Opinion
Nos. 4001, 4002, 4003.
June 20, 1929.
Petition to Review Judgment of Board of Tax Appeals.
Separate petitions by the Commissioner of Internal Revenue to review a judgment of the Board of Tax Appeals on petition for allowance of deductions by George D. Widener and Joseph E. Widener. Judgment affirmed.
The opinions in the Board of Tax Appeals were as follows:
Sternhagen. The first question to be answered is whether the activities of the petitioners in respect of their racing and breeding stables constituted a business. An affirmative answer carries with it the right to deduct the expenses of their operation and the losses sustained.
Sec. 214. (a) That in computing net income there shall be allowed as deductions:
(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered. * * * (40 Stat. 1066, 42 Stat. 239).
(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in trade or business.
(5) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business. * * *
The evidence establishes that the petitioners were engaged in the business of breeding, buying, and selling race horses and entering them in racing contests for gain. They testified that they sought at all times to make a success of the enterprises and that their only measure of success was financial gain. Their horses were purchased as investments, the selective breeding was influenced by the thought of winning stakes and purses, and the disposition of horses was either for profit by sale or for riddance of those not economically useful. These are among the characteristics of business. Wilson v. Eisner (C.C.A.) 282 F. 38, 2 A.F.T.R. 1744. The fact that petitioners were wealthy enough to afford a hazardous occupation in which they found pleasure despite discouraging losses does not establish the essential nature of the occupation. If they were utterly indifferent to whether there was loss or gain, or if it were shown that the stables were an incident to the social or domestic aspects of their daily lives, the result might be against them, as in Thacher v. Lowe (D.C.) 288 F. 994, 2 A.F.T.R. 1931. Instead, it appears that they devoted themselves seriously and assiduously to the economic promotion of their stables, always in the hope that profit would result. The winning of a single race or the chance purchase of a yearling might at any time convert steady losses into a net profit, and make it a successful business. The expenses and losses are deductible, and the determination of respondent in respect of the first two assignments of error is reversed. This likewise disposes of the third assignment, which is an alternative only, and therefore need not be considered.
The second issue presented is whether the petitioners, being beneficiaries of the trusts established by the wills of P.A.B. Widener and George D. Widener, Sr., are each entitled, in the computation of their individual net income, to deduct an aliquot part of the losses and depreciation of the trust estate, although the petitioners received from the trust the distribution of income without such deductions. This question has been ruled adversely to petitioners in Baltzell v. Mitchell (C.C.A.) 3 F.2d 428, 5 A.F.T.R. 5230, certiorari denied, 268 U.S. 690, 45 S. Ct. 510, 69 L. Ed. 1159; Appeal of Louise P.V. Whitcomb et al., 4 B.T.A. 80; Appeal of Elizabeth M. Abell et al., 4 B.T.A. 87; Appeal of Mary P. Eno Steffanson, 1 B.T.A. 979; Appeal of George M. Studebaker et al., 2 B.T.A. 1020; Appeal of Helene R. McConnell, 3 B.T.A. 260; Marguerite T. Whitcomb v. Commissioner of Internal Revenue, 5 B.T.A. 191 [now on review in Court of Appeals, District of Columbia, 58 App. D.C. 104, 25 F.2d 528]; Appeal of Sophia G. Coxe, 5 B.T.A. 261; O. Ben Haley v. Commissioner of Internal Revenue, 6 B.T.A. 782; Arthur H. Fleming et al. v. Commissioner of Internal Revenue, 6 B.T.A. 900; and, as stated in Arthur H. Fleming v. Commissioner of Internal Revenue, supra, the decision in Appeal of Julia N. De Forest, 4 B.T.A. 1059, is, by reason of its different facts, not a contrary authority. The respondent has allowed the trustee of each estate to deduct the losses and depreciation in computing the net income of the estate, and this is in accordance with the foregoing decisions. The beneficiaries are not entitled to the deductions, and the respondent is on the fourth assignment sustained.
The last error assigned is that the respondent taxed the petitioners in respect of the entire distributions received by them annually from the income of the two trusts of which they are beneficiaries. Petitioners contend that the value of the expectancy of life interest, the right to receive annual income, was capital to each of them acquired by bequest, and that they are entitled to set aside untaxed the annual distributions until they aggregate this so-called capital sum before taxing any part thereof as income. They say that the expectancy was property clearly capable of valuation, the value of which was substantially agreed upon, and that, since this property was expressly bequeathed it is exempt from income tax by sections 213(b)(3) of the Revenue Acts of 1918 and 1921 here involved; and, furthermore, that otherwise the Constitution would be violated.
