Case Name: UNITED STATES of America, Appellant, v. Shelby LANGSTON, Appellee
Court: United States Court of Appeals for the Fifth Circuit
Jurisdiction: United States
Decision Date: 1962-10-10
Citations: 308 F.2d 729
Docket Number: No. 19115
Parties: UNITED STATES of America, Appellant, v. Shelby LANGSTON, Appellee.
Judges: 
Reporter: Federal Reporter 2d Series
Volume: 308
Pages: 729–736

Head Matter:
UNITED STATES of America, Appellant, v. Shelby LANGSTON, Appellee.
No. 19115.
United States Court of Appeals Fifth Circuit.
Oct. 10, 1962.
John R. Brown, Circuit Judge, dissented.
Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Atty., Dept, of Justice, Washington, D. C., Edward F. Board-man, U. S. Atty., Miami, Fla., Joseph Kovner, Atty., Dept, of Justice, John B. Jones, Acting Asst. Atty. Gen., I. Henry Kutz, John A. Bailey, Attys., Dept, of Justice, Washington, D. C., La-vinia L. Redd, Asst. U. S. Atty., for' appellant.
Robert Paul, George H. Salley, Miami, Fla., for appellee.
Before TUTTLE, Chief Judge, and BROWN and BELL, Circuit Judges.

Opinion:
TUTTLE, Chief Judge.
The United States appeals from a judgment entered by the district court without a jury granting the appellee a refund of federal income taxes. The sole issue before the trial court, and thus the sole issue before us, is whether when there is a flat sale of bonds together with accrued interest thereon, which interest accrued after the seller acquired the bonds, that part of the flat sale price which is attributable to such accrued interest must be treated by a cash basis-taxpayer as a realization of accrued interest and be taxed to the seller as ordinary income rather than as a capital gain.
The facts are not in dispute. On August 1, 1950, the taxpayer purchased "flat" $100,000 face amount of Missouri Pacific Railroad Company bonds for $107,827.60. At the time of the acquisition of these bonds by the taxpayer, there were accrued and unpaid interest coupons in the sum of $42,500. During taxpayer's holding period, $35,-000 of this past due interest was paid and an additional $17,638.89 of interest accrued. The taxpayer sold the same bonds "flat" for $107,382.40 in 1954. In his 1954 income tax return taxpayer, who was on a cash basis, then reported the sale of the bonds as a long-term capital gain, the gain being the difference between the sales price $107,382.40 and his adjusted basis of $72,827.60, less his expenses of sale of $1,000, or a gain of $33,554.80.
The Commissioner asserted a deficiency based upon his contention that part of the total gain of $33,554.80 represented a sale of the defaulted interest which had accrued during the taxpayer's holding period. The Commissioner allocated the gain as between face amount of bonds and the accrued interest, and determined that the taxpayer had realized $15,136.03 as interest income upon the sale of the bonds with the unpaid coupons attached.
There are several legal principles as to which there seems to be complete agreement as between the parties. The first of these is that when Langston received $35,000 from the Missouri Pacific Railroad Company in payment of coupons that had been in default at the time he acquired the bonds, he was not required to report this as interest but was entitled to consider it as a return of capital, thus reducing his basis in the bonds. McDonald v. Commissioner, 6 Cir., 217 F.2d 475; Clyde C. Pierce Corporation v. Commissioner, 5 Cir., 120 F.2d 206. The second is that a taxpayer may not avoid reporting as income interest payments that are about to fall due and as to which there is no speculative factor by transferring them to another who collects the interest, Helvering v. Horst, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75. The same principle applies with respect to the transfer of other anticipated income, Commissioner v. P. G. Lake, Inc., 356 U.S. 260, 78 S.Ct. 691, 2 L.Ed.2d 743; Floyd v. Scofield, 5 Cir., 193 F.2d 594. A third principle that seems to be agreed upon by the parties here is that if the bonds were sold on terms that prescribed a stated amount for principal and a stated amount for interest, the amount paid for interest would be taxable as ordinary income.
It seems, therefore, that the questions that arise under the agreed state of facts here are: (1) whether the failure to specify a part of the sales price by the taxpayer, as being the amount paid by the purchaser for the unpaid interest coupons, changes the character of the proper proportion of the sales price which would truly represent the amount so paid from interest to capital, and (2), whether, if such "flat" sale does not have the effect of converting what would otherwise be interest into capital, may the Commissioner make an allocation in the manner in which he did in this case.
