MARIS, Circuit Judge.
The issue presented on this appeal is whether all or only one-thirteenth of the net income of a trust fund created by the will of the plaintiff's deceased husband is taxable, for income tax purposes, against her. The dispute arises out of the following facts:
The testator, Edward A. Gallagher, a resident of Philadelphia, Pennsylvania, died on March 19, 1942, survived by his widow, who is the plaintiff, and thirteen children. By the terms of his will he created a trust during the lifetime of his widow or until her remarriage. In the event of her death or remarriage the estate was to be distributed among twelve
At the time of the testator's death he owned an 85% interest in the partnership of E. A. Gallagher & Sons, which consisted of the testator and his son, Arthur A. Gallagher. By the terms of Paragraph Two of the will the testator authorized his trustees to continue his interest in the business and conferred upon them every power he might have possessed in respect thereto if living. Pursuant to this authorization the trustees and the surviving partner continued the business and the trustees received 85% of the net income therefrom. The entire net trust income for the taxable period from March 20, 1942 to December 31, 1942 was reported in the individual federal income tax return of the plaintiff. For the years 1943 through 1948 the plaintiff and twelve of testator's children (being all of his children except Edward, Jr.) each reported a one-thirteenth part of the income of the trust estate upon their individual income tax returns.
On December 2, 1947 the plaintiff executed a paper entitled "Confirmation of Release and Disclaimer" by which she confirmed her release, disclaimer and renunciation of all past, present and future interest as beneficiary of the trust or under the intestate laws of Pennsylvania in excess of one-thirteenth of the distributable trust income. On June 10, 1948, the first account of the trustees
Assessments for deficiencies of income tax for the years 1943 through 1948 were made by the Commissioner of Internal Revenue against the plaintiff on his October, 1950 assessment list pursuant to a notice of deficiencies sent June 20, 1950. On November 14, 1950 the plaintiff paid under protest $600.00 on account of the deficiency assessment for each of the six years, a total of $3,600.00, and instituted the present action in the District Court for the Eastern District of Pennsylvania to recover this amount as an overpayment. She asserted that the Commissioner had assessed the deficiencies against her on the alleged ground that all of the distributable trust income was taxable to her and that the assessment was illegal because, as she contends, she was entitled by law to only a one-thirteenth share thereof which she had received and properly reported as taxable income. She also asserted that in any event she had released and disclaimed any greater interest in the trust estate. Furthermore she contended that her interest under the will had been adjudicated to be only a one-thirteenth share by the Orphans' Court of Philadelphia County which alone had jurisdiction of the estate and that its adjudication is conclusive.
The United States intervened as a party defendant in the present suit. It filed an answer and a counterclaim in which it asserted the deficiency assessments which the Commissioner of Internal Revenue had made against the plaintiff for the years 1943 through 1948. The assessments totaled $413,927.96; interest thereon totaled $76,820.42. A credit of $16,305.95 was given plaintiff for payments previously made, including the payment of $3,600.00 for which the plaintiff had brought this suit, leaving a balance of $474,422.43 for which the counterclaim was filed. Both parties moved for summary judgment. The plaintiff also moved for judgment on the pleadings.
The district court found that the plaintiff was entitled under the will to receive the entire net income of the trust estate, that her confirmation of release and disclaimer of interest in excess of a one-thirteenth share did not affect her tax liability because under the law of Pennsylvania the plaintiff, being a beneficiary under a spendthrift trust, could revoke the release and receive future income, and that the adjudication of the Orphans' Court of Philiadelphia County was not binding on the district court because the proceedings were of a nonadversary nature. The motion of the defendants was accordingly granted, the complaint was dismissed, and judgment was entered against the plaintiff on the counterclaim in the amount, including interest, of $550,034.57. 119 F.Supp. 360.
