United California Bank v. United States

439 U.S. 180, 99 S. Ct. 476, 58 L. Ed. 2d 444, 1978 U.S. LEXIS 2453, 42 A.F.T.R.2d (RIA) 6300

Opinions

Mr. Justice White

delivered the opinion of the Court.

Under the provisions of the Internal Revenue Code of 1954 in effect during the years in question, taxpayers, including decedents’ estates,¹ with net long-term capital gains exceeding net short-term capital losses, paid either a “normal” income tax calculated by applying ordinary graduated rates to taxable income computed with a 50% capital-gains deduction permitted by § 1202 of the Code or, if it was a lesser sum, the alternative tax calculated as directed by § 1201 (b).² Under the latter section the taxable income for normal tax purposes was first reduced by the portion of the capital gain remaining in that figure, and the regular tax rates were then applied to the resulting amount. To this partial tax was added an amount equivalent to 25 % of the “excess of the net long-term capital gain over the net short-term capital loss.”

The issue here involves the computation of the alternative tax of a decedent’s estate that had net long-term capital gains,³ a portion of which — pursuant to the terms of the decedent’s will — was “during the taxable year, paid or permanently set aside” for charitable purposes within the meaning of § 642 (c), 26 U. S. C. § 642 (c) (1964 ed.). That section permitted an estate to deduct “without limitation” amounts designated for charitable purposes by the controlling instrument, subject, however, to “proper adjustment ... for any deduction allowable to the estate or trust under section 1202 . ...” ⁴

I

Walter E. Disney, who died in 1966, left 45% of the residue of his estate by will to a designated charitable trust. During the years 1967 and 1968, petitioners, executors of the estate, sold securities making up part of the residue of the estate, thereby realizing a long-term capital gain in the amount of $500,622.38 in 1967 and $1,058,018.43 in 1968. There were no short-term capital losses, but a net short-term capital gain of $16,944.16 was realized in 1967. Forty-five percent of the net long-term capital gain was set aside as part of the residue of the estate for the benefit of the specified charity. In their fiduciary income tax returns for these years, the executors sought to use the alternative tax prescribed by § 1201 (b). In computing this tax, they excluded from the long-term capital gain to which the alternative tax was applicable the 45% portion of long-term gain permanently set aside for charity. The District Director disallowed this exclusion, without which the alternative tax was higher than the normal tax computed with the § 1202 capital-gains deduction. The normal tax rather than the alternative tax was therefore due. Additional taxes were assessed and paid, and this suit for refund followed.

Agreeing with the judgment of the Court of Appeals for the Second Circuit in Statler Trust v. Commissioner, 361 F. 2d 128 (1966), the District Court sustained the executors’ position that, in computing the alternative tax under § 1201 (b), any amount deductible by the estate from its gross income as being permanently set aside for charity could be excluded from the net long-term capital gain subject to the alternative tax. The Court of Appeals reversed, 563 F. 2d 400 (CA9 1977), holding that the alternative tax was to be computed on the total excess of net long-term capital gains over net short-term capital losses, unreduced by any amount deductible by the estate as a charitable set-aside under § 642 (c). The court expressly disagreed with the decision in Statler Trust, supra. We granted the executors’ petition for certiorari, 435 U. S. 922 (1978).

In this Court, as in the courts below, the parties agree on the method of calculating the normal tax but sharply disagree in regard to the proper computation of the alternative tax under § 1201 (b). To illustrate, the normal tax for 1967 amounted to $88,000 in round figures.⁵ According to the executors, the alternative tax was $70,800,⁶ which, being a lesser amount than the normal tax, would be the amount due. The Government calculates the alternative tax to be $125,000 and thus insists that the normal tax in the amount of $88,000 was properly payable.⁷ As we have indicated, resolution of the issue turns on whether the net long-term gain to which the alternative tax is applicable is permissibly reducible by the amount of the charitable set-asides in the years in question. On this score, we agree with the executors and reverse the Court of Appeals.

II

The Government’s position rests on what it deems to be the plain language of § 1201 (b), which directs that the “excess of the net long-term capital gain over the net short-term capital loss” be taxed. This language, it is said, unambiguously embraces income distributed to or set aside for charitable beneficiaries, even though in their hands the same income would be tax exempt.

