Easley Trust v. Commissioner

*51 These proceedings involve deficiencies in income taxes of petitioner-trusts for the year 1948, as follows:

The only question presented is whether the interest on a tax overassessment received by each petitioner-trust in 1948 is includible in the respective recipient's gross income, or, in the alternative, *51 if so includible, is deductible as an ordinary and necessary expense or as a payment of interest on indebtedness. These proceedings are submitted on a complete stipulation of facts with exhibits attached.

FINDINGS OF FACT.

All of the facts having been stipulated are so found and the stipulation filed by the parties is included herein and made a part hereof by this reference.

The petitioners herein, the Wayne Hugh Easley Trust (hereinafter sometimes referred to as Trust No. 1) and the Roger Kent Easley Trust (hereinafter sometimes referred to as Trust No. 2) were created on October 1, 1940, by separate written declarations of trust of the same date executed by W. H. Easley and Margaret A. Easley as settlors. Since that date and throughout the period here involved, each petitioner has been a duly existing trust under the provisions of the respective declarations of trust and under and by virtue of the laws of the State of California. Since the creation of the trust and throughout the period involved, W. H. Easley has been the duly qualified and acting trustee of each petitioner-trust.

During the period here under review, each petitioner-trust kept its books of account and filed its*52 income tax returns on the calendar year basis and on the cash method of accounting. Such returns were filed with the collector of internal revenue for the first collection district of California.

*52 At all times material herein, the settlors of the trusts in question were husband and wife who, prior to October 1, 1940, conducted a business of bottling and selling a beverage known as "Seven-Up" under a franchise from the Seven-Up Company of St. Louis, Missouri. Such business was conducted at San Francisco, California, and was known as the Seven-Up Bottling Company of San Francisco (hereinafter called the Bottling Company). Under the laws of the State of California, the business was the community property of the settlors.

Under and by virtue of the declarations of trust of October 1, 1940, Easley and his wife, as settlors, transferred to W. H. Easley, as trustee of the trusts, respectively, an undivided one-fourth interest each in their business, the Bottling Company. They duly filed gift tax returns reporting as gifts the transfers thus effected and subsequently paid deficiencies in gift tax determined by respondent. For each of the years 1940 through 1945, a partnership*53 return of income was filed in the name of the Bottling Company, in which returns the settlors and the petitioners were named as partners and one-quarter of the net income of the Bottling Company was reported as the respective share of each of these partners. Each petitioner-trust duly reported its share of the net income in its income tax returns.

By decisions entered in Docket Nos. 6287 and 6288 and promulgated January 27, 1947, reported as W. H. Easley, 8 T. C. 153, this Court determined that all of the income of the Bottling Company was taxable to the settlors of petitioner-trusts, Easley and his wife, as their community income. As a result thereof, deficiencies in tax and interest were assessed against the settlors and, correspondingly, overassessments of tax and credits for interest thereon were determined with respect to each of the petitioner-trusts for the taxable years 1940 through 1945. Pursuant to a "consent to credit" executed and filed by W. H. Easley, Trustee, in behalf of each trust, and covering each of the aforementioned years, the collector of internal revenue applied the overassessments of tax, so determined with respect to each*54 petitioner-trust, in reduction of the deficiencies assessed against the settlors, or either of them, for such years and issued notices and demands for the remaining balance of the deficiencies, plus interest. The collector, during the year 1948, mailed to each petitioner-trust checks covering the interest allowed on the overassessments for the taxable years 1940 through 1945. Easley, as trustee for each trust, endorsed such interest checks and he and his wife, as settlors, or either of them, used the funds in part payment of the deficiencies in interest assessed against them or either of them, except as to the deficiencies of Margaret A. Easley for the years 1940 and 1941.

