Healy v. Commissioner
(1953)
HEALY ET AL. v. COMMISSIONER OF
INTERNAL REVENUE
No. 76
SUPREME COURT OF THE UNITED STATES
345 U.S. 278; 73 S. Ct. 671; 97 L.
Ed. 1007;
53-1 U.S. Tax Cas. (CCH) P9292; 43
A.F.T.R. (P-H) 382; 1953-1 C.B. 68; 1953 P.H. P72,008
December 12, 1952, Argued
April 6, 1953, Decided
PRIOR HISTORY: CERTIORARI TO THE UNITED STATES COURT
OF APPEALS FOR THE SECOND CIRCUIT. *
* Together with No. 138, Commissioner of Internal
Revenue v. Smith, on certiorari to the United States Court of Appeals for
the Sixth Circuit.
No. 76. The Tax Court held that the petitioners'
income for a prior year should be recomputed to their advantage. 16 T. C.
200. The Court of Appeals reversed. 194 F.2d 662. This Court granted
certiorari. 344 U.S. 811. Affirmed, p. 285.
No. 138. The Tax Court held that respondent's income
for a prior year should be recomputed to his advantage. 11 T. C. 174. The
Court of Appeals affirmed. 194 F.2d 536. This Court granted certiorari.
344 U.S. 813. Reversed, p. 285.
DISPOSITION: 194 F.2d 662, affirmed. 194 F.2d 536,
reversed.
SYLLABUS: An individual taxpayer received a salary
from a closely held corporation and reported it in full in his income tax
return for the year in which it was received. In a subsequent year, it was
determined that the salary was excessive and the taxpayer was required as
transferee to make payments on tax deficiencies of the corporation for
prior years. Held: The taxpayer's income tax for the year in which he
received the excessive salary may not be recomputed so as to exclude from
his income for that year that part of his salary held to be excessive and
which resulted in his transferee liability. Pp. 279-285.
(a) Having received the salary under a "claim of
right," the taxpayer was required to report it as income and to pay a
tax thereon. Pp. 281-282.
(b) Funds are held under a "claim of right"
within the meaning of North American Oil v. Burnet, 286 U.S. 417, when
received and treated by a taxpayer as belonging to him, even though the
claim may subsequently be found invalid. P. 282.
(c) That the receipt of the excessive portion of the
salary resulted in transferee liability as a "constructive
trustee" does not prevent application of the "claim of
right" doctrine. Pp. 282-283.
(d) Nor can the salary be treated as money received
subject to a "restriction on its use" within the scope of the
"claim of right" doctrine, even though the facts which
ultimately gave rise to the transferee liability were in existence at the
end of the taxable year. Pp. 283-284.
(e) A different result is not required by the fact
that, in this particular case, an inequity might result from requiring the
taxpayer to treat as income an amount which eventually turned out not to
be income. Pp. 284-285.
COUNSEL: James H. Heffern argued the cause and filed a
brief for petitioners in No. 76.
Assistant Attorney General Lyon argued the cause for
petitioner in No. 138 and respondent in No. 76. With him on the briefs
were Ellis N. Slack, Lee A. Jackson and Melva M. Graney. Solicitor General
Cummings was also on the brief in No. 76. Robert L. Stern, then Acting
Solicitor General, and Philip Elman were also on the brief in No. 138.
Sol Goodman argued the cause and filed a brief for
respondent in No. 138.
JUDGES: Vinson, Black, Reed, Frankfurter, Douglas,
Jackson, Burton, Clark, Minton
OPINIONBY: VINSON
OPINION: MR. CHIEF JUSTICE VINSON delivered the
opinion of the Court.
The income tax liability of three individual taxpayers
for a given year is here before the Court. Only a single question, common
to all the cases, is involved. The Tax Court held a view favorable to the
taxpayers. n1 The Commissioner of Internal Revenue sought review before
the appropriate Courts of Appeals. As to two of the taxpayers, the Court
of Appeals for the Second Circuit reversed, n2 while the Court of Appeals
for the Sixth Circuit took a contrary view of the law. n3 We granted
certiorari to resolve the conflict. n4
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n1 Gordon W. Hartfield and Edwin E. Healy, 16 T. C.
