1951 U.S. Tax Ct. LEXIS 16">*16 Decisions will be entered under Rule 50.
1. Petitioner, a resident of California and an employee of Shell Company, became a member, in 1915, of an employees' fund. Under the plan of the fund, an employee deposited annually a percentage of his salary and Shell deposited a similar or greater amount. The deposits by the employee and by Shell were carried by the fund in the name of the employee, but the account was segregated into two parts. The earnings on the segregated deposits were regularly credited to the proper parts. The credit of the deposits made by Shell and the earnings thereon were conditional until the employee had concluded a minimum period of service. The employee's interest in the fund could not be assigned or pledged and no withdrawals could be made and no amounts became payable to the employee until the employee retired or left the employ of Shell. Petitioner retired in 1941 and then became entitled to receive, and did receive, the total of the deposits made by him and by Shell and the earnings thereon in five annual installments. Under the plan of the fund, the distributions, when made, were to be applied first in satisfaction of the deposits which had been1951 U.S. Tax Ct. LEXIS 16">*17 made by the employee. Held, that the amounts received by petitioner after the receipt of an amount equal to the total of the deposits made by him constituted the receipt by him of ordinary income.
2. The total of the amounts deposited by petitioner in the fund during the period of his employment amounted to $ 8,035.96, of which $ 4,106.36 represented payments during the period from 1915 to June 30, 1927. Held, that of the payments received by petitioner from the fund after the payments received had equaled the amount of his total deposits, a portion thereof represented community income and the remainder represented his separate income. The percentage of each of these classes of income determined.
3. Petitioner incurred and paid certain legal expenses in connection with investigation of reported infringements of a patent owned by him and for related work. After completion of the investigations and related work the petitioner transferred his rights of action on the reported infringements to a corporation for a portion of its stock. During 1942 the corporation was dissolved without assets following a judicial determination in that year that the petitioner's patent had been1951 U.S. Tax Ct. LEXIS 16">*18 anticipated by a prior patent or patents. Held, that petitioner sustained a capital loss in 1942 as a result of his stock becoming worthless. Section 23 (g) (2), Internal Revenue Code.
17 T.C. 994">*995 The respondent has determined deficiencies in the sum of $ 99.30 in the income tax of Jean Laing Carter for 1944 and 1945, and deficiencies of $ 1,207.91, $ 1,262.84, and $ 1,126.76 in the income tax of L. L. Carter for 1943, 1944, and 1945, respectively. Issues presented for determination are (1) whether certain amounts received during the years 1942 through 1945 by L. 1951 U.S. Tax Ct. LEXIS 16">*19 L. Carter from the Provident Fund Of The Combined Petroleum Companies constituted long term capital gain, (2) whether such amounts are taxable as community income in whole or only in part, (3) whether a loss deduction taken in 1942 was a capital loss, and (4) whether the respondent erred in determining the amounts deductible as medical expenses for the years 1942 through 1944.
FINDINGS OF FACT.
The petitioners are husband and wife. They were married in 1916 and have resided continuously in California since that time. They filed their income tax returns for the years in controversy with the collector at San Francisco, California.
During 1914 the petitioner, L. L. Carter, hereafter referred to as petitioner, entered the employ of Shell Company, sometimes hereafter referred to as Shell, and continued in that employment until his retirement on June 30, 1941.
In 1912 a group of petroleum companies established the Provident Fund Of The Combined Petroleum Companies, sometimes hereafter 17 T.C. 994">*996 referred to as the Fund, with its domicile and head office in The Hague, Holland. Shell joined the Fund, the object of which was "to accumulate for the benefit of the Companies' employees who 1951 U.S. Tax Ct. LEXIS 16">*20 have joined the Fund, certain sums as a provision for themselves and their families." The fund was administered by a board of administrators appointed by the establishing companies under regulations adopted by those companies for that purpose. Membership in the Fund was optional with the employees of the participating companies.
