Opinion
Docket Nos. 6514-6525, 6547.
Promulgated May 14, 1947.
In the taxable year 1940, petitioners were members of the New York partnership of J. P. Morgan Co. On March 29, 1940, under the Banking Law of New York, they organized a trust company in the name of "J. P. Morgan Co. Incorporated." They acquired more than 72 per cent of its outstanding stock. On March 30, 1940, by bill of sale and agreement, the partnership transferred certain of its assets to the trust company. The latter assumed all the liabilities of the partnership and paid to it in cash the difference between the fair market value of the assets transferred and the liabilities assumed. On the same date, the partnership, on behalf of its members, contributed certain defaulted securities and cash to the surplus of the trust company. The respondent denied to petitioners any losses resulting from these transfers, under the provisions of section 24 (b) (1) (B), I. R. C. In Docket No. 6524, respondent included in the gross income of the decedent certain income of a trust created by decedent which was paid to named beneficiaries and, also, included the sum of $25,000 paid by decedent to beneficiaries pursuant to the provisions of the will of decedent's father. Held:
(1) The securities listed in the bill of sale were sold by the partnership to the trust company, and respondent improperly disallowed deduction of the resulting losses under the provisions of section 24 (b) (1) (B), I. R. C.
(2) The contribution of the defaulted securities and cash was in effect made by the partners individually to the trust company, and, since there was no sale or exchange, but rather a contribution to the surplus of the trust company, no deductible losses resulted from such transaction in the taxable year.
(3) In Docket No. 6524, respondent properly included the contested items as income of the decedent.
Montgomery B. Angell, Esq., and George Craven, Esq., for the petitioners.
Conway N. Kitchen, Esq., for the respondent.
These consolidated proceedings involve income tax deficiencies totaling $883,685.85 for the calendar year 1940, as follows:
In respondent's answer he requests an increase in deficiency of $16,672.54.
The primary issue common to all petitioners is whether certain losses resulting from the transfer, pursuant to a bill of sale and agreement dated March 30, 1940, between J. P. Morgan Co., a partnership, the partners of that firm individually, and J. P. Morgan Co. Inc., a trust company, are nondeductible by virtue of the provisions of section 24 (b) (1) (B) of the Internal Revenue Code.
A secondary issue is whether with respect to certain other property which was contributed to J. P. Morgan Co. Inc. any losses are deductible.
An alternative issue is whether the 13 individual petitioners, as ex-partners of J. P. Morgan Co., sustained a deductible loss of 1940 measured by the difference between the adjusted cost or basis of the interest of each in the firm as of March 30, 1940, and the cash and property received by each in the final liquidation and winding up of the firm on that date.
In Docket No. 6524, in which the estate of J. P. Morgan, deceased, is petitioner, two additional issues are presented:
(1) Whether there should be included in decedent's gross income for 1940 ordinary income of $38,682.24 and a capital net gain of $9,883.54, realized by an irrevocable trust created by the decedent on February 7, 1930, under which the decedent reserved the power to alter or amend without any right to retake the principal or income of the trust, whether ordinary income or capital gain.
(2) Whether there should be included in decedent's income the amount of $25,000 which was payable under the terms of the will of decedent's father (the elder Morgan) to a named beneficiary, Annette B. Markoe, and which was paid by the decedent to such beneficiary pursuant to an obligation imposed upon him by such will.
FINDINGS OF FACT.
On March 31, 1916, the partnership of J. P. Morgan Co. was formed for the purpose of carrying on a general banking business in New York City under the name of J. P. Morgan Co., and in Philadelphia, Pennsylvania, under the name of Drexel Co.
The 13 petitioners involved herein filed their Federal income tax returns for the taxable year 1940 with the collector of internal revenue for the second district of New York. J. P. Morgan Co.-Drexel Co. filed a partnership return on Form 1065 for the period January 1 to March 31, 1940, with the collector of internal revenue for the second district of New York.
On March 30, 1940, the members of J. P. Morgan Co. and the dates of their admission to this firm or its predecessor firms were as follows:
J. P. Morgan ....................... Jan. 1, 1892 Thomas W. Lamont ................... Dec. 31, 1910 Junius S. Morgan ................... Dec. 31, 1919 George Whitney ..................... Dec. 13, 1919 R. C. Leffingwell .................. June 30, 1923 Francis D. Bartow .................. Dec. 31, 1926 Arthur M. Anderson ................. Dec. 21, 1926 Thomas S. Lamont ................... Dec. 31, 1928 H. P. Davidson ..................... Dec. 31, 1932 Charles D. Dickey .................. Jan. 2, 1932 Henry C. Alexander ................. Feb. 17, 1939 I. C. Raymond Atkin ................ Feb. 17, 1939 William A. Mitchell ................ Feb. 17, 1939 Edward Hopkison, Jr. ............... Dec. 31 1928
Hopkinson withdrew in the morning of March 30, 1940, and his interest in the firm was settled.
