Court Opinion

ID: 4611338
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:48:46.176655+00
Date Added: 2024-06-11T07:54:14.485679
License: Public Domain

MELLIE ESPERSON STEWART, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Stewart v. CommissionerDocket No. 68781.United States Board of Tax Appeals35 B.T.A. 406; 1937 BTA LEXIS 882; February 5, 1937, Promulgated 1937 BTA LEXIS 882">*882  1.  In Texas, the husband's assignment to the wife of his interest in the future community income from the separate property of his wife, does not relieve him from income tax on that assigned income.  2.  Under theTexas Community Property Law, husband and wife are each taxable upon one-half of the net community income after the deduction of the allowable expenses incident to its production.  Llewellyn A. Luce, Esq., for the petitioner.  Thomas F. Callahan, Esq., for the respondent.  LEECH35 B.T.A. 406">*406  The respondent determined a deficiency in income tax for the year 1930 in the amount of $4,106,58.  He asks here an alternative increase therein to $4,276.58.  The petitioner denies any deficiency, and asserts that she overpaid her taxes for that year in an amount not less than $2,699.51.  35 B.T.A. 406">*407  FINDINGS OF FACT.  Petitioner is a resident of Houston, Texas.  She acquired, in 1922, upon the death of her first husband, a very substantial separate estate consisting of both real and personal property.  In 1925 petitioner married Harry Stewart, from whom she was divorced in 1934.  On March 19, 1927, by an instrument designated as a "Deed and Bill1937 BTA LEXIS 882">*883  of Sale", for a recited consideration of $10 and natural love and affection, he assigned, released and conveyed to petitioner all of his right, title or interest in any community property of himself of the petitioner and any and all rents, dividends, interest, revenue, income or receipts or increase of any kind from the separate property of the petitioner or from the income or increase therefrom which theretofore may have been received or thereafter might be received by either of them or to which either of them might be entitled.  This conveyance further provided that the intention thereof was to make all such property the separate property of the petitioner for her sole and separate use, free from any right, title claim, interest, control or management upon the part of her husband.  Treating the execution of this instrument as effecting an extinguishment of the community status under Texas law with respect to the property of the petitioner and her husband, they each filed, for the calendar year 1930, separate returns.  Petitioner reported in her return all of the income from her separate estate, deducted therefrom all of the expenses and other deductions permitted by the taxing1937 BTA LEXIS 882">*884  act, and returned the net income thus computed, individually.  All the income so reported by petitioner was actually received by her, deposited to her account in bank, and this account was not subject to withdrawal by her husband.  All of the expenditures for which petitioner took credit upon her return were made by her from the funds deposited to her account, and subject wholly to her separate control.  Respondent, in determining the deficiency here in question, has adjusted the items of income and deductions in several instances in small amounts, and these adjustments are not in controversy.  The adjustment made by him in determining the deficiency, and contested here, arises through his treatment of the income of petitioner and her husband as community income, irrespective of the execution of the instrument of March 19, 1927.  Petitioner reported gross income as follows: Interest received$40,988.24Rents46,879.54Gas royalties$1,008.17Oil royalties71,015.0572,023.22Dividends8,337.08Other income23,881.0635 B.T.A. 406">*408  From this income, she reported deductions as follows: Interest paid$39,885.10Taxes paid21,183.21Bad debts2,954.60Contributions2,244.00Loss on sale of stocks in 193033,703.28Esperson Industrial District expense$2,556.00Depreciation3,891.40Oil Well expense4,739.44Salaries33,300.00Miscellaneous office expense10,955.811937 BTA LEXIS 882">*885  In determining the deficiency, respondent has treated as her separate income the oil and gas royalties, in the total amount of $72,023.22, less a deduction for depletion in the amount of $19,529.13.  The other items of income reported, he has treated as community income and has increased the amount by the sum of $1,350.16, representing rental income received by her husband.  Of the total of community income thus arrived at, he has treated petitioner as being taxable upon one-half, allowing her the benefit of one-half of the deductions taken by her and heretofore set out.  He now alleges that this allowance was erroneous as to one item of $2,556 for Esperson Industrial District expense, and that $2,000 of this amount represents a nondeductible capital expense.  This latter item of $2,000 was a payment made by petitioner to engineers for services in laying out and plotting for subdivision a tract of land included in her separate estate.  The item of "other income" reported by the petitioner, in the sum of $23,881.06, respondent reduced by the sum of $1,711.24, which adjustment is not in controversy.  He treated $1,692.31 of the balance as community income, and $20,477.51 as separate1937 BTA LEXIS 882">*886  income of petitioner.  He also increased the deductions treated as community deductions by $2,710.22, interest paid by her husband and deducted upon his return.  Petitioner, in 1930, sold, at a loss of $33,401.28, certain corporate stock which she had purchased in the prior year.  This stock had been acquired by her on open account, through a brokerage house, and paid for by her by check drawn upon her personal funds in bank.  