The difficulty with the Government’s position is that § 1201 (b) is not always understood to mean what it seems to say. The Government concedes here that if 45% of the net long-term gain had been distributable to taxable beneficiaries rather than to charity, the net long-term gain subject to the § 1201 (b) alternative tax would have been reduced to the extent of the noncharitable distribution, despite the failure of the section’s language to provide for this treatment. In that event, the alternative tax would have been $70,800, precisely the amount due by the executors’ computation where the 45% distribution or set-aside is for charitable purposes. Thus, it cannot be said that § 1201 (b) never permits reduction of the total net long-term capital gain in response to imperatives emerging from other sections of the Code.⁸

The Government explains its application of § 1201 (b) to capital gains distributable to noncharitable beneficiaries by-noting that the Internal Revenue Code of 1954 manifests a general pattern of treating estates and trusts as conduits for distributable income. Accordingly, although estates are taxable entities, their distributable income is taxable to the beneficiaries rather than to the estates. Hence, to avoid assessing taxes against both the estate and its beneficiaries, the amounts includable in the beneficiaries’ gross income are excluded in computing the estate’s alternative tax. Sections 661 (a) and 662 (a) are the sections said to implement this end.⁹ Section 661 (a) permits an estate or trust to deduct from its gross income any income required to be distributed currently and any other amount properly paid or credited or required to be distributed for the taxable year. Section 662 (a) in turn essentially directs a beneficiary to include in its gross income amounts described in § 661 (a).¹⁰

We agree that these provisions of the Code provide a sound justification for treating income distributable to taxable beneficiaries as belonging to them rather than to the estate and hence for reducing the net long-term gain to be taxed to the estate under § 1201 (b) by the amount of gain distributable and taxable to the beneficiary. We also agree, as do the executors, that because § 663¹¹ provides expressly that amounts qualifying as charitable deductions under § 642 (c) “shall not be included as amounts falling within section 661 (a) or 662 (a),” charitable distributions or set-asides are not within the conduit system applicable to noncharitable beneficiaries. We reject the Government’s view, however, that this explanation for the application of § 1201 to taxable distributions of capital-gains income also negates similar treatment for amounts of current income that are distributed to, or permanently set aside for, charitable beneficiaries and that are deductible by the estate under § 642 (c). Indeed, the latter section serves to extract income destined for charitable entities from the taxable income of the estate and thus supplies a conduit for charitable contributions similar to that provided by §§ 661 (a) and 662 (a) in regard to income passing to taxable distributees. The express exclusion from §§ 661 (a) and 662 (a) of those amounts deductible under § 642 (c) in no way refutes conduit treatment of such amounts. Rather, the exclusion pursuant to § 663 prevents a second deduction for charitable set-asides and recognizes as well that they are accorded separate treatment elsewhere under the Code.¹²

The Government makes much of § 1202’s directive to exclude capital gains distributable to taxable beneficiaries in computing the capital-gains deduction, and of the absence of a similar mandate with respect to charitable distributions or set-asides, which are only subject to a deduction under § 642 (c). Hence, it is argued, income distributions to charity are not to be considered the property of the beneficiary in the same sense as income passing to taxable entities is attributed to the distributees. We doubt that so much should turn on § 1202.¹³ The provision having the operative role in removing the noncharitable distribution from the estate income is § 661 (a), and that section unmistakably provides a deduction for such sums, just as § 642 (c) permits deductions for distributions to nontaxable entities.

Nor do we agree that charitable and noncharitable distributions of long-term gain should be regarded differently because in the one case the distribution is taxable in the hands of the beneficiary and in the other it is tax free. Indeed, it is arguable that the reduction of the gain taxable under § 1201 (b) is even more justified when the income distribution is not only deductible from estate income but also looked upon with such favor that it is not taxable at all in the hands of the dis-tributee.¹⁴ Furthermore, distributions of income to taxable beneficiaries retain the same character in their hands as they had in the hands of the estate. 26 U. S. C. § 662 (b) (1964 ed.). If such distributions are wholly or partly composed of capital gain, the distributee treats them as such in his own return. He is entitled to offset the gain with his own capital losses that accrued in other transactions having nothing to do with the estate. He may, therefore, suffer no tax at all on the gain. Nevertheless, and even though the estate would have paid a tax on the capital gain had it not been distributable, the estate’s net long-term capital gain for § 1201 (b) purposes would be reduced by the amount of the distribution. The executors’ position, with which we agree, is that a similar reduction of the net long-term gain taxable under § 1201 should not be denied simply because the beneficiary is a charity that will pay no tax on the gain set aside for it.

