UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT
filed: February 8, 1977.
INSLEE A. HOPPER AS EXECUTOR OF THE ESTATE OF GERTRUDE THOMAS GARDNER, DECEASED APPELLANT
GOVERNMENT OF THE VIRGIN ISLANDS, REUBEN WHEATLEY, COMMISSIONER OF FINANCE (D.C. CIVIL ACTION NO. 74-124) ESTATE OF JOHN LIVINGSTON THOMAS, BY WILLIAM W. BAILEY, EXECUTOR V. REUBEN B. WHEATLEY, COMMISSIONER OF FINANCE (D.C. CIVIL ACTION NO. 74-285)
ON APPEAL FROM THE DISTRICT COURT OF THE VIRGIN ISLANDS DIVISION OF ST. THOMAS AND ST. JOHN.
Seitz, Chief Judge, Gibbons and Hunter, Circuit Judges.
GIBBONS, Circuit Judge.
This appeal concerns the tax status to the beneficiary of payments received from a decedent's estate. Appellant Inslee A. Hopper, as executor of the estate of Gertrude T. Gardner, seeks review of an order of the District Court for the Virgin Islands redetermining a deficiency in the tax paid by decedent Gardner for taxable years 1967 through 1971.*fn1 We affirm in part, reverse in part, and remand the case to the District Court for the Virgin Islands for further proceedings.
John Livingston Thomas (Thomas) died on May 25, 1963. Article III of his Last Will and Testament directed his executor, William W. Bailey to pay $1,500 per month to Thomas' sister, Gertrude Thomas Gardner, until such time as his estate was finally adjudicated, provided she continued to live.*fn2 Those payments were made from 1963 until mid-1971, when Gertrude Thomas Gardner died.
The issues raised by this case first came to light in February, 1973, when the Estate of John Livingston Thomas filed its fiduciary tax returns for 1963-1972, inclusive. That estate claimed deductions from estate income for the sums paid out to Gardner. It characterized them as payments from income. Thus the real dispute is between Thomas' estate and Gardner's estate. One of them may have to bear the tax consequences of additional income of $1,500 per month for the period in question.
Initially, the Department of Finance made a determination that the beneficiary, Gertrude Thomas Gardner, was liable for the tax. Accordingly, it assessed those amounts against her estate on October 26, 1973, notified the Thomas estate that its returns were being accepted as filed, and issued a Notice of Deficiency to Gardner's executor, Inslee A. Hopper (appellant herein), on November 16, 1973. Subsequently, however, Max Kirchner, Technical Advisor for the Department of Finance was called upon to review both files since a statutory notice had been issued. He determined that there was no reason why the Government should bear the risk of the ultimate judicial characterization of these distributions. Thus a Notice of Deficiency was also prepared and sent to William W. Bailey, Esq., the executor of the Estate of John Livingston Thomas, on February 27, 1974. By following this multiple deficiency notification approach, Mr. Kirchner testified, the Government would be able to protect itself from the possibility of an adverse judicial ruling with respect to one of the potentially liable taxpayers.
While undertaking this review, however, Technical Advisor Kirchner unfortunately also discovered that the Department of Finance had committed several procedural errors in its handling of the Gardner case. With respect to tax years 1967 and 1968, Kirchner realized that Finance had made and entered certain assessments without first obtaining a Form 870 Waiver from the taxpayer or mailing a Notice of Deficiency and waiting the statutory period. With respect to tax years 1969, 1970, and 1971 (for which no returns had been filed), on the other hand, Kirchner noticed not only that the executed Commissioner's Returns had not been signed but also that assessments had been made and entered pursuant thereto without a Form 870 Waiver having been obtained or a Notice of Deficiency having first been mailed. For these reasons, the Technical Advisor believed the assessments to be illegal and invalid. Accordingly, he issued an inter-departmental memorandum on February 15, 1974 directing that the assessments be abated. Pursuant to this directive Notices of Adjustment were mailed out on February 20, 1974.*fn3 Moreover, in order to insure that there would be no misinterpretation about this abatement, Kirchner took the further step of writing a letter to Gertrude Gardner's accountant one week later, in which he specifically advised that the last date for the timely filing of a 33 V.I.C. § 943(a) Redetermination Petition would be March 8, 1974. Inslee A. Hopper's petition for the Gardner estate was filed on that date.