On February 15, 1940, there was filed with the State Superintendent of Banks of New York a notice of intention to organize a new trust company, pursuant to the Banking Law of New York, under the name of "J. P. Morgan Co. Incorporated," with an authorized capital of $20,000,000, divided into 200,000 shares, each of the par value of $100. Under date of March 29, 1940, the State Superintendent of Banks of New York issued a certificate authorizing J. P. Morgan Co. Inc. to transact the business of a trust company in New York, N Y
On March 30, 1940, a special meeting of the directors of J. P. Morgan Co. Inc. (hereinafter referred to as the trust company) was held. The directors of the trust company were composed entirely of the then 13 partners of J. P. Morgan Co. At this meeting a resolution was adopted authorizing the trust company to purchase the assets and to assume the liabilities and obligations of J. P. Morgan Co. as set forth in a bill of sale and agreement presented to the meeting. On the same date the bill of sale and agreement was executed by J. P. Morgan Co., the 13 individual partners, and the trust company. At the above mentioned meeting, a letter was presented signed by J. P. Morgan Co. and addressed to the trust company, offering on behalf of the partners to make a contribution of certain defaulted securities and cash, in the amount of $55,073.01, to the surplus of the trust company. The offer was accepted by appropriate resolution. At a special meeting held on the same day, the stockholders approved the action of the directors and confirmed the execution of the bill of sale and agreement. The total agreed value of the assets, rights, and property transferred to the trust company, exclusive of the contribution, was $597,098,131.87. The agreed amount of the liabilities assumed by it totaled $584,832,737.78. On the same day the excess of the value of such transferred assets over the assumed liabilities, which was the sum of $12,265,394.00, was paid by check of the trust company to J. P. Morgan Co., and deposited in the firm's account. Likewise, on the same day the amount of $12,210,321.08, representing the $12,265,394.09 less the cash item of $55,073.01, was paid over to the trust company to the credit of the individual personal accounts of the 13 partners as follows:
J. P. Morgan ................................... $1,061,923.59 Thomas W. Lamont ............................... 6,822,418.97 Junius S. Morgan ............................... 467,094.03 George Whitney ................................. 82,987.64 R. C. Leffingwell .............................. 606,930.89 F. D. Bartow ................................... 984,772.19 A. M. Anderson ................................. 561,204.03 T. S. Lamont ................................... 370,568.06 H. P. Davidson ................................. 708,670.28 C. D. Dickey ................................... 516,599.58 H. C. Alexander ................................ 19,787.62 I. C. R. Atkin ................................. 5,127.96 W. A. Mitchell ................................. 2,236.24
The bill of sale and agreement contained a provision whereby each of the 13 partners agreed "for himself and for his heirs, executors, administrators and assigns" that, except as an employee of the trust company, he would not engage in any business under the name J. P. Morgan Co. or under any similar name.
The trust company issued its entire amount of authorized capital stock, totaling 200,000 shares, to original subscribers for $200 per share, of which $20,000,000 represented capital and $20,000,000 paid-in surplus. Of the 200,000 shares, 145,830 were subscribed and paid for by the 13 partners as follows:
Shares Amounts subscribed for paid in cash for stock J. P. Morgan ........................ 20,000 $4,000,000 Thomas W. Lamont .................... 70,625 14,125,000 Junius S. Morgan .................... 9,790 1,958,000 George Whitney ...................... 9,500 1,900,000 R. C. Leffingwell ................... 17,500 3,500,000 Francis D. Bartow ................... 5,000 1,000,000 Arthur M. Anderson .................. 6,250 1,250,000 Thomas S. Lamont .................... 2,000 400,000 H. P. Davison ....................... 2,500 500,000 Charles D. Dickey ................... 2,000 400,000 Henry C. Alexander .................. 500 100,000 L. C. Raymond Atkin ................. 100 20,000 William A. Mitchell ................. 65 13,000 ------- ---------- Total ........................... 145,830 29,166,000 Of the 9,790 shares subscribed by Junius S. Morgan, 40 shares were for his children, for which he paid $8,000 in cash by withdrawal from his firm account. I. C. Raymond Atkin paid the sum of $20,000 for his 100 shares out of his personal funds, which he did not withdraw from the firm. The firm of J. P. Morgan Co. did not subscribe for, purchase, or at any time own any of the trust company stock. The percentage in value of the stock ownership of the 13 partners was 72.915. On March 27, 1940, relatives of the 13 partners purchased 10,505 shares, or a percentage in value of 5.2525.The undisputed amounts of the short term capital gains, the amounts of the long term capital gains after applying the percentages specified in section 117 (b), the amounts of short term capital losses, and the amounts of the long term capital losses after applying the percentages specified in section 117 (b) of the Internal Revenue Code are set forth in the following schedule:
Long term Short term gains taken gains into account under sec. 117(b) J. P. Morgan .......................... $173,629.84 $210,039.44 Thomas W. Lamont ...................... 159,076.91 119,275.36 Junius S. Morgan ...................... 82,230.33 48,835.83 George Whitney ........................ 138,251.54 91,500.41 R. C. Leffingwell ..................... L(5,978.86) 87,913.81 Francis D. Bartow ..................... 110,423.41 59,488.77 Arthur M. Anderson .................... 110,423.41 59,448.76 Thomas S. Lamont ...................... 82,230.32 32,044.81 H. P. Davison ......................... 82,230.32 32,044.84 Charles D. Dickey ..................... 82,412.81 35,611.02 Henry C. Alexander .................... 14,799.60 I. C. Raymond Atkin ................... 14,799.62 William A. Mitchell ................... 14,799.63 ------------ ---------- Total ............................. 1,059,328.88 776,243.05 Long term Short term losses taken losses into account under sec. 117(b) J. P. Morgan .......................... $225,002.77 $220,730.22 Thomas W. Lamont ...................... 206,527.34 171,617.49 Junius S. Morgan ...................... 107,684.48 84,644.69 George Whitney ........................ 179,685.48 146,148.20 R. C. Leffingwell ..................... 161,843.57 135,414.91 Francis D. Bartow ..................... 143,843.34 113,436.73 Arthur M. Anderson .................... 143,843.34 113,436.73 Thomas S. Lamont ...................... 107,684.49 80,257.73 H. P. Davison ......................... 107,684.57 80,257.74 Charles D. Dickey ..................... 107,842.84 84,423.57 Henry C. Alexander .................... 35,742.96 I. C. Raymond Atkin ................... 35,742.93 William A. Mitchell ................... 35,742.90 ------------ ------------ Total ............................. 1,598,871.01 1,230,368.01In computing the net income of the 13 partners the respondent included the short term and long term capital gains. He disallowed the short term and long term capital losses under section 24 (b) (1) (B) of the Internal Revenue Code.