200 (1951) (consolidated proceedings); Hall C. Smith, 11 T. C. 174 (1948).
n2 Commissioner v. Hartfield, 194 F.2d 662 (1952).
n3 Commissioner v. Smith, 194 F.2d 536 (1952).
n4 344 U.S. 811, 813 (1952).
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All controlling facts in the three situations
are similar. Each taxpayer reports his income on the cash receipts
and disbursements method. Each, in the respective years involved,
received a salary from a closely held corporation in which he was
both an officer and a stockholder. The full amount of salary so
received was reported as income for the year received. Subsequently,
after audit of the corporate returns, the Commissioner disallowed
the deduction by the corporations of parts of the salaries as exceeding
reasonable compensation. As a result, deficiencies in income taxes
were determined against the corporations. The Commissioner also
determined that the officers were liable as transferees under @
311 of the Internal Revenue Code for the corporate deficiencies.
The receipt of excessive salary was the transfer upon which the
transferee liability was predicated. As a result of either litigation
n5 or negotiation, various amounts became established as deficiencies
of the corporations and as transferee liabilities of each of the
three officers. In each case, the entire process of determining
these amounts -- from the start of the audit by agents of the Commissioner
to the final establishment of the liabilities -- occurred after
the end of the year in which the salary was received and reported.
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n5 Charles E. Smith & Sons Co. v. Commissioner,
184 F.2d 1011 (1950).
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The question before the Court is whether part of the
salary should be excluded from taxable income in the year of receipt since
part was excessive salary and led to transferee liability for the unpaid
taxes of the corporations. The taxpayers contend that an adjustment should
be made in the year of original receipt of the salary; the Government that
an adjustment should be made in the year of payment of the transferee
liability.
One of the basic aspects of the federal income tax is
that there be an annual accounting of income. n6 Each item of income must
be reported in the year in which it is properly reportable and in no
other. For a cash basis taxpayer, as these three are, the correct year is
the year in which received. n7
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n6 Reo Motors v. Commissioner, 338 U.S. 442 (1950);
Heiner v. Mellon, 304 U.S. 271 (1938); Burnet v. Sanford & Brooks Co.,
282 U.S. 359 (1931). See I. R. C., @ 41.
n7 I. R. C., @ 42 (a). Other permissive methods of
accounting for tax purposes are the accrual basis, I. R. C., @@ 41 and 42,
and the installment basis, I. R. C., @ 44.
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Not infrequently, an adverse claimant will contest the
right of the recipient to retain money or property, either in the year of
receipt or subsequently. In North American Oil v. Burnet, 286 U.S. 417
(1932), we considered whether such uncertainty would result in an amount
otherwise includible in income being deferred as reportable income beyond
the annual period in which received. That decision established the claim
of right doctrine "now deeply rooted in the federal tax system."
n8 The usual statement of the rule is that by Mr. Justice Brandeis in the
North American Oil opinion: "If a taxpayer receives earnings under a
claim of right and without restriction as to its disposition, he has
received income which he is required to return, even though it may still
be claimed that he is not entitled to retain the money, and even though he
may still be adjudged liable to restore its equivalent." 286 U.S., at
424.
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n8 United States v. Lewis, 340 U.S. 590, 592 (1951).
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The phrase "claim of right" is a term known
of old to lawyers. Its typical use has been in real property law in
dealing with title by adverse possession, where the rule has been that
title can be acquired by adverse possession only if the occupant claims
that he has a right to be in possession as owner. n9 The use of the term
in the field of income taxation is analogous. There is a claim of right
when funds are received and treated by a taxpayer as belonging to him. The
fact that subsequently the claim is found to be invalid by a court does
not change the fact that the claim did exist. A mistaken claim is
nonetheless a claim, United States v. Lewis, 340 U.S. 590 (1951).
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n9 4 Tiffany, Real Property, @ 1147.
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However, we are told that the salaries were not
received as belonging to the taxpayers, but rather they were received by
the taxpayers as "constructive trustees" for the benefit of the
creditors of the corporation. Admittedly, receipts by a trustee expressly
for the benefit of another are not income to the trustee in his individual
capacity, for he "has received nothing . . . for his separate use and
benefit," Eisner v. Macomber, 252 U.S. 189, 211 (1920).
