Freedman v. Commissioner

*956 This proceeding involves a deficiency in income tax for the year 1932 in the amount of $142.79. Only so much of the proposed deficiency is in controversy as arises from the respondent's addition to income of the sum of $3,000 received by the petitioner as compensation for services rnedered to the Department of Banking of the Commonwealth of Pennsylvania. Petitioner contends that his compensation is exempt from tax on the ground that he was an *957 employee of the commonwealth engaged in carrying on a governmental function.

FINDINGS OF FACT.

The petitioner is a lawyer, practicing his profession in Philadelphia, Pennsylvania. On October 2, 1931, the attorney general of the Commonwealth of Pennsylvania directed to the petitioner a letter reading as follows:

It gives me pleasure to appoint you an attorney in this Department assigned to the liquidation work of the Department of Banking. *622 Your salary will be at the rate of $3,000.00 per annum.

The Special Deputy Attorneys General who are assigned to this work in Phladelphia are being advised of your appointment and that you will be available to assist them in any way in which they may find it necessary to call upon you.

The petitioner accepted the appointment conferred by the above letter. He was thereafter continuously employed on matters relating to the liquidation of closed banks, as hereinafter more fully related, until March 9, 1935, when his employment was terminated on the occasion of a change in the political party in control of the state government, whereupon he was directed to turn his files over to his successor.

The department of justice and the department of banking are administrative divisions of the Commonwealth of Pennsylvania. The head of the department of justice is the attorney general and the head of the department of banking is the secretary of banking, these offices being provided for by statute. The attorney general has statutory power "to appoint and fix the compensation of Special Deputy Attorneys General and Special Attorneys to represent the Commonwealth, for any department, board, *623 or commission thereof, in special work or in particular cases." Purdon's Penna. Stats., title 71, §296. The secretary of banking is by statute given broad powers over banks within the commonwealth. When it appears to him that a bank is in an unsafe or unsound condition he may, after notice and hearing and with the consent of the attorney general, take possession of the business and property of the bank; under certain conditions he may take possession without hearing and without the attorney general's consent. When he takes possession of a bank, he is vested with "all the rights, powers, and duties of a receiver appointed by any court of equity in this Commonwealth"; while in possession of the bank he is "the representative of the creditors" thereof. The banking law provides that, in the case of banks the property of which is in the possession of the secretary of banking, all expenses in connection with such possession and of continuing the business or of liquidation "shall first be payable out of the funds of" such bank *958 "including the compensation of special deputies, assistants, and others employed by the Secretary to assist him in such proceedings; the allowance*624 of all such expenses to be subject to the approval of the Court." Purdon's Penna. Stats., title 7, §§ 29, 49.

The petitioner was assigned to work under special deputy attorneys general in Philadelphia County in connection with legal matters pertaining to closed banks in that county. Such closed banks were being liquidated by the secretary of banking pursuant to statute. The petitioner's duties consisted of attempting to collect dubts due such closed banks, rendering legal opinions to the deputy receivers in charge thereof, handling the legal matters for the banking department that came up from surrounding counties, prosecuting suits in court, consulting with creditors, depositors, and stockholders of closed banks concerning their claims, procuring substitute trustees for trust estates being administered by such banks, preparing, filing, and presenting accounts in the Orphans' Court, preparing data in connection with the proposed state banking code, and "in general anything that was assigned by the Special Deputy Attorney General at the time." Such attorneys were considered by the department of justice as "available for any purpose at any time."

The petitioner handled legal matters*625 for the state banking department in connection with the liquidation of the Northern Central Trust Co., the Darby Bank & Trust Co., the United States Bank & Trust Co., the Central Trust & Savings Co., the Mortgage Security & Trust Co., the Park Trust Co., and the Wharton Turst Co., among other closed banks in the Philadelphia area. The petitioner was one of approximately twenty lawyers assigned to like work in Philadelphia County.

The particular work and the matters to which the petitioner gave attention were determined by the attorney general's office. He was free to use his discretion only in simple matters. In regard to all proposed litigation and appeals, he was required first to consult with his superior officers. He was required to follow prescribed forms issued by the attorney general's office as to preparation of documents and pleadings. His legal opinions were reviewed and often revised by his superiors before being issued. Likewise, briefs were reviewed and frequently entirely redrafted. All matters of policy in particular cases were decided by the attorney general and his deputies. The petitioner's advice to depositors of closed banks was limited to matters on*626 which his superiors had ruled. All such attorneys were instructed to take no steps and render no opinions on any legal problem involved in closed banks without approval of the attorney general.

