22 



HARDWOOD RECORD 



Mav -^r,. VJ-il 



Recent Tax Decisions Explained 



In spite 1)1' thf wide imblicily tliat iuis Iji-i-n gixcri to tin; lecuiil 

 decisions of tlie Supreme Court on tlie question of the taxability 

 undc^ the Federal Ineonie statutes of tlie gains from the sale of 

 capital assets it appears that there still remains in the minds of 

 many some confusion as to the net result of these decisions. This 

 is due, doubtless to the fact that the ordinary business man has 

 not the inclination nor time to carefully digest these decisions and 

 the customary newspaper accounts at the time the decisions are 

 rendered were hurriedly prepared and stated the principles in 

 equivocal language, leaving certain doubts in the minds of readers. 

 I shall attempt, therefore, briefly to state the [irinciples established 

 in these cases with a view to clearing up doubts and uncertainties. 

 The cases decided, dealing with sales of capital assets were four 

 ill niinibor. T will treat them separately: 



Value on 

 Marcli 1, 1013 



Sellinz Price 

 iu 1016 



Cnse No. 1 



The Mcrvhautt' l.iiuii and Trust Cnmpnnii as Trustee of the Kulatr of 

 Arthur Rijcrson, Dereascd v. SmirtanUa, Collector of Internal Pevenue: 



This Is known as the "R.vcr.son" case, .\rthur Ryerson died in 1012 

 IcavinK amoii!; other property, certain sliaros of stocl! in tlie hanils of 

 tlie Mcrchaiit.s' Loan and Trust (\>nipany as Trustee. The Trustee was to 

 pay the income from tliese stoclis to the widow of Mr, Ryerson during 

 hor life and tliereafter to certain children until each became twcntyfive 

 years of age, at which time the property was to be divided. The Trustee 

 was given fullest dominion over the property and iiiarte final judse as to 

 what was income to be jiaid over to the beneficiaries and what was to 

 remain a part of the estate until final distribution, except that the will 

 provided that stock dividends and accretions of selling values should be 

 consideriMl principal and mil income. Holow T show graphically the trans- 

 action to illustniti' tlip principles announced: 



Value on 

 March 1, lOl.'? 



Selling Price 

 March, lOlG 



Cost prior to 

 March 1. 101.-! 

 Not sliown but 

 apparently less 

 than the March 

 1.1913 value .$.5fil, 708.00 $1,280,906.64 



Income tax was collected on the dilTerence Ix'twccn the March 1, 1913, 

 value and the selling price. The ground of protest against payment of this 

 tax was that this difference represented merely an appreciation in the 

 value of the capital assets of the estate and was not Income within the 

 meaning of the Sixteenth .Vmendnn-nt. and could therefore not be con- 

 stitiitioii,-illy ta.\«i without apportionment as required by Section 2, clause 

 3 and by Section 9, clause 4 of .\rlicle I of the Constitution, The con- 

 tention was based on two iirincipai grounds: (1) This taxpayer was not 

 engaged in the business of buying and selling property and therefore any 

 increase in the capital of the estate resulting from a conversion of a part 

 of the assets to cash resulted merely in an accretion to the capital itself. 

 In support of this there was reference made to decisions dealing with 

 interests of lifi- tenant and remainderman in gains derived from invested 

 capital, which discussions the court found of little value for the purpose 

 of this case: (2i It was not the intention of the franiers of the Sixteentli 

 .\mendment that such gains be treated as ta.xabic income. 



The Court held, however, that the difTercnce between the March 1, 1013, 

 value and the 1017 selling price was taxable income. 



The case further atflrms the principle which lias l>een followed by the 

 department that the dilTerence between the March ], 1913. value and the 

 later selling price of propiTty acipiired prior to March 1, 191:^, is taxable 

 income provided the value prior to March 1. 1913, was less than that on 

 March 1, 1913, In other words, where property acquired prior to March 

 1, 191.3, Is sold subsequent to that date at a price in excess of the original 

 cost, the increase in value accruing sulisequent to March 1, 1913. is taxable 

 income when realized. This was decided upon the wording of the 1016 

 .\ct as amended l>y the 1017 .Vet. The decision is clearly binding, not 

 only as to transactions coming under those two Acts, but also to trans- 

 actions coming under the 1018 Act. It Is also clear that the principle 

 applies to Income of Individuals aud corporations as well as to that of a 

 Trustee. 



Case No. II. 