The aggregate amount of the checks mailed to each petitioner-trust during 1948 covering interest allowed on the overassessments for the *53 years designated was $ 27,842.05 and $ 27,517.65 for Trusts Nos. 1 and 2, respectively, as per the following schedule:

In computing its gross*55 income for the taxable year 1948, each petitioner-trust excluded the total amount of interest checks received on the overassessments. In the determination of each petitioner's income tax liability for the year 1948, the respondent added the amount of such interest checks to each trust's net income disclosed by its return. The addition of such interest checks is the sole cause of the income tax deficiencies here in controversy.

The settlors, Easley and his wife, on their 1948 income tax returns deducted, as interest paid on the deficiencies resulting from the taxation to them of the net income reported by petitioner-trusts, the interest deficiencies assessed against them reduced by the amount of the interest checks received by petitioner-trusts. In determining overassessments against the settlors for the year 1948, respondent increased their respective deductions for interest by the amount of the interest checks received from petitioner-trusts.

OPINION.

The sole question presented here is whether the interest payments made in 1948 to the petitioners on their respective overassessments of income taxes are properly includible within the gross income of each recipient pursuant to section*56 22 (a) of the Internal Revenue Code, ¹ as determined by respondent.

Petitioners contend that the interest payments did not constitute gross income to them for the reason that they were under an obligation to pay over such interest to the settlors to whom in equity it rightfully belonged and that in the performance of such obligation they acted merely as conduits.

In support of the position thus taken, they cite Charles A. Clark, 19 T. C. 48, and Horace Mill, 5 T. C. 691, in both of which cases it was held that where payments are made to a taxpayer who is under a legal obligation to pass them on to another, such payments are not includible in the gross income of the initial recipient.

Petitioners maintain that the obligation so to perform arose from *54 their duty to make restitution*57 to the settlors of the tax refunds and interest thereon on the grounds of unjust enrichment. They devote much space on brief to an exposition of the doctrine of unjust enrichment and the recognition and application thereof by the California courts. Further, they contend that the settlors were also entitled to restitution of tax and interest under the doctrine of reformation based upon mistake. The arguments thus advanced are based upon equitable doctrines. At the most, they show that in a court of equity, petitioners might possibly be held to have been unjustly enriched at the expense of the settlors, or an equitable reformation or modification might be made. However, regardless of the niceties of the situation and the moral suasion involved, such equitable arguments can here avail petitioners nothing in the absence of a showing that a legal obligation existed to pay over the receipts in question to the settlors. See Healy v. Commissioner, 345 U.S. 278. No such showing has been made on this record. The interest payments were made by the Government to the petitioners for retention of funds which, for aught the record shows, were trust funds*58 that had been mistakenly paid out. Under such circumstances, the interest payments did not constitute gross income to the settlors. Cf. Abe Schreiber, 6 T. C. 707, affd. 160 F. 2d 108; Loretto McKenna Richards, 19 T. C. 366. To the contrary, such payments were income to the trusts which owned the claims for the refunds and for the interest paid on those claims, and to which trusts the interest was in fact paid. New Oakmont Corporation v. United States, 86 F. Supp. 897. We, therefore, answer the question posed in the affirmative and hold that the interest payments received by petitioners constituted gross income to them.

Petitioners present the alternative argument that if the interest payments in controversy are includible in their respective gross incomes, then and in that event such payments are deductible as either an ordinary and necessary expense, or as a payment of interest on indebtedness, the principal indebtedness being the debt owed by the trusts to the settlors in the amount of the overassessment or the tax deficiency against the settlors, the benefit*59 from which was received by the trusts. Petitioners cite and rely upon New Oakmont Corporation v. United States, supra;United States Fidelity & Guaranty Co., 40 B. T. A. 1010; New McDermott, Inc., 44 B. T. A. 1035; Howard Gould, 14 T. C. 744. All such cases are clearly distinguishable on the facts from the one before us. Moreover, in each case there was present an agreement, or other legal obligation, under which the taxpayer involved acted. As pointed out above, no such agreement, or other legal obligation, on the part of the trusts to reimburse the settlors has been shown here. Thus, this argument must also fail. Consequently, respondent is sustained.

Decisions will be entered for the respondent.