The petitioner's duties and the manner in which they should be performed were prescribed in part by a large number of mimeographed *959 circulars issued by the attorney general at Harrisburg at frequent intervals and sent to all attorneys handling closed bank matters. Also, his instructions were received periodically from a deputy attorney general at regular meetings held for the purpose of discussing their problems and deciding on procedure.

The petitioner received no compensation for his services other than his $3,000 salary, but was reimbursed for his expenses. He was furnished with necessary office facilities. He was required to use official letterheads furnished by the department of justice, and signed his letters as "attorney" for the department of justice. The files in matters handled by him were considered the property of the state and were turned over by him to his successor when his employment was terminated. While the department of justice could have required all*627 his time and had first call on his services, he was permitted to engage in private practice. In 1932 he spent more than 50 percent of his time on state business. He had to give up certain regular employment to accept the employment in the department of justice. His professional income for 1932, aside from the $3,000 salary, was $2,735.60. He was not a member of a law firm.

Petitioner's salary was paid to him semimonthly by checks drawn by representatives of the state banking department in charge of closed banks in Philadelphia, the checks being countersigned by the secretary of banking at Harrisburg. In the early part of 1932 his salary was charged against funds of three closed banks whose assets had been taken over by the secretary of banking, but later in the year it was charged against funds of four closed banks, although his services were not confined to matters relating to the affairs of those particular banks. The banks against which the petitioner's salary was charged were determined by the attorney general and the secretary of banking. The salaries of attorneys handling matters relating to the several closed banks were ordinarily paid out of the funds of such banks*628 in approximate proportion to the amount of work done for each bank.

Petitioner did not include in his income tax return for 1932 the $3,000 salary received as compensation for services rendered to the department of banking.

OPINION.

ARUNDELL: This case involves the application of the principle of immunity of state instrumentalities from Federal taxation. As Mr. Chief Justice Hughes puts it in Willcuts v. Bunn,282 U.S. 216, 225:

The familiar aphorism is "that as the means and instrumentalities employed by the General Government to carry into operation the powers granted to it are exempt from taxation by the States, so are those of the States exempt from taxation by the General Government". Ambrosini v. United States,187 U.S. 1, 7.

*960 Many of the recent cases involving this principle carefully point out, in juxtaposition with the statement of it, its limitations. "The limitation of this principle to its appropriate applications is also important to the successful working of the governmental system." *629 Willcuts v. Bunn, supra."It is a principle implied from the necessity of maintaining our dual system of government. * * * Springing from that necessity it does not extend beyond it." Board of Trustees of the University of Illinois v. United States,289 U.S. 48, 59. "Of course, the reasons underlying the principle mark the limit of its range." Indian Motocycle Co. v. United States,283 U.S. 570. "This Court, in drawing the line which defines the limits of the powers and immunities of state and national governments, is not intent upon a mechanical application of the rule that government instrumentalities are immune from taxation, regardless of the consequences to the operations of government." Educational Films Corporation v. Ward,282 U.S. 379, 391.

The immunity question has many facets and in this case the parties are at odds on nearly all of them. They argue the questions of whether petitioner was either an officer or employee of the state; whether his services were rendered in connection with the exercise of an essential governmental function; the materiality of the source of his compensation; *630 and whether the tax will result in any burden on the state.

Our conclusion, based on reasons hereinafter given, is that the $3,000 compensation received by the petitioner in 1932 is not exempt from taxation by the Federal Government.

In the first place, we are not satisfied that petitioner can properly be classified as an employee of the Commonwealth of Pennsylvania. The facts are that in 1932 the petitioner, while appointed and supervised by the attorney general, was actually performing the duties of counsel for the liquidator for a group of banks in the Philadelphia area. The duties performed, as set out in the findings of fact, were those that would usually be performed by an attorney for a liquidator or receiver of insolvent corporations. These duties did not require all of his time, but left him free ot follow his profession in private practice, which he did, resulting in income of $2,700 from outside sources. These considerations leave considerable doubt as to whether it can be said that petitioner was an employee of the commonwealth in the usually accepted sense of the term. His relation with the secretary of banking appears to be that of attorney and client rather*631 than that of employee and employer.