Ixirid .If. Goodriih v. Kduardu, Collector of Internal Revenue: 

 This case involves two transactions which will be treated under two 

 subdivisions (at and (b) : 



la) The first transaction was a sale of stock which may be Indicated 

 graphically thus : 



I ,,^l |,ii.,r I.. 



March 1, 1913 



11012) 



.$.-,00 $693 S13.931.22 



Here there is the same situation as in Case No. I and the court held 

 tliat this case is ruled by the decision in Case No. I. 



(bl The second transaction w-as a sale of stock which may be indicated 

 graphically thus : 



Cost prior to Value on Selling Price 



.Marcli I. 1013 March 1, 1913 in 1916 



I 1012) 

 .'i;201. 600.00 $148,635.50 .S260.346.25 



The income tax act in effect during 1916 stated: 



■Tor the purpose of ascertaining the gain derived from the sale or 

 other disposition of property, real, personal, or mixed, acquired before 

 March 1, 191.3, the fair market price or value of such property as of 

 March 1. 1013. shall be the basis for determining the amount of such gain 

 derived." 



Substantially the same provision applies from 1916 on in the later acts 

 and what is said here clearly applies equally to transactions under the later 

 acts. 



In this case a tax had been collected on the difference between the 

 March 1, 1913. value and the selling price, but at the trial before the 

 Supreme Court the Government confessed error and agreed that Inasmncb 

 as the selling price was less than the original invostme'nt, there was no 

 gain to be ta.xed. The net result of this transaction was a loss of .$22.- 

 253.75. It docs not appear that any claim for a right to take a deduction 

 in this amount in the ye.Tr of the sale was made and this point is not 

 mentioned in the opinion. 



The principle established by this case is that the March 1. 1013. value 

 is ignored in such a transaction as tbis one where viewing tlie transaction 

 as a wliole there is uo net gain. To state the principle more broadly, 

 where the March 1, 1013, value represents an accrued loss, a subsequent 

 sale results in a taxable net gain only in the event such selling price 

 exceeds the original cost. 



Case No. III. 



•fiimft< J. ll'ff/«7i. Collector of Internal lierenuc v. Frederick F. Brewster: 



'I'liis case involves two principal transactions which will be treated under 

 two subdivisions la) and lb) : 



(a) The first transaction involves a sale t»f bonds which may l>e indi- 

 cated graphically thus : 



Cost prior to Value on Selliug Price 



March 1, 1913 March 1. 1913 in 1016 



$191,000.00 $151,845.00 $191,000.00 



The court here held that inasmuch as the selling price was tlje same as 

 cost prior to March 1, 1913. there was no taxable income. This follows 

 the principle laid down in Case No. II (b) above. 



lb) This transaction involved also a sale of bonds which ma.v be indi- 

 cated graphically thus : 



Cost prior to Value on Selling Price 



March 1,1913 March 1. 1913 in 1016 



$231,300.00 $164,480.00 $276,150.00 



The court held that the only taxable income was the difference between 

 the original cost and the selling price carrying the principle of the Good- 

 rich Case, No. II (b) above, one step farther, so that the principle there 

 established may now be stated thus : 



When the March 1, 1913, value represents an accrued loss, a subsequent 

 sale results iu a taxable net gain only and to the extent only^ that such 

 sale price exceeds the original cost. 



Case No. IV. 



Eldorado Coal and Mininff Company v. Mayer, Collector of Internal 

 Revenue: 



The facts in this case are very similar iu principle tt) those in Case No. I 

 which it was held controlled ami ueeti not. tlierefore, be further discussed. 

 The "La Belle Iron Works" Case 



The case now before the Supreme Court which is of the greatest 

 interest to taxpayers is La Belle Iron Works v. The United States. 



This case involves the question of invested capital which is a very 

 technical subject and for this reason the exact points involved have 

 become confused. I shall attempt to briefly outline the points which It 

 is hoped will be decided in this ease, with the thought that when the 

 decision is handed down those interested will more readily understand the 

 effect of the holding of the court. 



The La Belie Iron Ti'orks, a corporation organized in 1875 in West 

 Virginia, acquired ore lauds prior to the .vear 1904 for the sum of $190,- 

 000.00. Extensive exploration and development work was carried on and 

 it was proved that the land contained large bodies of ore so that between 

 1904 and 1012 the property increased in known value to $10,105,400 and, 

 {Continued on patjc 24) 



