#### JOHN D. HORST v. THE UNITED STATES

[No. E-90.

Decided January 16, 1928]

*On the Proofs*

*Income tax; dividends paid im, 1917 out of earnings for prior years;*“ *most recently accumulated*” *profits; failure to show date of earnings; “ tax-free covenant*” *bonds.*See *George D. Horst*v. *United States, ante,*p. 438.

*The Reporter's*statement of the case:

*Mr. II. F. Kantner*for the plaintiff.

*Mr. Alexander H.*MeCot'mieh, with whom was *Mr. Assistant Attorney General Herman J.*Galloway, for the defendant.

The court made special findings of fact, as follows:

I. John D. Horst is now and at all times hereinafter mentioned was a cjtizen of the United States and resided in Cumru Township, Berks County, Pennsylvania.

II. Under the revenue act of 1916, as amended by the revenue act of 1911, on official Form No. 1040, furnished to him by the Commissioner of Internal Eevenue, plaintiff prepared his income-tax return for the calendar year 1917, reporting his total net income as $34,579.33.

III. Plaintiff therein reported dividends received by him on the dates and from the corporations hereinafter named:

1917

Jan. 22. Nolde & Horst Company-$25, 000.00

Mar. 3. Nolde *&*Horst Company- 12, 500.00

Apr. 17. Nolde & Horst Company- 12, 500.00

Peb. 12. E. Richard Meinig Company_ 8,000. 00

Mar. 2. E. Richard Meinig Company_ 8, 000.00

Mar. 19. B. Richard Meinig Company_ 8, 000. 00

Mar. 31. E. Richard Meinig Company_ 8, 000.00

May 4. E. Richard Meinig Company_ 8,000.00

May 16. E. Richard Meinig Company- 8,000.00

June 18. E. Richard Meinig Company- 8, 000.00

The Nolde & Horst Company dividends were declared on January 13 and March 3, 1917, respectively, of 100% each; *450the dividend of E. Richard Meinig Company was for *700%,*was declared on January 8, 1917, and paid in seven installments on the foregoing dates. This 700% dividend was declared by a resolution of the board of directors payable out of the net earnings for the year 1916, and it was paid in installments on the dates aforesaid out of the earnings of the corporation actually accumulated during the year 1916. The dividends received by the plaintiff from the Nolde & Horst Company were declared by the board of directors on January 13 and March 3, 1917, respectively, of 100% each. The first dividend was paid on January 22,1917; the second, in two equal installments, on March 3 and April 17, 1917, respectively, and the dividends were declared by the board of directors payable from the net earnings of the corporation for the year 1916 and were paid out of earnings actually accumulated by the corporation during the year 1916. Plaintiff included the said dividends in h,is return as aforesaid and computed his tax liability by applying to said dividends the rates of tax prescribed by law for the year 1916. Said return was duly filed by the plaintiff on March. 29, 1918, with the United States collector ■ of .internal revenue at Philadelphia, Pennsylvania, and $6,572.94 tax shown thereon paid.

IY. On January 15, 1923, the Commissioner of Internal Revenue notified the plaintiff that an additional assessment of income tax for the calendar year 1917, amounting to $3,146.68, would be listed against him. The Commissioner of Internal Revenue determined that $12,744.29 of the dividend of $56,000 received by the plaintiff from E. Richard Meinig Company and $17,766.73 of the dividends of $50,000 received by him from Nolde & Horst Company during the year 1917 as heretofore stated were earned bjr said corporations in the year 1917 and taxable at 1917 rates.

Y. The Commissioner of Internal Revenue also included in and as part of plaintiff’s net income for the year 1917 the sum of $484.06 for taxes paid by corporations on “tax-free covenant ” bonds thereof held by plaintiff. The plaintiff in making his return returned under paragraph G, “ Interest on tax-free covenant bonds (on which one normal tax of 2% was withheld at source),” the sum of $24,202.78. This was *451included in his return as part of the amount subject to the normal tax of 2%, and under item 31 of his return, “Less tax withheld on tax-free covenant bonds (2% of net total of item G),” $484.06 was deducted from his tax. The Commissioner of Internal Revenue held that the amount paid by the corporation obligor for the bondholder pursuant to a tax-free covenant clause contained in the bond was in the nature of additional income to the bondholder and disallowed the last-named sum. The amount of the tax assessed by the commissioner on the said sum of $484.06 is not proved.

VI. By reason of the addition by the commissioner of said sums of $12,744.29, $17,766.73, and $484.06 to plaintiff’s net income reported as aforesaid, the same was increased from $34,579.33 to $65,574.41, and the computation of the tax thereon for a part of the dividends received at 1917 rates and the balance at 1916 rates by the commissioner resulted in the assessment of a total tax of $9,719.62, upon which plaintiff was credited with the sum of $6,572.94 for tax previously assessed and paid, making the additional tax of $3,146.68 assessed as aforesaid.

VII. Plaintiff thereupon on February 13,1923, excepted to the action of the Commissioner of Internal Revenue and filed his appeal therefrom with the committee on appeals and review, before which an oral hearing was held on May 22, 1923. On October 13, 1923, said committee on appeals and review sustained the action of the Income Tax Unit.

