King v. Commissioner

*1158 This proceeding is for the redetermination*1181 of a deficiency in income taxes for the calendar year 1925, in the amount of $1,000.37. The only issue is whether the respondent erred in including in the taxable income of petitioner for the year 1925, the amount of $26,000, representing one-half of a fee received by him during that year for certain legal services rendered during the period from October, 1920, to September, 1924, claimed by petitioner, a resident of the State of Texas, to constitute income of the estate of his deceased wife who died in August, 1923. The proceeding was submitted upon the pleadings, an agreed statement of facts, and the oral testimony of petitioner.

*1159 FINDINGS OF FACT.

Petitioner is an individual, residing in the city of Houston, Texas, and is now and was at all times material to this proceeding, engaged in the practice of law.

The books of account of petitioner were kept, and his income-tax return for the calendar year 1925 was filed, on the basis of cash receipts and disbursements.

On March 1, 1920, and for a number of years prior thereto, petitioner and one Samuel B. Dabney of Houston were general counsel for James A. Baker, who, at all times material to this proceeding, *1182 was engaged as receiver of the International & Great Northern Railway Company in a certain receivership suit then pending in the United States District Court for the Southern District of Texas, Houston Division, being Docket No. 49 in Equity, on the docket of that court.

In the fall of 1919, while the properties of the International & Great Northern Railway Company were being operated under Federal control, two fuel oil contracts were made and entered into between the Director General of Railroads and Baker, as parties of one part, and the Pierce Oil Corporation as the other party, whereby the Pierce Oil Corporation obligated itself to sell and deliver fuel oil in monthly installments for a period of one year from the date of the two contracts, such deliveries to be made to the Director General until the termination of Federal control and to Baker, when, as and if Federal control was terminated during the life of the contracts, which oil was to be delivered at the prices stipulated per barrel, as set forth in the contracts.

Federal control of the properties of the International & Great Northern Railway Company was duly terminated at midnight of February 29, 1920, and Baker resumed*1183 possession and operation of the railway properties at that time, and on March 1, 1920, the Pierce Oil Corporation refused to further perform the two fuel oil contracts for the remainder of the period of such contracts.

On October 11, 1920, a decree was duly entered in the above mentioned receivership proceeding, being Docket No. 49 in Equity, authorizing Baker to file suit against the Pierce Oil Corporation for damages for alleged breach of the two contracts, and on that date such suit was so instituted, ancillary to the main suit. This suit was instituted by petitioner and his associate, Dabney, as counsel for the receiver of the International & Great Northern Railway Company. At that time it was agreed by and between petitioner and Baker that the institution and prosecution of this suit would not constitute a part of petitioner's regular duties under this retainer, but would constitute a special employment, for which, but wholly contingent upon *1160 the successful outcome of the suit, he should be entitled to compensation in an amount to be determined if and when the suit was successfully terminated.

On November 2, 1920, the defendant, the Pierce Oil Corporation, *1184 filed a motion to dismiss the suit filed on October 11, 1920, which motion was overruled by the United States District Court for the Southern District of Texas, on June 20, 1921.

A special master in chancery was appointed and the case was heard by the master on April 26, 1922. On September 2, 1922, the master filed his findings of fact and recommendations with the court, in which he recommended a judgment in favor of Baker for the amount of $2,088,483.40, less an offset of $33,105.

On February 28, 1923, petitioner and Dabney, as counsel for the receiver, recovered a judgment against the Pierce Oil Corporation in the United States District Court for the Southern District of Texas, Houston Division, in the amount of $2,088,483.40, less an offset of $33,105.

On April 27, 1923, an appeal from the judgment of the District Court was filed by the Pierce Oil Corporation in the United States Circuit Court of Appeals for the Fifth Circuit, and the case was duly briefed on appeal by counsel for the Pierce Oil Corporation and by petitioner and Dabney and also Sam Streetman as special counsel for the receiver.

On August 29, 1923, the United States District Court for the Southern District*1185 of Texas, by decree entered in cause No. 49 in Equity, reserved jurisdiction in this receivership suit to determine what additional compensation should be awarded to Streetman, and also to determine what additional compensation should be paid to petitioner and Dabney, as counsel for the receiver, for services rendered, contingent upon recovery.

During this time and until August 31, 1923, petitioner was married to Mary McAdoo King, they having one child by this marriage, namely, Leon McAdoo King. On August 31, 1923, petitioner's wife died intestate, leaving as her heir at law, her son, Leon.