In 1915 the petitioner became a member of the Fund and continued as such until his retirement. From 1915 to 1936 he made regular payments to the Fund measured by a percentage of his salary. Under the regulations of the Fund, Shell was required to pay to the Fund with respect to the petitioner at least an amount equal to the same percentage of petitioner's salary as was paid to the Fund by the petitioner. During the years 1915 to 1936, Shell, in addition to making such payments, appears to have paid additional amounts on some occasions. The Fund maintained the petitioner's account on its books in pounds sterling. In accordance with the regulations of the Fund, the account was segregated into two parts. One part showed the petitioner's payments and the interest credited thereon by the Fund. The other showed Shell's payments and the interest credited thereon1951 U.S. Tax Ct. LEXIS 16">*21 by the Fund. The total of the two parts showed the amount of the petitioner's credit in the Fund. The Fund furnished the members annual statements of their interest therein. These statements showed in one column the balance of the credit at the beginning of the year arising from the member's payments with interest, payments during the year, interest credited for the year and the total at the end of the year. Like information was given in another column with respect to the credit arising from the participating company's payments. The totals of the columns were combined to show the total credit at the end of the year.
Under the regulations of the Fund, a member could discontinue payments when his total credit in the Fund amounted to # 10,000. The petitioner's credit reached that amount in 1935 and he elected to make no further payments. From that time until his retirement in 1941, interest accruing on his credit in the Fund was paid to him directly instead of being credited to his account as theretofore was done.
Under the regulations of the Fund the rights of a member to the amounts due him by the Fund were personal and could not be ceded or pledged. At the discretion of the1951 U.S. Tax Ct. LEXIS 16">*22 board of administrators members violating this provision were to be entitled to receive only the amount of their own payments plus interest accrued thereon. As long as a member was in the service of a company which had joined the 17 T.C. 994">*997 Fund he had no claim whatever to a refund of the amount standing to his credit in the Fund or any part thereof. In the event a member died while in the service of a company which had joined the Fund or before the amount of his credit in the Fund had been paid to him, such amount was to be paid to those entitled to his estate. Upon leaving the service of a company which had joined the Fund, a member who had less than 3 years paid service, or 5 years if the employment began on or after July 1, 1921, could claim only the amount he had paid to the Fund plus the accrued interest thereon. In the case of a member under 50 years of age leaving a participating company's service within 20 years from the time he entered its service, the board of administrators, if it deemed it advisable in the member's interest, was authorized to withhold the amount standing to his credit until he reached 50 years of age. The regulations also provided that if the amount1951 U.S. Tax Ct. LEXIS 16">*23 of a member's credit in the Fund exceeded # 2,000 at the time of the termination of his service and he was a citizen or resident of the United States and last employed by a company established in the United States, the amount of his credit should be paid to him in the following order: First, such part of the credit as represented his payments to the Fund and then the remaining portion of the credit. The first payment was to be made within 6 months after termination of service and was to be in the amount of at least # 2,000. The balance was payable in one or more annual installments.
The petitioner's total payments to the Fund during the period from 1915 to 1936, stated in terms of dollars, amounted to $ 8,035.96, of which $ 4,106.36 represented payments during the period from 1915 to June 30, 1927. The record does not disclose the amount of the payments made by Shell during either of those periods.
After the petitioner retired, the Fund paid him his credit of # 10,000 in five annual installments of # 2,000 each, with the first being paid in 1941. Stated in terms of dollars, the petitioner received $ 8,034.05 in 1941, $ 8,034.98 in 1942, $ 8,034.84 in 1943, $ 8,034.72 in 1944, 1951 U.S. Tax Ct. LEXIS 16">*24 and $ 8,040 in 1945.
In his determination of the deficiencies herein the respondent, in keeping with the regulations of the Fund, treated the first $ 8,035.96 received by the petitioner from the Fund as being the repayment to him of the total deposits made by him over the years in the Fund and the remainder of the payments as ordinary income.