We do not believe that these taxpayers were trustees
in the sense that the salaries were not received for their separate use
and benefit. Under the equitable doctrine that the funds of a corporation
are a trust fund for the benefit of creditors, a stockholder receiving
funds without adequate consideration from an insolvent corporation may be
held, in some jurisdictions, to hold the funds as a constructive trustee.
n10 So it was that these taxpayers were declared constructive trustees and
were liable as transferees in equity. A constructive trust is a fiction
imposed as an equitable device for achieving justice. n11 It lacks the
attributes of a true trust, and is not based on any intention of the
parties. Even though it has a retroactive existence in legal fiction,
fiction cannot change the "readily realizable economic value"
n12 and practical "use and benefit" n13 which these taxpayers
enjoyed during a prior annual accounting period, antecedent to the
declaration of the constructive trust.
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n10 15A Fletcher, Cyclopedia Corporations, @@
7369-7389.
n11 3 Scott on Trusts, @ 462.1; 3 Bogert, Trusts and
Trustees, @ 471.
n12 Rutkin v. United States, 343 U.S. 130, 137 (1952).
n13 Eisner v. Macomber, 252 U.S. 189, 211 (1920).
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We think it clear that the salaries were received
under a claim of individual right -- not under a claim of right as a
trustee. Indeed one of the parties concedes, as is manifestly so, that the
reporting of the salary on the income tax returns indicated that the
income was held under a claim of individual right. The taxpayers argue
that the salary was subject to a restriction on its use. n14 Since all the
facts which ultimately gave rise to the transferee liability were in
existence at the end of the taxable year, we are told those facts were a
legal restriction on the use of the salary. Actually it could not have
been said at the end of each of the years involved that the transferee
liability would materialize. The Commissioner might not have audited one
or all of these particular returns; the Commissioner might not have gone
through the correct procedure or have produced enough admissible evidence
to meet his burden of proving transferee liability; n15 or, through
subsequent profitable operations, the corporations might have been able to
have paid their taxes obviating the necessity of resort to the
transferees. n16
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n14 The rule announced in North American Oil v.
Burnet, supra, requires a receipt without "restriction on use"
as well as under a claim of right.
n15 I. R. C., @ 1119 imposes upon the Commissioner the
burden of proving transferee liability. This may be contrasted to the rule
that normally the burden of proof is on the taxpayer contesting the
determination of the Commissioner. I. R. C., @ 1111; Rule 32, Tax Court of
United States.
n16 Transferee liability is secondary to the primary
liability of the transferor. To sustain transferee liability the
Commissioner must prove that he is unable to collect the deficiency from
the transferor. 9 Mertens, Law of Federal Income Taxation, @ 53.29.
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There is no need to attempt to list hypothetical
situations not before us which put such restrictions on use as to prevent
the receipt under claim of right from giving rise to taxable income. But a
potential or dormant restriction, such as here involved, which depends
upon the future application of rules of law to present facts, is not a
"restriction on use" within the meaning of North American Oil v.
Burnet, supra.
The inequities of treating an amount as income which
eventually turns out not to be income are urged upon us. The Government
concedes that each of these taxpayers is entitled to a deduction for a
loss in the year of repayment of the amount earlier included in income.
n17 In some cases, this treatment will benefit the taxpayer; in others it
will not. Factors such as the tax rates in the years involved and the
brackets in which the income of the taxpayer falls will be controlling. A
rule which required that the adjustment be made in the earlier year of
receipt instead of the later year of repayment would generally be
unfavorable to taxpayers, for the statute of limitations would frequently
bar any adjustment of the tax liability for the earlier year. n18 Congress
has enacted an annual accounting system under which income is counted up
at the end of each year. It would be disruptive of an orderly collection
of the revenue to rule that the accounting must be done over again to
reflect events occurring after the year for which the accounting is made,
and would violate the spirit of the annual accounting system. This basic
principle cannot be changed simply because it is of advantage to a
taxpayer or to the Government in a particular case that a different rule
be followed.
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n17G. C. M. 16730, XV-1 Cum. Bull. 179 (1936).
n18 I. R. C., @ 322 (b). See also I. R. C., @@ 275 and
311 (b).
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The judgment of the Court of Appeals for the Second
Circuit in No. 76, being consistent with this opinion, is affirmed, while
the contrary judgment of the Court of Appeals for the Sixth Circuit in No.
138 is reversed.
It is so ordered.
MR. JUSTICE DOUGLAS dissents.
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