The item of contributions, in the total of $2,244, for which petitioner took credit on her return, consisted of charitable contributions made by her individually from funds deposited to her account in bank.  The respondent, in treating these contributions as community deductions, increased the sum by the amount of $45.70, constituting similar contributions made by her husband and deducted on his return.  OPINION.  LEECH: There appears to be no dispute with respect to the income received or the amounts of the several deductions.  The only questions raised are as to what portions of the income and deductions constitute separate income and separate deductions of the petitioner, and what portions, if any, are community income and deductions.  35 B.T.A. 406">*409 1937 BTA LEXIS 882">*887  Petitioner contends that by reason of the execution by her husband of a conveyance of all of his interest in the community property and the community income thereafter to be received, all of the income from her separate property was her separate income.  With this we do not agree.  We think that, under the decisions of the Texas courts, a husband may convey to his wife, by gift or otherwise, as her separate property, community property, but such property must then be in existence.  Frame v. Frame,36 S.W.(2d) 152; Kahn v. Kahn,58 S.W. 825">58 S.W. 825; Heaton v. State,87 S.W.(2d) 256; Sorenson v. City National Bank,49 S.W.(2d) 718; Owen v. Willis,20 S.W.(2d) 338; Polk v. Mead,3 S.W.(2d) 112; Cauble v. Beaver-Electra Refining Co.,274 S.W. 120">274 S.W. 120; Armstrong v. Turbeville,216 S.W. 1101">216 S.W. 1101. The income here in dispute was received in 1930.  Thus, in determining petitioner's gross income for the purpose of Federal income tax computation, that income must be treated as community income under the rule that an assignment of future income1937 BTA LEXIS 882">*888  does not relieve the assignor from the burden of the income tax thereon.  Lucas v. Earl,281 U.S. 111">281 U.S. 111; Turbeville v. Commissioner, 84 Fed.(2d) 307; Rose v. Commissioner, 65 Fed.(2d) 616. Since, under the general rule in Texas, income from the separate property of a spouse is the income of the community (Anna Davis Terry,26 B.T.A. 1418">26 B.T.A. 1418; affd., 69 Fed.(2d) 969), the interest, rents, and dividends received by petitioner constitute community income taxable to petitioner and her husband in equal amounts. The record is not clear as to the source of the "other income" reported by petitioner in the sum of $23,881.06.  This has been treated in part as community and the balance as separate income.  In view of the record, we sustain the respondent upon his allocation.  However, oil and gas royalties are an exception to the general rule just stated.  Under the laws of Texas, an oil and gas lease constitutes a sale of those minerals in place.  True, for Federal income tax purposes, those royalties are ordinary income from the property leased. 1937 BTA LEXIS 882">*889 Burnet v. Harmel,287 U.S. 103">287 U.S. 103. But, in Texas, such royalties are not income from the property, per se, but are the separate property, in another form, of the spouse owning the lands from which the royalties arise, and thus are not community income.  Commissioner v. Wilson, 76 Fed.(2d) 766; David Hannah,31 B.T.A. 971">31 B.T.A. 971; Rosalie Hampton,31 B.T.A. 853">31 B.T.A. 853; J. T. Sneed, Jr.,30 B.T.A. 1121">30 B.T.A. 1121. It follows that the oil and gas royalties received by petitioner from her separate property, less the depletion of $19,529.13, are taxable in their entirety to petitioner.  This brings us to the question of the deductions which respondent has treated as allowable in equal parts to petitioner and her husband, with the exception of one item of $2,000 which he now alleges is a capital expense.  Petitioner urges that even though it be held that 35 B.T.A. 406">*410  certain of the income received by her from her separate estate constitutes community income, taxable one-half to her, she is entitled to the deduction of the total amount of her deductible expenses actually paid by her from her funds, and that the expenditures1937 BTA LEXIS 882">*890  included in the deductions taken were so paid.  It is argued that her husband, not having paid any portion of this expense, is not entitled to the benefit of the deduction of any part thereof from that portion of the community income taxed to him.  This argument overlooks the fact that the portion of community income taxable to the husband is not gross but net taxable income, after the deduction of the expenses incidental to its production.  Before the execution by petitioner's husband of his conveyance of all his interest in petitioner's separate estate, his tax liability with respect to the income from petitioner's separate estate was a sum not in excess of one-half of the net income.  Obviously, the execution of that instrument did not increase his tax liability on that income.  We must bear in mind that the community is entitled not to the gross income from the separate property of husband and wife, but to the net income remaining after payment of expenses incidental to its production.  The inclusion of gross income from separate property in the community, without deducting the expenses of producing it, would deplete the separate property or, in other words, would result in an1937 BTA LEXIS 882">*891  inclusion in the community of a portion of the separate property, since the gross income therefrom would necessarily constitute, in part, a liquidation of capital.  