On July 22, 1924, a decree was entered authorizing the receiver to settle the case against the Pierce Oil Corporation for $1,555,425, and the case was immediately settled on that basis.

On September 8, 1924, hearing was had in the United States District Court for the Southern District of Texas, on a petition filed for that purpose by the International Great Northern Railroad Company, the purchaser of the properties of the International & Great Northern Railway Company, to determine the amount of the fee to be allowed petitioner, Dabney, and Streetman, and on the same date the court, by*1186 order entered, allowed petitioner and his co-counsel a *1161 fee of $200,000, of which amount petitioner's share was $52,000, which amount petitioner received in cash on May 11, 1925.

On March 15, 1926, petitioner duly filed his individual income-tax return for the calendar year 1925, and reported therein as income the above mentioned fee of $52,000, together with other income of $9,911.49. He claimed as deductions from gross income $2,397.21 for interest and taxes, $750 for depreciation of law library, and $4,724.94 as net losses of the prior year, leaving a net income reported of $54,039.34. The respondent, in his determination of a deficiency in tax of $1,000.37, accepted the gross income reported by petitioner as correct, but disallowed one-half of the depreciation claimed by petitioner and all of the alleged net loss of $4,724.94.

About the year 1927, petitioner made a settlement with his son, Leon, in which settlement petitioner recognized the above mentioned fee of $52,000 as the community property of petitioner and his deceased wife, and the settlement thus made included the equivalent of one-half of the fee in question.

No income-tax return was filed for*1187 or on behalf of the estate of May McAdoo King for the year 1925.

OPINION.

LOVE: We are asked to decide whether petitioner is taxable on the entire fee of $52,000, or on only one-half thereof. Petitioner contends that, under the community property laws of the State of Texas, the fee, when received, was community property belonging one-half to himself and one-half to the estate of his deceased wife, and that he was taxable only on his one-half. The respondent, however, argues that since the fee was conditioned upon the successful outcome of the lawsuit in question, and petitioner's wife having died before that condition was fulfilled, the fee can not be said to have been "acquired * * * during marriage" of petitioner and his wife, and was not, therefore, so impressed with the character of community property that one-half of the fee was taxable to the estate of petitioner's deceased wife instead of to petitioner.

In , the Supreme Court decided that "the interest of a wife in community property in Texas is properly characterized as a present vested interest, equal and equivalent to that of her husband, and that one-half of the*1188 community income is therefore income of the wife." It further decided that "She and her husband are entitled to make separate returns, each of one-half of such income."

If petitioner's wife had lived, there can be no doubt but that each would have been permitted to have returned one-half of the $52,000 fee in separate income-tax returns. Our *1162 problem, then, is to determine what effect the death of petitioner's wife had upon the taxability of the fee which became fixed and was paid to petitioner after the death of his wife. Was the entire amount "income" to petitioner?

Sections 210 and 211 of the Revenue Act of 1926 imposes a normal and surtax, respectively, upon the "net income of every individual." These sections were construed and applied by the United States Supreme Court in , in which the court said in part:

The use of the word "of" denotes ownership. It would be a strained construction, which, in the absence of further definition by Congress, should impute a broader significance to the phrase.

The Commissioner concedes that the answer to the question involved*1189 in the cause must be found in the provisions of the law of the State, as to the wife's ownership of or interest in community property. What, then, is the law of Washington as to the ownership of community property and of community income including the earnings of the husband's and wife's labor?

The answer is found in the statutes of the State, and the decisions interpreting them.

If, then, under the laws of the State of Texas, the estate of Mary McAdoo King had a valid claim to one-half of the fee in question, such amount would not be the "income of" petitioner and would not be taxable to him. We, therefore, turn to the statutes and court decisions of the State of Texas relating to the ownership of property under conditions such as are present in the instant proceeding.

Article 4619 of Vernon's Annotated Revised Civil Statutes of the State of Texas defines community property as follows:

All property acquired by either husband or wife during marriage, except that which is the separate property of either, shall be deemed the common property of the husband and wife, and during coverture may be disposed of by the husband only.

*1190 Article 2578 of the same statutes provides that, upon the dissolution of the marriage relation by death, the community estate, if there be a child or children of the deceased, shall pass one-half to the survivor and the other half to such child or children.