Contributed Securities.
On March 30, 1940, J. P. Morgan Co. tendered to the trust company the defaulted securities and cash of $55,073.01 as a contribution to surplus under a letter dated March 30, 1940, addressed to the trust company and signed "J. P. Morgan Co." The letter recited that "We desire, on behalf of our partners, to make a contribution (without expense to your Corporation) to the surplus of your Corporation," and then listed the defaulted securities and the cash, adding that the value of such securities and cash on March 30, 1940, aggregated $1,527,731.01. The trust company accepted this contribution to surplus, and the defaulted securities and cash were delivered to the trust company. The fair market value on March 30, 1940, of the defaulted securities and the cash so contributed was $1,527,731.01.
On March 30, 1940, the following journal entries were made on the trust company books on account of the receipt of such contributions: Debit: Credit: Surplus Reserve
Missouri Pacific Railroad Co. loan ..... $1,365,613.00 Missouri Pacific Railroad Co. 5 1/2% bonds ......................... 19,537.50 Florida East Coast Railway Co. 5% bonds ............................. 7,812.50 Mobile Ohio Railroad Co. 5% secured notes .......................... 79,695.00 ------------- $1,472,658.00 Cash ................................................. 55,073.01 ------------- Surplus Contribution received from J.P. Morgan Co. ....... $1,527,731.01 Debit Surplus Credit Cash transferred ..................................... $1,527,731.01 These contributed securities were not included in the bill of sale and agreement of March 30, 1940, because the Banking Laws of the State of New York prohibit the purchase of securities in default by a trust company. While the certificates of deposit were not technically in default themselves, the certificates underlying those certificates of deposit were in default, and it was thought the statute applied to those securities.At the time of the transfer on March 30, 1940, pursuant to the bill of sale and agreement, of assets totaling $597,098,131.87, the contributed securities remained on the partnership books and were carried thereon as assets in the total amount of $1,472,658. At the time of the assumption on March 30, 1940, by the trust company of partnership liabilities totaling $584,832,737.78 pursuant to the bill of sale and agreement, there remained on the partnership books as liabilities the following:
General reserve ......................... $260,173.22 Special reserve ......................... 856,796.42 Profit and loss ......................... 410,761.37 ------------ Total ............................... 1,527,731.01
The "Special Reserve" of $856,796.42 represented the balance on March 30, 1940, on the partnership books in an account which was opened in 1916 for the purpose of making payments to retired employees of the partnership. When the present firm of J. P. Morgan Co. was created on March 31, 1916, there was set aside by the predecessor firm the sum of $600,000, which was to be held by the new firm as a pension reserve for the purpose of paying annual allowances to aged and retired employees. Since the creation of the "Special Reserve" in 1916, all payments made by the firm to its retired employees were paid out of and charged to this fund. Each year additional amounts were transferred to this special reserve out of profit and loss. When a partner retired or died, such partner was never credited with anything on account of any interest in the special reserve. In every year when contributions to the fund were made, the share of each partner in such contributions was taken as a deduction in his income tax returns, and such treatment for income tax purposes was approved by the revenue authorities.
When the trust company made its opening entries respecting the contributed cash and securities, the parties overlooked the "Special Reserve" of $856,796.42. On December 16, 1940, a resolution was passed, directing that the sum of $856,796.42 be charged to surplus reserve and credited to the special reserve fund. This transfer was made on the books of the trust company. All amounts paid by the trust company to the ex-employees of J. P. Morgan Co. after April 1, 1940, through November 1940, aggregating $114,579.42, were charged to the special reserve fund and credited to expenses. Since the creation of the special reserve on the books of the trust company, all payments made to ex-employees of J. P. Morgan Co. have been charged to the special reserve and not to income.
The adjusted cost of the contributed securities on March 30, 1940, to J. P. Morgan Co. was $3,707,189.14, after adjustment on that date for the settlement with Hopkinson. The market value of such securities on March 30, 1940, was $1,472,658.
The undisputed short term and long term losses on the contributed securities, after applying the percentages specified in section 117 (b) of the code, are as follows:
Short term Gross long Net long term losses term losses losses taken in account under sec. 117 (b) J. P. Morgan ............ $7.77 $550,405.33 $275,189.74 Thomas W. Lamont ........ 7.14 318,134.44 159,060.00 Junius S. Morgan ........ 3.72 147,261.17 73,627.50 George Whitney .......... 6.20 260,818.09 130,401.82 R. C. Leffingwell ....... 5.59 249,910.00 124,947.25 Francis D. Bartow ....... 4.96 187,321.59 93,654.08 Arthur M. Anderson ...... 4.96 187,321.59 93,654.08 Thomas S. Lamont ........ 3.72 109,798.01 54,860.92 H. P. Davison ........... 3.72 109,798.01 54,860.92 Charles D. Dickey ....... 3.72 107,938.14 53,964.42 Henry C. Alexander ...... 1,971.09 I. C. Raymond Atkin ..... 1,971.09 William A. Mitchell ..... 1,971.09 -------- ------------ ----------- 5,964.77 2,228,566.37 1,114,220.73 The petitioners claim a fractional part only of such losses, determined by applying the fraction 856,796.42/1,527,731.01. The numerator represents the amount of the "Special Reserve" and the denominator represents the current market value of the defaulted securities and cash contributed to the trust company. The fractional portions so claimed of the above losses are as follows: Fractional portion of — Short term Gross long Net long term losses term losses losses taken in account under sec. 117 (b) J. P. Morgan ............ $4.36 $308,683.47 $154,334.50 Thomas W. lamont ........ 4.00 178,419.14 89,205.52 Junius S. Morgan ........ 2.09 82,588.39 41,292.46 George Whitney .......... 3.48 146,274.45 73,133.17 R. C. Leffingwell ....... 3.14 140,156.87 70,074.09 Francis D. Bartow ....... 2.78 105,055.45 52,523.96 Arthur M. Anderson ...... 2.78 105,055.45 52,523.96 Thomas S. Lamont ........ 2.09 61,538.68 30,767.61 H. P. Davison ........... 2.09 61,538.68 30,767.61 Charles D. Dickey ....... 2.09 60,534.87 30,767.61 Henry C. Alexander ...... 1,105.45 I. C. Raymond Atkin ..... 1,105.45 William A. Mitchell ..... 1,105.45 ---------- ------------ ----------- 3,345.25 1,249,845.45 624,887.71 The respondent disallowed any losses in respect to the contributed securities.Morgan Cie.