Sec. 213. That for the purposes of this title (except as otherwise provided in section 233) the term "gross income" —
The distributions in question are, by the terms of the trusts, made only from the income of the trust, and do not invade the corpus. They are not fixed annuities, such as were involved in Ronald De Reuter v. Commissioner of Internal Revenue, 7 B.T.A. 600, to be paid in any event whether from corpus or income. If there be no income of the trust, there will be no annual distribution. Nor were they acquired by investment, as the court held in respect of the periodic payments in Warner v. Walsh (C.C.A.) 15 F.2d 368, 6 A.F.T.R. 6340.
The present situation is squarely within Irwin v. Gavit, 268 U.S. 161, 45 S. Ct. 475, 69 L. Ed. 897, 5 A.F.T.R. 5380, and, as in that case, it is not to be supposed that Congress, in section 213(b)(3) intended to restrict the scope of the broad intendment of section 213(a).5 While it may be, so far as the court's opinion discloses, that no attempt was made by Gavit to establish a value of the expectancy at death, claiming rather that all distributions were in themselves the bequest, nevertheless the reasoning of the opinion gives no warrant for the belief that the decision would have been at all different if such valuation had been fixed in the record. The taxpayer argued that the periodic receipts by him were but the realization of his bequest and hence exempt, and the court held that they were entirely income. The court recognized that the expectancy constituted an interest in the fund itself, and, since it had long been recognized (under the 1898 Legacy Tax Act [30 Stat. 464]; United States v. Fidelity Trust Co., 222 U.S. 158, 32 S. Ct. 59, 56 L. Ed. 137; Simpson v. United States, 252 U.S. 547, 40 S. Ct. 367, 64 L. Ed. 709, 4 A.F.T.R. 4735) that such interest was property of value subject to death duty (a doctrine prevailing in several of the states), we are compelled to believe that the decision in the Gavit Case was reached in the full light of that established law.
These two taxes — the death duty, whether upon the legacy or upon the estate, and the income tax — are wholly different in concept and theory, and the fact that they may impinge upon each other in ultimate incidence by striking at the beneficiary so as to diminish first his inheritance and then his income therefrom is a legislative matter which Congress has presumably considered. Our present concern is to consider whether the distributions of what is indisputably income of the trust are income to petitioners, and, if so, whether as such the statute taxes them or exempts them.
The petitioners argue that, irrespective of the statutory exemption of bequests, the full amount of distributions is not income, because out of such distributions they are entitled to recover, as capital, the value of the right to receive them. This is the theory that, because the right had a value which would serve to measure a legacy tax, it was capital of petitioners from thenceforth; that it is thereafter being diminished; that the diminution is in some way brought about by the distributions of income; that such distributions are the only means to offset the diminution, and hence, to the extent of such offset, the distributions are a "return of capital." We may pass the question whether in the true sense this "right to receive income" is capital; whether the capital, if any, is not represented only by the interest in the fund which produces the income; whether it is not subversive of the entire concept of income to say in turn that a gratuitous right to receive it is capital and hence the realization upon that right is recovery of capital. There is a point of revolt against the tyranny of logic. But suppose it is capital, wherein is it impaired or diminished? It persists in full force. It begins at death as a right to receive income from, and thus an interest in, the fund, and continues throughout in as great a measure as it began. To be sure, the lapse of time affects the probable number of future payments, but how can this change the nature of the payments as income when received? Suppose they were to go on forever, would they be more capital because of longer expectancy, or less capital because beyond the formula of valuation? Nothing invades the interest in the fund, and no receipt of the distributable income reduces it, a complete distinction from the situation in Doyle v. Mitchell Bros. Co., 247 U.S. 179, 38 S. Ct. 467, 62 L. Ed. 1054, 3 A.F.T.R. 2979, cited by petitioners. Why then should any part of the distributable income be left untaxed, since it takes nothing from the right to receive it? Income it is called in the trust instrument, and income it is, and hence within the language and intendment of section 213(a). This is substantially in accordance with Appeal of Ernest P. Waud, Ex'r, Estate of Griffin, 6 B.T.A. 871, and with the obiter of Ernest M. Bull, Ex'r, Estate of Bull, v. Commissioner of Internal Revenue, 7 B.T.A. 993, which in effect say that income is no less income because it is received pursuant to a pre-existing valuable right.
The second question then arises, whether this income is a bequest and hence within the exemption of section 213(b)(3). This, as already stated, is in our opinion answered in Irwin v. Gavit, supra, to the effect that the income itself is not the bequest, which in our opinion carries with it the decision that the income is not to be limited by reason of a valuation given to the right to receive it. It is, as petitioner contends, established that a testamentary right to the income from a fund is subject to legacy tax and for that purpose is capable of valuation. But this does not bring it within the intendment of the exemption of section 213(b)(3). The Supreme Court in the Gavit Case said that that exemption provision "assumes the gift of a corpus and contrasts it with the income arising from it, but was not intended to exempt income properly so-called simply because of a severance between it and the principal fund. No such conclusion can be drawn from Eisner v. Macomber, 252 U.S. 189 [40 S. Ct. 189, 64 L. Ed. 521, 9 A.L.R. 1570], 3 A.F.T.R. 3020. The money was income in the hands of the trustees and we know of nothing in the law that prevented its being paid and received as income by the donee."
