Court Opinion

ID: 4611417
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:48:56.488189+00
Date Added: 2024-06-11T07:54:14.945502
License: Public Domain

ESTATE OF L. W. MALLORY (J. A. MALLORY AND LLOYD W. HIRST, EXECUTORS), PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Mallory v. CommissionerDocket No. 95595.United States Board of Tax Appeals44 B.T.A. 249; 1941 BTA LEXIS 1359; April 23, 1941, Promulgated *1359  1.  The decedent, by will, left his residuary estate in trust with directions that the trustees pay over to his window and his sons, from principal and from profits and income realized thereon, such sum or sums at such time or times as in the judgment of the trustees might seem wise and provident.  The widow elected to take under the will in lieu of her dower rights.  Held, that certain amounts paid to the widow during the years 1934, 1935, and 1936 from the income of those years, respectively, constituted allowable deductions for such years under subdivision (c) of section 162 of the Revenue Acts of 1934 and 1936, respectively.  2.  Throughout the period from the decedent's death in August 1931 until the end of 1933 the petitioners kept their books and filed their returns on the cash basis.  Without requesting or receiving the permission of the Commissioner to change their basis of reporting income, they filed their returns for the years 1934 through 1936 on the acrual basis.  Held, that the respondent did not err in determining taxable income for the years 1934 through 1936 on the cash basis.  John S. Sears, Esq., for the petitioners.  R. P. Hertzog, Esq.*1360 , for the respondent.  TURNER *249  The respondent determined deficiencies in income tax of $4,041.95, $9,418.51, and $3,705.28 for the years 1934, 1935, and 1936, respectively.  The issues presented are the deductibility of (1) certain amounts claimed as fees of trustees and attorneys; (2) certain amounts claimed as distributions of income to the widow of decedent; and (3) certain amounts claimed for interest, taxes, fees of accountant, expenses of sale of capital assets, and miscellaneous expenses.  The question as to the first and last issues is whether the petitioners were entitled to report income on the accrual basis.  FINDINGS OF FACT.  L. W. Mallory, a resident of Sioux City, Woodbury County, Iowa, died testate on August 22, 1931.  The petitioners, J. A. Mallory and Lloyd W. Hirst, named as executors in the will of the decedent, were duly appointed joint executors of the will by the District Court of Woodbury County, Iowa, on September 9, 1931, and have since continued as the duly qualified and acting executors of the will.  The estate of the decedent is still open.  The will of the decedent provided in part as follows: FIRST: After the payment*1361  of all just claims against my estate, if any, I do hereby give, devise and bequeath to my son, Julius A. Mallory, and to *250  Lloyd W. Hirst, all the rest, residue and remainder of my estate, of which I may die seized and possessed, of whatsoever kind and character and wheresoever situated, both real, personal and mixed, in trust, nevertheless, to hold, manage, control, sell, transfer, dispose of, invest and reinvest, including the undistributed income therefrom, in such manner as they, in their judgment, may deem wise and provident, for the following uses and purposes, that is to say: To pay over from time to time, from the principal thereof, and from the profits, emoluments, dividends, interest and income realized thereon, to my wife, Cora E. Mallory, and to my sons, Lemuel C. Mallory and Julius A. Mallory, such sum or sums, at such time or times as in the judgment of my said trustees may seem wise and provident.  After a period of twelve years from and after my death, but in no event prior to the death of my said wife, Cora E. Mallory, if she survive me, I direct that the remainder of my estate hereby devised and bequeathed to my son, Julius A. Mallory and to the said*1362  Lloyd W. Hirst, in trust, including the undistributed profits and income derived therefrom, if any, shall be divided in equal shares and paid over to my said sons, Lemuel C. Mallory and Julius A. Mallory, as their sole and absolute property.  On September 9, 1931, the District Court of Woodbury County, Iowa, also appointed the petitioners joint trustees of the trust provided by the will of the decedent and they have since continued as the duly qualified and acting trustees of said trust.  Cora E. Mallory, the widow of the decedent, filed her written election to take under the will of the decedent and on her application was allowed the sum of $1,000 a month for the 12 months subsequent to the death of the decedent, for her support and maintenance, under the provisions of section 11923 of the Code of Iowa (1931) and such allowance was fully paid to her before March 3, 1933, by the trustees of the estate of the decedent from moneys furnished to them by the executors of said estate.  