VIII. Following such notice and on December 20, 1923. the Commissioner of Internal Revenue, through the collector of internal revenue at Philadelphia, Pa., made demand upon plaintiff for the payment of $3,146.68 as additional income tax for the year ending December 31,1917. On December 27, 1923, the plaintiff under threat by the collector of seizure and sale of his property if he failed to make such payment, and in the belief that such threat would be carried out, paid to the said collector of internal revenue at Philadelphia, Pa.7 the said sum of $3,146.68. Said payment was made under protest, and at the time of making such payment the plaintiff filed with the said collector of internal revenue a written protest against such additional assessment and against the payment thereof. The said sum of $3,146.68 so paid by *452plaintiff under, protest to ,the said collector of internal revenue was thereafter by the latter turned over and deposited into the Treasury of the United States of America in the usual course of his official business. On February 13, 1924, plaintiff filed with said collector a claim for refund, which on June 17, 1924, was rejected in full.

IX. During 1917, as ascertained at the end of the year, the Nolde & Horst Company had net profits of $1,133,450.90. It distributed dividends on the basis above stated of $250,000, January 22; $125,000, March 3; and $125,000, April 17,1917; a total of $500,000. During the year 1917 the net profits of the E. Richard Meinig Company amounted to $277,818.82, ascertained at the end of the year, and it distributed in dividends $350,000 on the dates aforesaid in equal installments of $50,000 each. There is.no proof as to the months of the year 1917 in which the above-mentioned profits were earned by either company.

X. Under the revenue act of 1918, on official form No. 1040, furnished to him by the Commissioner of Internal Revenue, plaintiff prepared and filed his income-tax return for the calendar year 1919 and reported his net income as $28,325.59.

XI. Plaintiff received during 1919 of Nolde & Horst Company a cash dividend of $50,000, no portion of which was included in his return. Plaintiff paid $3,032.38 in payment of the tax shown due upon his return.

XII. On January 18, 1923, the Commissioner of Internal Revenue notified the plaintiff that an additional assessment for income tax for the calendar year 1919 amounting to $12,581.39 would be assessed against him, which additional tax was based upon the receipt by plaintiff of a cash dividend during said year, as hereinafter stated.

XIII.On February 21, 1919, the Nolde & Horst Company declared a stock dividend of 900% on its capital of $250,000, payable from earnings March 1, 1913, to February 21, 1919, and said corporation thereupon issued an additional $2,250,000 of stock, which was distributed pro rata among the holders of its shares on said date. Plaintiff received 2,250 shares thereof, of the par value of $100 per share, as his pro rata share of said distribution.

*453XIY. On February 28,1919, tbe board of directors of said Nolde & Horst Company declared and ordered to be distributed March 6, 1919, payable from profits accumulated prior to March 1,1913, a dividend of 20% on its then capital of $2,500,000, payable in cash, or a dividend of $500,000. Plaintiff received $50,000 in cash as his portion of said dividend on March 6, 1919.

XV. Plaintiff on February 13, 1923, excepted to the action of the Commissioner of Internal Revenue and filed his appeal therefrom to the committee on appeals and review before which an oral hearing was held on May 22, 1923. On October 13, 1923, said committee on appeals and review sustained the action of the Income Tax Unit. Following such notice and on December 20, 1923, the Commissioner of Internal Revenue, through the collector of internal revenue at Philadelphia, Pa., made demand upon plaintiff for the payment of $12,581.39 as additional income tax for the year ending December 31,1919. On December 27,1923, the plaintiff, under threat by the said collector of seizure and sale of his property if he failed to make such payment, and in the belief that such threat would be carried out, paid to the said collector of internal revenue at Philadelphia, Pa., the said sum of $12,581.39. Said payment was made under protest, and at the time of making such payment the plaintiff filed with the said collector of internal revenue a written protest against such additional assessment and against the payment thereof. The said sum of $12,581.39 so paid by plaintiff under protest to the said collector of internal revenue was thereafter by the latter turned over and deposited into the Treasury of the United States of America in the usual course of his official business.

XVI. On February 13, 1924, the plaintiff duly filed with the said collector of internal revenue a claim for refund of $12,581.39. On June 17, 1924, such claim for refund was rejected in full by the Commissioner -of Internal Revenue.

XVII. In declaring the said stock dividend of $2,250,000 February 21,1919 (Finding XIII), the Nolde & Horst Company transferred on its books to capital account $2,250,000 of the company’s, surplus of $1,100,000 appearing thereon as *454.accumulated prior to January 1, 1913* and $1,652,845.27 appearing as accumulated thereafter to the end of February 1, 1919, a total surplus of $2,752,845.27. In arriving at the said surplus of $1,652,845.27 accumulated after January 1, 1913, the said company deducted from its gross surplus $1,100,000 as a reserve for 1918 taxes and added to said gross surplus $250,000 as an estimate of its profits for January and February, 1919.

