*263 Decisions will be entered under Rule 50.
1. At his death, Daniel F. Crilly, father of petitioner Edgar Crilly, left in trust, to pay the income to his five children for life, a leasehold estate on which he had erected an office building. The rent payable under the lease was 6 per cent of the appraised value of the land, which was to be re-appraised at 10-year intervals. The trustees resisted an appraisal made as of May 8, 1925, and by court action, which became final in 1935, obtained an appraisal in a lesser amount but not as low as the amount on which the rent had been payable prior to May 8, 1925. In the interval, the trustees had paid the rent at the rate previously established, and distributed the income remaining to the five life beneficiaries. Following the fixing, in 1935, of the value of the land as of May 8, 1925, the owner of the land sued the two trustees for the additional unpaid rent for the intervening period and in 1938 obtained a judgment for $ 319,935. In the meantime, the property had been repossessed by the lessor, leaving the trust with no assets except the family mausoleum. This judgment was settled in 1945 by the payment of $ 75,000, the money therefor, *264 by agreement of the beneficiaries, being supplied by an inter vivos trust Daniel F. Crilly had set up and of which they were also income beneficiaries. Held, that the petitioner is entitled to deduct as a loss, in 1945, $ 15,000, that amount being his pro rata part of the $ 75,000 paid in satisfaction of the above judgment.
2. Petitioner Erminnie M. Hettler was the granddaughter of Daniel F. Crilly, and was the beneficiary of her mother's estate, the mother having died in 1939. To avoid the filing of a claim against her mother's estate, for her mother's pro rata part of the above judgment, the petitioner agreed to pay whatever amount should thereafter be determined as her mother's share of the judgment. This amount being later determined at $ 15,000, she paid that amount in 1945 through the instrumentality of the inter vivos trust. Held, that the petitioner in so paying the $ 15,000 was satisfying a charge against her mother's estate at the time of her death, and as to the petitioner, the payment in question is not deductible as an expense or as a loss, within the meaning of the Internal Revenue Code.
*529 The respondent determined deficiencies in income tax against the petitioners*266 for the taxable year ended December 31, 1945, as follows:
| Docket No. | Petitioner | Deficiency |
| 23646 | Sangston and Erminnie M. Hettler | $ 8,569.70 |
| 23647 | Edgar Crilly | 3,202.30 |
The question is whether the respondent erred in disallowing a deduction of $ 15,000 claimed in the joint Federal income tax return of Sangston and Erminnie M. Hettler for the year 1945, and a deduction in the same amount claimed in the Federal income tax return of Edgar Crilly for the same year, these amounts being listed as their respective pro rata shares of a payment of $ 75,000 made by a living trust in settlement of a personal judgment rendered against Edgar Crilly and his brother, George Snyder Crilly.
FINDINGS OF FACT.
Sangston and Erminnie M. Hettler are husband and wife, and reside in Chicago, Illinois. Edgar Crilly is an individual, and his place of business is located in Chicago. They report their income on the cash basis, and filed their returns for 1945 with the collector of internal revenue for the northern district of Illinois.
On January 24, 1917, Daniel F. Crilly established a trust, sometimes referred to as the living trust, granting and conveying certain described realty to his five*267 children, Erminnie Crilly Mathews, George Snyder Crilly, Frank Lloyd Crilly, Isabelle Crilly Butler and Edgar Crilly, as trustees. It was provided, however, that all power and authority granted to the trustees should be exercised by George Snyder Crilly, Frank Lloyd Crilly and Edgar Crilly, or the survivor or survivors of them. The income of the trust was to be paid in equal shares to the five named children of Daniel F. Crilly during their lives, and upon death, to their respective surviving descendants per stirpes. On the death of the last survivor of the settlor's children the trust was to terminate and all property, both real and personal, was to be distributed to the descendants of the five children per stirpes. Subsequently Frank Lloyd Crilly left the state and George Snyder Crilly and Edgar Crilly remained the only trustees of the living trust.
Daniel F. Crilly died in 1921. By the terms of his will, the residue of his estate was left to trust, with his three sons as trustees. After Frank left the State of Illinois, George and Edgar continued as the only trustees. The principal asset of the testamentary trust was a *530 leasehold from the Board of Education*268 of the City of Chicago covering certain lands in the business district of the city, on which the testator had erected an office building, known as the Crilly Building. So far as pertinent to the issues of this case, the beneficiaries, remaindermen and the period of duration of the testamentary trust were the same as those of the living trust.