The facts under the subheading "Morgan Cie." become material only if it becomes necessary to determine the alternative contention of the petitioners.
On March 30, 1940, J. P. Morgan Co. had a position as a partner in Morgan Cie. of Paris, a French partnership. The firm did not carry such position on its books, since the amounts invested in Morgan Cie. had been completely recovered. Under the French articles, J. P. Morgan Co. had an interest in frs. 515,000 out of a capital of frs. 1,000,000 and a 36 per cent interest in profit and loss. On March 30, 1940, the capital and net worth of Morgan Cie. was very small. J. P. Morgan Co. considered its interest as of no value and more of a liability than an asset, since the firm was liable as a partner and the war in Europe was then in progress. In the bill of sale and agreement of March 30, 1940, it was recited that J. P. Morgan Co. was a partner in Morgan Cie., and it was stated that the trust company "shall succeed to the business of Morgan Cie., * * * either directly through the acquisition and operation [of it as a branch] * * * or indirectly through a subsidiary or otherwise [and that the steps required to effect the sale] * * * shall be taken as promptly as is reasonably possible and, pending the consummation thereof, the business of Morgan Cie. shall be conducted in the usual manner and no transactions out of the ordinary course of business shall be effected without the approval of the * * * [trust company]." The bill of sale also recited that the partners of Morgan Cie. had expressed their approval and consent to these provisions. Due to conditions in Europe, the acquisition of the business of Morgan Cie. was not accomplished by a direct purchase as originally intended. Instead a New York corporation, Morgan Cie., Inc., was organized, with a capital of $150,000 consisting of 1,500 shares of the par value of $100 per share. The 13 partners of J. P. Morgan Co. subscribed for and purchased all its authorized stock and thereupon contributed the Morgan Cie., Inc., stock to the trust company. In May 1945, when conditions in Europe permitted, Morgan Cie., Inc., acquired all the business and assets of Morgan Cie. Basing negotiations on a document captioned "Balance Sheet per March 31, 1940," of Morgan Cie., two of the Paris partners and two of the J. P. Morgan Co. partners finally agreed upon the figure of frs. 3,787,575.55 as the value of Morgan Cie. as of March 30, 1940. The rate of exchange of francs on that date was $.020005, or a value in United States currency of $30,378.14. The computation is set forth in the following schedule:
Over-all value ......................... frs. 3,787,575.55 Less capital ................................ 1,000,000.00 ------------ Balance ..................................... 2,787,575.55 ============ Value of interest of J. P. Morgan Co. Capital ................................... 515,000.00
Non-capital interest 36% of frs. 2,787,575.55 ......................... frs. 1,003,527.20 ------------ Total value .......................... frs. 1,518,527.20 Conversion into dollars at exchange rate Mar. 30, 1940, of $.020005 ................ $30,378.14
The value of the interest of J. P. Morgan Co. in Morgan Cie. on March 30, 1940, was distributable among the 13 partners in the following fractions and amounts of dollars:
Interest Value of interest in Morgan Cie. J. P. Morgan .................. 125/860 $4,415.43 Thomas W. Lamont .............. 115/860 4,062.20 Junius S. Morgan............... 60/860 2,119.40 George Whitney ................ 100/860 3,532.34 R. C. Leffingwell ............. 90/860 3,179.11 Francis D. Bartow ............. 80/860 2,825.87 Arthur M. Anderson ............ 80/860 2,825.87 Thomas S. Lamont .............. 60/860 2,119.41 H.P. Davison .................. 60/860 2,119.41 Charles D. Dickey ............. 60/860 2,119.41 Henry C. Alexander ............ 10/860 353.23 I. C. Raymond Atkin ........... 10/860 353.23 William A. Mitchell ........... 10/860 353.23 --------- --------- Total .................... 860/860 30,378.14 The values received by each of the 13 partners, petitioners herein, on the dissolution, liquidation, and winding up of J. P. Morgan Co. on March 30, 1940, were as follows: Value of interest Cash in Morgan Total Cie. J. P. Morgan ............... $1,061,923.59 $4,415.43 $1,066,339.02 Thomas W. Lamont ........... 6,822,418.97 4,062.20 6,826,481.17 Junius S. Morgan ........... 467,094.03 2,119.40 469,213.43 George Whitney ............. 82,987.64 3,532.34 86,519.98 R. C. Leffingwell .......... 606,930.89 3,179.11 610,110.00 Francis D. Bartow .......... 984,772.19 2,825.87 987,598.06 Arthur M. Anderson ......... 561,204.03 2,825.87 564,029.90 Thomas S. Lamont ........... 370,568.06 2,119.41 372,687.47 H. P. Davison .............. 708,670.28 2,119.41 710,789.69 Charles D. Dickey .......... 516,599.58 2,119.41 518,718.99 Henry C. Alexander ......... 19,787.62 353.23 20,140.85 I. C. Raymond Atkin ........ 5,127.96 353.23 5,481.19 William A. Mitchell ........ 2,236.24 353.23 2,589.47 ------------- ------------- ------------- Total .................. 12,210,321.08 30,378.14 12,240,699.22 Upon the assumption that the losses sustained by J. P. Morgan Co. on the sale of securities under the bill of sale and on the contributed securities are not allowed, losses were sustained by each of the 13 partners, petitioners herein, on the dissolution, liquidation, and winding up of J. P. Morgan Co., and such losses on the three alternative hypothesis shown below and after applying the percentages set forth in section 117 (b), where required, were as follows: Losses taken into account if the losses are capital Losses if the losses and the losses are holding period is ordinary fixed by the time losses during which each partner held his partnership interest J. P. Morgan ......................... $956,593.68 $478,296.84 Thomas W. Lamont ..................... 712,109.89 356,054.94 Junius S. Morgan ..................... 351,160.84 175,580.42 George Whitney ....................... 604,213.31 302,106.65 R. C. Leffingwell .................... 560,085.28 280,042.64 Francis D. Bartow .................... 