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Loeb v. Commissioner of Internal Revenue. Commissioner of Internal Revenue

December 20, 1946


Author: Evans

Before EVANS and MINTON, Circuit Judges, and LINDLEY, District Judge.

EVANS, Circuit Judge.

The Commissioner has imposed deficiency income taxes upon Herbert Loeb for the years 1939 and 1940, which the Tax Court has sustained in the amounts of $7,159.18 and $20,785.16, respectively.

The alleged deficiency grows out of the Commissioner's assertion that Loeb was taxable on $60,000 dividends, declared in the years in question,*fn1 upon ten thousand shares of Hillman Company stock, which Loeb had transferred, December 15, 1939, to two trusts, for the benefit respectively of his two adult sons. The transfer of this stock in trust was subject to a pre-existing contract and lien of one Max Adler as sole security for a $499,615.08 indebtedness of Loeb to him, and subject to the prior pledge of the stock to Pick & Co. (hereinafter called Pick) to secure Loeb's debt to it of $239,910.22 and of Loeb's associate's debt to Pick of $262,965.93.

The trustee named in said trusts had paid income tax on the dividends and Loeb had paid gift tax on the corpus of the trusts at the time of their creation.

The Terms of the Trusts. Loeb transferred five thousand shares of Hillman's, Inc. to each of two trusts, December 15, 1939, one for the benefit of his son, Herbert A. Loeb, Jr., and the other for the benefit of his son, Edward Loeb. The transfer in trust was "subject, however, to the existing pledge of said property for an indebtedness of the Grantor to George Pick & Company and subject also to the terms and provisions of the agreement dated January 12, 1935, made between Max Adler and the Grantor."

The trust instrument gave power to the trustees to "spend all or any part (of the net income * * * for the reduction of liens or encumbrances against the trust estate * * *."

During the ten year life of the trust the income might be paid to the beneficiary, and at the end of the term the trust was to terminate and the corpus and accumulated income would be paid to the beneficiary.

The Terms of the Max Adler Contract. The Adler contract, executed January 12, 1935, recited an existing indebtedness of $782,236.05; an assignment to Adler of two accounts, totaling $282,620.97, due Loeb, thereby reducing the existing debt to $499,615.08; a transfer of 1,026 shares of H-H Corporation stock (predecessor of Hillman) to Adler. The H-H stock was represented by two certificates, one for twenty-six shares, being in Loeb's possession, and one for the thousand shares, which it was recited by the agreement was pledged with Pick to secure a $239,910.22 debt to that company. The agreement also provided for an indorsement across its face of notice of the Adler agreement.

One of the important provisions of the Adler contract is paragraph 6 which provides that seventy-five per cent of all cash dividends declared upon the stock shall be paid to Adler in reduction of the debt "unless by reason of the receipt of said dividends and by reason of * * * salary or other compensation from H-H Corporation * * * (etc.) (treating said dividends and such compensation as the only income received by said Herbert A. Loeb) is in excess of * * * 25% of the aggregate amount of such income, in which case the percentage of said dividends payable to * * * Adler shall be reduced to the extent that such income tax * * * is in excess of * * * 25%. * * *" The agreement then provided for the return of a proportionate amount of the stock given as security upon reduction of the debt. Release of the stock also released dividends upon such stock where release was effected by payment out of funds other than dividends. If Adler made payments upon the Pick indebtedness, payments under the Adler contract were to apply first to the advances so made to Pick. Loeb reserved the right to vote the stock.

The agreement also provided "It is understood and agreed that said Max Adler accepts this contract and the agreements therein contained in full settlement of the indebtedness above described due him from said * * * Loeb, and hereby discharges him from any further personal liability therefor, said Max Adler accepting in full satisfaction of said indebtedness his right to receive the dividends from said stock * * *." If the entire debt was not paid out of dividends in a ten year period, a public sale was to be had of the stock and the proceeds applied to the debt.

The Pick Pledge.*fn2 Pick not only had the Hillman stock, involved in the instant trusts, on pledge, but had in addition seven thousand of other shares of Hillman stock, and listed and readily marketable stock in other companies, and Loeb claims Pick carried that indebtedness primarily upon Loeb's personal liability and upon the listed stock, and not upon the Hillman stock. He had agreed in 1939 to pay Pick $25,000 per year on the indebtedness until the listed collateral equalled the balance, and he made three payments of $12,500 pursuant to such agreement. On December 31, 1939, the Pick indebtedness amounted to $176,244.35 and the listed collateral had a market value of $137,014.06; and a year later the debt amounted to $142,348.88 and the listed collateral had a value of $124,303.13.

The Tax Court held Loeb to be taxable on the entire $60,000 dividends declared on the trust stock (less trust expenses) on these theories: (1) as to the seventy-five percent of the dividends applicable to the Adler contract it held them taxable to Loeb on the theory that it was "constructively received" by him. The Tax Court said: "* * * petitioner * * * was not, after the * * * 1935 contract, personally liable on his old debt, * * *. But he secured his release from that liability by the expedient of assuming for his own benefit a new and different obligation - the obligation to pay over the stipulated percentage of the dividends to Adler. This obligation was to continue during the life of the contract which expressly required that any transfer of the stock be made subject thereto. The transfers to the trusts * * * were in fact made specifically subject to the requirements of petitioner's contract with Adler. The payments made to Adler out of the dividends after the transfer were therefore made at his direction in satisfaction of petitioner's obligation assumed for his own economic advantage. This is true not because the payments were credited to the old debt, but because they were made pursuant to and in satisfaction of a valid and existing contractual obligation of petitioner." (2) ...

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