Source: https://supreme.justia.com/cases/federal/us/336/28/
Timestamp: 2019-04-24 17:53:21+00:00

Document:
In 1938, 1939, and 1940, an individual taxpayer, in straitened financial circumstances but solvent, purchased at less than their face amount certain secured negotiable bonds originally issued by him at face value for cash. Some of the purchases were directly from the bondholders, others were through agents of the taxpayer or of the bondholders. Although each seller knew that the bonds were being bought by or for the maker, there was nothing to indicate that any seller intended to transfer or release something for nothing, or to make a gift of any part of his claim, as distinguished from making a sale and assignment of his whole claim for the highest available price.
Held: under § 22(a) of the Revenue Act of 1938 and of the Internal Revenue Code, the gain to the taxpayer from each purchase was includible in gross income for the year in which he made the purchase, and was not excludable as a "gift" under § 22(b)(3) of that Act and Code. Pp. 336 U. S. 29-52.
1. The taxpayer's gains from such transactions must be included in his gross income under § 22(a). Pp. 336 U. S. 38-47.
(a) On the facts of this case, the taxpayer realized an immediate financial gain from his purchase of these bonds at a discount. Pp. 336 U. S. 38-41.
(b) The amendments to § 22(b) of the Internal Revenue Code by the Revenue Act of 1939, though relating to corporate taxpayers, are persuasive that a natural person is obliged to include in his gross income under § 22(a) gains of the kind here involved. Pp. 336 U. S. 41-47.
2. Gains of this type are not excluded from the taxpayer's gross income by the general exemption of "gifts" from taxation prescribed by § 22(b)(3). Pp. 336 U. S. 47-52.
(a) The provision of the Internal Revenue Code for the exclusion of "gifts" from gross income is to be construed with restraint in the light of the purpose of Congress to tax income comprehensively. Pp. 336 U. S. 47-49.
(b) On the facts of this case, there is nothing to indicate that the bondholders intended to transfer or did transfer something for nothing. Pp. 336 U. S. 50-51.
(c) The decision in this case is not rested on the fact that the sale was made before maturity, or that the seller may have received valid consideration for a total release of his claim because the debtor's payment was made before maturity. P. 336 U. S. 51.
(d) Helvering v. American Dental Co., 318 U. S. 322, distinguished. P. 336 U. S. 51.
3. The situation in each transaction is a factual one, turning upon whether the transaction is, in fact, a transfer of something for the best price available, or is a transfer or release of only a part of a claim for cash and of the balance "for nothing." Pp. 336 U. S. 51-52.
solvent natural person, in straitened financial circumstances, must include in his gross income for federal income tax purposes the difference between (1) the face amount of his personal indebtedness as the maker of secured bonds, originally issued by him at face value for cash, and (2) a lesser amount paid by him for their purchase. The debtor's obligations were not unpaid balances of purchase prices which could be readjusted by the discharge of the obligations. The proceeds of the obligations were not traced into identifiable losses offsetting the debtor's realized gains from the discharge of these obligations. Each seller knew that the bonds he sold were being bought by or for the maker of them. In each sale, the bondholder sought to minimize his probable loss by getting as much as possible, directly or indirectly, from the maker of the bonds as the one available purchaser of them. The maker of the bonds, at the same time, sought to reduce his obligations as much as possible by buying the bonds as cheaply as he could. While each seller thus knew that he was receiving from the maker of the bonds less than their face amount, there is no finding that any seller intended to transfer or release something for nothing, or to make a gift of any part of his claim, as distinguished from making a sale and assignment of his whole claim for the highest available price. The maker thus realized a gain from each purchase, and the Commissioner of Internal Revenue found correctly that, for federal income tax purposes, the maker must include that gain in his gross income for the tax year in which he made the purchase.
in the purchases from bondholders through the secretary of the bondholders' committee and the security dealers, under the doctrine of the Supreme Court in United States v. Kirby Lumber Co., 284 U. S. 1, he being at all times solvent."