464,492.27 232,246.13 Arthur M. Anderson ................... 464,492.27 232,246.13 Thomas S. Lamont ..................... 319,531.23 159,765.62 H. P. Davison ........................ 319,531.32 159,765.66 Charles D. Dickey .................... 324,920.37 162,460.18 Henry C. Alexander ................... 36,495.18 36,495.18 I. C. Raymond Atkin .................. 36,495.15 36,495.15 William A. Mitchell .................. 36,495.12 36,495.12 ------------- ------------- Total ............................ 5,186,615.91 2,648,050.66 Losses taken into account if the losses are capital losses and the holding period is fixed by the time during which the securities were owned by the firm (J. P. Morgan Co.) Short term Long term J. P. Morgan ......................... $225,007.13 $372,857.01 Thomas W. Lamont ..................... 206,531.34 258,791.91 Junius S. Morgan ..................... 107,686.57 124,877.45 George Whitney ....................... 179,688.96 217,515.20 R. C. Leffingwell .................... 161,846.71 203,899.44 Francis D. Bartow .................... 143,846.12 164,547.71 Arthur M. Anderson ................... 143,846.12 164,547.71 Thomas S. Lamont ..................... 107,686.58 109,965.64 H. P. Davison ........................ 107,686.66 109,965.65 Charles D. Dickey .................... 107,844.93 113,628.70 Henry C. Alexander ................... 36,495.17 I. C. Raymond Atkin .................. 36,495.14 William A. Mitchell .................. 36,495.11 ------------- ------------- Total ............................ 1,601,156.54 1,840,596.42Additional Issues Raised in Docket No. 6524, Estate of J. P. Morgan.
J. P. Morgan (hereinafter referred to as "decedent") on February 7, 1930 created a trust, with Junius S. Morgan and Henry S. Morgan as trustees. He thereupon transferred and delivered to the trustees certain property, to be held pursuant to its provisions. The trust instrument provided, inter alia, that the net income should be paid from time to time to certain life beneficiaries as specified in a schedule attached to the trust indenture, with the provision that, if at any time the current income from the trust should not be sufficient to meet the payments provided in the schedule or any amendment thereto, the trustees should have full power and authority to apply any part of the principal to the payment of such income charges.Articles second and fourth of the trust indenture are as follows:
Second: Upon the death of any life tenant the trust created hereunder shall pro tanto cease and determine and the Trustees shall assign, transfer and pay over such principal of the said trust to the Grantor if living, otherwise to those persons who are named as residuary legatees in the Last Will and Testament of the Grantor.
Fourth: The right to alter or amend the terms and conditions of this Indenture are hereby reserved to the Grantor, including the right to the Grantor to withdraw at any time any particular security forming part of the capital assets and to substitute any other security or cash in lieu of such security withdrawn, but no right is reserved to revoke, repeal or in any wise revest any of the income of the trust herein created to the said Grantor.
The trustees were authorized to invest and reinvest in any type of corporate stock, bonds, or other securities, real estate mortgages, or any other kind of property; to sell any part of the trust corpus at public or private sale; and to borrow money and to execute and deliver notes in that connection. The trustees were specifically relieved of responsibility or liability for losses sustained by the trust and exempted from giving bond or security for the faithful performance of their duties. During the lifetime of decedent no investments could be acquired or disposed of except on his advice and consent.
On various dates between July 1, 1930, and December 28, 1942, the decedent exercised his right to alter or amend the trust by adding new beneficiaries; removing other beneficiaries; increasing the amounts payable to then existing beneficiaries; and reducing the amounts payable to certain beneficiaries.
In the year 1940 the net income of the trust, before deducting the amounts distributable to beneficiaries, amounted to $84,380.88, of which $9,883.54 constituted net long term capital gains realized on the sale of certain securities held as the corpus of the trust and taken into account in computing the net income of the trust, and the balance of $74,497.34 was ordinary net income. Of this $74,497.34, $38,682.24 was in fact distributed to the named beneficiaries within 1940.
The balance of net income of $35,815.10 was included by decedent in his income tax return for 1940 and is not here in controversy. The capital net gain of $9,883.54 was retained by the trustees and the trustees paid tax on it.
None of the persons who received the $38,682.24 was a member of the decedent's immediate family or a creditor or a legal dependent of the decedent; all such beneficiaries were either friends or former employees of decedent.
Decedent's father, the elder J. P. Morgan, died on March 31, 1913, leaving a last will and testament, which was duly admitted to probate on April 22, 1913. Decedent was the residuary legatee and devisee of his father's estate and was one of the executors of and trustees under his father's will.
Article XVI of the will is as follows:
Article XVI. I direct my executors to set apart a sum which in their judgment shall be sufficient, under all probable contingencies, to yield a net annual income of Twenty-Five Thousand Dollars, and I give and bequeath such sum unto my said executors and trustees, In Trust to collect and receive the income thereof and to pay over out of said income the sum of Twenty-Five Thousand Dollars per annum, in equal quarterly installments, unto my friend Doctor James W. Markoe, during his natural life, and upon the further trust, if his wife Annette B. Markoe shall survive him, from and after his death to pay over the said sum of Twenty-Five Thousand Dollars per annum, in equal quarterly installments, unto the said Annette B. Markoe during her natural life.