Furthermore, while the section exempts the value of bequests, it carefully provides that the income from the bequest is not exempt. Here, as we have seen, the distributions are the income from the petitioners' interest in the fund, and are, as such, expressly removed from the exemption.
What has been said is sufficient to demonstrate that the distributions are income under the Constitution as well as under the statute, and that Congress was therefore authorized by the Sixteenth Amendment to tax it as it did. In essence there is a similarity in the argument to that of Bowers v. Taft and Bowers v. Greenway (C.C.A.2d Circuit) decided July 5, 1927, 20 F.2d 561, in that the value of the gift at the time of transfer is said to be capital and as such necessarily to be recovered before finding income. But the Circuit Court of Appeals held that the gain was properly subject to tax to the donee as it would have been to the donor. And in the Gavit Case Mr. Justice Holmes seemed to have the same concept when he said that income in the hands of the trustee was taxable when received by the donee.
Petitioners cite Warner v. Walsh, supra. That case is distinguishable for at least one reason, that the court expressly laid it on the ground of a purchased annuity, the consideration for which was the widow's relinquishment of her fixed and valuable rights. The value of the consideration was a capital investment, which is not the situation here.
It is our opinion that the full amounts of the distributions are taxable income to petitioners, and the respondent is sustained as to the fifth assignment.
Reviewed by the Board.
Judgment will be entered on fifteen days' notice under Rule 50.
Arundell did not participate.
Smith, Trammell, Trussell, Love, and Van Fossan dissent on the first point.
* * * * * * * (b) Does not include the following items, which shall be exempt from taxation under this title:* * * * * * * (3) The value of property acquired by gift, bequest, devise, or descent (but the income from such property shall be included in gross income). 40 Stat. 1065, 42 Stat. 238.
Mabel Walker Willebrandt, Asst. Atty. Gen., and John Vaughan Groner and Barham R. Gary, both of Washington, D.C. (C.M. Charest, General Counsel, and Shelby S. Faulkner, Sp. Atty. Bureau of Internal Revenue, both of Washington, D.C., of counsel), for appellant.
Ellis Ames Ballard, William R. Spofford, and Schoffield Andrews, all of Philadelphia, Pa. (Ballard, Spahr, Andrews Ingersoll, of Philadelphia, Pa., of counsel), for appellees.
Before BUFFINGTON and WOOLLEY, Circuit Judges, and THOMSON, District Judge.
These cases present the question whether the Board of Tax Appeals erred in holding, as it did, that the racing stables of these taxpayers were operated as a "business," or a "transaction entered into for profit," within the meaning of the Revenue Acts of 1918 and 1921 (40 Stat. 1057, 42 Stat. 227). The Board of Tax Appeals held they were, and allowed reductions for losses thereby sustained. Thereupon the Commissioner took this appeal. The facts are not in dispute, and the warrant for the conclusions drawn therefrom by the Board are so fully and satisfactorily set forth in the record as to make a restatement by this court unnecessary.
Finding no error, judgment of the Tax Board is affirmed.
I disagree with the action of the Board in holding that the losses sustained by the petitioners, Joseph E. Widener and George D. Widener, in maintaining and operating racing stables, are deductible from the respective gross income of the petitioners in each of the several taxable years.
Horse racing has long been called the "sport of kings." There is a well-defined difference between sport and business. The one is pursued for personal pleasure, relaxation, or recreation; the other is engaged in for the purpose of earning profits or as a means of livelihood. It is one of the characteristics of sport that it wastes capital. On the other hand, a primary attribute of business is the conservation and increase of capital. Sport employs wealth to secure pleasure; business utilizes it to create more wealth. The motives that impelled one of these petitioners to enter the horse-racing business are set forth in the findings of fact as that "he was fond of horses and wanted an outdoor occupation." This does not suggest an intention to engage in a business for profit.
In the cases of both the Wideners there is in the record a very definite statement of receipts, expenses, and losses for each of the taxable years, but there is no information as to the amount of capital employed. It is hardly possible to determine whether an enterprise is conducted as a business, if the amount of the investment is not known. It is obvious from the figures here that, unless the stables of the petitioners were heavily financed at the outset, the original capital was lost several times over prior to and during the taxable years. The huge annual deficit disclosed by the record must have been made good by equally huge additional capital contributions. This is a process aptly described in the speech of the common man as "throwing good money after bad," and is rarely indulged in by real business men. Ordinarily it is impossible in an enterprise carried on for profit or as a means of livelihood, but it is not at all an unusual procedure for those who, regardless of expense, pursue some sport, recreation or pastime for personal gratification. The excess profits tax law recognized the principle that capital employed in business for profit is entitled to a fair return before any income emerges. If these petitioners were in a position to claim an 8 per cent. return on their capital investment and also to reduce their respective gross incomes by the amount of these alleged losses, it is plain that in time they might entirely avoid any payments to the public revenues, even though they were eventually in receipt of substantial annual receipts in excess of expenditures.
