*274 Decision will be entered under Rule 50.
In 1928 the petitioner's husband entered into an employment agreement with a recently organized corporation under which he was to render service to the corporation for a period of ten years and was not to engage in any other business or occupation during the period of his employment. Upon his death in 1930 the corporation, pursuant to the terms of the agreement, became obligated to pay his estate $ 30,000 annually for ten years and in certain contingencies to pay a percentage of its annual net earnings during the same period. As sole beneficiary of the will of her husband, the petitioner became entitled to receive the payments which the corporation was obligated to make. The value of the agreement or corporation's obligation to make payments thereunder was determined to be $ 243,326.70 for estate tax purposes of the husband's estate. By agreement from time to time between the petitioner and the corporation, the corporation paid smaller amounts than $ 30,000 in some years. No amount representing a percentage of earnings has ever been paid by the corporation. By the end of 1941 the petitioner had received payments totaling approximately*275 $ 7,900 in excess of the value determined for the agreement for estate tax purposes. Additional payments were received in 1942 and 1943. Held:
(1) That the above agreement and the rights thereunder, not the periodic payments thereafter received pursuant to the agreement, constituted property received by bequest within the meaning of section 22 (b) (3) of the Internal Revenue Code, and that the excess of the payments received by petitioner over and above the fair market value of the agreement at the date it was acquired by her was taxable income.
(2) That the petitioner was not entitled to allocate the income resulting from the agreement over the life of the agreement.
(3) That income resulting from payments made under the agreement was not from a sale or exchange of property and, therefore, was not capital gain under section 117 of the code.
(4) That the period of limitations for assessment provided in section 275 (c) and as extended by an agreement had not run against assessment of the deficiency for 1941.
*238 The respondent determined deficiencies of $ 2,199.18 and $ 6,695.02 in the petitioner's income tax for 1941 and 1943, respectively. The principal question presented is the taxability to the petitioner of certain payments received by her during the taxable years under the terms of an employment contract which her husband had executed with a corporation prior to his death. Certain alternative issues, to be considered in event it is held that the payments constituted taxable income to petitioner, are also presented.
FINDINGS OF FACT.
The proceeding was submitted on a stipulation of facts and certain documentary evidence. The stipulated facts are found as stipulated.
The petitioner is a resident of Cedarhurst, Long Island, New York, and she filed her 1941, 1942, and 1943 income tax returns with the collector for the second district of New York.
The petitioner*278 is the widow of Frederic H. Hatch, deceased, who died testate and a resident of Nassau County, New York, on April 2, 1930. Pursuant to the provisions of article first of the decedent's will, his entire estate was left to the petitioner.
Prior to May 19, 1928, the decedent was the senior controlling partner in Frederic H. Hatch & Co., a partnership engaged in the business of dealing in investment securities in New York, New York. He was also the sole owner of the assets employed in that business, and he turned them over to "Frederic H. Hatch & Co., Inc." which had been organized to take over the business of the partnership. On May 19, 1928, the decedent and the corporation entered into an agreement which, among other things, recited that the corporation had been formed under an arrangement whereby the decedent was to become chairman of its board of directors upon the basis thereinafter set forth and that the partnership business had been taken over, and was about to be conducted, by the corporation. The agreement contained the following respecting the decedent's employment:
First: The Corporation hereby employs Frederic H. Hatch [decedent] as the Chairman of its Board of Directors, *279 or in such other executive or advisory capacity, satisfactory to Frederic H. Hatch, as the Corporation may from time to time determine, for a period of ten years, beginning on the date hereof, at an annual salary of $ 30,000 per year, payable $ 2,500 per month at the end of each month.
Second: The Corporation agrees to pay to Frederic H. Hatch, in each year during the said ten year period of employment, in addition to the said salary, an amount equal to 10% of the net earnings of its business in such year available for the payment of dividends on its common stock, in excess of $ 270,000 per year * * * to be paid as soon as said net earnings are determined after the end of each fiscal year.