Six of the sixteen judges dissented, and five of those six voted to uphold Commissioner completely on the ground that none of the transactions was gratuitous. 6 T.C. 1048, 1057-1059. The Commissioner petitioned the Court of Appeals for the Seventh Circuit to review that part of the judgment which was unfavorable to him. The respondent did the same as to the remainder of the judgment. That court decided against the Commissioner on both petitions. It held that, because the respective sellers knew that the bonds they sold were being bought by or for the respondent, as the maker of them, any excess of the face values of the bonds over their sales prices should be treated as gifts to the respondent, and as exempt from income tax. 164 F.2d 594. Due to the importance of the issues in the unsettled field of the taxability of gains derived by a debtor from his discharge of his own obligations at a discount, we granted certiorari in both cases. 333 U.S. 866. We have heard and decided them together.
the total principal amount of $90,000, with $2,500 maturing semiannually up to and including November 1, 1931. The balance of the bonds, totalling $57,500, were to mature May 1, 1932. The original proceeds were used by the respondent to retire the existing encumbrance, of an undisclosed amount, on the property, pay for a $16,250 addition made by him to the building on the leasehold and pay the necessary brokerage commission of approximately 10 percent of the loan, plus the cost of printing the bonds and other expenses in connection with the loan. A remaining "small surplus" was paid to the respondent. In 1925, the respondent, for the purposes of computing depreciation, allocated $76,580.56 to the improvements, including the new addition, and $40,000 to the leasehold, out of their total cost to him of $116,580.56.
the principal of each bond, leaving a total outstanding balance of $51,750 payable on these bonds.
"On the strength of the showing of petitioner's assets and liabilities, we find petitioner was solvent during each of the taxable years 1938, 1939, and 1940."
"The Tax Court found that the taxpayer was solvent during each of the taxable years 1938, 1939, and 1940, and we accept the finding, although a perusal of the record makes it quite apparent that he was in straitened financial circumstances."
for nothing, as distinguished from an intent to get the highest available price for their entire claims, treated the respondent's gain from each purchase as exempt from the taxation imposed by § 22(a) of the Revenue Act of 1938 [Footnote 2] and of the Internal Revenue Code, because that court felt itself obliged by precedent to classify each such gain as a "gift" under § 22(b)(3) of that Act [Footnote 3] and Code. We hold, however, that those Sections do not, in the light of the decisions of this Court, permit that result.
The first test of the taxability of the taxability of such gains relates to their inclusion within such gains relates to their inclusion with the gross income of the taxpayer under § 22(a), without reference to the specific exclusions made from it by § 22(b). The other test consists of the application to such gains of any of those specific exclusions. We hold that these gains come within § 22(a), but not within any of the exclusions from gross income stated in § 22(b).
If § 22(a) stood alone, without the exclusions stated in § 22(b), the gain realized by the respondent in this case unquestionably would constitute gross income for income tax purposes. The provisions of § 22(b) and the decisions of this Court do not change that result. On the contrary, they confirm it.
they prescribe, as in the clear light which their own limitations shed upon §§ 22(a) and 22(b) to the extent that those Sections remain unchanged.
Amendments upon the unamended Sections is emphasized by their temporary character. The Amendments expressly provide that they shall not apply to a taxable year beginning after December 31, 1942. This indicates that, for its permanent program, Congress regarded such gains as properly taxable, and it indicates that the Amendments were intended to authorize temporary changes in policy, and were not clarifications of existing or continuing tax policies. While the time limit originally prescribed has been subsequently extended, the extensions have been made by separate Acts, each for a period of one to three years. [Footnote 9] This repeated emphasis upon their temporary character increases the contrast which they make with the permanent policy of Congress as to the general taxability of this kind of gains under § 22(a).
a situation quite similar to one contemplated by § 22(b)(9), except that the taxpayer here is a natural person. This emphasizes the taxability of the gains before us.