Certainly no one would contend that the fact that an enterprise sustains losses in a given year or even for a series of years is proof that it is not conducted for profit. Due to commercial conditions, crop failures, changes in an art, the vagaries of fashion, or any one of the numerous other causes, many men have found themselves forced to continue a losing business year after year in the hope of recouping their fortunes by some favorable turn of affairs. Such conditions do not exist here. These petitioners voluntarily engaged in an enterprise that is notoriously uncertain. They made good their losses and continued their operation after it was clear that there was little if any prospect of profit. The motives and purposes that governed them were not based either on the hope of or the desire for profits. They were willing to pay and able to pay for the pleasure which they derived from indulging in the "sport of kings" and doubtless the resulting personal gratification was ample compensation for the costs incurred.
The findings of fact, supra, indicate that racing rather than the breeding and sale of horses was the principal purpose for which these petitioners conducted their alleged business. It is recited that the employees of the stables included trainers, jockeys, blacksmiths, rubbers, exercise boys, and veterinarians. Services rendered by such men are peculiarly necessary in conducting a racing stable, but they have a relatively small place in the organization and operation of a breeding farm. None of the so-called business activities of the petitioners during the taxable years appear to have resulted in profit or to have been conducted with any hope of profit. Had these enterprises been conducted for gain, there should have been some sales of proved and winning horses at profitable prices. It appears, however, that only those animals that had been tested and found wanting in speed were sold. Apparently all the sales set forth in the record were made, not for purposes of gain, but to realize losses already manifest, in proved lack of racing quality or to prevent further losses.
Only the taxable years 1919, 1920, 1921, and 1922 are involved in these appeals. It would seem, therefore, that the finding that, after the results of the operations for 1919-1922, inclusive, were known, Joseph E. Widener reorganized his stables and made a greater effort to secure favorable results, is not pertinent here. The fact that some time after the last of the taxable years this petitioner imported a breeding sire from England and received large stud fees for the services of that animal has no relation to the issues now under consideration. For all that the record shows, this animal may not have been bought until some time in the year 1924. None of the amount of $110,000 earned as stud fees was received in either of the taxable years. Very rarely, if at all, should tax liability for a given year be determined by events occurring subsequent to such year.
The taxes here in controversy were imposed by act of Congress, at a time when the republic was in desperate need of revenue. Every good citizen values the privilege of contributing to the public income in proportion to his ability to pay. Had Congress elected, as is within its power, to levy a tax on gross income, this and thousands of other tax disputes would have been avoided. For reasons that doubtless are sound and defensible, the lawmaking body chose to tax net income. This made it necessary to lay down rules governing credits, exemptions, and deductions.
In the statutes enacted for the guidance of all who have to do with the assessment and collection of federal income taxes, there are provisions that each taxpayer is entitled to deduct from his gross income for any taxable year all the losses sustained and all the ordinary and necessary expenses paid or incurred in carrying on his trade or business in such year. The losses which these petitioners seek to deduct resulted from the payment of expenses incident to the conduct of racing stables. If such expenses are not in themselves deductible, neither are losses resulting therefrom. While the law nowhere says so in exact terms, it was obviously the intention of Congress to authorize the reduction of gross income by the cost of producing such income before the determination of tax liability. In this connection there is an express provision that personal expenses are not so deductible. This principle rests on the sound basis that business expenses represent the cost of producing income, while personal expenses relate only to the uses that are made of such income. The deductions here claimed were not losses incurred in the production of any part of the income which the respondent proposes to tax, nor, in my judgment, were they sustained in carrying on any trade or business for profit. They resulted from expenses purely personal to the petitioners.
I am convinced that Congress had incomes such as we have under consideration in mind when it provided that there should be no deduction from gross income on account of personal expenses. To permit these petitioners and others of their type to reduce their tax liability by the deduction of the costs of maintaining racing stables, expensive estates, and other similar activities, would result in a shifting of the burden of public taxation, which it seems to me would be wholly inconsistent with the public interest. I am satisfied that these petitioners have not sustained the burden of proof necessary for us to find that the alleged losses were sustained during the taxable years in a business conducted for profit. I feel that the allowance of the deductions claimed would be contrary to the intent of Congress, detrimental to the public interest and a dangerous perversion of the sound and equitable principles upon which just taxation must rest.