Under the terms of the lease with the Board of Education, the lessee was to pay an annual rental equal to 6 per cent of the appraised value of the land, exclusive of improvements. The rent was payable quarterly. Appraisals of the land were to be made, in a manner specified, at 10-year intervals. Pursuant to the provisions in the lease just mentioned, an appraisal of the realty was made as of May 8, 1925, and the value was determined as $ 1,809,600. On July 28, 1925, Edgar Crilly and his brother George, in their capacity as co-trustees, took issue with the value determined and sought to enjoin the Board from collecting the additional rentals based on the May 8th appraisal. Their attempt at procuring an injunction failed, but the proceeding was remanded for further action looking to an ultimate and final determination of the value. After*269 considerable litigation, the value as of May 8, 1925, was finally determined and fixed on November 27, 1935, at $ 1,379,040.
During the course of the litigation, up to May 8, 1934, the rental paid by the trustees to the Board was computed on the basis of the valuation as it stood prior to the appraisal of May 8, 1925. Not only was no increased rental paid during that period on the basis of the original appraisal of May 8, 1925, but no funds were set aside by the trustees from the income of the trust for the purpose of paying any additional rent, upon the contingency of a final appraisal of the property in an amount over and above that which had stood prior to May 8, 1925. The income remaining after the payment of the rent on the old basis was distributed currently to the beneficiaries of the trust. By reason of such distributions, the trust was without funds to pay the increased rent due upon the valuation of $ 1,379,040 determined on November 27, 1935, as of May 8, 1925.
In 1936, the Board of Education instituted an action in court against petitioner Edgar Crilly and his brother George, individually and personally, for recovery of the added rent due for the period from May 8, *270 1925, to May 8, 1935. While the suit was against the two individuals personally, the complaint recited as a basis therefor their status as trustees of the testamentary trust of Daniel F. Crilly and their failure to pay from the income of the trust the added amount due as rent, and the distribution of the income by them to the beneficiaries of the said trust. The defendants filed a counterclaim to the Board's complaint, asserting that they were entitled to a credit of $ 500,000 against the unpaid rent. This amount, it was claimed, represented *531 the value of the Crilly Building located on the leased premises, which had been taken over by the Board on February 13, 1936, for nonpayment of rent. On October 28, 1938, judgment was entered against Edgar and George Crilly, personally and individually, for unpaid rent and accumulated interest in the amount of $ 319,935. The counterclaim for the $ 500,000 credit remained pending and undecided.
The Board of Education having taken possession of the leasehold and the Crilly Building located thereon in 1936 for nonpayment of rent, the testamentary trust, at the date the judgment for unpaid rent was affirmed, on October 28, 1938, had *271 no property other than a family mausoleum.
Erminnie Crilly Mathews died in 1939. At some date thereafter, Edgar Crilly outlined the situation with respect to the judgment against him and his brother George for unpaid rent to the Board of Education to Erminnie M. Hettler, daughter of Erminnie Crilly Mathews. He explained to her his view that her mother's estate, of which she was beneficiary, was liable to a claim for a pro rata share of the judgment, if and when paid. Erminnie M. Hettler agreed that no claim need be filed and that she would see that whatever her mother's share of the obligation should be would be paid.
The above judgment not having been paid, the Board of Education employed special counsel to make the necessary investigations and to take the needed steps for collection of the judgment. In that connection, an investigation was made as to the earnings and personal status of Edgar and George Crilly. A study was also made for the purpose of determining the possibility of reaching the living trust for the purpose of collecting the amount due under the judgment.
Faced with the possibility that the Board of Education would institute proceedings for recovery of the judgment*272 which might reach the income of the living trust, or otherwise tie up the income therefrom available for distribution to the income beneficiaries, Edgar Crilly and his brother George decided, upon advice of counsel, to make an offer of settlement. The income beneficiaries and the remaindermen under the living trust agreed that this be done. An offer of settlement was accordingly made. By this offer, the judgment debtors agreed to the dismissal of their counterclaim for a credit of $ 500,000 as being the value of the Crilly Building at the time it was taken over by the Board of Education. They agreed to release and convey to the Board all right, title and interest which they might have as lessees and otherwise in and to the Crilly Building, and further agreed to pay to the Board $ 75,000 in cash. This offer was accepted, and approved by the court. Decision of the court was dated June 11, 1945.