Third: In the event of the death of Frederic H. Hatch or after he shall cease to act in the capacity assigned to him by the Board of Directors, the Corporation*239 agrees that for a period of ten years beginning on the date of the death of said Hatch or the date on which he shall cease to act in the capacity assigned to him (whichever shall first occur), it will pay to Frederic H. Hatch or to his estate, as the case may be, the following amounts:
(a) The annual salary provided for in *280 paragraph First hereof, and
(b) The annual share of net earnings computed according to paragraph Second hereof;
provided, however, that no payments shall be made to Frederic H. Hatch or to his estate under this paragraph Third after the total amounts paid to said Hatch or his estate under this paragraph Third plus the total amounts previously paid to said Hatch under the foregoing paragraph Second shall aggregate $ 400,000.The agreement also contained a provision respecting the employment of the decedent by the corporation at the expiration of the ten-year period covered by paragraph first and provided that the decedent was not to engage in any other business or occupation whatsoever during the period of his employment or any extension thereof.
For Federal estate tax purposes the value of the agreement at the time of the decedent's death was determined to be $ 243,326.70, computed in accordance with the factor contained in table B of Regulations 105 for a ten-year term certain.
By mutual consent of the petitioner and the corporation the annual payments required to be made by the corporation under the agreement were varied from time to time and such payments were made in sums less*281 than $ 30,000 per year. As sole legatee of decedent's will, the petitioner from time to time received payments from the corporation pursuant to the provisions of the agreement as modified by mutual consent of the petitioner and the corporation. However, at no time has she received any amount from the corporation pursuant to the provisions of the agreement relating to payments from net earnings of the corporation available for dividends on its common stock.
As of December 31, 1940, the petitioner had received from the corporation pursuant to the agreement payments totaling $ 235,500. In 1941 she received $ 15,750, so that as of December 31, 1941, she had received a total of $ 251,250, which was $ 7,923.30 in excess of the $ 243,326.70 determined to be the value for estate tax purposes of the amounts to be paid under the agreement. In each of the years 1942 and 1943 she received a payment of $ 12,000, which likewise was in excess of the value determined for estate tax purposes.
In determining the deficiencies here involved, the respondent determined that amounts received by the petitioner pursuant to the agreement in excess of the value determined for the agreement for estate tax*282 purposes constituted taxable income and accordingly included the above mentioned amounts of $ 7,923.30, $ 12,000, and $ 12,000 in the petitioner's taxable income for the years 1941, 1942, and 1943, respectively.
The petitioner's 1941 income tax return was filed on March 6, 1942. *240 On that return she showed dividends received in the amount of $ 9,651.60, interest of $ 1,906.27, short term gain on capital assets of $ 210.04, a long term loss on capital assets of $ 935.67, and a total income of $ 10,832.24. The long term loss of $ 935.67 represented 50 per cent of $ 1,871.35, which was the difference between long term losses totaling $ 2,811.12 and long term gains of $ 939.77. She omitted from her gross income the $ 7,923.30 heretofore mentioned which she received in 1941 pursuant to the above mentioned agreement.
On November 29, 1946, the petitioner and the respondent entered into an agreement extending to June 30, 1948, the time for making assessment of 1941 income tax against petitioner, as provided in section 275 (c) of the Internal Revenue Code. The notice of deficiency was mailed to the petitioner on February 3, 1948.
OPINION.
It is the contention of the petitioner *283 that the $ 7,923.30 received by her in 1941 and the $ 12,000 received in each of the years 1942 and 1943 under the contract between Frederic H. Hatch and Frederic H. Hatch & Co., which contract was acquired by her as legatee under the will of Frederic H. Hatch, were not income to her as determined by the respondent. It is her contention that the amounts in question constituted bequests, devises, or inheritances and are therefore specifically excluded from gross income by the provisions of section 22 (b) (3) of the Internal Revenue Code. 1 It is the claim of the respondent that, inasmuch as the amounts in question represent amounts received by petitioner in excess of $ 243,326.70, the amount at which the said contract was included in the estate of Frederic H. Hatch for Federal estate tax purposes, they represent income to petitioner within the meaning of the Internal Revenue Code.