If the estimate of $250,000 for January and February, 1919, profits be déducted from the aforesaid surplus of $1,652,845.27, the net surplus would appear as $1,402,845.27 for the years 1913 to 1918, inclusive, which, added to $1,100,000 accumulated prior thereto, makes a net surplus at the beginning of the year 1919 available for transfer to capital account $2,502,845.27.

The accumulated surplus and undivided profits of the Nolde & Horst Company at the end of the year 1918 were $3,602,845.27, of which $1,100,000 was on February 21, 1919, set aside by the company as aforesaid as a reserve to pay taxes on the net earnings for 1918, making the net amount of said surplus and profits $2,502,845.27.

After the stock dividend of February 21, 1919, the capital stock of the Nolde & Horst Company was $2,500,000, and its surplus, including the estimated profits of $250,000 for January and February, 1919, $502,845.27.

XVIII. At the end of the year 1918 the Nolde & Hoist Company had an undistributed gain or profit of $1,759,-255.30, of which it set aside as a reserve for the payment of 1918 taxes $1,100,000 (see Finding XVII), making the net gain or profit $659,255.30.

The gross profits of Nolde & Horst Company for 1919 amounted to $2,689,326.29 and the total general expenses $646,157.46, a net gain of $2,043,168.83. The reserve, if any, set aside for taxes does not appear.

The court decided that plaintiff was-not entitled to recover.

Gkaham:, *Judge,*

delivered the opinion of the court:

The principles of law ruling the facts of this case are passed upon and decided in the opinion in the case of *455*George D. Horst*v. *United*States, No. E-89, this day handed down, *ante,*p. 433. It is unnecessary to restate them here.

From the E. Richard Meinig Company the plaintiff received in seven equal installments a dividend of $56,000, declared January 8, 1911. This was a 700 per cent dividend and was ordered by the corporation to be paid “ out of the net earnings shown for the year 1916.” The plaintiff contends that it was actually paid out of the net earnings accumulated by said corporation in 1916. The plaint.iff in making his tax return accounted for this dividend at the 1916 rates.

The Commissioner of Internal Revenue determined that $12,744.29 of the $56,000 received by the plaintiff was earned by the corporation in 1917 and taxable at 1917 rates. The facts are that the E. Richard Meinig Company’s net profits for 1917 amounted to $277,818.82, and that it paid out in dividends $350,000, of which plaintiff received $56,000. Of this latter sum $20,581.50, by prorating, was earned prior to the time the dividend was paid, and under the decision in the case of *Mason*v. Routzahn, decided by the Supreme Court November 21, 1927, 275 U. S. 175, should be allocated to the year 1917 and taxed according to the rate of that year. As only $12,744.29 was taxed at that rate, it is evident plaintiff was not overassessed and is not entitled to a refund as to this item.

The earnings of the Nolde & Horst Company for 1917 were $1,133,450.90, and it distributed in dividends during that year a total of $500,000, including $50,000 to the plaintiff, so that the earnings for 1917 were more than sufficient to pay the dividends, and under the ruling in the *Mason case, supra,*the pro rata part of the plaintiff’s dividend earned prior to the payment of same amounted to $31,753.17, which was subject to assessment on the basis of the 1917 rate. As the commissioner taxed only $17,766.73 at that rate, the plaintiff was not overassessed as to this dividend and is not entitled to a refund.

As to the assessments on plaintiff’s income for 1919, the facts, briefly stated, are: On February 21, 1919, the Nolde & Horst Company declared a stock dividend of 900% on its *456capital of $250,000, issuing $2,250,000 additional stock, of which plaintiff received 2,250 shares, par value $225,000. Again, on February 28,1919, the corporation declared a dividend of 20% on its new capital of $2,500,000, of which plaintiff on March 6, 1919, received $50,000 in cash.

The dividend so declared on February 28, 1919, was ordered by the board of directors to be paid from profits accumulated prior to March 1, 1918, and on February 21, 1919, to be paid from earnings March 1, 1913, to the date of declaration. Finding XYII shows that on February 21, 1919, the company’s surplus was $502,845.27, including estimated profits of $250,000 for January and February, 1919, so that there was enough surplus March 6, 1919, out of which to pay a cash dividend of $500,000 (20% of $2,500,000), and the rates of taxation for 1918 and 1919, which are the same, are applicable. It was on this basis that plaintiff was assessed, and he is therefore entitled to no refund. (See *George D. Horst ease, supra.)*

In this case, as in the *George D. Hoi-st*ease, there is the question whether the tax paid by the obligor at the source on “ tax-free covenant ” bonds was income for which plaintiff as holder of the bonds was liable. The commissioner held that it was income and liable for tax and included as part of plaintiff’s net income the sum of $484.06 for taxes paid by the obligor, and plaintiff is entitled to a refund of the tax levied upon this amount. The amount assessed against him on this account by the commissioner does not appear from the record, and it is not possible, therefore, to enter a judgment in favor of the plaintiff for any sum.

The petition should be dismissed, and it is so ordered.

Moss, Judge, and Booth, Judge, concur.

See dissenting opinion by Campbell, *Chief*Justice, in case of *George D.*Horst, No. E-89, decided this day, cmte, p. 438.