As the Government and the Court of Appeals construe the Internal Revenue Code, the estate in this case, which set aside part of its capital gain for charity, must pay a higher income tax than if the same portion of capital gain had been distributed to a taxable beneficiary. Because the tax will inevitably reduce the residue, the burden of the extra tax will be borne either by the charities themselves or by noncharitable residual legatees. We doubt that Congress intended either result. The former allocation would contravene the statutory provision for the deduction of charitable set-asides — § 642 (c) provides for their deductibility “without limitation” — and would indirectly offend the exemption extended to charities by § 501. Allocating the burden to the noncharitable legatees would result in taxation of the capital gain accruing to their benefit at an effective rate higher than the 25% ceiling that § 1201 was intended to impose on the taxation of net long-term capital gain. If all of the net long-term capital gain in this case had been added to corpus and none distributed to or set aside for charity, there is no doubt that the estate’s alternative tax would have been lower than its normal tax and the tax on its net gain would have been limited to 25%. We cannot agree that the estate is not to have the full benefit of the 25% ceiling simply because part of its gain is set aside for a tax-exempt entity.

Ill

In support of its position, the Government presents an interesting history of the income taxation of capital gains. The central submission of this exegesis is that in 1924 taxpayers were permitted to deduct the excess of ordinary deductions over ordinary income from capital gains subject to an alternative tax otherwise resembling § 1201, see Revenue Act of 1924, § 208 (a) (5), 43 Stat. 262, but that in 1938, when the alternative tax in its present form emerged, no allowance was made for reduction of the gain subject to the alternative tax by ordinary losses, see Revenue Act of 1938, § 117 (c)(1), 52 Stat. 501. This development is interpreted by the Government — mistakenly we think — as a deliberate rejection of the computational method advocated by the executors.

The issue here is not whether an excess of deductions over ordinary income may serve generally to reduce the gain subject to the alternative tax; rather, the inquiry concerns whether there is income properly attributable to the charitable beneficiary that should not be taxed to the estate at all. Assuredly, had all of the capital gain been set aside for charity and had there been no other estate income, there would have been no tax at all; the § 642 charitable deduction would have negated the entire capital-gains income of the estate, thus subjecting no taxable income whatsoever to the normal tax. Equally clear is that when 45% of the capital gain is set aside for a charitable entity, the gain subject to the normal tax is reduced to that extent. The Government does not dispute that the net effect of this § 1202 computation is to recognize •the entire amount set aside for the exempt organization. The executors now ask no more than full recognition of the conduit principle in the computation of the alternative tax. The legislative history on which the Government relies is not at all incompatible with the general applicability of the conduit concept. In fact, the legislative history of the 1954 Code makes plain that Congress sought rigorously to adhere “to the conduit theory of the existing law[, which] means that an estate or trust is in general treated as a conduit through which income passes to the beneficiary.” H. R. Rep. No. 1337, 83d Cong., 2d Sess., 61 (1954).¹⁵

IV

The Government asserts nonetheless that a ruling favoring the executors would run counter to the Court's decision in United States v. Foster Lumber Co., 429 U. S. 32 (1976), rendered two Terms ago. That case involved § 172 of the Internal Revenue Code of 1954, 26 U. S. C. § 172 (1964 ed.), which provided that a net operating loss incurred by a corporate taxpayer in one year may be carried as a deduction against taxable income for preceding years. The issue was whether a loss was absorbed by capital gain in addition to ordinary income in the year to which it was first carried, or whether it was limited to offsetting only ordinary income. Section 172 in terms provided that, when a loss had been carried back to the first available year, it survived for carryover to subsequent periods only to the extent that it exceeded the taxable income of the earlier year. Because taxable income was defined generally in the Code to include both capital gain and ordinary income, the Court concluded that a loss carryback must be applied to the sum of the two.

The taxpayer in Foster Lumber never disputed that losses in carryover years could not be deducted from capital gain in executing the second step of the alternative tax.¹⁶ In fact, because of that limitation, the taxpayer insisted that loss carrybacks should not be treated as absorbed by capital gains for purposes of § 172. Otherwise, in utilizing the alternative tax, the taxpayer would lose the benefit of that portion of the loss corresponding to capital gain. In rejecting the taxpayer’s contention, the Court "noted that relevant legislative history belied any notion of a congressional intention to ameliorate all “wastage” of loss deductions. It was able to conclude that “Congress has not hesitated in this area to limit taxpayers to the enjoyment of one tax benefit even though it could have made them eligible for two.” 429 U. S., at 46.