*284 It is provided in section 22 (a) of the code that "'Gross income' includes gains, profits, and income derived from * * * sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, * * * or gains or profits and income *241 derived from any source whatever." In the instant case the petitioner acquired the contract between Frederic H. Hatch and Frederic H. Hatch & Co., as sole legatee under the will of Frederic H. Hatch. As such legatee she was entitled to receive under the agreement for a period of ten years, beginning on the date of Hatch's death, $ 30,000 per year, plus 10 per cent of the net earnings of Frederic H. Hatch & Co., available for common stock dividends in excess of $ 270,000 per year. For the purpose of determining Federal estate tax due and owing by the estate of Frederic H. Hatch, the value of the agreement was determined to be $ 243,326.70 and the petitioner does not here take issue with the value so determined. She also admits that if she had at any time sold the contract for an amount in excess of $ 243,326.70, such excess would have constituted*285 taxable gain to her. Relying on United States v. Carter, 19 Fed. (2d) 121, however, she contends that there was no realization of gain by her in that she has not at any time made any sale, converted, or otherwise disposed of the asset and that in such circumstances the full amount received, including the amounts here in question, represent property acquired by her by "bequest, devise, or inheritance."
According to the scheme of the Internal Revenue Code, there is realization of gain from the sale or other disposition of property where the amount received is in excess of the cost or other basis therein provided, and in the case of property received by bequest, devise, or inheritance it is provided that the basis for determining gain or loss shall be the fair market value of such property at the time of acquisition. 2 In this case what the petitioner received as sole legatee under the will of her deceased husband was not money, but a contract between her husband and Frederic H. Hatch & Co. At the time of acquisition that contract had a value not here disputed of $ 243,326.70. By reason of the payments over the years the petitioner herein has realized*286 in excess of that basis the amounts involved in this case. As stated by the court in Helvering v. Roth, 115 Fed. (2d) 239, a case quite comparable to the case here, there can be no doubt that such a transaction, namely, the collection of moneys under rights or contracts acquired as in this case, which moneys are in excess of the value of those rights or contracts as of the date of inheritance, results in a gain to some one, and under section 22 (a) of the code gross income includes "gains, * * * of whatever kind." In this instance the realization of gain could have been by no one other than this petitioner. The amounts in question were not received by bequest, but rather the bequest consisted of the contract and the rights thereunder. The payments received over the years represent the realizations by the petitioner on that contract and by reason of her ownership thereof *242 and, the amounts involved in this proceeding being in excess of the basis for determining gain or loss on the contract in her hands, the respondent has correctly determined that they constitute income to her and are includible in her gross income. United States v. Carter, supra,*287 does give support to the petitioner's claim, but, just as in Helvering v. Roth, the Circuit Court of Appeals for the Second Circuit was unable to see anything in the Carter case which would justify the conclusion reached, we likewise are unable to regard the Carter case as a correct pronouncement of the law. Helvering v. Roth, in our judgment, represents the sound view, and we regard the principles therein declared as controlling here.
The petitioner also relies on Commissioner v. Winslow, 113 Fed. (2d) 418. In that case, however, the payments involved were payments made under an insurance policy and the code provides specifically in section 22 (b) (1)3 that such payments shall not be included in gross income and shall be exempt from the Federal income tax. There is no such statutory provision with respect to gains realized upon property or property rights received by gift, bequest, or devise.