On some undisclosed date during the 1920's, the petitioner was granted a patent on a tool device for use in the petroleum industry. The device was developed and the patent was obtained while the petitioner was in the employ of Shell. That company paid most, if not all, of the expenses of developing and obtaining the patent and had a shop right therein which gave it the right to use the patent 17 T.C. 994">*998 without liability for royalty or other payment to the petitioner therefor. Except for the shop right in Shell, the petitioner was the sole owner of the patent.
In 1931 and 1932 the petitioner received reports that his patent was being infringed in New Mexico and Texas oil fields. Being unable to obtain definite information, he employed his brother, R. A. Carter, an attorney, to investigate the reports. In 1933, R. A. Carter made a trip to those1951 U.S. Tax Ct. LEXIS 16">*25 oil fields in Texas and New Mexico in which infringements were reported to have occurred. He spent about five and one-half months investigating and found what he considered to be evidence of numerous infringements.
Following R. A. Carter's return and during 1934, he and the petitioner conferred with a firm of patent attorneys in Los Angeles, of which Ford Harris was one, respecting the evidence and the filing of infringement suits. It was estimated that from $ 7,000 to $ 10,000 would be required to finance the number of suits considered to be the most worth while. Since the petitioner was unable to finance such litigation, a corporation known as D Company was formed about June 1, 1935, for that purpose. The petitioner assigned his rights of action for infringements, but not his patent, to D Company for 113 shares of its common stock, and R. A. Carter and Ford Harris each received 56 shares of common stock in return for agreeing to perform the necessary future legal services. California Quarries Company acquired all the preferred stock in D in return for a payment of $ 10,000, which was used to finance the litigation. The litigation was pursued until 1942, when a Circuit Court1951 U.S. Tax Ct. LEXIS 16">*26 of Appeals decision adverse to petitioner and the D Company was rendered on the ground that the petitioner's patent had been anticipated by a prior patent or patents. Shortly after that decision D Company, which was then without assets, was dissolved. All of the expenses of investigation and litigation incurred subsequent to the formation of D Company were paid by that corporation.
So far as disclosed by the record, the patent involved herein was the only patent ever owned or developed by the petitioner and it is not shown that he ever licensed it or otherwise exploited it or attempted to do so, or that he ever received any income from it.
In his 1942 income tax return the petitioner took an aggregate loss deduction of $ 2,594.94. Of that amount, $ 2,352.55 represented the total of amounts paid by him to his brother, R. A. Carter, between the years 1932 and 1942. These payments were for expenses incurred by R. A. Carter in connection with his investigation, in 1933, of reported infringements of the petitioner's patent and his fee therefor and for other related services he performed for the petitioner down to the time of the formation of the D Company in 1935 and the 17 T.C. 994">*999 1951 U.S. Tax Ct. LEXIS 16">*27 transfer of the rights of action to it. Of the $ 2,352.55, $ 1,000 or more was paid in 1933, at the time of the investigation, and the balance was paid in small undisclosed amounts on undisclosed dates down to 1942. The respondent determined that the loss deduction taken by the petitioner was a capital loss.
OPINION.
The respondent's determination that the petitioner realized income upon receipt of payments from the Fund in an amount equal to the excess of the total of the amounts received by him over the amounts which he had deposited and that the income so received was ordinary income, was in our opinion a sound and proper determination. The parties are agreed that the Fund was not an employees' trust, within the provisions of section 165 of the Internal Revenue Code, and that the payments made by the petitioner to the Fund over the years did not constitute the purchase of an annuity within the meaning of the Code.