testimony evidencing the release. This is not saying that the form of the transaction is conclusive. Assuming that the extension of the maturity of the bonds in the instant case was binding on the creditor, we do not rest this case upon the fact that the sale was made before maturity, or that the seller may have received valid consideration for a total release of his claim because the debtor's payment was made before maturity. It is quite possible that a bondholder might make a gift of an entire bond to anyone, including the maker of it. The facts and findings in this case do not establish any such intent of the seller to make a gift in contradiction of the natural implications arising from the sales and assignments which he made. It is conceivable, although hardly likely, that a bondholder, in the ordinary course of business and without any express release of his debtor, might have sold part of his claims on the bonds he held at the full face value of those parts, and then have made a gift of the rest of his claims on those bonds to the same debtor "for nothing." It is that kind of extraordinary transaction that the respondent asks us, as a matter of law, to read into the simple sales which actually took place and from which he derived financial gains. We are unable to do so on the findings before us. Cf. Bogardus v. Commissioner, 302 U. S. 34.
justified in finding a taxable gain, rather than an exempt gift, in each of the transactions before us. The judgment of the Court of Appeals accordingly is reversed, and the cause is remanded for further action in accordance with this opinion.
MR. JUSTICE RUTLEDGE, although joining in the Court's judgment and opinion, is of the view that the result is essentially in conflict with that reached in Helvering v. American Dental Co., 318 U. S. 322.
"It was self-interest and good business judgment exercised by all prudent persons to take cash settlements when otherwise greater losses might be incurred. I have done that very thing myself, and have advised clients to do so in similar circumstances. Most real estate bonds in Chicago were selling from 5¢ to 25¢ on the dollar in 1932 to 1940."
In the instant case, the respondent was found to have been solvent before, as well as after, his realization of the gains in question. The payment of the bonds purchased by him was secured by the mortgage of his leasehold property, which property had a fair market value substantially in excess of the face amount of the bonds. The record fails to establish any sufficient basis for a claim that the respondent had suffered losses which, for tax purposes, offset his gains from his purchase of the bonds. Little of the $90,000 originally received by him for the bonds was used to purchase property. There is no finding or substantial evidence showing specifically how those funds were invested. Even if they are traced, in part, into the addition made to the building on the leasehold premises and into the discharge of the then existing encumbrance on those premises, the total so used is not shown, and the shrinkage in the value of those investments is not clearly ascertained in the taxable years in question. The ratio of the loss in value of the leasehold property indicated by the Tax Court findings is about 32 percent of its cost in 1925, but this loss is merely based upon estimates. The respondent claims a larger shrinkage, but there is not a sufficient ascertainment of it to permit consideration of its use as an offset to the respondent's gains in 1938, 1939, or 1940. See 2 Mertens, Law of Federal Income Taxation, § 11.20 and n. 99 (1942).
"(a) GENERAL DEFINITION. -- 'Gross income' includes gains, profits, and income derived from salaries, wages, or compensation for personal service, 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. . . ."
This was re-enacted as § 22(a), I.R.C., 53 Stat. 9, and amended in a manner not material here in 53 Stat. 574, 575, 26 U.S.C. (1940 ed.), § 22(a). The Revenue Act of 1938 applied to the respondent's income in 1938 and the Internal Revenue Code to that in 1939 and 1940.
"(b) EXCLUSIONS FROM GROSS INCOME. -- The following items shall not be included in gross income and shall be exempt from taxation under this title:"
"(3) GIFTS, BEQUESTS, AND DEVISES. -- The value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income). . . ."
This was reenacted as § 22(b)(3), I.R.C., 53 Stat. 10, 26 U.S.C. (1940 ed.), § 22(b)(3), without material change.
See note 1 supra, showing the varied uses to which the respondent applied these proceeds, and showing that it is not practicable in this case to determine his losses from his resulting investments, and much less to offset them against his gains now at issue. His tax benefits from those losses are thus postponed until some such occasion as the sale of the properties reflecting them makes it possible to ascertain the losses clearly.