*288 In the alternative the petitioner contends that, in the event it is held that the amounts received in excess of the value of the agreement at the time acquired by her constituted taxable income, such income should be allocated over the life of the agreement or contract, and further that if taxable income was realized it was capital gain within the meaning of section 117 of the Internal Revenue Code. In making the allocation argument petitioner starts with the premise that $ 300,000 should have been regarded as the total amount to be realized by her on the contract and $ 56,673.30, the difference between her basis of $ 243,326.70 and $ 300,000, as the total gain and that such part of the amount paid in any year as was of the same ratio that $ 56,673.30 bears to $ 300,000 should be allocated as the gain realized in the year of such payment. By such formula she would arrive at taxable income of $ 2,975.35 for 1941 and $ 2,266.93 for each of the years 1942 and 1943.
As a general factual proposition, it can not be said that any one has realized gain from the disposition or liquidation of property until he has recovered something in excess of his cost and, with some few exceptions specifically*289 provided for, such is the statutory pattern. In this instance, the cost or other basis to petitioner of the contract and the rights thereunder was $ 243,326.70. The petitioner has pointed to nothing in the statute which supports or justifies any method for *243 computing the gain realized or of determining the year or years of realization different from those determined by the Commissioner. This is not, for instance, the case of an installment sale specifically dealt with in section 44 of the code, and there is no claim or contention on the part of any one that the payments received constitute annuities within the meaning of section 22 (b) (2) of the code. Simply put, we think it may be said that we have here the collection of amounts which have become due and owing under the contract and which are to be applied in liquidation or satisfaction of the obligation of Frederic H. Hatch & Co. under its contract and such payments constitute taxable income to petitioner after her cost or other basis for the contract has been received. We find in that situation no basis for allocation of such gain in the manner desired by petitioner.
The petitioner's argument that, if it be held *290 that taxable gain was realized on the contract such gain was capital gain within the meaning of section 117 of the Internal Revenue Code, is not in our judgment well taken, for the reason that in this instance the gain was not realized as the result of a sale or exchange of a capital asset. That section defines capital gain as gain from the sale or exchange of capital assets and it is well settled that, in the absence of some statutory exception, only gain so realized is capital gain. See John H. Watson, Jr., 27 B. T. A. 463; Herbert's Estate v. Commissioner, 139 Fed. (2d) 756; certiorari denied, 322 U.S. 752">322 U.S. 752. In this instance the contract acquired by the petitioner as the sole legatee of her deceased husband and which had thereafter ripened into a matured obligation after his death, was merely being discharged or liquidated. There was no sale or exchange. We accordingly find and hold that the gain realized by the petitioner was not a capital gain within the meaning of the code. See and compare Fairbanks v. United States, 306 U.S. 436">306 U.S. 436; John H. Watson, Jr., supra;*291 John H. S. Lee, 42 B. T. A. 920; affd., 119 Fed. (2d) 946; and R. W. Hale, 32 B. T. A. 356; affd., 85 Fed. (2d) 819. Susan J. Carter, 9 T. C. 364; affd., 170 Fed. (2d) 911; George James Nicholson, 3 T. C. 596; and United States v. Yerger, 55 Fed. Supp. 521, relied on by the petitioner, are distinguishable. In those cases the transactions were sales or exchanges and the gain was capital gain within the spirit and letter of the statute.
As to the year 1941, it is the further claim of the petitioner that the determination of the deficiency was not timely made within the meaning of section 275 (a) of the code and that it is accordingly barred by the statute of limitations. It is the contention of the respondent that the period of limitation governing 1941 is found in section 275 (c) and under the provisions of that section his determination was timely made. Under section 275 (c) of the code, a period of five years from the time the return is filed *292 is allowed for assessment of tax where the taxpayer omits from gross income an amount properly includible *244 therein which is in excess of 25 per cent of the amount of gross income stated in the return. Here the petitioner omitted from gross income for 1941 an amount of $ 7,923.30, which is in excess of 25 per cent of the gross income stated on her return for that year. Therefore, a period of five years from March 6, 1942, the date the return was filed, was allowed for making assessment of the tax for 1941. Prior to the expiration of the five-year period the petitioner and the respondent entered into an agreement extending the period for assessment to June 30, 1948. Since the notice of deficiency was mailed to the petitioner on February 3, 1948, it was timely, and accordingly the period of limitations for assessment of the petitioner's 1941 income tax liability had not expired.