I hereby authorize my said executors and trustees, if in their judgment the same shall seem prudent and desirable, in lieu of setting apart said trust fund in this article mentioned, to accept the bond or obligation of my son John Pierpont Morgan, Junior, if he shall survive me, and if not, then the bond or obligation of my grandson Junius Spencer Morgan, Junior, to pay to the said James W. Markoe and to his wife, or to my said executors and trustees for his or her account, the said annual sum of Twenty-Five Thousands Dollars in the manner above provided, hereby giving to my said executors and trustees full power and authority to determine what, if any, security they shall require from my said son or my said grandson for the performance of such bond or obligation.
I make this provision for the benefit of Dr. Markoe and his wife in recognition of our long friendship and of his devotion for many years of almost his entire time and energy to the service of the Lying-In Hospital, an institution in which I have been greatly interested.
Acting under the discretion conferred upon them in the will, the executors and trustees under the will of the elder J. P. Morgan did not set up a trust fund to yield income with which to make the annual payments of $25,000 provided in article XVI of the will, but, in lieu of setting up such trust fund, accepted the bond of decedent pursuant to which decedent agreed to make such annual payments.
James W. Markoe, named in article XVI of the will, died in April 1920, and his wife, Annette B. Markoe, survived him. Annette B. Markoe was living during the entire year 1940. Decedent in the year 1940 made a payment of $25,000 to Annette B. Markoe, pursuant to the provisions of the bond which he had given the executors and trustees under his father's will.
The residuary estate of the elder J. P. Morgan which was received by decedent had a net value well in excess of $10,000,000. At the time of the death of the elder J. P. Morgan it would have required a capital sum of $600,000 to produce a net annual income of $25,000.
In his income tax return for 1940 decedent claimed a deduction on account of said $25,000 payment to Annette B. Markoe in that year. In his deficiency notice respondent failed to disallow the $25,000 deduction for the taxable year 1940. In his answer filed herein the respondent asks for an increased deficiency in the amount of $16,672.54, as a result of increasing the taxable income of decedent for the year 1940 by the sum of such $25,000.
OPINION.
The primary issue, common to all petitioners, is whether the respondent properly denied to them any losses in the taxable year 1940 resulting from the sale of certain assets of the copartnership of J. P. Morgan Co. by virtue of the applicability of the provisions of section 24 (b) (1) (B) of the Internal Revenue Code. Petitioners concede that together they owned "more than 50 per centum * * * of the outstanding stock" of the trust company within the purview of section 24 (b) (2) (A) and (B), as added by section 301 of the Revenue Act of 1937.
SEC. 24. ITEMS NOT DEDUCTIBLE.
(b) LOSSES FROM SALES OR EXCHANGES OF PROPERTY. —
(1) LOSSES DISALLOWED. — In computing net income no deduction shall in any case be allowed in respect of losses from sales or exchanges of property, directly or indirectly —
* * * * * * *
(B) Except in the case of distributions in liquidation, between an individual and a corporation more than 50 per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual.
On March 30, 1940, by an instrument entitled "Bill of Sale and Agreement," assets owned by J. P. Morgan Co., a New York partnership, and having a then fair market value of $597,098,131.87, were transferred to J. P. Morgan Co., Inc., a trust company organized under the Banking Laws of the State of New York. In consideration therefor, the trust company assumed all the liabilities of the partnership, totaling $584,832,737.78, and paid the difference of $12,265,394.09 by check to the order of J. P. Morgan Co. The amounts of gains and losses sustained on the transfer of this property under the bill of sale and agreement are not in dispute.
Thus the issue is narrowed to the proper construction of the language, "Except in the case of distribution in liquidation, between an individual and a corporation," contained in that section. We pass consideration of the question whether "distributions in liquidation" is applicable to the facts here, and consider only whether the transfer of the assets pursuant to the bill of sale and agreement constituted a sale "between an individual and a corporation" within the meaning of the section.
In contending that the transaction of March 30, 1940, was a sale "between an individual and a corporation" the respondent relies heavily on the instrument under which the transfer was made. He directs attention to the fact that the partners of J. P. Morgan Co. were individually named as parties and all 13 executed the agreement as individuals. These are isolated facts. Considered in the light of the entire instrument, we do not think they warrant the significance the respondent would have us place upon them. It is to be noted that the bill of sale and agreement recites that it is between J. P. Morgan Co., a partnership, the partners of the firm individually, and J. P. Morgan Co. Inc. In the preamble it is stated: "Whereas, the Firm * * * now desires to sell to the Bank its banking business * * *." It then provides:
The Firm and each of the Partners, respectively, hereby sells, assigns, transfers and delivers to the Bank, all of its and his respective right, title and interest in and to all of the * * * assets, rights and properties of the Firm.
It then recites: "The sum of $12,265,394.09 payable by the Bank to the Firm upon the execution of this Agreement, the receipt whereof is hereby acknowledged by the Firm. * * *"
The agreement was executed by J. P. Morgan Co., each of the 13 individual partners, and the trust company. The agreement contains a personal covenant of each partner not to engage in any banking or other business under the name of J. P. Morgan Co., or a similar name. This provision was inserted for the protection of the purchaser. Its effectiveness required that the individual partners be named as separate parties to the agreement and to so execute it.
