to receive payment under their contract for a nominal sum. They would then aver that the gain.realized was a capital gain because it represented gain on the sale or exchange of property. True, it is not the function of courts to legislate in an effort to close tax loopholes, but certainly it is not the function of courts to create the loopholes which is what we would be doing if we acceded to taxpayer’s contention.

In Arnfeld, supra, this court reviewed the authorities on this question. We feel no useful purpose would be served by restating the principles therein discussed. We affirm our decision in that case and hold that the amount received by taxpayer in excess of his cost is taxable as ordinary income to him. To do otherwise would overlook the actual and practical occurrences of this particular instance. Plaintiff purchased this contract right in 1938, and Bonnin died in 1942. Bonnin was not a lawyer, even though he had a legal right to share in the fees. The fees were paid in 1951. The point is that the accretion in the value of the contract right was due mainly as the result of taxpayer’s own efforts and performance of his personal services. . This being true, we are of the opinion that the provisions of section 107(a) should apply to limit taxpayer’s liability by computing the tax as if the income had been received from the time the contract right was purchased until the date of actual receipt. Since the gain is taxable as ordinary income, it does not qualify as “property” within the meaning of section 117 of the Code, nor as “property” as determined by judicial review in interpreting Treasury regulations. Therefore, the amount of gain realized must be attributable to earned income. It should be noted that this determination increases taxpayer’s adjusted gross income which, in turn, increases the amount of the charitable deduction to the extent of 15 percent of the new figure.

Defendant is entitled to recover on its counterclaim only to the extent set forth in this opinion.

The third issue is whether the taxpayer is entitled to treat the gain from the sale of a contract right as a capital gain. Defendant raises this issue by way of answer in setoff.

On May 15, 1960, plaintiff purchased one-third of the remaining Bonnin interest in the fee discussed above from Bonnin’s widow. On October 1, 1951, plaintiff sold this right at a profit. He reported this profit on his 1951 income tax return as a long term capital gain. The defendant avers that this gain is taxable as ordinary income to the plaintiff.

The facts involved in this issue are even more favorable to the position taken by the defendant as discussed in the second issue. Therefore, we are of the opinion that the reasons set forth at length in the second issue adequately dispose of this question. For the reasons stated above, we hold that the gain to the taxpayer is income to himand, therefore, it is taxable as ordinary income to him. Consequently, defendant’s answer in setoff is well taken.

The plaintiff raises the question of estoppel claiming that he relied on the advice of the defendant’s agents. We believe this contention is without merit. Inasmuch as we have held that plaintiff is entitled to recover on the first issue, there is no need to discuss plaintiff’s reliance on the advice of the Government’s agent as to that issue. The plaintiff contends, however, that the gift was made in reliance on the agent’s advice that the gift was a gift of property and, as such, would not be includible in taxpayer’s income. Courts have uniformly held that the taxpayers, cannot rely with impunity on representations or statements of Revenue agents. Restating this principle, the assertions or representations of a Revenue agent, pertaining to a question of law, are not binding upon the United States. Darling v. Commissioner, 4 Cir., 49 F.2d 111, cert. denied, 283 U.S. 866, 51 S.Ct. 657, 75 L.Ed. 1407; Martin’s Auto Trimming, Inc. v. Riddell, 9 Cir., 283 F.2d 503; Agricultural Securities Corp. v. Commissioner, 39 B.T.A. 1103, affirmed, 9 Cir., 116 F.2d 800.

The refund of tax deficiency here sought by the plaintiff in the petition is granted, the recovery sought by defendant in its counterclaim is granted to the extent set forth above, and judgment will be entered to that effect. The amounts of recovery, on the claim and counterclaim, will be determined pursuant to Rule 38(c), 28 U.S.C., taking into consideration the effect of the answer in setoff.

It is so ordered.

DURFEE, Judge, concurs. DAVIS, Judge, took no part in the consideration and decision of this case.

1 . Although the action is brought jointly by husband and wife, inasmuch as the controversy pertains to the activities of the husband, we shall use the terms “plaintiff” and “taxpayer” to refer to Ernest L. Wilkinson.

2 . L.O. 1118, 1923-2, Cura.Bull. 148:

“In view of the fact that no gain or loss is realized by a gift of property (article 141, Regulations 45), the question is presented as to whether Congress intended to tax indirectly the unrealized appreciation in value of property, the subject of a charitable gift, by not permitting a deduction therefore to the extent of the appreciation in value.

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“On account of the clear purpose of ■Congress in enacting the charitable contributions section and the express language used permitting a taxpayer to deduct charitable gifts to the amount of 15 percent of his net income, it is not considered that Congress intended to tax indirectly any unrealized appreciation in the value of property given to charitable organizations by allowing as a deduction something less than the amount of tiie property given (subject to the 15 percent limitation), nor, in the opinion of this office, was it the intention of Congress to allow as a deduction any unrealized loss or decline in value where the property has decreased in value subsequent to its acquisition.”

3 . “§ 117. Capital gains and losses — (a) Definitions. As used in this chapter — (1) Capital assets.

“The term ‘capital assets’ means property held by the taxpayer (whether or not connected with his trade or business), but does not include — * * * ” 26 U.S.C. § 117 (1952 Ed.) [Exceptions not important here.]