Decision will be entered under Rule 50.
Van Fossan, J., dissenting: Being of the opinion that United States v. Carter, 19 Fed. (2d) 121, is the correct statement of law that should govern in the present case, and feeling that Commissioner v. Winslow, 113 Fed. (2d) 418,*293 is by analogy also good authority in support of petitioner's position, I respectfully dissent.
Hill, J., dissenting: In the Roth case, cited and relied on in the majority opinion, the notes in question were valueless at the time of Roth's death and were so returned for estate tax purposes. Some years thereafter the executors of Roth's estate received payment of the notes in full. The Circuit Court of Appeals held that there was realized gain to the estate in the amount of such payment and that such gain was taxable. The factual situation and the legal question in that case are not comparable to those of the instant case.
In the instant case the legacy had a maximum potential value of $ 400,000 at the time of decedent's death, realizable in ten annual payments. The legacy was of dollars, payable in dollars in the amounts and as directed in the contract. Every dollar of each annual payment made to petitioner was received by her as part of the legacy. The legacy was not paid by the testamentary transfer of the contract for such payment.
The commuted value of the legacy did not limit the amount of the legacy to such value. If the money received by petitioner under the terms*294 of the contract was income, it must represent realized appreciation of the legacy. But the legacy did not and could not appreciate. Obviously there were no rents, issues, or profits arising from or out of the legacy, for every payment received by petitioner in accordance with the contract was received as legacy and not as an accretion to it or as an issue from it.
*245 In legal theory the commuted present value of an obligation is equivalent to the face value of such obligation payable over a period of future years or at a long deferred future date. The converse is likewise true. But commutation to present value of long term payments of a legacy does not alter the amount or character of the legacy when and as paid under the testamentary terms therefor. In the instant case the value of the legacy was progressively determined by payments thereon as and when paid. The total value of the legacy was determinable only upon the payment of the last yearly installment thereof and such value was, of course, the sum of all the payments made in compliance with the testamentary provisions for such payments.
The majority holds that all payments received by petitioner under the terms *295 of the legacy which were in excess of the commuted value thereof were not received as legacy. Such holding carries its own negation, since it is an incontestable fact that every such payment had its exclusive origin and authorization in the legacy.
For the purposes of the estate tax upon decedent's estate it was necessary to determine the value of the property in the legacy as of the date of decedent's death, but we are not here concerned with determining a basis of the legacy to petitioner, since there has been no sale or other disposition of it by her. It is a generally accepted legal principle that the payment of an obligation is not a disposition of it within the meaning of the taxing statutes, dictum to the contrary by the Circuit Court of Appeals for the Second Circuit in the Roth case notwithstanding.
I am unable to agree with the majority holding. In my opinion it is speciously artificial and wholly unrealistic.
Footnotes
1. SEC. 22. GROSS INCOME.
* * * *
(b) Exclusions from Gross Income. -- The following items shall not be included in gross income and shall be exempt from taxation under this chapter:
* * * *
(3) Gifts, bequests, devises, and inheritances. -- The value of property acquired by gift, bequest, devise, or inheritance. There shall not be excluded from gross income under this paragraph, the income from such property, or, in case the gift, bequest, devise, or inheritance is of income from property, the amount of such income. For the purposes of this paragraph, if, under the terms of the gift, bequest, devise, or inheritance, payment, crediting, or distribution thereof is to be made at intervals, to the extent that it is paid or credited or to be distributed out of income from property, it shall be considered a gift, bequest, devise, or inheritance of income from property;↩
2. Sec. 113 (a) (5), I. R. C.↩
3. (b) Exclusions from Gross Income. -- The following items shall not be included in gross income and shall be exempt from taxation under this chapter:
(1) Life insurance. -- Amounts received under a life insurance contract paid by reason of the death of the insured, whether in a single sum or otherwise (but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income).↩