The opinion of the court was delivered by: HANNUM
Before the Court for resolution are cross motions for summary judgment filed by the Trustee in Bankruptcy of I. J. Knight Realty Corp. ("Trustee") and the United States regarding the government's claim for certain federal income taxes. Disposition by summary judgment is appropriate since the parties have submitted a joint stipulation of facts.
To provide the context for the legal questions raised, a brief summary of the facts and prior proceedings is appropriate. I. J. Knight Realty Corp. ("I. J. Knight") is a Pennsylvania corporation which formerly owned as its principal asset the Fretz Building located at 10th and Diamond Streets in Philadelphia. I. J. Knight's business consisted of leasing space in this building and maintaining it for the benefit of its tenants.
On November 16, 1962, the corporation filed a petition for an arrangement under Chapter XI of the Bankruptcy Act, 11 U.S.C. §§ 701-799. Francis Shunk Brown, Esquire, was appointed receiver and authorized to continue operation of the business. Approximately six weeks later, on January 1, 1963, the Fretz Building was totally destroyed by fire in one of the largest conflagrations in Philadelphia history. The fire destroyed all of I. J. Knight's corporate records and damaged adjoining properties severely. Because of the destruction of the corporation's principal asset, no business remained for the receiver to operate. There were, however, numerous claims filed with the receiver for damage resulting from the fire. The dollar amount of these claims was considerably in excess of I. J. Knight's total assets. It was alleged (and ultimately held by the Supreme Court in Reading Co. v. Brown, 391 U.S. 471, 88 S. Ct. 1759, 20 L. Ed. 2d 751 (1968)) that these claims constituted administrative expenses of the Chapter XI proceeding and therefore took priority over the claims of general creditors.
Left with no business and crippling damage claims, I. J. Knight filed for bankruptcy, and on May 14, 1963, was adjudicated a bankrupt. Francis Shunk Brown, Esquire, the former receiver, was elected trustee in bankruptcy. Besides its land and a small amount of cash, at this point, I. J. Knight's value lay in insurance claims against Lloyds, London, Southwest Casualty Co., and Annapolis Fire & Marine Insurance Co., in a gross amount of $1,440,000. The trustee settled the claim against Lloyds for $800,000., received in fiscal 1964, and later, in fiscal 1966, settled the claims against the other two companies for $56,250. A portion of these funds was placed in interest bearing accounts while awaiting distribution in liquidation.
On February 15, 1967, counsel for the Trustee filed federal income tax returns for fiscal years 1963-1966.
These returns showed miscellaneous income including interest on the deposited money, and for years in which insurance settlements had been received, these amounts in full were listed as "Gain from disposition of Depreciable Property under Section 1245." It was noted, however, that actual gain on the involuntary conversion caused by the fire could not then be computed. Because I. J. Knight's corporate records had been lost in the fire, its adjusted basis in the Fretz Building was unknown. Based on the figures then available to the Trustee, each return showed no taxable income after deductions and net operating loss carry-overs and, hence, no federal income tax due. Returns for subsequent years were filed on or before their due dates and followed basically the same format.
In 1971, the I.R.S. conducted an audit of the Trustee's returns for fiscal years 1963 through 1970. As a result of this audit, certain deductions and net operating loss carry-overs were disallowed. In addition, the auditing agent determined the adjusted basis of the Fretz Building to be $237,036.78, thus making the gain on its involuntary conversion $619,213.22. This gain in its entirety was allocated to fiscal year 1964 by the auditor. The above changes resulted in deficiencies which were assessed against the Trustee. The I.R.S. also claimed that I. J. Knight owed Personal Holding Company Tax under Section 541 of the Internal Revenue Code.
In September and October 1972, the Trustee and the Government each filed motions for summary judgment based on the facts as stipulated. It was the Trustee's contention at that time that a "non-operating" trustee for a bankrupt corporation is not liable for the payment of federal taxes on income generated during the liquidation and distribution of the bankrupt estate. On August 14, 1973, this Court so held in a Memorandum and Order granting the Trustee's motion for summary judgment and denying the government's motion for summary judgment. In Re I. J. Knight Realty Corp., 366 F. Supp. 450 (E.D.Pa.1973). Since that ground alone was dispositive of both motions, the Court did not consider the other contentions of the parties.
On July 31, 1974, the Third Circuit Court of Appeals reversed the judgment of this Court and remanded the case for further proceedings. In Re I. J. Knight Realty Corp., 501 F.2d 62 (3d Cir. 1974). Between that time and the present, the parties have tried diligently to settle the claims to no avail. The issues have, however, been considerably simplified and refined in two respects. First, taxes for post-1966 fiscal years have been eliminated from consideration. The Trustee has conceded that the federal income tax claims for these years are administrative expenses of the bankruptcy proceeding and that interest accrues on these claims as provided by law. The parties have agreed upon the amounts due for these years and by order of this Court dated August 21, 1975, the Trustee was authorized to pay these amounts. Second, the United States has abandoned its claim for personal holding company taxes.
Accordingly, there are four questions left for resolution by the Court with respect to fiscal years 1964, 1965 and 1966. These are:
2. Whether the Trustee was entitled to a deduction under Section 461(f) of the Internal Revenue Code and, if so, the amount of that deduction.
3. Whether the claim of the United States for fiscal 1964 is an expense of the administration of the Chapter XI proceeding which gives it a priority only as high as the fire damage claims, or an expense of the succeeding bankruptcy which would give the claim priority over the fire loss claims.
4. Whether the Trustee is subject to additions to tax imposed by Section 6651(a) of the Internal Revenue Code for fiscal years 1964 and 1965.
In connection with issue 3, the Court has granted the motion of the Reading Company (the principal fire loss claimant) and other fire loss claimants represented by the ...