J. P. Morgan Co. admittedly was a valid New York partnership. Under the law of that state, which is here controlling, not the individual partners, but the partnership itself owned its assets. The interests of the several partners in the partnership were merely the respective shares of the profits and surplus, less its obligations. New York Partnership Law, sec. 52. Cf. Robert E. Ford, 6 T.C. 499; Allan S. Lehman, 7 T.C. 1088; Blodgett v. Silberman, 277 U.S. 1; Case v. Beauregard, 99 U.S. 119. However, a more difficult aspect of the problem remains to be considered. Does the term "individual" as used in section 24 (b) (1) (B) include a partnership?
Respondent acquiesces, C. B. 1946-2, p. 2.
Words used in a statute are to be taken in their usual everyday meaning, and this is particularly true of revenue statutes. Welch v. Helvering, 290 U.S. 111; Lang v. Commissioner, 289 U.S. 109; Old Colony R. R. Co. v. Commissioner, 284 U.S. 552, 560. Black's Law Dictionary defines the term "individual" as follows:
As a noun, this term denotes a single person as distinguished from a group or class, and also, very commonly, a private or natural person as distinguished from a partnership, corporation, or association; but it is said this restrictive signification is not necessarily inherent in the word, and that it may, in proper cases, include artificial persons. See Bank of U.S. v. State, 12 Smedes M. (Miss.) 460; State v. Bell Telephone Co., 36 Ohio St. 310; 38 Am. Rep. 583; Pennsylvania R. Co. v. Canal Com'rs, 21 Pa. 20; In re New Era Novelty Co. (D.C.), 241 Fed. 298, 299.
See also People v. Doty, 80 N.Y. 225, 228. We find nothing in the context of the section to indicate the term "individual" was used in other than in its commonly accepted meaning. The specific provision with which we are here concerned first appeared in identical language as section 24 (a) (6) of the Revenue Act of 1934. The hearings before the Ways and Means Committee considering a bill to revise the revenue laws in 1934 clearly evidence that the purpose of the section was to close "loopholes" which permitted the avoidance of taxes. Experience had shown that, by means of so-called sales between members of families and between individuals and corporations they controlled, large losses had been claimed as deductions against income. The difficulty of determining the bona fides of such transactions led to the conclusion that all losses resulting from sales coming within the prescribed categories should be denied recognition for income tax purposes. There is no suggestion that partnership losses were considered in connection with this provision. That they were not intended to be affected by the provision is indicated by the fact that the subject of partnership losses was separately treated. See also Commissioner v. Lamont, 156 F.2d 800.
SEC. 24. ITEMS NOT DEDUCTIBLE.
(a) GENERAL RULE. — In computing net income no deduction shall in any case be allowed in respect of —
* * * * * * *
(6) Loss from sales or exchanges of property, directly or indirectly, (A) between members of a family, or (B) except in the case of distributions in liquidation, between an individual and a corporation in which such individual owns, directly or indirectly, more than 50 per centum in value of the outstanding stock. For the purpose of this paragraph (C) an individual shall be considered as owning the stock owned, directly or indirectly, by his family; and (D) the family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants.
[See S. R. 558, 73d Cong., 2d sess., p. 27.]
In the preliminary report of the subcommittee of the Ways and Means Committee appointed inter alia to investigate tax avoidance, of which Congressman Hill was chairman, it is stated in paragraph (9):
"Under the present law (sec. 182 Revenue Act of 1932) as interpreted by the Treasury, a member of a partnership is entitled to reduce his ordinary income by a net loss of the partnership of which he is a member, according to his distributive share in the partnership * * *. Your subcommittee is of the opinion that partners should not be permitted to offset against their ordinary income losses sustained by the partnership. * * *"
In response to this suggestion the Treasury replied as follows:
"* * * The Treasury Department believes that this change is of doubtful wisdom. A partnership for other legal purposes, as well as for the purposes of the tax law, is not regarded as a legal entity. * * * The treatment of partnership income and deductions should be consistent. So long as the partner must report all partnership income he should be permitted to deduct the corresponding partnership losses. The losses now deducted are not fictitious or imaginary and do not represent either evasion or avoidance of the income tax. In the opinion of the Department, the proposal would probably operate with extreme injustice upon the many small businesses scattered over the country, which typically are unincorporated."
Later at the hearings of the Ways and Means Committee, Chairman Hill made the following statement:
"* * * A partnership in that strict sense is not a legal entity, but it is as a matter of fact a business set-up, separate and apart from each individual associated in the partnership.
"In other words, the partnership business is separate from the individual business of the partners. It seems to me that it could very properly be considered for purposes of taxation a legal entity although it is not, as I concede, under the present set-up.
"It is upon that theory that I understand, of course, the Treasury has said, if you are going to apportion net gains to the partners for taxation purposes, then you should apportion net losses to the partners as offsets against the income that they might have.
"But I think it is not at all inconsistent with the idea that we carry out in connection with corporations, to say that you must absorb your losses within that particular entity. Then if you have any net gains, we will tax them. That is the theory on which the subcommittee proceeded."
In the Report of the Ways and Means Committee (H. R. 704, 73d Cong., 2d sess.; C. B. 1939-1, Part 2, p. 567) adopting the report of the subcommittee it is stated:
"* * * Under the bill, the partnership will be permitted to deduct losses on the sale of capital assets only to the extent of gains from such sales (section 117 (d)). Thus the partnership can have no capital net loss and therefore the partner can have no deduction on account of any capital loss of the partnership. In this way the main source of the tax avoidance by banking and security partnerships in the past can be eliminated."
Similar language appears in the Report of the Senate Committee on Finance. (S. R. No. 558, 73d Cong., 2d sess.; C. B. 1939-1, Part 2, p. 600.)
"Section 186 [Revenue Act of 1932] Capital Gains and Losses: This section is omitted on account of the change in policy in taxing capital gains and losses." (C. B. 1939-1, Part 2, p. 579.)