"The question is one of statutory construction. We think that the definitions of gross income (Revenue Acts, 1926, § 213, 1928, § 22) are broad enough to cover income of that description. They are to be considered in the light of the evident intent of the Congress 'to use its power to the full extent.' Irwin v. Gavit, 268 U. S. 161; Helvering v. Stockholms Enskilda Bank, 293 U. S. 84, 293 U. S. 89. We have held that income was received by a taxpayer when, pursuant to a contract, a debt or other obligation was discharged by another for his benefit. The transaction was regarded as being the same in substance as if the money had been paid to the taxpayer, and he had transmitted it to his creditor. Old Colony Trust Co. v. Commissioner, 279 U. S. 716; United States v. Boston & Maine Railroad, 279 U. S. 732."
". . . By the Revenue Act of (November 23,) 1921, c. 136, § 213(a), gross income includes 'gains or profits and income derived from any source whatever,' and, by the Treasury Regulations authorized by § 1303, that have been in force through repeated reenactments,"
"If the corporation purchases and retires any of such bonds at a price less than the issuing price or face value, the excess of the issuing price or face value over the purchase price is gain or income for the taxable year."
Article 545(1)(c) of Regulations 62, under Revenue Act of 1921. See Article 544(1)(c) of Regulations 45, under Revenue Act of 1918; Article 545(1)(c) of Regulations 65, under Revenue Act of 1924; Article 545(1)(c) of Regulations 69, under Revenue Act of 1926; Article 68(1)(c) of Regulations 74, under Revenue Act of 1928. We see no reason why the Regulations should not be accepted as a correct statement of the law.
". . . The defendant in error has realized within the year an accession to income if we take words in their plain popular meaning, as they should be taken here."
United States v. Kirby Lumber Co., 284 U. S. 1, 284 U. S. 2-3.
"ART. 22(a)-14. CANCELLATION OF INDEBTEDNESS. -- (a) In general. -- The cancellation of indebtedness, in whole or in part, may result in the realization of income. If, for example, an individual performs services for a creditor who, in consideration thereof, cancels the debt, income in the amount of the debt is realized by the debtor as compensation for his services. A taxpayer realizes income by the payment or purchase of his obligations at less than their face value."
"ART. 22(a)-18. SALE AND PURCHASE BY CORPORATION OF ITS BONDS. -- (1)(a) If bonds are issued by a corporation at their face value, the corporation realizes no gain or loss. (b) If the corporation purchases any of such bonds at a price in excess of the issuing price or face value, the excess of the purchase price over the issuing price or face value is a deductible expense for the taxable year. (c) If, however, the corporation purchases any of such bonds at a price less than the issuing price or face value, the excess of the issuing price or face value over the purchase price is gain or income for the taxable year."
Treasury Regulations 101, promulgated under the Revenue Act of 1938.
In Treasury Regulations 103, promulgated under the Internal Revenue Code, §§ 19.22(a)-14 and 19.22(a)-18 were identical with the above. Even today, they are the same in Treasury Regulations 111, promulgated under the Internal Revenue Code, as §§ 29.22(a)-13 and 29.22(a)-17.
"SEC. 215. DISCHARGE OF INDEBTEDNESS."
"(a) INCOME FROM DISCHARGE OF INDEBTEDNESS. -- Section 22(b) of the Internal Revenue Code (relating to exclusions from gross income) is amended by adding at the end thereof the following new paragraph: "
" (9) INCOME FROM DISCHARGE OF INDEBTEDNESS. -- In the case of a corporation, the amount of any income of the taxpayer attributable to the discharge, within the taxable year, of any indebtedness of the taxpayer or for which the taxpayer is liable evidenced by a security (as hereinafter in this paragraph defined) if --"
"~ (A) it is established to the satisfaction of the Commissioner, or"
"~ (B) it is certified to the Commissioner by any Federal agency authorized to make loans on behalf of the United States to such corporation or by any Federal agency authorized to exercise regulatory power over such corporation,"
"that at the time of such discharge the taxpayer was in an unsound financial condition, and if the taxpayer makes and files at the time of filing the return, in such manner as the Commissioner, with the approval of the Secretary, by regulations prescribes, its consent to the regulations prescribed under section 113(b)(3) then in effect. In such case, the amount of any income of the taxpayer attributable to any unamortized premium (computed as of the first day of the taxable year in which such discharge occurred) with respect to such indebtedness shall not be included in gross income and the amount of the deduction attributable to any unamortized discount (computed as of the first day of the taxable year in which such discharge occurred) with respect to such indebtedness shall not be allowed as a deduction. As used in this paragraph, the term 'security' means any bond, debenture, note, or certificate, or other evidence of indebtedness, issued by any corporation, in existence on June 1, 1939. This paragraph shall not apply to any discharge occurring before the date of the enactment of the Revenue Act of 1939, or in a taxable year beginning after December 31, 1942."
