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Law v. Rothensies

decided: March 29, 1946.

LAW
v.
ROTHENSIES, COLLECTOR OF INTERNAL REVENUE.



Author: Mclaughlin

Before BIGGS, MCLAUGHLIN and O'CONNELL, Circuit Judges.

MCLAUGHLIN, Circuit Judge.

This appeal involves six life insurance policies*fn1 under which the appellee was the sole beneficiary of her husband. After her husband's death in 1936 the appellee exercised the twenty year installment and thereafter for life options under the policies. The amount of each installment exceeded the aliquot part of the proceeds of the policies. This excess was included by the Commissioner of Internal Revenue in the gross income of the appellee for 1938 and 1939. Accordingly the appellee paid the taxes thereon and then sued for their recovery. The District Court upheld the plaintiff-appellee on her motion for summary judgment, deciding that Section 22(b) (1) of the Revenue Act of 1938, 26 U.S.C.A. Int. Rev. Code, ยง 22(b) (1), excluded from gross income installment payments under an insurance policy option when exercised by the beneficiary after the death of the insured.

All six policies contained installment options for a limited period and for life. Four of the six had an interest payment option. The provisions of the Metropolitan Life Insurance Company policy No. 777,204, issued June 24, 1911, which contained all three options reads:

"(1) Interest. - For the annual payment of interest to the beneficiary at the rate of 3 1/2% upon the amount payable under the policy which was left with the company and for the payment of the amount at her death to the beneficiaries, executors, administrators or assigns.

"(2) Installments for a limited period. - For the payment of equal installments for a specified number of years in accordance with a table set out in the policy.

"(3) Installments for life. - For the payment of equal annual installments for a fixed period of twenty years and for so many years longer as the beneficiary shall survive in accordance with a table set out in the policy."

Another of the policies, Metropolitan Life Insurance Company policy No. 2,419,504, issued October 23, 1919, provided that the sums payable under options 2 and 3 are based upon an assumed interest earning of 3 1/2%.

The appellant urges that the excess of each installment payment over the particular part of the proceeds of the policy is interest within the meaning of the parenthetical phrase of Section 22(b) (1) of the Revenue Act of 1938 and therefore taxable as income to the beneficiary in the years the installments were paid. This is in line with the interpretation of the section by Treasury Regulations 101 Art. 22(b) (1) - 1 and 103 Section 19.22(b) (1) - 1 as amended, Section 22(b) (1) excludes from gross income and exempts from taxes: "(1) Life insurance. Amounts received under a life insurance contract paid by reason of the death of the insured, whether in a single sum or otherwise (but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income)."

The contention of the appellant is squarely contrary to the holding of the only Circuit Court of Appeals case on the precise facts, Commissioner v. Pierce, 2 Cir., 146 F.2d 388. There the Court held, page 389, that "The parenthesis applies to cases where the capital sum is retained for a season undiminished, and only the interest is paid to the beneficiary * * *." Judge Learned Hand further said at page 390: "Nothing will justify the violence to the language necessary to the Commissioner's interpretation, unless it is necessary to effectuate the underlying purpose of the statute. In this instance it would defeat that purpose."

The Pierce opinion which was in affirmance of the Tax Court, followed five Circuit Court of Appeals decisions all to the effect that where an insured during his lifetime had exercised more or less similar policy options, the excess in installment payments over the policy proceeds was not includible in the beneficiary's gross income. Commissioner v. Winslow, 1 Cir., 113 F.2d 418, 133 A.L.R. 405, Commissioner v. Bartlett, 2 Cir., 113 F.2d 766; Commissioner v. Buck, 2 Cir., 120 F.2d 775; Allis v. La Budde, 7 Cir., 128 F.2d 838 and Kaufman v. United States, 4 Cir., 131 F.2d 854.

The statutory background of 22(b) (1) is highly significant. Its forerunner, Section II, B of the Tariff Act of 1913, 38 Stat. 167, reads: "* * * the proceeds of life insurance policies paid upon the death of the person insured * * * shall not be included as income." During the Congressional discussion of that language, Mr. Hull, in charge of the bill in the House, was asked: "* * * whether a widow will be required to pay an income tax on the money secured as the result of her husband's death * * *?" He answered: "It was never contemplated to tax the proceeds of life insurance policies." He agreed that "* * * no tax was levied upon the beneficiary of a policy or upon the amount paid, such as on a 20-year policy, * * *." (63rd Cong., 1st Sess., Vol. 50 Congressional Record, pages 508-512).

The Revenue Act of 1916, 39 Stat. 758, section 4, exempted the proceeds of life insurance policies paid to individual beneficiaries upon the death of the insured. This was enlarged in 1918 to include the estate of the insured. 40 Stat. 1065. The 1921 Act changed the exemption to read: "The proceeds of life insurance policies paid upon the death of the insured." 42 Stat. 238. Thereafter came the 1926 Act, Section 213(b) (1), 26 U.S.C.A. Int. Rev. Acts, page 163: "(1) Amounts received under a life insurance contract paid by reason of the death of the insured, whether in a single sum or in installments (but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income); * * *."

Regarding this, the Conference Committee said (69th Cong., 1st Sess., H. Rept. 356) p. 33: "Amendment No. 17: Under existing law, the proceeds of life insurance policies 'paid upon the death' of the insured are exempt. The House bill, in order to prevent any interpretation which would deny the exemption in the case of installment payments, amended this provision so that proceeds 'paid by reason of the death' of the insured would be exempt. In order to prevent an exemption of earnings where the amount payable under the policy is placed in trust upon the death ...


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