By the various steps taken, the testamentary trust had, for all practical purposes, come to an end. It had had no assets other than the *532 family mausoleum from and after February 13, 1936, when the Board of Education had repossessed the leasehold property and taken over the Crilly*273 Building. The situation was explained to the beneficiaries of the living trust, who were told by Edgar and George Crilly that they felt that all five interests were ratably liable for the settlement of $ 75,000 agreed to. Some, if not all, of the beneficiaries were without the necessary funds to make payment of the amount required. It was accordingly agreed that the money to cover the settlement should be paid by or through the living trust. The living trust at that time had $ 15,000 of cash on hand, and the necessary steps were taken whereby the said trust, on June 18, 1945, borrowed $ 60,000 from a Chicago bank, delivering its demand note therefor. Using the $ 15,000 in its bank account and the proceeds of the loan, the trustees of the living trust tendered a check for $ 75,000 to the Board of Education, pursuant to the settlement agreement. The Board refused the check and demanded a cashier's check. A cashier's check, on the Northern Trust Company for $ 75,000 payable to the Board of Education, was obtained on December 15, 1945, and the check was delivered to the Board in settlement of the judgment. It was cashed on January 22, 1946.
Neither Edgar Crilly, George Crilly, *274 nor any of the other beneficiaries of the living trust, executed a note in favor of the living trust covering the $ 75,000 paid to the Board of Education, or any part thereof, and no account showing an indebtedness on the part of the beneficiaries to the trust in connection therewith was set up on the books of the trust.
The $ 60,000 bank loan to the living trust was paid by the said trust as follows:
| 1945 | $ 13,000 |
| 1946 | 27,000 |
| 1947 | 20,000 |
The trustees and beneficiaries have treated and regarded the payment of the loan as having been paid out of trust income distributable to the life beneficiaries.
The books of the living trust were kept, and its fiduciary income tax returns were filed on the basis of a fiscal year ending January 31.
Edgar Crilly receives and has received for his services as trustee of the living trust a salary of $ 3,600 a year. He received no compensation for his services as trustee of the testamentary trust.
In their individual income tax returns for the year 1945, Edgar Crilly and Erminnie M. Hettler respectively claimed a deduction of $ 15,000, as representing one-fifth of the $ 75,000 paid to the Board of Education in settlement of the judgment against*275 Edgar and George Crilly for the unpaid rent and interest thereon of the testamentary trust. In determining the deficiencies here in question, the respondent, *533 in each instance, disallowed the $ 15,000 deduction claimed, as not being deductible by reason of the provisions of sections 23 and 24 of the Internal Revenue Code.
OPINION.
It is the claim of the petitioners that the $ 15,000, in each instance, is deductible either as a non-trade or nonbusiness expense, under section 23 (a) (2) of the Internal Revenue Code, 1*276 or as a loss incurred under section 23 (e) (2). 2 Petitioner Edgar Crilly further claims that, as to him, the deduction is allowable as a trade or business expense, under section 23 (a) (1) of the Code.
As to petitioner Erminnie M. Hettler, we think the respondent's disallowance in question must stand. At no time was she ever more than a contingent beneficiary of the testamentary trust. In the event of her mother's death prior to the death of all of the other primary beneficiaries, she might have become an income beneficiary. Upon the death of all the primary beneficiaries, she might possibly have realized something as remainderman. Prior to the death of her mother, however, the trust lost all of its assets, and all that remained was its liability for unpaid rents from May 8, 1925. This liability had been incurred by reason of a failure on the part of the trustees to pay any added annual rental on the basis of an increased valuation of the leased property. The trust income not so used had been distributed to the five*277 primary beneficiaries, and if there were rights in the Board of Education to follow the said income, such rights were against the income beneficiaries. Petitioner's mother, not the petitioner, was the income beneficiary who had received the income distribution in question. Whatever the claim accruing to the Board of Education by reason of such distribution of the trust income, it was against the petitioner's mother, not against petitioner. It was, we think, a claim against the estate of the petitioner's mother, but was never petitioner's obligation. It is true the petitioner agreed to satisfy a pro rata part of the ultimate amount which might be determined as payable to the Board of Education, but that agreement was based on the proposition that there was a charge against her mother's estate. In short, she received her mother's estate subject to the said claim. In that situation, *534 the claim of the petitioner that the amount of the payment was deductible by her as a nonbusiness expense, under section 23 (a) (2), supra, or as a loss under section 23 (e) (2), supra, is without merit.