"(b) BASIS REDUCED. -- Section 113(b) of the Internal Revenue Code (relating to the adjusted basis of property) is amended by adding at the end thereof the following new paragraph: "
" (3) DISCHARGE OF INDEBTEDNESS. -- Where, in the case of a corporation, any amount is excluded from gross income under section 22(b)(9) on account of the discharge of indebtedness the whole or a part of the amount so excluded from gross income shall be applied in reduction of the basis of any property held (whether before or after the time of the discharge) by the taxpayer during any portion of the taxable year in which such discharge occurred. The amount to be so applied (not in excess of the amount so excluded from gross income, reduced by the amount of any deduction disallowed under section 22(b)(9)) and the particular properties to which the reduction shall be allocated, shall be determined under regulations (prescribed by the Commissioner with the approval of the Secretary) in effect at the time of the filing of the consent by the taxpayer referred to in section 22(b)(9). The reduction shall be made as of the first day of the taxable year in which the discharge occurred except in the case of property not held by the taxpayer on such first day, in which case it shall take effect as of the time the holding of the taxpayer began."
"(c) TAXABLE YEARS TO WHICH APPLICABLE. -- The amendments made by this section shall be applicable to taxable years beginning after December 31, 1938."
See also Treasury Regulations 103, promulgated under the Internal Revenue Code; § 19.22(b)(9)-1, Income from discharge of indebtedness; § 19.22(b)(9)-2, Making and filing of consent; § 19.113(b)(3)-1, Adjusted basis: Discharge of corporate indebtedness: General rule; § 19.113(b)(3)-2, Adjusted basis: Discharge of corporate indebtedness: Special cases.
While § 22(b)(9) originally did not apply to any discharge occurring in a taxable year beginning after December 31, 1942, 53 Stat. 875, this date was changed to December 31, 1945, 56 Stat. 811; December 31, 1946, 59 Stat. 574; December 31, 1947, 60 Stat. 749, and December 31, 1949, 61 Stat. 179.
The exclusions made by § 22(b) apply to the taxes imposed by the Income Tax Chapter of the Internal Revenue Code. These include the ordinary income taxes, but not the additional income taxes such as those imposed on personal holding companies or the excess profits taxes.
"the case of specific property (other than inventory or notes or accounts receivable) against which at the time of the discharge of the indebtedness, there is a lien (other than a lien securing indebtedness incurred to purchase such property). . . ."
It even provides that, if any excess of amount excluded from gross income under § 22(b)(9) exceeds hose two adjustments, the cost or other basis of all the property of the debtor other than inventory and notes and accounts receivable shall be reduced proportionately and, finally, the balance, if any, of the amount excluded from the debtor's gross income is applied to the reduction of the cost or other basis of the debtor's inventory or notes or accounts receivable. It thus offers affirmatively a broad alternative plan for reaching the corporate debtor's gains from its discharge of its indebtedness at a discount.
Subsequent Amendments have altered these provisions, but have not changed their general effect, nor their reflection upon the meaning of § 22(a). For the extension of the temporary nature of the provisions, see note 9 supra. The requirement of a specially certified "unsound financial condition" for a corporate taxpayer in order to make § 22(b)(9) applicable was eliminated by the Revenue Act of 1942. That Act also eliminated the limitation to securities in existence on June 1, 1939. 56 Stat. 811.
