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DOVEY v. UNITED STATES

June 13, 1957

Charles S. DOVEY, Sr., Plaintiff,
v.
UNITED STATES of America Defendant. Francis S. DOVEY, Plaintiff, v. UNITED STATES of America Defendant



The opinion of the court was delivered by: GRIM

Two life income beneficiaries of a trust created by the will of Cecelia S. Brill, who died in 1937, have brought these actions to recover certain income taxes assessed against them for the year 1947 and paid.

When the trust was created in 1937 it owned 1,690 shares of $ 100 par value cumulative preferred stock of The Brill Corporation, appraised at that time at $ 38 a share, a total of $ 64,220. In 1944, following a merger of The Brill Corporation with American Car and Foundry Motors Company, the trustees exchanged their Brill stock for debentures and common stock of the merged corporation (known as ACF-Brill Motors Company) and cash, as follows: $ 20,702.50 in cash, $ 118,300 in par value of new ACF-Brill Motors Company 6% income debentures, 13,520 shares of new ACF-Brill Motors Company common stock.

 In 1946 the trustees sold the ACF-Brill common stock for $ 243,360. They, therefore, still holding the debentures (which had a market value almost equal to their par value), then had a trust asset which had increased its original value of approximately $ 64,000 some five or six fold, although, at least prior to 1944, apparently no income had been paid on it to the beneficiaries. *fn1" Because no dividends had been paid on the Brill preferred stock for so many years and in view of the exchange of securities and the large increase in the value of the securities in the trust estate, some of the life beneficiaries contended to the trustees that, under the Pennsylvania law of apportionment between life tenants and remaindermen, they were entitled to a distribution of some of the assets of the trust as income from the trust.

 In order to have the claims of the beneficiaries legally determined, the trustees filed an account in the Orphans' Court of Philadelphia County, Pennsylvania. The contending parties then agreed upon a compromise and settlement of their claims. On May 8, 1947, the Orphans' Court filed an adjudication in accordance with the settlement agreement and awarded to the life beneficiaries almost all of the 6% income debentures of ACF-Brill Motors Company obtained by the trustees as a result of the corporate merger and exchange of securities. The adjudication directed distribution to the life beneficiaries of debentures having a market value as of May 8, 1947, of $ 101,400. In 1947, following the adjudication, debentures of this value were transferred by the trustees to the life beneficiaries.

 The Treasury Department made a determination, to which it still adheres, that when the trustees in 1944 exchanged their Brill preferred stock for cash, debentures, and common stock of the merged corporation the exchange was income tax free to the trustees except for the $ 20,702.50 in cash. *fn2"

 The government contended and now contends that although the transfer to the trustees of the ACF-Brill debentures as part of the exchange was tax free, the transfer of the $ 101,400 worth of these debentures to the beneficiaries was not, and that the debentures were taxable to the beneficiaries as ordinary income. The life beneficiaries, following the government's contention, paid a tax on the transfer of the debentures to them as ordinary income as part of their 1947 income tax. The present suits have been brought by two of the life beneficiaries to recover the income tax so paid.

 Plaintiffs contended in their claims to the trustees and in the litigation in the Orphans' Court that under the Pennsylvania law of apportionment some of the debentures should be transferred to them as income. They have not changed their position in reference to this, but they contend here that although the distribution to them of the debentures constituted income under the law of Pennsylvania, the distribution to them was not income to them under the federal income tax law. They contend that the debentures in their hands should be accorded the same tax free treatment as the debentures were accorded when received by the trustees.

 The applicable sections of the Internal Revenue Code of 1939 are as follows:

 ' § 161. Imposition of tax. (a) Application of tax. The taxes imposed by this chapter * * * upon individuals shall apply to the income of estates or of any kind of property held in trust * * *.'

 ' § 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 legatees heirs, or beneficiaries, but the amount so allowed as a deduction shall be included in computing the net income of the legatees, heirs, or beneficiaries whether distributed to them or not.' 26 U.S.C.A. §§ 161(a), 162(b).

 Amplifying this, the Supreme Court said in Freuler v. Helvering, 1934, 291 U.S. 35, 41, 54 S. Ct. 308, 310, 78 L. Ed. 634: 'Plainly the section *fn3" contemplates the taxation of the entire net income of the trust. Plainly, also, the fiduciary, in computing net income, is authorized to make whatever appropriate deductions other taxpayers are allowed by law. * * * This (net income) the fiduciary may be required to accumulate, or, on the other hand, he may be under a duty currently to distribute it. If the latter, then the scheme of the act is to treat the amount so distributable, not as the trust's income, but as the beneficiary's. * * * The tax on the entire net income of the trust is to be paid by the fiduciary or the beneficiaries or partly by each * * *.'

 Reduced to its simplest terms, the question in this case is whether the tax free nature of the exchange of the securities shielded the beneficiaries from tax when some of the new securities were distributed to them in kind as 'income' under ...


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