Petitioner and his deceased wife had one son, Leon, who was the only child and who survived his mother. Since the contract between petitioner and Baker which resulted in petitioner receiving the $52,000 fee was entered into prior to the death of petitioner's wife, it would appear that the contract itself was at least a part of the community estate, and a one-half interest therein would, under article 2578, supra, pass to the surviving child. But what did this one-half interest represent? The respondent contends that since the contract was for an indefinite amount of compensation conditioned upon the successful outcome of the suit then contemplated, and, further, since *1163 this condition had not been performed prior to the death of petitioner's wife, the fruits of the contract can not be said to have been "acquired * * * during marriage," within the meaning of article 4619, supra, and, not being a part of*1191 the common property, no part thereof would constitute a part of decedent's estate.

The word "acquired" as used in article 4619, supra, "is not to be construed in any restricted sense, but must necessarily have that broad significance as will include all effects or gains or property of every kind coming to the husband or wife during coverture in any manner other than by 'gift, devise, or descent.'" ; . The court in the Lee case also quoted with approval from the Supreme Court of Arizona in ; , as follows:

The law makes no distinction between the husband and wife in respect to the right each has in the community property. It gives the husband no higher or better title than it gives the wife. It recognizes a marital community wherein both are equal. Its policy plainly expressed is to give the wife in this marital community an equal dignity, and make her an equal factor in the matrimonial gains. It recognizes that property acquired during marriage by community funds or the labor and industry of either spouse * * * *1192 is the common property of the husband and wife. All that either the husband or wife or both may acquire during the existence of the marriage, other than is specifically excepted, is an acquest of the community, and the presumption in all doubtful cases is strongly in favor of treating that which either spouse may own as community property. It recognizes that the wife in her station is as much an agency in the acquisition as the husband, and is entitled to just as great an interest. [Italics supplied.]

In view of the liberal construction to be placed upon the word "acquired," can it be said that, since the right to the fee had its inception in the contract made with the receiver in 1920, the character of the fee is determined by the character of the right which produced it? Petitioner contends that in cases of inchoate rights it is the time of the inception of the initial rights that determines the status of property as between community and separate. In this connection, McKay, a recognized authority, in his book on Community Property, 2d ed., par. 520, says:

An inchoate title or pecuniary right is property in the sense of the law of separate and common property, *1193 just as truly as the most unimpeachable or perfect title. It takes its rank as separate or common property, for the same reason, and in response to the same tests, as the perfect or complete title or right, and it retains its character as separate or common so long as it can be traced; its development from an inchoate to the absolute or complete form does not shift it from one fund to another; it may be relieved of conditions and burdens but this does not change its character; it may pass from a conditional to an unconditional form, without change or legal character; it may be exchanged for other things or rights, and its character as separate or common*1164 passes to whatever was acquired by the exchange. If the property consists of an obligation, either contractual or delictual, it may be performed or enforced; and whatever is so acquired takes the same character as the obligation. [Italics supplied.]

At paragraph 533, the same author, in referring to property acquired in discharge of an obligation, says:

* * * but the case is not so clear when the contract contains conditions which must be performed to preserve the contract right. In some of the cases it*1194 seems at first blush as though the final fruits of the contract are acquired by the performance of the conditions, but clearly this is not in accord with legal principle and is against the great weight of authority.

And, again, at paragraph 353 and 356, the same author continues as follows:

PAR. 535. When a contract containing conditions is closed before marriage, and the conditions are performed during marriage by the community, some confusion has arisen in the authorities, due to the mistaken view taken by some courts that in such cases the property is acquired not through the separate ante-nuptial contract, but through the performance of the conditions during marriage. If the contract is largely executory and the conditions and stipulations of the contract are burdensome, and are performed by the community, it may seem to some like a legal nicety devoid of substantial justice to refer the origin of the property to the date of closing the contract through which it was acquired; but generally justice is better subserved by the rule now firmly established that property acquired by contract is deemed to have its origin as of the date of the contract.

And it is not difficult*1195 to find a justification for the rule: The contract itself is property, and having been acquired before marriage it is separate by force of the plain terms of the statute. If it should be sold without performance of the conditions clearly the proceeds of the sale would be separate, and if the conditions are performed after marriage through the expenditure of separate funds no one would insist that the property is common. The community may be reimbursed for its funds used to perform the conditions and when this is done even and exact justice is done to all; the separate estate obtains the advantages of its separate contract, or suffers the disadvantages of any, and the community is reimbursed for its outlay. If the circumstances impose no obligation to make reimbursement, this should not change the rule just stated.