It is not contested by the taxpayer here that if he had been on an accrual basis of reporting his income he would have had to report the full amount of the accrued and unpaid coupons during his holding period as income, nor is it denied that the effect of the treatment argued for by the taxpayer here would have the effect of eliminating this interest income forever from treatment as income either in the hands of the taxpayer or a subsequent purchaser. The Government strongly stresses this feature of the case, saying that the manner in which the cash basis taxpayer realizes his gain should not be permitted to give him a benefit that would in effect change an interest payment into a return of capital, whereas an accrual basis taxpayer could under no circumstances place himself in the sanie situation.
We conclude that if the state of the record was susceptible of a determination by the Commissioner that the above par price received by the taxpayer for the bonds truly represented some payment for the past due interest coupons that had accrued during the holding period of the taxpayer, then there was such realization by the taxpayer of income as would require his reporting it as ordinary income. We think the case of Fisher v. Commissioner, 6 Cir., 209 F.2d 513, is directly in point. In that case the taxpayer sold promissory notes with past due interest, which had accrued during the time of his holding the notes, for something more than the face amount of the notes. The Court of Appeals for the Sixth Circuit affirmed the judgment of the Tax Court, which had held that the gain must be allocated as between a return of capital and a realization of income. We find that nothing in this decision is in conflict with the opinion of this Court in Clyde G. Pierce Corporation v. Commissioner, 5 Cir., 120 F.2d 206, because in that case this Court merely dealt with the treatment of payments received by taxpayer on interest coupons which had accrued prior to his acquisition of the bonds. See also in this connection, First Kentucky Co. v. Gray, D.C., 190 F.Supp. 824 (on appeal to the Court of Appeals, 6 Cir,), and Jaglom v. Commissioner, 36 T.C. 126. See also Tunnell v. United States, 3 Cir., 259 F.2d 916, where it is stated on page 919:
"The general rule is that a right to receive ordinary income, produced by a capital asset, is not transmuted into a capital asset by the sale or assignment of the capital asset together with the right to receive the ordinary income."
Turning now to the question whether the record before the district court warranted that court in rejecting the Commissioner's determination that a part of the sales price for the bonds represented a payment for the interest coupons, we need only turn to the brief of the appel-lee in this Court, where it is stated:
"The sales price represents a price for the entire unit — principal and defaulted interest. The purchaser speculates that defaulted interest will be paid during his holding period, or if not, that the expectation of such future payments (that is of the defaulted interest) will cause the market value of his bonds to increase. The purchaser buys the bond plus the expectation." (Emphasis added.)
Thus it seems clear that the taxpayer concedes that he received on the sale of his bond, a price which included the worth of the principal amount of the indebtedness plus something for the unpaid interest coupons. Clearly, therefore, a determination to that effect by the Commissioner was thoroughly justified. If the taxpayer considered that the Commissioner's method of allocating the gain as between the interest coupons that accrued during the holding period of the taxpayer and the principal of the bonds was improper, the burden was on him to undertake to show by proof what would be a fair allocation. The taxpayer does not argue that the allocation was unfair or unrealistic as such; he merely takes the position that since the parties themselves did not break the sales price down into the two elements, which the taxpayer concedes went into its total, the action of the Commissioner was arbitrary and unjustified.
The failure of the taxpayer to bring forward any proof undertaking to show that, contrary to the Commissioner's determination, the bonds themselves, on account of the favorable rate of interest, they bore, or because of some other particularly valuable characteristic which they possessed, were themselves worth more than par, required that the district court approve the determination of the Commissioner as to this matter. The-Commissioner's determination, in light of' the fact that $35,000 of the $42,500 of coupons in default at the time of Langston's purchase were paid during this taxpayer's holding period of about four-years, and in view of the fact that past due coupons were payable before any payment on principal, has ample support to place the burden on the taxpayer to-challenge it if he disagreed with the-allocation figures. The judgment of the trial court is reversed and the case remanded for the entry of a judgment for the United States.
. The term "flat" as used in this opinion has no legal significance. It simply means that a purchase was made at a stated price for bonds that had unpaid coupons attached, but without any specified allocation as to bow the price was computed as between principal and interest.
. Subsequent to the time this opinion was prepared and its filing deferred pending filing of the dissent, the Second Circuit reached this same conclusion in Jaglom v. Commissioner, 2 Cir. 1962, 303 F.2d 847.