Four days later, Hein Christensen, the accountant for both John Livingston Thomas and his estate, wrote Mr. Kirchner a letter protesting the estate's receipt of its "90 Day Letter," which communication was answered by the Technical Advisor on March 22, 1974. Following this, the Estate of John Livingston Thomas filed its own 33 V.I.C. § 943(a) Redetermination Petition on May 28, 1974. Eventually, the two cases were consolidated and the matter came on for hearing in the District Court of the Virgin Islands on Friday, November 28, 1975. After listening to the testimony of the four witnesses, the Court specifically found, inter alia, "that the abatement did not go the entire tax liability but only to those assessments which they have now administratively determined had been erroneously made . . . ." In making such a determination, the court effectively ruled that the question was no longer whether the Government was entitled to the taxes it sought but instead which of the two taxpayers was liable therefor.
The district court issued a Memorandum Opinion several months later. It analyzed the problem in terms of 26 U.S.C. §§ 661 and 662 and characterized the Government as "sitting in the middle of the two Petitioners, with apron spread wide open." Final Judgment was entered on May 7, 1976. That Judgment (i) granted the Thomas Estate's petition in toto (ii) granted the Gardner Estate's petition insofar as it sought relief from the 25% penalty, but (iii) denied the remainder of that petition. This appeal followed.
The government does not appeal from that part of the court's order granting the petition of the estate of John Livingston Thomas and granting that part of the petition of the estate of Gertrude Thomas Gardner which sought relief from the 25% penalty. In fact, it argues for affirmance in all respects.
Appellant Hopper argues that the tax liability of the Gardner estate has been extinguished by the notices of adjustment abating the assessments for the taxable years in question. This is an issue of first impression, but we find appellant's contention without merit. Essentially, appellant contends that when an assessment is abated because it is illegal, any statutory notice of deficiency sent prior to such abatement is thereby rendered invalid and void. Reliance is placed on Crompton-Richmond Co. v. United States, 311 F. Supp. 1184 (S.D. N.Y. 1970). There, the district court, on a motion for summary judgment in a refund suit, decided that when an abatement of assessment issued in error, the assessment could be reinstated if the error resulting in abatement was the result of a mistake of fact or a bookkeeping error.
We find Crompton-Richmond wholly inapposite to the question posed in this case, which concerns the relationship of an illegal assessment and a valid abatement to a prior valid notice of deficiency. Crompton-Richmond, a refund suit, did not involve the validity of the notice of deficiency. The Department of Finance cites Noyes et al. v. United States, 55 F.2d 870 (9th Cir. 1932) which is more in point, though only marginally relevant. In Noyes, the Ninth Circuit considered the effect of a letter which gave the taxpayer notification of a deficiency "which has been assessed." In context, this was an ambiguous phrase which might have put the taxpayer in doubt as to whether the IRS letter was notice of a jeopardy assessment. However, as in our case, the letter also came with waiver forms in the event the taxpayer chose not to dispute the deficiency determination in the Tax Court. Moreover, a subsequent letter explained that there had been a prior erroneous assessment, and reminded the taxpayer of his right to appeal within 60 days. It was held that the letters, despite the prior invalid assessment, constituted an effective notice of deficiency. The distinctions are, first, that Noyes antedated the 1954 act; second, it concerns a notice of deficiency after an invalid assessment, in contrast with notice of the abatement of an invalid assessment following an otherwise valid notice of deficiency.
However, these distinctions are insufficient to completely undercut Noyes. We think that the proper rule is that minor imperfections in procedure which cause no substantial prejudice to taxpayers' rights are no defense against an otherwise valid notice of deficiency.*fn4 Appellant does not complain, nor could he, of inadequate notice. Moreover, we note that appellant's assertion of the invalidity of the deficiency notice is inconsistent with the procedure he elected to follow in contesting the Department of Finance's determination. Rather than pay the tax and sue for a refund, Hopper chose to petition for a redetermination of deficiency. In doing so, he implicitly conceded the validity of the notice of deficiency which he now challenges. We conclude that the notice sent by the Department of Finance, abating illegal assessments for taxable years 1967-1971, did not operate to nullify the statutory notices of deficiency for those years.
Hopper also challenges the holding below that all sums paid to Gertrude T. Gardner pursuant to Article III of the Thomas will were taxable income to her. His chief contention is that funds were also paid to Adelaide Thomas, John Thomas' wife, and that an allocation should be made between the two beneficiaries to the extent of the Thomas estate's distributable net income.*fn5 The district court rejected this argument, finding that the payments to Adelaide Thomas were irrelevant to Gertrude Gardner's tax liability, and that there was ample estate income to cover all payments to Gardner. We agree.