The Government maintains that the executors’ construction of the alternative tax conflicts with our assessment of its operation in Foster Lumber. The executors, in the Government’s view, are no more entitled to exclude charitable set-asides in computing the second component of the alternative tax than was the taxpayer in Foster Lumber able to subtract excess ordinary deductions. But the construction of the alternative tax accepted by both parties in Foster Lumber, and assumed valid by this Court, merely accorded recognition to decisions discerning a congressional refusal — evidenced by the legislative history discussed in Part III, supra — to permit subtraction of ordinary losses from capital gains in the application of § 1201.¹⁷ The executors do not deny that a taxpayer cannot reduce capital gains by the amount of ordinary losses in figuring the alternative tax, but argue that capital gains set aside for charity are not taxable to an estate to begin with. The Government acknowledges that there is ample support in the provisions of Subchapter J for reducing the estate’s net long-term capital gain by amounts distributable to taxable beneficiaries, and that Foster Lumber is thus distinguishable in that context. We believe the decision is similarly inapposite when charitable beneficiaries are involved.¹⁸

We think, then, that the Court of Appeals for the Second Circuit arrived at the correct result in the Statler Trust case. The court there recognized what this Court had earlier said: that currently distributable income is not treated “as the [estate's] income, but as the beneficiary’s,” whose “share of the income is considered his property from the moment of its receipt by the estate.” Freuler v. Helvering, 291 U. S. 35, 41-42 (1934). That principle survived in substance in the 1954 Code; and to treat differently charitable and nonchari-table distributions of capital gain for the purpose of computing the alternative tax under § 1201 (b) “stresses the form at the neglect of substance.” Statler Trust v. Commissioner, 361 P. 2d, at 131. We agree with the Second Circuit that “the letter of § 1201 (b) must yield when it would lead to an unfair and unintended result.” Ibid.

The judgment of the Court of Appeals is reversed.

It is so ordered.

1

Subchapter J of the Code, 26 U. S. C. §641 et seq. (1964 ed.), deals with the taxation of estates, trusts, beneficiaries, and decedents. Section 641 (b) provides that the tax on estates and trusts “shall be computed in the same manner as in the case of an individual, exeept as otherwise provided in this part.”

2

Title 26 U. S. C. § 1202 (1964 ed.) provides:

“In the case of a taxpayer other than a. corporation, if for any taxable year the net long-term capital gain exceeds the net short-term capital loss, 50 percent of the amount of such excess shall be a deduction from gross income. In the case of an estate or trust, the deduction shall be computed by excluding the portion (if any), of the gains for the taxable year from sales or exchanges of capital assets, which, under sections 652 and 662 (relating to inclusions of amounts in gross income of beneficiaries of trusts), is includible by the income beneficiaries as gain derived from the sale or exchange of capital assets.”

Title 26 U. S. C. § 1201 (b) (1964 ed.) provides:

“(b) Other taxpayers.

“If for any taxable year the net long-term capital gain of any taxpayer (other than a corporation) exceeds the net short-term capital loss, then, in lieu of the tax imposed by sections 1 and 511, there is hereby imposed a tax (if such tax is less than the tax imposed by such sections) which shall consist of the sum of—

“(1) a partial tax computed on the taxable income reduced by an amount equal to 50 percent of such excess, at the rate and in the manner as if this subsection had not been enacted, and

“(2) an amount equal to 25 percent of the excess of the net long-term capital gain over the net short-term capital loss.”

3

Because the estate incurred no short-term or long-term capital losses in 1967 and 1968, for brevity’s sake we sometimes speak simply of “net long-term capital gain” or “capital gain.”

4

Title 26 U. S. C. § 642 (c) (1964 ed.) provides in relevant part:

“(c) Deduction for amounts paid or permanently set aside for a charitable purpose.