The petitioners, as joint executors and as joint trustees, being one and the same persons acting in a dual capacity, have maintained two bank accounts, one as joint executors and one as joint trustees. *1363  At the time of his death on August 22, 1931, the decedent owned the following assets: All of the voting common stock and 250 shares of preferred stock of the par value of $25,000 of the Pratt-Mallory Co., an Iowa corporation engaged in the wholesale grocery business, with its principal place of business at Sioux City, and having a paid up capital stock consisting of $300,000 voting common stock, $150,000 employees' nonvoting common stock, and $454,300 7 percent cumulative preferred stock; 80 percent of the outstanding common stock of Hess-Mallory Co., an Iowa corporation engaged in the wholesale dry goods and notions business, with its principal place of business at Sioux City, and having a paid up capital stock of $100,000; 20 percent of the voting common stock of the Artificial Ice Co., a Missouri corporation which owned and operated an ice plant in St. Louis and one in Kansas City, with its principal place of *251  business in St. Louis, and had a paid up capital stock of $100,000; the controlling interest, amounting to $116,600, in the M & L Baking Co., an Iowa corporation engaged in the wholesale baking business, with its principal place of business at Sioux City; 500*1364  shares of cmmon stock of the par value of $50,000 of the Davidson Brothers Co., an Iowa corporation engaged in the operation of a retail department store, with its principal place of business at Sioux City; an obligation, in the amount of $103,200, of Porter Fox & Co., a Delaware corporation with its principal place of business in Chicago, which was secured by common stock of the McGraw Electric Co., a Delaware corporation with its principal place of business in Chicago; the Argonaut Apartment House in Sioux City, containing 30 apartments above the first floor and four retail store rooms on the ground floor; and an investment of $15,000 in other real estate situated in Sioux City.  Following the death of the decedent the trustees continued to hold the foregoing assets throughout the years 1934, 1935, and 1936, except the obligation of Porter Fox & Co., which was disposed of in 1935.  The decedent was also the owner of notes in the principal amount of $47,087.91 given by employees of the Pratt-Mallory Co. for the purchase of preferred and profit-sharing common stock, the said notes having been purchased by the decedent from the Pratt-Mallory Co.  He was also the owner of an account*1365  described as "Employees Stock Collection Account." The balance due petitioner in that account at the date of his death was $35,388.36.  The notes bore interest at 6 percent, while the interest on the employees stock collection account was computed at 4 percent.  At the date of the decedent's death the interest accrued and unpaid on the notes and the stock collection account amounted to $1,426.92 and $678.51, respectively.  Collections on the notes were made monthly by the Pratt-Mallory Co. and credited thereon.  The collections so made were carried for the decedent by the company in a special account, which account provided for interest at the rate prescribed by the notes.  The record further indicates that the employees stock collection account was similarly handled by the Pratt-Mallory Co.  Exclusive of the two accounts just described, the decedent maintained an open account with the Pratt-Mallory Co. to which he was indebted at the date of his death in the amount of $85,350.49.  The decedent's books of account consisted of a cash journal and ledger which, for some years, had been kept by Lloyd W. Hirst.  After the decedent's death Hirst continued the use of the cash journal and*1366  ledger, recording therein entries covering the transactions by the executors and trustees.  With respect to the Argonaut Apartment House, however, the books kept by Hirst contained only a yearly *252  summary.  John R. Foley, manager of the apartment house, kept a cash receipts and disbursements book in which he recorded the rents received, expenses paid, purchases made, and the transfers of unexpended funds to the executors and trustees.  He maintained a separate bank account in his name as agent.  On December 1, 1931, Hirst entered in an account entitled "Interest" the sum of $1,893.26 against the Pratt-Mallory Co., which amount represented interest accrued to December 1, 1931, on the notes of the employees of that company given as described above for the purchase of stock.  It does not appear that the interest on the employees stock collection account was similarly accrued.  Against the amounts owing to decedent's estate on the stock purchase notes and the employees stock collection account, Hirst, on the books kept by him, offset the interest accrued to December 1, 1931, on the open account of $85,350.49 owing by decedent to Pratt-Mallory Co.  During 1932 Hirst made certain*1367  entries indicating the accrual of five items of interest payable in the total amount of $7,258.91.  Three of the entries covered interest accrued between August 22, 1931, and January 2, 1932, on three itmes of indebtedness owing to J. A. Mallory.  