As Corpus Juris states the principle, citing Sharp v. Zeller,110 La. 61">110 La. 61; 34 So. 129">34 So. 129: Where separate property is encumbered, the revenue therefrom may be applied to the discharge of the encumbrance, leaving only the excess to fall into the community [31 C.J. 32, Sec. 1116.] In accordance with this principle, the respondent has consistently computed the income of the spouses by including in the net income of each, one-half of the net community income, thus giving each, equally, the benefit of the deductions properly attributable to such income. As far as we have been able to find, no question has been raised heretofore as to this treatment.  The usual method pursued was to have each spouse report all of the community income, and the deductions therefrom, and then include in his or her individual income, one-half of the net amount so computed.  The rule consistently applied is stated by O.D. 909, 1937 BTA LEXIS 882">*892 4 C.B. 254, as follows: In returns in which community income is divided between husband and wife domiciled in States where such income is divisible for income tax purposes, both husband and wife should report in detail the gross income from such community property.  The deductions properly chargeable against such income should be equally divided between husband and wife.  35 B.T.A. 406">*411  We approve that rule and hold that the deductions, constituting expenses, depreciation, interest and taxes pertaining to petitioner's separate property, the income from which falls into the community and is taxable in equal parts to petitioner and her husband, are to be equally divided between the two.  The gross income of the community shall be taxed equally between the two spouses and each granted the benefit of one-half of the deductions.  It is conceded that the contested contributions made by petitioner in 1930 were of charitable character as defined by the applicable revenue act.  Respondent contends, however, that they constitute a community deduction because made from a bank account in which community income was deposited.  But, the funds in such bank account belonged to the petitioner1937 BTA LEXIS 882">*893  and not to the community.  The contributions were made by the petitioner our of her funds, and she is, therefore, entitled to deduct them in full.  No part of the charitable contributions made by petitioner's husband is deductible by her.  Included in the deductions is one of $4,739.44, expenses incurred in connection with receipt of oil and gas royalties.  Respondent does not question the accuracy or reasonableness of this expense but treats it as a community deduction.  This is error, as decided above, since these royalties were separate income of and taxable, in their entirety, to petitioner.  We conclude this item is a deduction, to the whole of which petitioner is entitled.  We also hold respondent to be in error in treating as a community deduction a loss of $33,401.28 from sale of stock in 1930.  This stock was purchased by the wife and paid for with her separate property.  It became her separate property.  Trammell v. Trammell,269 F. 114; 216 S.W. 1101">Armstrong v. Turbeville, supra;O'Farrell v. O'Farrell,119 S.W. 899">119 S.W. 899; 1937 BTA LEXIS 882">*894 Gale Mfg. Co. v. Dupree,146 S.W. 1048">146 S.W. 1048. Any loss resulting from a sale of petitioner's separate property constitutes a reduction of or decrease in her separate estate.  Certainly, a decrease in her estate as a result of a sale, constitutes a loss substained by her.  In our judgment, the amount of this loss, which is not contested, is allowable in full to petitioner.  Similarly, the loss of $302 sustained by petitioner's husband on the sale of stock plays no part in computation of petitioner's net income.  The same reasoning applies to the bad debt deduction of $2,954.60, since this debt constituted an investment by petitioner of her separate property.  The loss occasioned by its becoming worthless is allowable in full to petitioner.  The items of deduction consisting of interest, taxes, depreciation, salaries, and miscellaneous office expenses are not questioned as to their amounts, except for certain small adjustments not in controversy.  As to these we sustain the respondent in treating them as community deductions to which petitioner and her husband are entitled in equal amounts.  35 B.T.A. 406">*412  As stated in our findings of fact, the respondent treated salaries1937 BTA LEXIS 882">*895  paid and miscellaneous office expenses, as community deductions to which petitioner was entitled to the benefit of one-half.  Petitioner claims these amounts, in their entirety, as separate deductions.  But the record discloses nothing indicating the portion of any that was incidental to petitioner's separate business.  Thus, respondent's determination is sustained on that issue.  With respect to the deduction of $2,556 as "Esperson Industrial District Expenses" we sustain the respondent in his contention that $2,000 of this amount, constituting payments for subdividing and plotting the Esperson Industrial District tract for sale, is a capital expenditure and not deductible.  Frishkorn Real Estate Co.,15 B.T.A. 463">15 B.T.A. 463. Respondent, apparently, does not question the balance of this total deduction as one to which petitioner is separately entitled. In addition to the deductions discussed, petitioner has claimed as community deductions, losses due to the financial collapse of certain corporations.  The bases for these losses are investment in stock and advances made to the corporations.  This issue has been closed by a formal stipulation that during 1930 petitioner1937 BTA LEXIS 882">*896  sustained a deductible capital loss in the amount of $10,000, which constituted her share of a community loss from the investments in question.  Effect will be given to this stipulation.  Reviewed by the Board.  Decision will be entered under Rule 50.