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MARTIN v. UNITED STATES

December 15, 1954

MARGARET B. MARTIN, INDIVIDUALLY, AND AS EXECUTOR OF THE LAST WILL OF JOHN C. MARTIN, DECEASED, PLAINTIFF,
v.
UNITED STATES OF AMERICA, DEFENDANT.



The opinion of the court was delivered by: Wham, Chief Judge.

The action herein was filed by the plaintiff, Margaret B. Martin, individually, and as executor of the last will of John C. Martin, deceased, for refund of income taxes and interest, pursuant to the provisions of Sec. 1346(a)(1) (ii) of Title 28 United States Code. The amount in dispute is $10,571.86, which said amount was paid by John C. Martin after a deficiency was assessed against him on his income tax return for the year 1948. The deficiency was assessed as a result of an interpretation by the defendant of certain business transactions, the income from which had been reported as "capital gain" in the said tax return, but which the defendant ruled to be "ordinary income" and thereby subject to a greater rate of taxation.

Over a period of years the tract of land was developed as a cemetery by Pacific and at the end of each quarter year Pacific forwarded a check to Martin in the amount of one-half of the sale price received from the completed sales made during the period along with deeds to the particular lots involved and Martin executed the deeds at Salem, Illinois and returned them to Pacific via a Mr. Decker, who was employed by Martin to make periodic checks of the books of Pacific.

In 1941 Martin purchased an additional tract of land containing 22 acres which was immediately adjoining the land purchased in 1935. Within a short period of time thereafter, on March 21, 1941, Martin again entered into a written contract with Pacific which contained covenants similar to those included in the earlier agreement. This 22 acre tract along with the 11.96 acre tract was then developed by Pacific and payment was made to Martin and deeds executed by him on a quarterly basis as the cemetery lots were sold to individual purchasers by Pacific. Martin took no part in the development, advertising or selling of the cemetery lots nor did he direct or supervise any of these activities.

Mr. Martin was, during his lifetime, a resident of the State of Illinois and at no time did he or Mrs. Martin become residents of the State of California. He conducted his business as President of the Salem National Bank at Salem, Illinois and served in various capacities as an elected and appointed state and national governmental official. Mr. Martin owned shares of stock in the Long Beach Cemetery Association, a California corporation, and served as president of that association, and as such attended its annual meeting of shareholders and directors in California. On one of these trips to California he learned of the property involved in the first transaction here in question, and purchased said property. The Long Beach Cemetery Association had no connection with Pacific other than Mr. Martin's interest in the Long Beach Cemetery Association. Neither Mr. Martin nor Mrs. Martin ever owned any property in California except the two tracts of land involved in the present dispute. They had no stock or other interest in Pacific. Neither of them was ever licensed as a real estate broker either in California or Illinois, or ever participated in or exercised control over Pacific or its business or activities.

Federal Income Tax Returns were prepared and filed in Illinois and from 1936 the investments in the tracts of land in California were treated as capital assets on the said tax returns and the money received from Pacific was reported as "long-term capital gain", and the tax was computed and paid on that basis. When the 1948 tax return was audited by the Internal Revenue Department, Martin was advised that the money received from Pacific was not properly considered as "capital gain" and a deficiency was assessed against him, whereupon he paid the deficiency assessment in the amount of $9,361.68 plus $1,210.18 in interest to the Collector of Internal Revenue.

A Claim for Refund was filed by Martin, which was denied, and all other administrative relief was exhausted and all conditions precedent to institution of legal action in this court were fulfilled. Thereafter, this action was commenced.

At the trial of this case there was no substantial conflict in the evidence with regard to the facts set out above. The conflict between the parties arose out of the interpretation to be given to the facts as outlined, particularly as to the effect of and the nature of the relationship between the parties to the aforementioned contracts.

The plaintiff takes the position that the sale of cemetery lots was a sale of a capital asset at the time of the transfer of title and that neither John C. Martin nor Margaret B. Martin were ever engaged in the trade or business of sub-dividing and selling cemetery lots and that the income received from the sale of said property should be considered as "capital gain" under the provisions of Section 117, Title 26 United States Code.*fn1

The defendant contends that Martin was engaged in a joint venture with Pacific and was thereby in the business of sub-dividing and selling cemetery lots and that the income received from the sale of said property should be considered as ordinary income under Section 22, Title 26 United States Code.*fn2 In the alternative, defendant contends that if the court finds that this was a sale of a capital asset, it is a "short term capital gain" rather than a long term gain for the reason that Martin did not hold the 22 acres more than six months before he entered into the agreement with Pacific, and thereby sold the property to Pacific.

Since the Federal Revenue laws are designed to establish a national program of taxation, what is or is not "capital gain" income for the purpose of Federal taxation is not to be determined by the laws of the several states, but is determined by application of Federal law; Commissioner of Internal Revenue v. Tower, 327 U.S. 280, 66 S.Ct. 532, 90 L.Ed. 670; and the provisions of the Internal Revenue Act are not deemed subject to state law unless the language, or necessary implication of the applicable section requires the application of the laws of the states. United States v. Pelzer, 312 U.S. 399, 61 S.Ct. 659, 85 L.Ed. 913; Helvering v. Stuart, 317 U.S. 154, 63 S.Ct. 140, 87 L.Ed. 154; Putnam's Estate v. C.I.R., 324 U.S. 393, 65 S.Ct. 811, 89 L.Ed. 1023. Although state law creates legal interests and rights, substance and not form are controlling in applying the provisions of the Act. The realities of the taxpayers economic interest, rather than the name given to such interest by the taxpayer or by a state court's interpretation of the interest should control and determine the court's interpretation of what is taxable "capital gain" income. Commissioner of Internal Revenue v. Griffiths, 7 Cir., 103 F.2d 110, affirmed Griffiths v. Helvering, 308 U.S. 355, 60 S.Ct. 277, 84 L.Ed. 319; Tinkoff v. Commissioner of Internal Revenue, 7 Cir., 120 F.2d 564; Thompson v. Commissioner of Internal Revenue, 3 Cir., 205 F.2d 73. If it be found that an interest or right created by the state law comes within the sphere of intended taxation, the name applied to such interest or right counts for naught, and the Federal law must prevail to accomplish the purpose intended. Morgan v. C.I.R., 309 U.S. 78, 626, 60 S.Ct. 424, 84 L.Ed. 585. This is true whether the contentions of the Commissioner or those of the taxpayer are being considered.

No fixed, inflexible formula has been devised which, by mere application, will solve the question of whether property sold by a taxpayer was property held for sale in the usual course of trade or business, or was property held as an investment or capital asset. In the final analysis, each case must stand on, and be determined by the individual facts involved. Mauldin v. Commissioner of Internal Revenue, 10 Cir., 195 F.2d 714; Higgins v. C.I.R., 312 U.S. 212, 61 S.Ct. 475, 85 L.Ed. 783; United States v. Pyne, 313 U.S. 127, 61 S.Ct. 893, 85 L.Ed. 1231; Boomhower v. United States, D.C., 74 F. Supp. 997.

In determining whether a taxpayer is involved in a trade or business, courts have considered various factors to use as guideposts in arriving at a final determination. The emphasis has shifted from one to another of these factors at different times and in different cases. These factors include the continuity of sales, and sales related activity over an extended period of time; the efforts and activity of the seller in improving, advertising, and enhancing the marketability of the property; and the purpose or motive of the taxpayer in acquiring and selling the property. There appears to be a present emphasis on the extent of the taxpayer's activity in the transactions. Snell v. C.I.R., 5 Cir., 97 F.2d ...


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