The other two entries represented interest for 1932 at 5 1/2 percent on an account owing by the executors and trustees to the Pratt-Mallory Co.  About April 1933, C. A. Willaims, a certified public accountant, installed a set of books for the executors and trustees, designed to reflect the transactions carried on by them from the date of decedent's death.  After January 1, 1933, Hirst had made no postings from the executors' and trustees' check books to the cash journal and ledger which had been kept by him.  Williams did not record in the books installed by him the five items of accrued interest payable which had been entered by Hirst during 1932 on his cash journal and ledger in the total amount of $7,258.91, as previously stated.  On December 31, 1933, however, Williams did record an adjustment entry under the direction of S. D. Leidersdorf & Co., certified public accountants, who had been employed by the Pratt-Mallory Co. and the executors*1368  and trustees to make an audit of the books of that corporation and the transactions of the executors and trustees.  At the direction of S. D. Leidersdorf & Co.  Williams charged an account entitled "Interest Paid" (year 1933) in the amount of $8,737.69 and an account entitled "Capital" in the amount of $8,680.77.  He credited "Accounts Payable (Pratt-Mallory Company)" in the amount of $17,418.46, with the explanation "To adjust accounts and show actual liability to Pratt-Mallory Company." He did not explain the charge entitled "Capital", $8,680.77.  With respect to that entry the parties have stipulated "it is assumed that this amount covers interest for the year 1931 and for the year 1932, whether partly prior to or all *253  subsequent to date of death of decedent." At December 31, 1932, the accrued interest on a mortgage on the Argonaut Apartment House amounted to $783.  It does not appear that any entry was made on the books with respect to this item until some time in 1933, when it was recorded by Williams as an expense for 1933 on the books installed by him.  In the fiduciary return filed by the executors for the period August 22 to December 31, 1931, reflecting net income*1369  in the amount of $1,799.41, the only accrual item reported was the previously described item of interest in the amount of $1,893.36 entered by Hirst on the cash journal and ledger kept by him, which item represented accrued interest receivable to December 1, 1931, on the stock purchase notes given by the employees of the Pratt-Mallory Co.  All other items represented actual receipts and disbursements, except certain items which were either duplications or entered in error avd are not material here.  On the fiduciary return filed by the executors for 1932 net income was reported in the amount of $3,888.88.  No accrued items, either of income or expenses, were reflected in that return.  The fiduciary return filed by the executors for 1933 shows a net loss of $13,585.91 and contains the statement that the books were kept on the cash basis.  All items reported on that return represented actual receipts and disbursements, except $9,645.64 of a deduction of $13,504.01 taken for interest paid.  The $9,645.64 represented accrued interest on three separate items of indebtedness owing to the Pratt-Mallory Co., Hess-Mallory Co., and J. A. Mallory.  During the period from August 22 to December 31, 1931, the*1370  executors kept their books and filed their returns on the cash receipts and disbursements basis.  The returns filed for the years 1931, 1932, and 1933 were received by the Bureau of Internal Revenue and no change has been made by the Bureau with respect to any of those returns.  At no time have the executors requested or received from the Commissioner permission to make any change in their system of accounting or the method of accounting used in preparing their income tax returns.  On each of the returns filed by the executors for 1934, 1935, and 1936, however, there is a statement that the books were kept on the accrual basis.  During each of the years 1934 and 1935 the joint trustees paid to Cora E. Mallory $9,000 and during 1936 until her death on April 24, 1936, they paid her $3,000.  All of said payments were made to her under the provisions of the will of the decedent from moneys furnished to the joint trustees by the joint executors and were deducted as widow's support in the income tax returns for the respective years *254  filed by the joint executors.  In the personal income tax returns, made on Form 1040, of Cora E. Mallory for said years and period the above amounts*1371  were reported as income and income tax was paid thereon.  In determining the deficiencies in controversy the respondent disallowed the deductions for said amounts in the income tax returns filed by the joint executors.  In the probate proceedings involving the decedent's estate the fees of the joint executors were fixed and determined at $25,678.10 as a part of the cost of administering the estate.  No part of those fees has ever been paid.  