“In the case of an estate or trust (other than a trust meeting the specifications of subpart B) there shall be allowed as a deduction in computing its taxable income (in lieu of the deductions allowed by section 170 (a), relating to deduction for charitable, etc., contributions and gifts) any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid or permanently set aside for a purpose specified in section 170 (c), or is to be used exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, or for the establishment, acquisition, maintenance or operation of a public cemetery not operated for profit. For this purpose, to the extent that such amount consists of gain from the sale or exchange of capital assets held for more than 6 months, proper adjustment of the deduction otherwise allowable under this subsection shall be made for any deduction allowable to the estate of trust under section 1202 (relating to deduction for excess of capital gains over capital losses)

Where the § 642 (c) charitable set-aside includes net long-term capital gain, the adjustment avoids a redundant subtraction of income destined for charitable beneficiaries. Its effect is to reduce the charitable deduction by one-half so as to reflect that part of the deduction already included in the 50% capital-gain deduction under § 1202. As indicated later in the text, the parties are not in dispute as to the interworkings of §§ 1202 and 642 (c). It is agreed, moreover, that the set-asides at issue were intended for a charitable entity within the meaning of 26 U. S. C. §§ 170 (c)(2), 501 (c)(3) (1964 ed.). Section 170 permits deductions for contributions to charitable organizations, and § 501 affords a tax exemption to the organizations themselves.

5

The agreed method for computing the normal tax may be illustrated by utilizing the 1967 figures, rounded off:

Normal tax

Estate gross income, including long-term capital gain of $500,000 $595,000

Less: § 1202 deduction (50% of $500,000 net long-term capital gain) (250,000)

Charitable deduction (remaining 50% of $225,000 charitable set-aside, plus $32,500 attributable to short-term capital gain and ordinary income set aside for charitable legatees) (145,000)

Miscellaneous deductions (54,000)

Estate taxable income 146,000

Tax (at normal rates) $88,000

6

The executors’ application of § 1201 (b) to income for 1967 approximated the following:

Alternative tax

Estate taxable income $146,000

Less: 50% reduction of net long-term capital gain under § 1201 (b) (1) (137,500)

The executors reduced the long-term capital gain of $500,000 by the 45% paid to charity (or $225,000), leaving a balance of $275,000 (50% of $275,000=$137,500)

Partial taxable income 8,500

Tax (at normal rates) on partial _ taxable income 1,800

Plus: tax on long-term capital gain (25% of $275,000) under § 1201 (b) (2) 69,000

Total tax $70,800

7

The Government’s computation, using approximate 1967 figures, was as follows:

Alternative tax

Estate taxable income $146,000

Less: 50% reduction of net long-term capital gain under § 1201 (b) (1) (250,000)

The capital-gain figure employed reflects the entire $500,000 of long-term capital gain unreduced by the amounts set aside for charity Partial taxable income -0-

Tax (at normal rates) on partial taxable income -0-

Plus: tax on long-term capital gain (25% of $500,000) under § 1201 (b) (2) 125,000

Total tax $125,000

8

The alternative tax has been applied flexibly in another context to effectuate a clear congressional policy facially inconsistent with the language of § 1201. It has been held that the income tax deduction permitted by 26 U. S. C. § 691 (c) for the amount of estate tax attributable to income in respect of a decedent can be offset against the estate’s capital gains before application of the alternative tax. The deduction was thought necessary to honor the congressional purpose animating the § 691 (c) deduction of avoiding imposition of both estate and income taxes on sums included in an estate as income in respect of a decedent. See, e. g., Read v. United States, 320 F. 2d 550 (CA5 1963); Meissner v. United States, 176 Ct. Cl. 684, 364 F. 2d 409 (1966); Estate of Sidles v. Commissioner, 65 T. C. 873 (1976), acq. 1976-2 Cum. Bull. 2.

9

Title 26 U. S. C. § 661 (a) (1964 ed.) states:

“(a) Deduction.

“In any taxable year there shall be allowed as a deduction in computing the taxable income of an estate or trust (other than a trust to which subpart B applies), the sum of—

“(1) any amount of income for such taxable year required to be distributed currently (including any amount required to be distributed which may be paid out of income or corpus to the extent such amount is paid out of income for such taxable year); and

“(2) any other amounts properly paid or credited or required to be distributed for such taxable year;

“but such deduction shall not exceed the distributable net income of the estate or trust.”

Title 26 TJ. S. C. § 662 (a) (1964 ed.) provides:

“(a) Inclusion.

