The opinion of the court was delivered by: Marovitz, District Judge.
Cross Motions for Summary Judgment
This is an action to recover income taxes alleged to have been
illegally and erroneously assessed and collected. This Court has
jurisdiction under 28 U.S.C. § 1346(a)(1).
Mary timely filed her 1959, 1960 and 1961 individual income tax
returns with the Internal Revenue Service and paid the amount of
tax computed by her to be due. The District Director of Internal
Revenue then assessed additional taxes for those three years on
the basis that an additional $10,000 should be included in her
income in the year 1959, and that an additional $12,000 should be
included in her income for each of the years 1960 and 1961. The
additional taxes, for all three years, amounted to $18,357.50,
and were paid by Mary to the District Director, together with
interest, on January 29, 1965. On March 5, 1965, Mary Thompson
filed claims for refund of those taxes with the District
Director; these claims have not been allowed.
George F. Harding, Mary's father, died testate on April 2,
1939. George Harding's will left the residue of his estate in
trust to Jessie Katz, as trustee, directing the trustee to pay
out of income, or from the corpus if income was insufficient, the
sum of $12,000 per year, in monthly installments, to Mary, his
sole heir at law, for life and thereafter $6,000 per year in
monthly installments to each of his two grandchildren (Mary's
children) George and Penelope, for life. Any income of the trust
estate not payable to these three was to go to the George F.
Harding Collection, now known as the George F. Harding Museum.
Upon the death of the last of these three, the trustee was to
distribute the remainder of the trust estate to the museum.
Subsequent to the 1942 amendment of the Internal Revenue Code,
a dispute arose between Mary and the museum as to the
interpretation of the trust instrument with respect to the
payment of income taxes on sums distributed to Mary by the
trustee. It was contended by Mary that her father had intended
that she receive trust distributions free of taxation. It was the
position of the museum that the trust instrument was subject to
interpretation in this regard and in 1950 the trustee filed suit
in Superior Court of Cook County, Illinois requesting an
interpretation of the trust with respect to the propriety of the
payment from the trust estate of income taxes becoming payable by
Mary on sums distributed to her by the trustee.
On July 9, 1951, Mary, the museum and the trustee entered into
an agreement which, as later amended, provided that (1) the
Superior Court case would be held in abeyance until the youngest
of Mary's children attained majority; (2) the trustee would make
payment to Mary of a sum equal to her income taxes (computed at
her highest tax bracket) payable by reason of her receipt from
the trust estate of $12,000.00 per year during the years 1942
through 1950 and would make payment to Mary in each year of a sum
equal to her income tax (computed at her highest tax bracket)
payable by reason of her receipt from the trust estate of
$12,000.00 during the previous year; (3) Mary and the museum each
retained the right to apply to a court of competent jurisdiction
to determine Mary's right to receive such income tax
reimbursement under her father's will; and (4) if such issue were
determined adversely to Mary she would refund all such
reimbursements to the trustee.
Between 1951 and 1957 the trustee and Mary, for personal
reasons, found it increasingly difficult to maintain a compatible
relationship. In 1957, the trustee instituted a suit, amended by
her in 1958, whereby she sought to have her accounts approved and
to have the question of the trust's liability for Mary's income
taxes on the amounts paid to her resolved and to have herself
discharged as trustee.
The successor trustee, as nominated by the decedent, refused to
Early in the next year, on January 15, 1959, the three life
beneficiaries under George Harding's will, together with the
trustee and the museum (the remainderman), entered into an
whereby, with court approval, the trust would terminate and all
of the assets would go to the museum as the absolute owner, free
of trust, with the proviso that the museum would "continue to
make the annual payments of $12,000.00 per year to Mary Harding
Thompson throughout her lifetime". Provision was also made in the
agreement to make the $6,000 per year payments to George and
Penelope on Mary's death.
The agreement also contained a proposed form of court decree
which was entered, without change, by the Circuit Court of Cook
County on March 16, 1959, approving the parties' actions. This
decree approved the accounts of the trustee, permitted her
resignation, terminated the trust and distributed all of the
assets to the museum as absolute owner thereof.
Consequently, the trustee was no longer the source of monthly
payments to Mary. The museum began making the $1,000 payments as
of March, 1959. It made no payments to Mary during the years
1959, 1960, and 1961 on account of income taxes.
It is the museum's monthly payments which are the subject of
this action. The question to be decided is whether the
transaction under which the museum received the assets of the
trust in exchange for the obligation to pay Mary and her children
their respective allotments was, in fact, a sale of a capital
asset, as contended by plaintiffs, or was a meaningless change in
payors, as contended by the Government. The determination of
whether a sale of a capital asset occurred requires an
examination of the nature of a capital asset and the purpose of
the law relating to the sale of such entities. Commissioner of
Internal Revenue v. Gillette Motor Transport, Inc., 364 U.S. 130,
134, 80 S.Ct. 1497, 4 L.Ed.2d 1617 (1960); Commissioner of
Internal Revenue v. P.G. Lake, Inc., 356 U.S. 260, 265, 78 S.Ct.
691, 2 L.Ed.2d 743 (1958). Further, as with most tax questions,
we must look to the substance ...