The basic ground for denying the petitioner's claim to immunity from tax, however, is that the source of his income precludes any possibility of a burden on the state resulting from a tax thereon. We do not think it can seriously be urged that petitioner was compensated *961 by the state merely because his checks were issued by the officers of the state, as the fact is that both by statute and in actual practice the source of his compensation was the assets of the several banks in the process of liquidation. These assets were not public funds as are taxes; they were not susceptible of appropriation by the legislature for general public use; they were private property being administered by the secretary of banking in a fiduciary capacity. Therefore, if any burden falls elsewhere than on petitioner, it is on those banks or their creditors, for whose benefit the petitioner was acting, rather than on the state. We held in Ned R. Harman,34 B.T.A. 654, that fees received by a statutory court reporter from litigants for transcripts of stenographic records are not exempt from tax because they are not paid by the state itself*632 and no burden on the state was shown. Similarly, it has been held that the compensation of an auditor appointed by the Orphans' Court in Pennsylvania to report on the financial condition of corporations applying as sureties on bonds tendered to the court was taxable since it was paid out of deposits made by the surety companis for that purpose with the clerk of the court, and was not paid by the state itself. Miller v. McCaughn, 22 Fed.(2d) 165; affd., 27 Fed.(2d) 128. The District Court in that case pointed out that the "moneys paid are never in any sense public moneys" and held:

The compensation must not merely come to a state officer or employee, but it must come to him from the state, to be exempt. Unless this second line is drawn, and drawn where we have drawn it, it is difficult to determine where it should be drawn. A moment's thought will bring to mind scores of instances in which the recipient might well be held to be such "officer or employee," but in which the compensation does not come directly or indirectly from the state, otherwise than in the sense that he would not be in the enjoyment of it, were it not for the relation of officer*633 or employee of the state which he enjoys.

The Circuit Court of Appeals for the Third Circuit, affirming the District Court, held that the taxpayer could not be regarded as an officer or employee of the state and also emphasized the lack of any burden on the state, saying:

The exemption of state employees from federal income tax rests on the ground that the agencies the state employs in government should not be burdened by federal taxes, which would lessen the state's power to employ, and compel it to pay more for the services of its employees. But no such reason exists in the case of this examiner. No power of the state is crippled or lessened by his paying tax on his income. Neither the state nor the court pay Mr. Miller.

Following the Third Circuit in the Miller case, the Board held, as one of the grounds for denying exemption in two cases decided by memorandum opinions, that no burden resulted to the state from taxation of compensation received from a source other than the state. Robert S. Spangler, Docket No. 46386 (1933); Charles A.*962 Roberts, Docket No. 74214 (1934). In the Spangler case, the taxpayer was a "special attorney" appointed*634 by the commissioner of banking of the State of Pennsylvania to represent him in the liquidation of a state bank and his compensation was paid out of the assets of the bank, and in the Roberts case the taxpayer was an attorney appointed by the superintendent of banks of the State of New York to assist in the liquidation of a trust company, his compensation being paid by the bank in liquidation. To the same effect see Mim. 3838, dated January 17, 1936, I. R. Bulletin XV, No. 5. Following the above cases it must be held here that the petitioner's compensation was not exempt from tax.

The petitioner advances the view that, once he has established himself to be an officer or employee of the state engaged in performing a governmental function, his immunity from Federal taxation is absolute, irrespective of the source of his compensation or of any other consideration. In view of the disposition that we have made of the petitioner's premise it is unnecessary to decide this matter, but it is worthy of brief note. The petitioner's contention is based on expressions in some of the cases to the effect that where the principle of immunity applies it is absolute and is not affected by*635 the amount of tax or the extent of the resulting interference. Cf. Indian Motocycle Co., supra.This contention, often urged in tax cases, has its genesis in the apprehension expressed in McCulloch v. Maryland,4 Wheat. 316. in the maxim that "The power to tax is the power to destroy." The cases quoted at the outset of this opinion establish that the courts are not stampeded into broadly granting exemption by the quotation of the McCulloch maxim. On the contrary, they inquire into all the facts and circumstances of the case. They inquire into whether an officer or employee is engaged in an essential governmental function, Helvering v. Powers,293 U.S. 214; Brush v. Commissioner, 85 Fed.(2d) 32; Ohio v. Helvering,292 U.S. 360; whether the tax works any substantial interference with governmental functions, Metcalf & Eddy v. Mitchell,269 U.S. 514; or whether it exerts but a remote influence, Willcuts v. Bunn,282 U.S. 216; *636 Brush v. Commissioner, supra.They also inquire, as we have here, into the source of the funds taxed, Miller v. McCaughn, supra.These cases indicate that the so-called rule of absolute immunity is not so broad in its application as is indicated by a literal reading of the words apart from the context of the case in which they are used. They also establish the right of inquiry into all matters affecting petitioner's employment, including that of the source of the funds from which he receives his compensation.

In view of the conclusion we have reached we do not deem it necessary to discuss other arguments advanced.

Decision will be entered for respondent.