“Subject to subsection (b), there shall be included in the gross income of a beneficiary to whom an amount specified in section 661 (a) is paid, credited, or required to be distributed (by an estate or trust described in section 661), the sum of the following amounts:

“(1) Amounts required to be distributed currently.

“The amount of income for the taxable year required to be distributed currently to such beneficiary, whether distributed or not. If the amount of income required to be distributed currently to all beneficiaries exceeds the distributable net income (computed without the deduction allowed by section 642 (c), relating to deduction for charitable, etc., purposes) of the estate or trust, then, in lieu of the amount provided in the preceding sentence, there shall be included in the gross income of the beneficiary an amount which bears the same ratio to distributable net income (as so computed) as the amount of income required to be distributed currently to such beneficiary bears to the amount required to be distributed currently to all beneficiaries. For purposes of this section, the phrase ‘the amount of income for the taxable year required to be distributed currently’ includes any amount required to be paid out of income or corpus to the extent such amount is paid out of income for such taxable year.

“ (2) Other amounts distributed.

“All other amounts properly paid, credited, or required to be distributed to such beneficiary for the taxable year. If the sum of—

“(A) the amount of income for the taxable year required to be distributed currently to all beneficiaries, and

“(B) all other amounts properly paid, credited, or required to be distributed to all beneficiaries

“exceeds the distributable net income of the estate or trust, then, in lieu of the amount provided in the preceding sentence, there shall be included in the gross income of the beneficiary an amount which bears the same ratio to distributable net income (reduced by the amounts specified in (A)) as the other amounts properly paid, credited or required to be distributed to the beneficiary bear to the other amounts properly paid, credited, or required to be distributed to all beneficiaries.”

10

The amount deductible by the estate under § 661 (a) and includable in the gross income of the beneficiaries under § 662 (a) is generally limited by “distributable net income,” defined in 26 U. S. C. § 643 (a) (1964 ed.) as taxable income computed with certain modifications. One such modification is the exclusion of “[g]ains from the sale or exchange of capital assets ... to the extent that such gains are allocated to corpus and are not (A) paid, credited, or required to be distributed to any beneficiary during the taxable year, or (B) paid, permanently set aside, or to be used for the purposes specified in section 642 (c).” § 643 (a) (3).

Section 643 (a) (3) has been variously interpreted by the Second and Ninth Circuits and by the parties in the course of this litigation. The Second Circuit in Statler Trust considered capital gains set aside for charity to be “inclu[ded] in the definition of distributable net income in § 643 (a)(3),” 361 F. 2d, at 131, hence indicating conduit treatment for such set-asides. The court below announced a more expansive view. It implied that all “[a]mounts distributed or set aside to charity . . . remain in distributable net income,” whether consisting of capital gain or ordinary income. 563 F. 2d, at 404. This construction was thought supportive of the Government’s position on the theory that “ ‘conduit’ treatment [for charitable set-asides] would suggest that amounts distributed or set aside for charity would be excluded from . . . distributable net income.” Ibid. (emphasis in original).

The executors have insisted all along that the total amount of income constituting distributable net income as defined by § 643 (a) (3) does not include charitable distributions or set-asides whether consisting of capital gain or not. In the executors’ view, though § 643 (a) (3) directs that taxable income be modified by excluding capital gains paid to principal except for income allocable to charity or possessing other specified characteristics, charitable set-asides are independently extracted from taxable income by virtue of the § 642 (e) deduction. The Government, unlike the court below, has never suggested that charitable set-asides consisting of ordinary income are included in total distributable net income. But the construction developed in the Government’s brief before this Court was that amounts deemed distributable to taxable beneficiaries do include capital gains added to residue but set aside for an exempt organization. The executors argued in reply,, however, that computation of distributable net income pursuant to the Government’s formal instructions for the years in question produced a figure equal to the amount of an estate’s income exclusive of capital gains set aside for charity. At oral argument, the Government appeared to have changed its mind and to be conceding that its initial view and the more far-reaching construction of the Court of Appeals were in error:

“[F]or purposes of this argument we would be willing to concede that the taxpayers’ version of the computation of distributable net income and its [sic] attack on the example which we set out in our brief is correct.

“But we do submit that that is just utterly irrelevant. You come to the question of distributable net income only after you have arrived at taxable income [which] has been diminished by that part of a charitable deduction or that part of a set aside for charity which comes out of gross income.