The record clearly reveals distributable net estate income, for each of the taxable years in question, which exceeded the payments to Gertrude Gardner. The only significant question is whether the payments to Adelaide Thomas, aggregating $35,000 in the years 1968-1970, require that appellant's tax deficiency for those years be recomputed in accordance with 26 U.S.C. § 662(a)(2). The allocation required by that section is to be performed only if distributable net income is exceeded by the sum of:
(A) the amount of income for the taxable year required to be distributed currently to all beneficiaries, and (B) all other amounts properly paid, credited or required to be distributed to all beneficiaries.
The John Thomas will did not provide for distributions of current income either to Adelaide Thomas or to Gertrude Gardner. Thus, § 662(a)(2)(A) is irrelevant. Article III, which mandated the payments to Gertrude Gardner, did not specify whether they were from principal or income. We need not decide the source, however, for these payments were clearly "required to be distributed." For tax purposes, such payments are presumed to be from current income. 26 U.S.C. § 662(a).
It is thus possible largely to avoid the necessity for tracing of income which exists generally under existing law. Instead of determining whether a particular distribution represents amounts of current or accumulated trust income, this revision, broadly speaking, provides that any distribution is considered a distribution of the trust or estate's current income to the extent of its taxable income for the year. This principle is similar to the determination of whether a dividend has been distributed, i.e., that every distribution made by a corporation is deemed to be out of earnings and profits to the extent thereof and from the most recently accumulated earnings and profits.
S. Rep. No. 1622, 83d Cong., 2d Sess. 349 (1954) (section-by-section analysis of 26 U.S.C. § 662). See Mott v. United States, 199 Ct. Cl. 127, 462 F.2d 512, 515 (1972), which refers to the current income presumption of § 662(a)(1) as a "conclusive presumption."
The same presumption does not apply, however, to the payments made to Adelaide Thomas. Section 661, dealing with deductibility by the estate of payments to beneficiaries, and § 662, concerning inclusion of those payments in the beneficiary's income, both refer to amounts "properly paid" or "required to be paid." The district court found no authorization in the John Thomas will for the payments to Adelaide Thomas. The will provided for her as follows:
EIGHTH: If my wife, Adelaide R. Thomas, survives me and at the time of my death is entitled by law to a share of my estate, I direct my Executor to set aside a portion of my estate equal to such minimum share in Trust for the life of my wife which will comply with the provisions of Section 10 subdivision (4) of Title 15 of the Virgin Islands Code; this portion to be disposed of as follows: (a) I give, devise and bequeath therefrom to my wife the sum of $2,500.00 outright; (b) the balance of such portion, I give, devise and bequeath to Louis Hoffman of St. Thomas, Virgin Islands, and the Chase Manhattan Bank of St. Thomas, Virgin Islands, as Trustees, to hold, manage, invest and reinvest the same, to collect income therefrom, to pay the net income therefrom in semi-annual instalments, to my wife, during her life, and upon her death to turn the principal over to Louis Hoffman and United States Trust Company of New York as Trustees under a certain Indenture of Trust executed by me dated December 10, 1959, and their successors, for the uses and purposes set forth in said Indenture, and accept the receipt of said Trustees therefor.
Thus, the executor was authorized, upon final settlement of the estate, to pay $2,500 outright out of the statutory widow's share and to pay the remainder of that share into a trust, of which Adelaide Thomas was to be life tenant. She was not the residuary legatee.*fn6 The determination whether payments from an estate are "properly paid" when the will is silent is governed by state [territorial] law. Rev. Rul. 71-335. The trial judge ruled that
such payments as were, in fact, made [to Adelaide Thomas] must have been laid out on some authority other than the Will for I find no such direction in that instrument.
We have read the will, and we agree with the district court. We have seen no Virgin Islands law which indicates that unauthorized payments from an estate are "properly paid" to the recipient thereof. We therefore agree with the district court that the payments to Adelaide Thomas are irrelevant to the tax liability of Gertrude Gardner because they are not such payments as create the necessity for allocation of income under 26 U.S.C. § 662.
Appellant raises one final point, which we find meritorious. In the redetermination proceeding, Hopper sought an allocation of the Thomas estate's depreciation deduction so that the estate of Gardner could claim its aliquot share as a deduction from income. The district court held
I see no authority for such an allowance, nor do I perceive any basis on which there is entitlement to such depreciation. Consequently I disallow it.
This was error. 26 U.S.C. § 167(h) and 26 C.F.R. § 1.167(h)-1(c) plainly provide that
In the case of an estate, the allowable [depreciation] deduction shall be apportioned between the estate and the heirs, legatees, and devisees on the basis of the income of the estate which is allocable to each.
The case will be remanded to the District Court of the Virgin Islands for redetermination of the tax deficiency of the Gardner estate for taxable years 1967 through 1971, according to the principles of 26 U.S.C. § 167(h).*fn7