The decision of the present case turns upon whether the adjudication by the Orphans' Court is to be given conclusive effect, taxwise, as to the interests of the plaintiff and the twelve children in the net income of the trust estate. Before considering this question some preliminary observations need to be made. The books are full of federal tax cases in which state court decisions have been refused controlling effect upon the ground that they were not res judicata in the federal tax case or because they were regarded as nonadversary or as in fact consent decrees or because they were obtained by collusion. But, as Mr. Paul points out in an excellent discussion of the subject,
One group of federal tax cases refuses to give state decisions conclusive effect in situations where Congress has imposed a federal criterion with respect to the taxability of income or property or the allowability of claimed deductions. For example, in ascertaining whether claims asserted against an estate "were contracted bona fide and for an adequate and full consideration in money or money's worth"
A second type of case is that in which the state decision does not involve a peculiar rule of federal tax law as in the type just discussed or a determination of the property rights of the parties as in the type about to be discussed but has merely made a determination of some other question of law or fact asserted to be involved in the federal tax case. If the United States was not a party to the state case it is perfectly clear that the decision in the state case cannot be res judicata against the United States or entitled to full faith and credit in the federal case, even though it may be entitled to consideration as declaratory of the state law. Since such a state decision is not entitled to be given the effect of res judicata its application may properly be rejected on that ground alone. Whether the state proceeding was adversary or nonadversary or the judgment was obtained by consent or even by collusion is, on principle, quite immaterial in such a case.
The third type of federal tax case in which a state decision is sought to be given effect is that in which a state court has determined the rights of the parties to income or other property involved in the tax litigation and the tax is imposed by the Internal Revenue Code solely upon the person entitled to the income or other property under the state law, the federal law having imposed no qualification upon or criterion for the taxability thereof. In other words Congress has made the operation of the tax law in such a case wholly dependent upon state law. In a case of this sort the state
The case now before us is of the type last described. The Internal Revenue Code imposed an income tax upon the plaintiff with respect to the income of the trust estate of her deceased husband only to the extent that it became her income payable to her as a beneficiary under the terms of the will creating the trust. The Code did not attempt to define or qualify her right; it merely imposed a tax upon her income, whatever it might be. Since the decedent was domiciled in Pennsylvania, all the interested parties reside there and the property of the decedent's estate, consisting largely of his interest in a Pennsylvania partnership, is located there, the effect of the will and the interest which the plaintiff received under it are to be determined by the law of that state. The plaintiff is, therefore, entitled to receive only such portion of the income of the trust as the will construed under Pennsylvania law accords her.
By the adjudication of the Orphans' Court of Philadelphia County, a court having jurisdiction in rem of the trust estate and judicial power to determine the rights of the parties interested therein,
The district court held, and the Government urges here, that the rule to which we have referred does not apply when the state court proceeding is of a nonadversary character. Reliance is placed on three of our cases: First-Mechanics Nat. Bank v. Commissioner of Internal Revenue, 1940, 117 F.2d 127, 132 A.L.R. 1459; Commissioner of Internal Revenue v. Childs' Estate, 1945, 147 F.2d 368, and Falk v. Commissioner of Internal Revenue, 1951, 189 F.2d 806, certiorari denied 342 U.S. 861, 72 S.Ct. 89, 96 L.Ed. 648, and upon three cases from the Fifth Circuit: Sewell v. Commissioner of Internal Revenue, 1945, 151 F.2d 765; Loggie v. Thomas, 1945, 152 F.2d 636; and Saulsbury v. United States, 1952, 199 F.2d 578. The First-Mechanics Nat. Bank case is inapplicable, however, since it did not involve the determination by a state court of a property right but merely the deductibility of a claim against an estate in diminution of estate tax liability. Likewise the Falk, Sewell and Loggie cases are inapposite for the state court judgments were sought to be applied in each of those cases as conclusive of the question whether income was taxable to the taxpayer under the Internal Revenue Code because it was subject to his unfettered command, a criterion imposed by the federal law, while the Saulsbury case is similarly inapplicable since it also involved the applicability of a federal criterion rather than an adjudication of property rights.