“And it is only at that point . . . that . . . distributable net income adjustments become relevant.” Tr. of Oral Arg. 35-36.

We need not attempt to resolve this contrariety of views, for we agree with the Government that the nature and function of distributable net income have little or nothing to do with the treatment of charitable set-asides under § 1201 (b).

11

Title 26 U. S. C. § 663 (a)(2) (1964 ed.) provides:

“(a) Exclusions.

“There shall not be included as amounts falling within section 661 (a) or 662 (a)—

“(2) Charitable, etc., distributions.

“Any amount paid or permanently set aside or otherwise qualifying for the deduction provided in section 642 (c) (computed without regard to section 681).”

12

The legislative history of the 1954 Code makes plain that capital gains passing to charity were not encompassed by §§ 661 (a) and 662 (a)— which ensure conduit treatment of capital gains distributable to taxable beneficiaries — because income paid or set aside for charitable purposes was already immunized from taxation by §642 (c). The House Committee explained that “[s]ince the estate or trust is allowed a deduction under section 642 (c) for these amounts, they are not allowed as an additional deduction for distributions nor are they treated as amounts distributed for purposes of section 662 in determining the amounts includible in the gross income of the beneficiaries.” H. R. Rep. No. 1337, 83d Cong., 2d Sess., A205 (1954); accord, S. Rep. No. 1622, 83d Cong., 2d Sess., 354 (1954).

13

Section 1202 is far less supportive of the Government’s position than the dissent would indicate. Our dissenting colleagues contend that, in excluding capital gains distributable to taxable beneficiaries from the computation of the capital-gains deduction, § 1202 authorizes a modification of the meaning of “excess” of the net long-term capital gain over net short-term capital loss for purposes of § 1201 as well as § 1202. The modification must be extended to § 1201, according to the dissent, in order to preserve the scheme of the alternative tax. More specifically, half of the “excess” is deducted under § 1202, and the other half is deducted pursuant to the first step of § 1201; thus, to ensure that 100% of the excess-is deducted by operation of both provisions, the term “excess” must be construed similarly for purposes of both sections. The same mandate is assertedly absent with regard to income passing to charity. See post, at 208-209.

The dissenters’ thesis, however, at most explains why the first step of § 1201 should be computed by excluding capital gains distributable to taxable beneficiaries. It provides no basis for removing such gains from the “excess” subject to the 25% flat rate under the second step of § 1201. Yet our dissenting Brethren agree that § 1201 (b) (2) — the second stage of the alternative tax — should not be literally construed to make capital gains passing to taxable beneficiaries taxable to the estate. The real reason is not to preserve consistency in abstract form, as the dissent’s definitional argument misleadingly suggests, but to maintain loyalty to conduit principles as manifested by §§ 661 (a) and 662 (a) in the context of capital gains distributable to taxable beneficiaries. See post, at 209.

Moreover, the absence of an exclusionary clause in § 1202 respecting capital gains distributable to charity is readily explainable in a fashion consistent with our position. The clause operates to prevent the estate from deducting under § 1202 50% of all capital gains distributable to taxable beneficiaries and then deducting an amount equal to 100% of such gains under § 661 (a). A redundant deduction is precluded in the context of gains passing to charity by a different, but equally effective, method. Specifically, the charitable counterpart of § 661 (a) — § 642 (c) — expressly contemplates an adjustment for deductions already taken under § 1202. In that way, § 642 (c) ensures that no more, but certainly no less, than the entire amount of gains passing to charity will be exempt from taxation under the normal tax. In substance, then, capital gains distributable to both taxable and nontaxable beneficiaries are- removed from income taxable to the estate by the normal method. Nothing our Brethren say warrants similar treatment for the former but not the latter under § 1201. See also n. 14, infra.

14

The dissent suggests, however, that charitable and noncharitable distributions should be treated differently because the congressional policy against double taxation is implicated in the latter context but not the former. See post, at 209-210. But in exempting charitable entities from tax liability Congress manifested a purpose to insulate all income contributed to charity from taxation. Taxing income en route to charity while temporarily in the possession of an estate is as inconsistent with the congressional policy to exempt such income from federal taxation altogether as taxing other income twice is inconsistent with the congressional policy to tax such income once.