In making these temporary provisions, Congress had in mind especially the conditions presented by railroads and other corporations then seeking to liquidate heavy indebtedness. The Committees reporting the bills for passage emphasized the limitations that were imposed by these Amendments upon corporations seeking to excluded from taxable income the gains derived from their acquisition of their own securities at a discount. H.R. Rep. No. 855, 76th Cong., 1st Sess. 5, 23-25 (1939); Sen.Rep. No. 648, 76th Cong., 1st Sess. 2-3, 5 (1939). Obviously it was expected that these provisions would decrease the existing burdens of income taxation. It certainly was not intended to impose a burden of postponed taxability upon gains which otherwise would have been completely exempted from taxation by § 22(b)(3).
Several provisions have extended comparable relief to other taxpayers. None of them applies to the respondent. They emphasize, however, the understanding of Congress that, without special provision for their exclusion, the gains of a taxpayer from the discharge of his indebtedness at a discount are required by § 22(a) to be included in his gross income. They recognize that the mere exclusion of "gifts" under § 22(b)(3) is not enough to cover factual situations like those presented in § 22(b)(9) or in the other relief provisions above mentioned.
Exclusion, from excess profits credit, of income derived from the retirement or discharge by the taxpayer of the taxpayer's own obligations if they have been outstanding more than 18 months. Internal Revenue Code, §§ 711(a)(1)(C), 711(a)(2)(E), and § 711(b)(1)(C), added by the Second Revenue Act of 1940, c. 757, 54 Stat. 976-978, repealed by the Revenue Act of 1945, c. 453, 59 Stat. 568.
Exclusion, from gross income, for income tax purposes, of the income of railroad corporations attributable to their discharge of their indebtedness to the extent realized from a modification or cancellation of indebtedness, pursuant to an order of court. Internal Revenue Code, § 22(b)(10), added by the Revenue Act of 1942, c. 619, 56 Stat. 812, applicable to taxable years beginning after December 31, 1939, but not applicable to any discharge in a taxable year beginning after December 31, 1945; this latter date extended to December 31, 1946, 59 Stat. 574; December 31, 1947, 60 Stat. 749, and December 31, 1949, 61 Stat. 179.
"SEC. 2. (a) That, subject only to such exemptions and deductions as are hereinafter allowed, the net income of a taxable person shall include gains, profits, and income derived from salaries, wages, or compensation for personal service of whatever kind and in whatever form paid, or from professions, vocations, businesses, trade, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in real or personal 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. . . ."
"SEC. 4. The following income shall be exempt from the provisions of this title [Title I. -- Income Tax]: "
"The proceeds of life insurance policies paid to individual beneficiaries upon the death of the insured; the amount received by the insured, as a return of premium or premiums paid by him under life insurance, endowment, or annuity contracts, either during the term or at the maturity of the term mentioned in the contract or upon the surrender of the contract; the value of property acquired by gift, bequest, devise, or descent (but the income from such property shall be included as income); interest upon the obligations of a State or any political subdivision thereof or upon the obligations of the United States or its possessions or securities issued under the provisions of the Federal farm loan Act of July seventeenth, nineteen hundred and sixteen; the compensation of the present President of the United States during the term for which he has been elected, and the judges of the Supreme and inferior courts of the United States now in office, and the compensation of all officers and employees of a State, or any political subdivision thereof, except when such compensation is paid by the United States Government."
(Italics supplied.) Revenue Act of 1916, c. 463, 39 Stat. 756, 757, 758, 759. See also An Act To reduce tariff duties and to provide revenue for the Government, and for other purposes. October 3, 1913, 38 Stat. 114, 167, § II, subd. B.
MR. JUSTICE REED with whom MR. JUSTICE DOUGLAS joins, dissenting.
We held in the American Dental case in 1943 that the "receipt of financial advantages gratuitously" was a gift under Int.Rev.Code § 22. Congress has made no change in the law since that time, nor has it been requested to do so. For the reasons discussed at length in that case, we are of the opinion that the judgment of the Court of Appeals should be affirmed.
* Helvering v. American Dental Co., supra, p. 318 U. S. 326, note 5; p. 318 U. S. 328, note 9, particularly tax-free railroad adjustments under c. XV, § 735, 53 Stat. 1140.

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