As to petitioner Edgar Crilly, the situation is different. The trust income from*278 which the added rent should have been paid was distributed among the trust beneficiaries, and, as such beneficiary, Edgar Crilly was entitled to one-fifth. The judgment as later adjusted in settlement was a proper charge against the amounts which previously had been distributed by the trust to the beneficiaries as trust income. As the matter finally terminated, it is clear that amounts were distributed as income to the income beneficiaries which should have been retained for the payment of added rent, and, by reason thereof, the amount of distributable income would have been correspondingly less. The trust was contesting the claim for added rents and to the extent that the amount claimed by the Board of Education was ultimately reduced the trust was successful. Following this course of action, the trust income on hand was currently distributed by the trust and was received by the income beneficiaries as such. In the circumstances, the income was received by the beneficiaries under a claim of right and constituted taxable income to them in the years received. It was later determined and decided that the trust income so distributed would have to be restored by the income beneficiaries. *279 These amounts were ultimately determined and paid in 1945, and by reason of their direct relation to the income items received in prior years, they constituted losses sustained. It is accordingly our conclusion that as to Edgar Crilly the $ 15,000, representing his pro rata part of the payment in satisfaction of the judgment, was, as to him, a loss within the meaning of section 23 (e) (2), supra. See, in this connection, the pronouncement of the Supreme Court at the conclusion of its opinion in North American Oil Consolidated v. Burnet, 286 U.S. 417">286 U.S. 417.
In light of the conclusion stated, it becomes unnecessary for us to consider the petitioner's alternate claim that the amount in question was an ordinary and necessary expense of his business of acting as trustee. See, in that connection, however, Commissioner v. Heide, 165 Fed. (2d) 699, and Commissioner v. Josephs, 168 Fed. (2d) 233, certiorari denied, 335 U.S. 871">335 U.S. 871.
For the reasons which have been stated in support of our conclusions above, we also regard the claim of the respondent, to the effect*280 that there was no payment of the judgment on the part of the trust beneficiaries and that as to them and the living trust the expenditure of the $ 75,000 should be regarded as a capital item, as having no substance. The effect of the transaction was a payment of the $ 75,000 by the living trust for and on account of the beneficiaries. The only way the living trust was involved was as an accommodation provider of funds for the beneficiaries and the payments by the beneficiaries being a repayment, *535 in part, of amounts previously, though erroneously, received by them as income, there is no basis for holding that they were capital in character.
Due to the fact that the cashier's check delivered to the Board of Education in satisfaction of the judgment was not cashed, as shown by the stamp on the back thereof, until January 22, 1946, the respondent, on brief, claims that it has not been shown that the $ 75,000 in question was paid in 1945, in satisfaction of the judgment, and, for that reason, no amount with respect thereto is deductible by the petitioners in 1945. While the pleadings were not as definitely and precisely drawn as they might have been, it is apparent that there*281 was never any disallowance of the deduction on the ground stated, and further, that both parties proceeded to trial with issues based on the proposition that the payment in question had been made in 1945 but that the deduction claimed was not allowable for other reasons. Such being the facts and circumstances, orderly procedure requires that the respondent, if he has any question such as he now attempts to raise on brief, must voice such question by a proper pleading, or, at the very least, by a representation at or during the trial, that the matter is covered in the issues which have been pleaded. We will not hear and decide an issue raised for the first time by a party on his brief.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) Expenses. --
* * * *
(2) Non-trade or non-business expenses. -- In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.↩
2. (e) Losses by Individuals. -- In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise --
* * * *
(2) If incurred in any transaction entered into for profit, though not connected with the trade or business; * * *↩