PAR. 536. A condition precedent must be performed before title passes. A right to have property on performance of a condition precedent is not ownership of the property but a right to have ownership on performance of the condition. On the other hand, the holder of property under a title subject to a condition subsequent is the owner, though his ownership may be lost*1196 by breach of the condition. In the first case ownership is in the future; in the second in the present, but conditional. In either case the right is vested and protected by law, and is property in the sense of the law of separate and common property; in the first case it is the same as the right of one under a covenant to have property delivered to him in full ownership on performance of his contract; in the second case he is owner, but his ownership may be lost. In neither case is the character of the right changed from separate to common or vice versa, by a performance of the condition. If the initial right is separate it*1165 remains so even though the condition be performed by the community and if the initial right be common, a performance of the condition at the expense of the separate estate does not divert the property to it; the property remains common. [Italics supplied.]

In , the Texas Court of Civil Appeals, among other things, said:

The character of the title to property with reference to being separate or community depends upon the existence or non-existence of the marriage at the time of the*1197 incipiency of the right by virtue of which title is finally vested, and when title is so vested it relates back to that time. ; .

In , one James Power and another, as empresarios, obtained a certain colonization contract with the State of Coahuila and Texas, by the terms of which, upon their compliance with certain conditions contained in the contract, they acquired the right to a grant of lands. Their right to the lands was contingent upon compliance by them with the conditions of their contract, they being not entitled, however, to any specific tract or tracts of land. The contract was entered into while Power was a single man. The conditions were complied with after his marriage. The question involved was whether the lands, which were acquired by him after his marriage as a result of his contract, were a part of the community or his separate estate. The point was raised and argued in the Supreme Court of the State of Texas that since the contract vested Power*1198 only with the potentiality of earning the land, and since this right was not fixed or earned prior to his marriage, that the property was community and not separate. The court held the land to be Power's separate property and at page 286 it said:

* * * In this cause the title originated in the contract of Power and Hewitson with the state of Coahuila and Texas. That contract, in the language of the Louisiana Court, was the "cause" of the title. Power was single when it was entered into, and the right to earn the lands acquired by it was his separate property. The title relates to its origin, and must take the impress of its character from it.

In , one Josiah Creamer and his first wife settled upon certain land to acquire it as a homestead under the laws then in force, and did everything necessary to that end, except to complete the three years or occupancy. After they had occupied the land for more than a year, Mrs. Creamer died, and Creamer, thereafter and during the three years, married a second time, and with his second wife completed the occupancy and obtained a patent. Creamer's second wife predeceased him and a contest*1199 arose as to *1166 whether the homestead was community property of Creamer and his first wife or Creamer and his second wife. The Supreme Court of Texas, in reversing the lower court, held that the heirs of the second wife had no interest whatever in the property. We quote from the opinion as follows:

* * * The original property right, having been "acquired" during the marriage, is community, and the title which completes that right relates back to its origin and takes character from it.

* * *

It follows, from what we have said, that the character of the property in controversy had been fixed as belonging to the community estate of the first marriage, when Creamer last married, and that such character could not be affected by that marriage. The last wife merely came into the family and resided on the homestead in use, the title to which was no more changed thereby than if it had been Creamer's separate property.

It is our opinion that the statutes and court decisions of the State of Texas uphold petitioner's contention that since the right to the fee had its inception in the 1920 contract, which was entered into during the marriage of petitioner and his deceased*1200 wife, the fee when received was impressed with the character of community property and belonged one-half to petitioner and one-half to the estate of his deceased wife. The fact that the marital relationship was dissolved by death before the condition in the contract was fully performed does not affect the property interest in the fee when it was received, because, as we have pointed out above, it is the time of the inception of the initial right which determined the status of the property, and its development from an inchoate to an absolute right did not shift the fee from one fund to another. This is also in accord with the settlement which petitioner made with his son about the year 1927.

The deficiency for the year 1925 should be redetermined by excluding the amount of $26,000 from the net income determined by the respondent.

Reviewed by the Board.

Judgment will be entered under Rule 50.

SMITH, STERNHAGEN, ARUNDELL, MURDOCK, and MCMAHON dissent.