The Fund was very carefully planned and set up. It was divided into two parts: Under one, the employee could indulge in a voluntary savings program, and under the other, the employer, on the basis of the continued employment of the employee, made matching or greater1951 U.S. Tax Ct. LEXIS 16">*28 deposits to the Fund under the employee's name. To each of these deposits were added periodically the earnings thereon. None of the amounts deposited in or earned by the fund standing in the name of an employee could be withdrawn so long as the employee continued in the service of his employer and the employee could not assign or pledge his interest therein. But upon retirement, as in the case of this petitioner, the total of the amounts standing to his credit became payable to him in five annual installments, the first of which was earmarked by the regulations of the Fund as a repayment of the amounts which he had deposited. Such being the facts, we think it abundantly clear that the amounts received by the petitioner in 1943, 1944, and 1945 were amounts over and above his deposits which had already been repaid, and were (1) the earnings which had accrued upon the amounts deposited by him, (2) the amounts paid into the Fund in petitioner's behalf by his employer on the basis of his services to such employer, and (3) the earnings on the deposits so made by the employer, all of which constituted ordinary income to him when so received.
The contentions of the petitioner (1) that1951 U.S. Tax Ct. LEXIS 16">*29 the deposits and earnings having irrevocably accrued to the Fund account in his name in years prior to the taxable years herein, were thereafter capital belonging to him and constituted his basis for determining the gain, if any, thereafter realized by him from the Fund, and (2) that his withdrawals 17 T.C. 994">*1000 from the Fund in the years here involved were, for the purposes of applying section 117 of the Code, exchanges or sales of capital assets and any gain which might have been realized was capital gain, are in our opinion wholly without merit. In the first place, there is no claim or showing that the petitioner kept and maintained any books of account, to the end that he might have properly reported his income on an accrual basis, rather than a cash basis. There is accordingly no basis of record for any conclusion other than that he regularly and properly reported his income on the cash basis. In the second place, at no time prior to the dates of payment herein could the petitioner have received or realized on the moneys here in question, since to have done so would have been a violation of the prohibition against the ceding or pledging by an employee of his interest in the 1951 U.S. Tax Ct. LEXIS 16">*30 Fund, and such violation would have made the eventual payment of any amount in excess of the employee's own deposits, plus accrued interest thereon, discretionary with the board of administrators. Compare E. T. Sproull, 16 T.C. 244, wherein there was no bar to assignment. The petitioner's employment with Shell continued until 1941, and in that year, for the first time, he became entitled to receive payments of the deposits and earnings according to the plan of the Fund, as set forth in its regulations, and being on the cash basis, as we have concluded above, he realized taxable gain in the years of payment when the amounts received by him exceeded the total of his deposits. Finally, the payment to him by the Fund of the amounts to his credit in no way partook of the nature of a sale or exchange of capital assets.
The respondent determined that of the $ 8,035.96 paid by Carter to the Fund, $ 4,367 was paid between the time he became a member in 1915 and the end of 1927, that the remainder, or $ 3,668.96, was paid during the years 1928 through 1935, that the payments to the end of 1927 were to be regarded as from his separate property and those thereafter1951 U.S. Tax Ct. LEXIS 16">*31 from community property, and that of the amounts received by him during the years 1942 through 1945 the part thereof equal to the proportion that the payments made to the end of 1927 bore to the total payments constituted his separate income and the balance was community income. Taking the position that at all times after his marriage in 1916 Carter's payments were made with community property, the petitioners contend that the entire amounts received by him during the years 1942 through 1945 constituted community income. Carter testified that during the years 1915 to 1936 he made payments "representing a percentage of" his salary to the Fund. Since the parties have grounded their arguments on the basis that the payments were from his salary and since there is no other evidence bearing on the point, we accept the interpretation placed on his testimony by the parties.
17 T.C. 994">*1001 As pointed out in Devlin v. Commissioner, 82 F.2d 731, prior to July 29, 1927, when the community property law of California was changed so as to give a present one-half interest in community property to the wife, the earnings of a husband in that state had substantially1951 U.S. Tax Ct. LEXIS 16">*32 all the characteristics of separate property and were taxable to the husband. The change in the law made in 1927 was prospective in effect and does not apply to the earnings of a husband prior to the date of change nor to property acquired prior thereto, nor to the income from such property. Rogan v. Delaney, 110 F.2d 336, certiorari denied, 311 U.S. 660">311 U.S. 660; Sara R. Preston, 35 B. T. A. 312. In view of that state of the law, it is apparent that receipts from the Fund during 1942 through 1945 attributable to payments to the Fund to July 29, 1927, were taxable to Carter as his separate income.
