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Kappel v. United States

decided: February 1, 1971.


Aldisert, Adams and Rosenn, Circuit Judges.

Author: Adams


ADAMS, Circuit Judge.

The taxpayers in this case improperly received distributions from four employees' pension trusts and upon threat of assessment by the Internal Revenue Service ("the Service") paid an income tax on the distributions. Proceeding to restore the distributions to the respective pension trusts, the taxpayers then deducted on their 1961 return, pursuant to § 1341 of the Internal Revenue Code of 1954 ("the Code"),*fn1 the amount of the income tax paid pursuant to the threatened assessment. The Internal Revenue Service disallowed the deduction. The taxpayers paid the contested tax and brought suit for a refund.

The issue raised on this appeal is whether the taxpayer-appellants are entitled to a refund of the taxes paid. This in turn depends primarily on whether they had a "legal obligation" to repay the amounts improperly received from the pension trusts so as to qualify for the deduction provided by § 1341 of the Code.*fn2

Although the taxpayers had presented to this Court alternative theories for deductions under §§ 162 and 165(c)(2)*fn3 of the Code, the District Court made no findings on these issues,*fn4 nor were these matters raised in the complaints filed in the District Court, in taxpayers' "narrative statement" to that Court, or in taxpayers' motions under Fed. R. Civ. P. 52(b) and 59(a) to amend findings of fact, to alter or amend judgment or for a new trial. We therefore decline to consider these claims since they are not properly raised by this appeal. See Hanley v. Chrysler Motors Corp., 433 F.2d 708, 711 (10th Cir. 1970).*fn5

Taxpayers John and William Kappel were officers, directors, and principal stockholders in four corporations which maintained separate employees' pension plans instituted in the 1930's and 1940's.*fn6

The pension plans were recommended to taxpayers by Jules Polachek, a Pittsburgh life insurance underwriter who held himself out as, and was generally reputed to be, an expert in the field of corporate pension plans. The pension plans in this case were governed by separate groups of trustees chosen by the boards of directors of each corporation. Taxpayers and their relatives constituted a majority of the trustees for each trust. Each trust was funded by one of the four settlor corporations, and the trustees contracted for separate annuity policies on each participating employee, including taxpayers, through several life insurance companies. The ownership of each policy was vested in the trustees governing the particular trust of the corporation employing each beneficiary.

In 1954, when both taxpayers were over 65 years of age but still active in the corporations, Polachek suggested a method which would remove the annuities in the pension trusts from the estates of the taxpayers: the Kappels were to continue their employment, but to agree to an immediate distribution of the proceeds of the annuity policies held by the pension trusts for the taxpayers' benefit; these proceeds would then be reinvested in deferred annuities, with members of taxpayers' families named as beneficiaries. Polachek told taxpayers they would incur no federal income, gift, or estate tax liability for these transactions.

Despite contrary provisions in the pension trusts,*fn7 the taxpayers relied on Polachek's advice, and the proceeds were removed and reinvested in 1954, 1955, 1957 and 1958. In each instance, application was made on behalf of the trustees to the various life insurance companies for payment in a lump sum of the proceeds that were being held to insure the lives of the taxpayers. These amounts were then forwarded to Polachek. The applications to the insurance companies were signed either by taxpayer John T. Kappel, or by William D. Kappel (son of William J. Kappel, the other taxpayer). The District Court found there was no consent, joinder, or formal action by all or a majority of the trustees of any pension fund in the application for payment of the annuity proceeds.

Late in 1959, the Service informed the Kappels of its intention to assess deficiencies regarding their individual income taxes for each of the years in which annuity proceeds had been received but not reported as income. In response to this information, the Kappels retained expert legal and accounting representatives. These counsel advised the Kappels that the pension benefits had been paid in violation of provisions of the pension trust agreements, and recommended that the taxpayers refund the payments to the pension trusts. After extended demands and negotiations, legal counsel secured refunds from the insurance companies of the premiums paid for the deferred annuities, and the taxpayers restored such funds to the pension trusts in 1960.

No legal proceedings were instituted to require such repayments, and the Government concedes none were necessary for the taxpayers to establish their eligibility for the deduction provided under § 1341 of the Code. Rather, the question on this appeal is whether there existed a legal obligation on the part of the Kappels to repay to the trusts the monies improperly received. In 1961, the Kappels claimed a deduction on their 1960 tax returns based on § 1341 of the Code for taxes paid upon the funds received from the pension trusts in 1954, 1955, 1957 and 1958. The Service disallowed the deductions, the Kappels paid the taxes due, and in 1964 filed in the District Court two complaints demanding a refund of such taxes. Honorable Gerald J. Weber, United States District Judge for the Western District of Pennsylvania, ordered the complaints consolidated.

After a trial lasting five days, Judge Weber found in an opinion reported at 281 F. Supp. 426 (W.D. Pa. 1968) that the taxpayers had no legal obligation to return the funds that had been withdrawn from the trusts, and accordingly, rendered a decision for the United States. Taxpayers then moved to take additional testimony to show that in 1967 the Service found the original pension trusts all to have been disqualified under § 503(c) (6) of the Code as qualified pension plans within the meaning of § 401 of the Code as of the years in which improper withdrawals were made. See also § 503(a)(2). The trial judge denied the motion for the taking of further testimony because "there was no such treat existing in 1960, either by other beneficiaries who could allege impairment of the trust res, or by those affected by the loss of tax benefits first raised * * *" several years later. The Court then entered judgments in favor of the Government, and the taxpayers appealed.

In order to prevail, the taxpayers rely on the claim of right doctrine codified in § 1341. This theory originated in North American Oil Consolidated v. Burnet, 286 U.S. 417, 424, 52 S. Ct. 613, 76 L. Ed. 1197 (1932), in part as a criterion for determining what constituted "gross income" within the meaning of the predecessor of § 61 of the Code, but primarily as an application of the annual accounting principle consistently mandated by Congress to be an integral part of the federal income tax system. See Burnet v. Sanford & Brooks Co., 282 U.S. 359, 51 S. Ct. 150, 75 L. Ed. 383 (1931). As the Supreme Court has recently stated in United States v. Skelly Oil Co., 394 U.S. 678, 681-682, 89 S. Ct. 1379, 1382, 22 L. Ed. 2d 642 (1969), "section 1341 of the 1954 Code was enacted to alleviate some of the inequities which Congress felt existed in this area. See H.R. Rep. No. 1337, 83d Cong., 2d Sess., 86-87 (1954) * * * Nevertheless it is clear that Congress did not intend to tamper with the underlying claim-of-right doctrine." An example of an inequity troubling Congress was the fact that prior to the enactment of § 1341 ...

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