The Childs' Estate case can be distinguished from the case now before us in that the question at issue in the federal court and which was urged to have been decided in the state court had not been presented to or considered by the latter court on the merits, its judgment having operated merely as a pro forma approval of what the parties had agreed upon. It therefore was in the nature of a consent decree. In our opinion in the case, however, we conceded that the state decree was binding upon the parties and determined their interests in the decedent's estate. Nonetheless we thought that since the state court did not give consideration to the question its decree was not binding on the Tax Court as to their interests, relying in this regard upon what was said in our previous opinion in the First-Mechanics Nat. Bank case. But, as now appears, that case, since it did not involve the state adjudication of taxable state property rights, was not controlling in the Childs' Estate case, which did involve such rights. Moreover, other courts have taken the view that a binding state judgment adjudicating property rights must be given conclusive effect in tax cases even though it was entered by consent,
Whatever may be the case with respect to consent decrees, however, it
Furthermore we think that our conclusion is soundly based in public policy. For it is quite common and highly commendable for all the members of a family group interested in a decedent's will to take a common view as to their rights under it, thus promoting family harmony and preventing that unseemly and disturbing spectacle, a family fight over a deceased relative's property. It is certainly quite proper for the persons interested in a trust estate thus frankly to express to the court which has jurisdiction a common view as to the correct legal solution of any questions which exist as to their rights in the trust. If the questions are fairly posed to the court and the tribunal is left free to decide them according to its own independent judgment it should not be necessary for the parties to take formal adversary positions and engage in legal shadow boxing in order that the judgment of the court should have conclusive effect, taxwise as well as propertywise.
An examination of the state court proceedings involved in the Blair case
Likewise in our cases of Sharpe v. Commissioner of Internal Revenue, 1939, 107 F.2d 13, certiorari denied 309 U.S. 665, 60 S.Ct. 591, 84 L.Ed. 1013, and Commissioner of Internal Revenue v. Crawford's Estate, 1943, 139 F.2d 616, as well as in the cases of Bullard v. Commissioner of Internal Revenue, 7 Cir., 1937, 90 F.2d 144, reversed on other grounds Helvering v. Bullard, 303 U.S. 297, 58 S.Ct. 565, 82 L.Ed. 852; Henricksen v. Baker-Boyer Nat. Bank, 9 Cir., 1944, 139 F.2d 877, and Eisenmenger v. Commissioner of Internal Revenue, 8 Cir., 1944, 145 F.2d 103, 156 A.L.R. 741, state judgments were held conclusive although none of them involved proceedings which were adversary in any real sense. We think the necessary conclusion is that whether the proceeding was adversary or nonadversary is not the test of conclusiveness in these cases but rather whether the judgment is an adjudication by the state court of a property right upon which solely the federal tax is imposed, which adjudication was and is final and binding upon the parties under the state law, and which was not obtained by collusion for the purpose of defeating the tax.
In the present case the Orphans' Court adjudicated the respective rights of the plaintiff and the twelve children in the income of the trust estate. There is no allegation of collusion. It appears that the questions whether or not the plaintiff and the twelve children were each entitled to a one-thirteenth interest in the income under the will or under the plaintiff's renunciation were fairly presented to the Orphans' Court for its adjudication.
The judgment of the district court will be reversed and the cause remanded for further proceedings not inconsistent with this opinion.
McLAUGHLIN, Circuit Judge (concurring).
I agree with the basic legal principle of the majority opinion that a state property right adjudication is controlling on the Commissioner of Internal Revenue and that the decisions of this circuit should be clarified regarding it. But I do not consider that this tax avoidance, streamlined passing of an account is exactly the type of case to carry the pronouncement. And I think it apparent the state judge here did not decide the rights involved apart from the release and disclaimer.
KALODNER, Circuit Judge (dissenting).