The petitioners contend that if it be held that only a portion of the payments received by Carter during 1942 through 1945 was taxable as community income, then it should be held that the amount of $ 4,106.36 shown by the evidence to have been paid to the Fund up to June 30, 1927, is to be used in arriving at the percentage so taxable instead of the amount of $ 4,367 at December 31, 1927, as employed by the respondent, and that this would result in 48.9 per cent of such receipts being allocated to community1951 U.S. Tax Ct. LEXIS 16">*33 income. Accepting the amount of Carter's payments to June 30, 1927, as shown by the evidence, as more accurately reflecting the total of his payments to July 29, 1927, than the amount thereof at December 31, 1927, the respondent, on brief, concedes that 48.9 per cent of the payments received from the Fund by Carter during 1942 through 1945 was taxable as community income. Since the parties are thus in agreement on the percentage of the receipts that constituted community income, the remainder or 51.1 per cent will be treated as Carter's separate income in a recomputation of the deficiencies.
On some undisclosed date during the 1920's, L. L. Carter was granted a patent which in 1942 was adjudicated to have been anticipated by a prior patent or patents. To June 1935, he had incurred expenses of $ 2,352.55 for legal services rendered in connection with investigations of reported infringements and related matters. A substantial portion of the expenses was paid prior to June 1935, and the balance was paid subsequent thereto but prior to 1942. In June 1935, and for a portion of its stock, he transferred his rights of action on such reported infringements to a corporation which thereafter1951 U.S. Tax Ct. LEXIS 16">*34 financed and prosecuted suits for infringements of the patent until the above-mentioned adjudication in 1942. Determining that the expenses in question represented cost to Carter of the stock he acquired in the corporation, and that the stock became worthless in 1942, the respondent disallowed a deduction of the expenses as taken by the 17 T.C. 994">*1002 petitioners as an ordinary loss and allowed instead a loss on a capital asset.
The evidence shows, and the respondent concedes, that the expenses were not considered in the determination of the amount of corporate stock Carter received in return for transferring his rights of action. Despite the fact that they were not so considered it seems apparent that whatever benefit that had resulted to Carter from the investigations and other related work either passed to the corporation when he transferred his rights of action to it or such benefit ceased to exist at that time. Obviously the corporation, as a result of the investigations and the related work that had been done, was in a much more advantageous position to proceed than would have been the case otherwise. It obtained that advantage when it acquired the rights of action. Consequently, 1951 U.S. Tax Ct. LEXIS 16">*35 we think it must be concluded that such benefits as resulted to Carter from the expenditures constituted a part of his cost of his stock in the corporation. The stock became worthless when it was adjudicated that no recovery could be had on the suits and the corporation was dissolved without assets. Both these events occurred in 1942. In such circumstances, the respondent's action in disallowing the claimed loss as an ordinary loss and allowing it as a capital loss was in accord with the requirements of section 23(g)(2) of the Internal Revenue Code and will not be disturbed.
The remaining issue relates to the respondent's action in determining the amounts allowable as medical expenses for 1942 through 1944. The parties state that they are in agreement as to the amounts expended during those years for medical expenses, that no controversy exists between them as to the application of the statute, and that the only question involved under this issue is the correct amount of the income of the petitioners for the respective years. Since that question will be disposed of in a recomputation of the deficiencies under our determinations of the issues heretofore considered, there does 1951 U.S. Tax Ct. LEXIS 16">*36 not appear to be any question under this issue for us to decide.
Decisions will be entered under Rule 50.