The Revenue Act of 1937, in order to further prevent evasion and avoidance of taxes, materially amended section 24 (b). Several new provisions denying losses from transactions between certain particularized groups were added. Here again partnerships were not specifically mentioned. But partnerships, although not regarded as entities for taxpaying purposes, are considered as such for computing their income. And Congress has treated partnerships as it has corporations generally, personal holding companies, foreign personal holding companies, and fiduciaries, specifically and with particularity in the revenue acts. Yet in section 24 (b) (1), although it expressly includes corporations, personal holding companies, and foreign personal holding companies, it does not mention partnerships. The respondent in effect argues that, in broadening the rule for determining stock ownership in a corporation by section 301 of the Revenue Act of 1937, Congress evidenced an intention to broaden the term "individual" to include partnerships. We do not agree. Those provisions, as clearly revealed by their contents, had merely to do with determining stock ownership for the purpose of passing on the question of 50 per cent ownership, which is only one of the determinants as to the applicability of section 24 (b). We do not find in these amendments any evidence of an intent to embrace a partnership within the term "individual." To so hold, we think, would enlarge the statute by judicial construction. Since section 24 (b) is expressly restrictive in character, we should not arbitrarily extend the boundary of the prohibited classes to include those not specifically mentioned or within the natural and ordinary meaning of the terms used. With respect to the securities listed in the bill of sale and agreement, the respondent erred in refusing to recognize the losses suffered.
See sec. 24 (b) (1) (B) and (C), as added by Revenue Act of 1937.
Supplement F — Partnerships, sec. 181-190; Supplement E — Estates Trusts, sec. 161-172; Supplement P — Foreign Personal Holding Companies, sec. 331-340; ch. 2, subch. A, Personal Holding Companies, sec. 500-511.
SEC. 301. DISALLOWED DEDUCTIONS.
(a) Section 24 (A) of the Revenue Act of 1936 is amended to read as follows:
* * * * * * *
"b) LOSSES FROM SALES OR EXCHANGES OF PROPERTY. —
* * * * * * *
"(2) STOCK OWNERSHIP, FAMILY, AND PARTNERSHIP RULE. — For the purposes of determining, in applying paragraph (1), the ownership of stock —
"(A) Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust, shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries;
* * * * * * *
"(C) An individual owning (otherwise than by the application of subparagraph (B)) any stock in a corporation shall be considered as owning the stock owned, directly or indirectly, by or for his partner;
* * * * * * *"
As to the losses claimed on the transfer of the "contributed securities" having a current value of $1,472,658, we think a different conclusion must be reached. While it was primarily intended to include such securities in the bill of sale and agreement, the plan was abandoned because of the belief that the trust company was prohibited by law from purchasing such securities.
The respondent argues that the transfer of the defaulted securities constituted a "gift." Whether it may be correctly so characterized here need not be decided, since, if it was not a gift, the result would be the same. It would then constitute a contribution to the capital of the trust company by the petitioner stockholders and therefore a part of the cost to them of their stock in that company. Since the contributed securities increased the capital value of the trust company, the value of the stock of the 13 partners, as well as that of all other stockholders, was proportionately enhanced.
In transferring the defaulted securities the partnership was not engaging in any function of the partnership. It was merely acting as the agent of the individual partners. That the transaction was so regarded seems implicit in the use of the phrase "on behalf of our partners," in the letter making the offer. The transfer was made through the partnership because the character of the securities made it undesirable, if not impractical, to attempt a proportional division in kind among the respective partners. In invoking the principle that substance prevails over form in matters of taxation ( United States v. Phellis, 257 U.S. 156, 168), the partnership in effect made a cash distribution in the amount of $55,073.01 and a distribution in kind of the defaulted securities to its 13 individual partners. Following this, the partners are to be regarded as having individually made a contribution to the capital surplus of the trust company. Each partner's proportionate share of the cash and defaulted securities is to be considered as increasing the cost of his shares in the capital stock of the trust company. Since the securities were contributed in kind to the trust company, there was no sale or exchange resulting in a closed transaction giving rise to gain or loss. Interstate Transit Lines v. Commissioner, 130 Fed. 2d 136; In re Park's Estate, 58 F.2d 965; certiorari denied, 287 U.S. 645; Menihan v. Commissioner, 79 F.2d 304; certiorari denied, 296 U.S. 651. We affirm the respondent's disallowance of any deduction on account of the transaction under which cash and defaulted securities were contributed to the trust company.
In view of our determinations, we think it unnecessary to pass upon the further contention of the petitioners that, if the term "individual" includes partnership, then a liquidation of the partnership was effected within the meaning of the excepting clause contained in section 24 (b) (1) (B). Nor is it necessary at this time to consider the status of the "Special Reserve" of $856,796.42. As a result, the transaction respecting the French partnership of Morgan Cie. is not involved. However, we have found the facts in connection with the special reserve fund and Morgan Cie. in the event an appellate court disagrees with our determination.
The remaining two issues are germane only to Docket No. 6524, in which the estate of J. P. Morgan, deceased, is petitioner. One of such issues involves the question whether there should be included in decedent's gross income for the taxable year 1940, ordinary income in the amount of $38,682.24 and a net capital gain of $9,883.54 realized by an irrevocable trust created by decedent in which the power to alter and amend was reserved without any right to retake the principal or income. The other issue involves the question whether there should be included in decedent's income the sum of $25,000 which was payable under the terms of the will of decedent's father to a named beneficiary. Both of these issues were determined by this Court in a prior proceeding, entitled "Estate of J. P. Morgan, Deceased," Docket No. 1770, now on appeal.
The petitioner presents these two issues only to preserve them in the event our prior decision is reversed. We conclude, on this record, that both the contested amounts were properly included in the gross income of the petitioner in the taxable year 1940 and, therefore, sustain the respondent on both such issues.
Reviewed by the Court.
Decisions will be entered under Rule 50.