thereon the higher surtaxes in that year, without adding like amounts to the income of the surviving beneficiaries and imposing similar taxes thereon, the Commissioner has imposed an unequal tax burden upon taxpayers who are in the same class, except for the fact that one of them is deceased. Where such increased burden results because of the necessity to prevent avoidance of tax it might be justified, but where the law can be applied without causing an inequality in the effect upon taxpayers, the more reasonable interpretation should be followed.
The fact that the accrued income was not actually collected until after the taxpayer's death does not in itself render the provision inapplicable ( Title Guarantee & Trust Co. v. Commissioner supra), and we also agree with the Commissioner that the life beneficiary of a trust, even though it be governed by a spendthrift clause, has a vested right to his share of the income on the trust assets, and not only to such part as might have been collected at his death. In re Davidson's Estate, 287 Pa. 354, 135 A. 130. The Act, however, was not intended to impose a tax upon a right to receive accrued income. Its purpose was to reach the accrued income, even though not collected, which would otherwise escape taxation. In the ordinary case of an individual taxpayer reporting on a cash basis, the provision is essential to the taxing plan and purpose. But where there is an intermediate taxable entity which can or might be assessed for the taxes which would otherwise be avoided, the application of Section 42 is unnecessary, and it should not be adopted.
Under Section 161 of the Act, 26 U.S.C.A. Int.Rev.Code, § 161, the trust estate is a taxable entity separate and apart from the taxable beneficiaries. Its income is subject to the income tax laws and to the regulations pertaining to cash or accrual returns. Regardless of whether the beneficiaries have a vested interest or not the Act imposes an income tax upon the income of the trust, except where, under Section 162, 26 U.S.C.A. Int.Rev.Code, § 162, it is currently distributable to the beneficiaries and the tax paid thereon by them. To impose the tax on accrued income under the circumstances of this case would be in effect the taxing of a decedent in 1934 upon the income of the trust estate received in subsequent years, and for which the trustees would have become liable on their usual cash basis of accounting. There appears to be a justification for distinguishing the income accruing to the trust from that which accrued to the estate of the deceased beneficiary through the operation of the trust.
A distinction similar to that suggested was made in Enright's Estate v. Commissioner, 3 Cir., 112 F.2d 919, which held that a partnership was a taxable entity separate and distinct from its members. The partnership income accruing to the deceased partner and for which he must account was only that shown to be distributable to him by the partnership return prepared pursuant to the partnership agreement, since it is only that distributable income which he is entitled to receive. That which is not in fact the taxpayer's income, cannot be made such by calling it income. Hoeper v. Commission, 284 U.S. 206, 215, 52 S. Ct. 120, 76 L. Ed. 248, 78 A.L.R. 346. In the Enright case the Court indicated that the uncollected accounts receivable due to the partnership were not distributable to and therefore were not accrued income to the individual partner. This principle can be adapted with equal force to the present case and justifies the conclusion that the income accrued to the trust estate, and not collected or distributable, is not taxable income to the plaintiff's decedent. To hold otherwise would be to extend the statute beyond its purpose.
Where a taxpayer is a beneficiary of a trust estate with the right to receive a share of the income therefrom, and he dies leaving the trust estate as a continuing taxable entity from which the taxes on his share of the accrued income may be collected on the basis of cash returns, the provisions of Section 42 relating to accrued income do not apply to his income for his life period. Applying the provision would work an inequiality that is avoidable, and it must be the policy of the law to seek an equitable application of all statutory provisions.
Our conclusion is that the section in question was not intended to, and therefore does not require the inclusion of the accrued trust income to the taxable income of the plaintiff's decedent in the year of his death. The plaintiffs are entitled to recover the amount of the income taxes assessed on the additional income for 1934 which represents income accrued to the trust estate but not collected or distributed to the decedent in that year.It is admitted, however, that if income taxes were paid by the estate on such accrued income in the years in which it was actually received, the total taxes thereon would be $5,849.14 which sum should be set off against the amount claimed by the plaintiffs. By reason of our disposition of the issues, it is unnecessary to include in the discussion the constitutional objections suggested by the plaintiffs, or to more particularly rule upon the requests for conclusions of law, which, so far as they do not conform hereto, are refused.
Judgment may be entered for the plaintiffs in accordance herewith.
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