15

In the same vein the Senate Committee explained that “[y]our committee’s bill contains the basic principles of existing law under which estates and trusts are treated as separate taxable entities, but are generally regarded as conduits through which income passes to the beneficiary.” S. Rep. No. 1622, 83d Cong., 2d Sess., 82 (1954). Capital gains were to be taxable “to the estate or trust [only] where the gains must be or are added to principal,” id., at 343. See also H. R. Rep. No. 1337, 83d Cong., 2d Sess., A194-A195 (1954); H. R. Conf. Rep. No. 2543, 83d Cong., 2d Sess., 54 (1954), excepting amounts paid, credited, or required to be distributed to any beneficiary in the taxable year or “paid, permanently set aside, or to be used for the purposes specified in section 642 (c).” Ibid. See also H. R. Rep. No. 1337, supra, at A194-A195; S. Rep. No. 1622, supra, at 343-344. This legislative history confirms our understanding of the statutory text as manifesting conduit treatment of capital gains passing to taxable and nontaxable beneficiaries alike.

16

The alternative tax involved in Foster Lumber was set forth in 26 U. S. C. § 1201 (a) (1964 ed.), which was the corporate counterpart of § 1201 (b), the provision directly involved herein.

17

See, e. g., Weil v. Commissioner, 23 T. C. 424 (1954), aff’d, 229 F. 2d 593 (CA6 1956). There, the taxpayers’ total deduction, which included charitable deductions, exceeded their ordinary income, and they sought to utilize this excess to reduce the amount of their capital gains before applying the 25% tax available under § 1201 (b). The claim was rejected because there was no basis in § 1201 or other provisions of the Code for reducing net long-term capital gains by both the net short-term losses and by the excess of ordinary deductions over ordinary income and because pertinent legislative history contradicted the taxpayers’ construction. See Part III, supra. The court in the Weil case, however, had no occasion to consider whether the net long-term gain belonging to a charitable income beneficiary of an estate may be excluded by the estate in computing the alternative tax. See Chartier Real Estate Co. v. Commissioner, 52 T. C. 346, 355 (1969), aff’d, 428 F. 2d 474 (CA1 1970).

18

It is notable, too, that the executors do not endeavor to pyramid the tax advantages associated with charitable income and capital gains in the face of a discernible congressional intention to “limit taxpayers to the enjoyment of one tax benefit.” United States v. Foster Lumber Co., 429 U. S., at 46. Indeed, it seems to us that the Government’s construction itself yields cumulative tax benefits that Congress very likely never intended. According to the Government, § 1201 (b) (1) compels the reduction of the taxable income figure computed under § 1202 by “an amount equal to 50 percent” of the total “excess” of net long-term capital loss rather than by 50% of the long-term gain not set aside for charity. Although not the ease here, in other circumstances the deduction afforded by the Government’s construction of § 1201 (b) (1) with its diminution of the partial tax may more than offset the higher tax resulting from the Government’s computation under § 1201 (b) (2) and may yield an alternative tax lower than the tax resulting from the executors’ approach and thus lower than that which would ensue if income moving to charity had never been held by the estate.

The contingency may be demonstrated by a hypothetical example. Assuming an effective tax rate on ordinary net income of 60% and estate receipts of $125,000 in ordinary income and $500,000 in long-term capital gains, with one-half of the capital gains allocable to a charitable beneficiary, the parties would compute the normal tax and the alternative tax as follows:

Normal tax

Gross income $625,000

Less: § 1202 deduction (250,000)

§ 642 (c) deduction (125,000)

Taxable income 250,000

Tax (at 60% rate) $150,000

Alternative tax, per executors’ method

Estate taxable income $250,000

Less: 50% of that portion of long-term capital gain not set aside for charity (50% of $250,000) (125,000)

Partial taxable income 125,000

Partial tax (60% effective rate) 75,000

Tax on long-term capital gain not set aside for charity (25% of $250,000) 62,500

Total alternative tax $137,500

Alternative tax, per Government’s method

Estate taxable income $250,000

Less: 50% of all the excess of net long-term capital gain over net short-term capital loss (50% of $500,000) (250,000)

Partial taxable income -0-

Partial tax -0-

Tax on all net long-term capital gain (25% of $500,000) 125,000

Total alternative tax $125,000

Significantly, the executors do. not complain that the redundant deduction available under the Government’s computational method would be “wasted” were ordinary income inadequate to absorb it. Quite to the contrary, it is their position that the cumulative deduction would never be afforded under conduit treatment of capital gains en route to charity.