In said proceeding the fees for attorneys for the executors were fixed and determined at $20,678.10.  This amount has been paid in full.  During 1933 the fees of the joint trustees were fixed and determined by the trustees and beneficiaries fo the trust at $5,000 annually for each trustee from February 22, 1933.  This determination as to annual fees continued in effect until January 1, 1939, but none of the fees has ever been paid.  The fees of the trustees were first set up on the books early in 1935, at which time entries were made as of December 31, 1933, and December 31, 1934, in the respective amounts of $8,583.34 and $10,000.  During 1933 the fees of the attorneys for the joint trustees were fixed and determined by the attorneys, the*1372  trustees, and the beneficiaries of the trust at $5,000 annually from February 22, 1933.  This determination as to annual fees continued in effect to January 1, 1939.  None of these fees has ever been paid except the amount of $6,295.89 paid on August 25, 1938, and the amount of $2,589.21 paid on January 19, 1939.  The fees of the attorneys were first set up on the books early in 1935, at which time entries were made as of December 31, 1933, and December 31, 1934, in the respective amounts of $4,291.66 and $5,000.  OPINION.  TURNER: Under the provisions of the will of the decedent the petitioners paid to Cora E. Mallory, the decedent's widow, $9,000 in each of the years 1934 and 1935 and $3,000 in 1936 prior to her death on April 24 of that year.  These amounts were taken as deductions in the income tax returns filed by them for the respective years, but were disallowed by the respondent.  The petitioners contend that by his will the decedent made no gift, devise, or bequest to his widow of any amount which was to be paid to her at all events either from income or from principal or from both; that they were under no legal obligations to pay her any amount or amounts whatsoever either*1373  of income or principal, but that the payment to her of any amount was discretionary with them; and that *255  the amounts paid to her during 1934, 1935, and 1936 were paid from the income of the respective years and were properly deductible by them in computing net income and constituted income taxable to her.  The respondent contends that the payments were not allowable deductions from income for the reason that they were payable out of either capital or income and that the widow improperly reported them as income on her individual income tax returns.  In argument on brief counsel for the respondent alludes to the absence in the record of any showing that the payments to the widow were actually made out of income.  The amounts so paid to the widow were claimed as deductions on the returns filed by the petitioner herein and were reported by the widow as income to her.  The respondent has made no determination that the distributions were not made from income and no issue to that effect was raised by the pleadings.  Furthermore, from the statements of the issues by counsel at the hearing there was no indication of any disagreement between the parties on that point.  We accordiingly*1374  assume for the purposes of this case that the payments made to the widow were from income for the respective years for which the deductions here in issue are claimed.  The Revenue Act of 1934 contains the following provisions, which are identical with the corresponding provisions of the Revenue Act of 1936: SEC. 162.  NET INCOME.  The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that - * * * (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not.  Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year; (c) In the case*1375  of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.  *256  The decedent left his residuary estate in trust, with directions that the trustees pay over to his widow and his sons, form principal and from profits and income realized thereon, such sum or sums at such time or times as in the judgment of the trustees might seem wise and provident.  The widow, having elected to take under the decedent's will in lieu of her dower rights, is accordingly a beneficiary of the trust as created by the will.  In the instant case the will did not provide for the payment currently of the net income of the estate to the widow, *1376  as was true in , where it was held that the payments made by the trustees to the widow constituted allowable deductions by the trustees.  Cf. . Nor did the will in the instant case provide for the payment to the widow of a stated amount at specified periods, at all events and independently of the amount of income of the estate, as was true in , where it was held that the payments made by the trustees to the widow did not constitute allowable deductions by the trustees for the reason that they did not represent distribution of income, but were in discharge of a gift or legacy.  