These principles are well-settled:
Where, in a state where the assignment is revocable, the beneficiary of a spendthrift trust makes an assignment of income payable to him under its terms, the circumstance that the assigned income was paid directly by the trustees to the assignee does not relieve the beneficiary from liability to pay the income tax imposed by law on such income.
Under Pennsylvania law an assignment by a beneficiary of income payable to him under the terms of a spendthrift trust is revocable at any time; in other words the beneficiary of a spendthrift trust cannot irrevocably assign or disclaim his trust interest.
The will under which the plaintiff was named a beneficiary became effective on March 19, 1942, and the trust clearly had become operative since the taxpayer reported all the trust income as her own for the year 1942. Consequently, the testamentary trust here involved comes squarely within settled Pennsylvania law. It is clear therefore that the plaintiff's disclaimer could not operate to divest her irrevocably of her full trust interest.
The propositions contained in the foregoing paragraphs are, for me, dispositive of the case and require an affirmance of the judgment of the District Court.
The majority does not find these propositions material to this appeal because
I do not, however, agree that this is the interpretation to be placed upon the disposition of the Orphans' Court.
In my view that Court merely confirmed the trustees' account and did not adjudicate the plaintiff's property rights in the trust.
With respect to the plaintiff's interest created by the will the Orphans' Court stated only that "the distribution of income shown by the account and the proposed future distributions are not inconsistent with the directions in decedent's will * * *." (Emphasis supplied.) Since under the will the plaintiff was requested, in precatory language, to provide funds for the "maintenance and support" of his children, an outright gift of income to them by the plaintiff would not be "inconsistent" with the testator's disposition. There is no intimation by the Orphans' Court that by the will itself any interest was vested in the children.
The Orphans' Court disposition must be viewed against the background of well-settled practice therein, of which we can take judicial notice, that amicable intra-mural family arrangements relating to distribution of estate and trust income and property be confirmed as a matter of public policy.
As stated in Re Way's Estate, 1954, 379 Pa. 421, 437, 109 A.2d 164, 172, "Family agreements or settlements are favorites of the law and when fairly made will not be disturbed. In re Edelman's Estate, 336 Pa. 4, 6 A.2d 511, 8 A.2d 799."
This settled practice strengthens my conviction that the Orphans' Court did not purport, in the instant case, to adjudicate property rights but merely followed its practice of refusing to disturb distributions to which all parties in interest had assented.
Since the plaintiff has therefore always had complete control of the "disclaimed" interest, in that she could at all times
For the reasons stated I would affirm the judgment of the District Court.
"(1) Have testator's widow and twelve children (Edward A. Gallagher, Jr., the oldest of testator's thirteen children, having been expressly excluded by testator from any share of the estate) each been entitled to an equal share of the Trust income under the provisions of the testator's Will, all of the children having resided continuously with their mother except while serving in the Military or Naval Forces of the United States?
"(2) Did not each of the twelve children become legally vested with the right to receive a 1/13 share of the net income, independently of the Will, by reason of the widow's admitted disclaimer and renunciation of any interest in the trust estate in excess of a 1/13 share of the net income?"
"In the opinion of the Auditing Judge, the distributions of income shown by the account and the proposed future distributions are not inconsistent with the directions in decedent's will and there can be no question of the right of the widow to disclaim or to renounce any beneficial interest to which she may be entitled under the will of her husband."
This principle was reaffirmed in Re Borsch's Estate, 1949, 362 Pa. 581, 67 A.2d 119. The Act of June 1, 1945, P.L. 1337, 68 P.S. § 581 et seq. provided for the release or disclaimer of property or income therefrom, irrespective of spendthrift provisions. The Act was held unconstitutional as applied to operating spendthrift trusts created prior to its enactment. In the course of its opinion the Court stated: "While the life tenant may presently decline spendthrift income (which in the interim may be distributed to others under the terms of the will or by law), it may subsequently develop that the creator of the trust was wiser than the beneficiary who may thereafter desire to repudiate her release and renunciation and receive future income." 362 Pa. at page 589, 67 A.2d at page 123.