Cf. . Nor did the will direct the trustees to pay currently the net income of the estate to the widow and in their discretion to make payments to her from time to time out of principal to meet her needs as was the case in , where it was held that a distribution of net income by the trustees to the widow was deductible by the trustees*1377  despite separate discretion given them by the will to make additional distributions out of principal to meet the needs of the widow. In the instant case the distributions, whether out of principal or out of income, were within the discretion of the trustees.  The will did not direct that any income "be distributed currently by the fiduciary to the beneficiaries" as contemplated by subsection (b) of section 162, supra, but under the will the income might, "in the discretion of the fiduciary", be distributed to the beneficiary as contemplated by subsection (c) of section 162, supra. In the case of income which in the discretion of the fiduciary may be distributed to the beneficiary, there is to be allowed as a deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is properly paid or credited during such year to any legatee, heir, or beneficiary.  No contention is made by the respondent that the payments to the widow were not properly made.  Under the circumstances it is our opinion that the payments here involved clearly come within the provisions of subsection (c) of secion 162, supra, and*1378  constitute allowable deductions.  The fact that other amounts might have been *257  paid out of principal by the trustees is in our opinion immaterial.  See The petitioners are sustained on this issue.  The remaining issues involve the deductibility, as accrued items, of fees of trustees and attorneys and certain other amounts deducted for interest, taxes, fees of accountant, and miscellaneous expenses.  The petitioners contend that they were entitled to use the accrual method of reporting income for the years 1934, 1935, and 1936 for the reason that they used that method in making their first report of income, namely, for the period August 22 to December 31, 1931, as well as all subsequent reports of income, and for the further reason that it is the method that will most clearly reflect their correct income for tax purposes.  The respondent's position is that the petitioners' original books were kept on the cash basis, that their first return as well as their returns for 1932 and 1933 were filed on that basis and, having elected to file their returns on that basis and having failed to request or secure permission to*1379  change to the accrual basis in 1934, 1935, and 1936, they are not entitled to have their taxable net income for 1934, 1935, and 1936 computed on the accrual basis.  A taxpayer's net income is to be computed "in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income." Sec. 41, Revenue Acts of 1934 and 1936.  "The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under section 41, any such amounts are to be properly accounted for as of a different period." Sec. 42, Revenue Acts of 1934 and 1936.  Deductions are to "be taken for the taxable year in which 'paid or accrued' or 'paid or incurred', dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions * * * should be taken as*1380  of a differect period." Sec. 43, Revenue Acts of 1934 and 1936.  A taxpayer who changes the method of accounting employed in keeping his books shall, before computing his income upon such new method for purposes of taxation, secure the consent of the Commissioner, which is not to be granted unless the taxpayer and the Commissioner agree to the terms and conditions under which the change will be effected.  Art. 322, Regulations 77, and art. 41-2, Regulations 86 and 94.  Also see ; affd., . *258 Neither the set of books kept by Hirst from August 22, 1931, to December 31, 1932, nor the set installed by Williams in 1933 were offered in evidence, and all we have as to the basis used prior to 1934 is certain statements stipulated by the parties and some ledger sheets submitted in connection therewith.  The evidence indicates that aside from errors and duplications the only identifiable items of income and deductions that were entered on the books as accruals during the period August 22, 1931, to December 31, 1933, relate to interest and in fact to only a portion of interest income or interest payable*1381  as the case may be, and that all other items of income or deductions represent actual cash receipts or disbursements.  Minor deviations from the cash basis are not sufficient to sustain a holding that the accrual basis was used.  Cf. . From the evidence it is our opinion, and we so condlude, that the petitioners' books of account as originally maintained were kept on the cash basis and that the few accruals therein were erroneous and inconsistent therewith and, further, that the petitioners have failed to show that the cash method does not clearly reflect income.  In the light of these conclusions, and since the consent of the respondent to change the method of accounting was neither requested nor obtained for any of the years before us, his action in determining the income for those years on the cash basis is sustained.  Decision will be entered under Rule 50.