*1289 1. The decedent established a trust, the corpus of which was shares of stock in two companies. Some of the shares were at the time pledged as collateral for loans made to decedent by a number of banks. The trust instrument provided that the income from the corpus of the trust should first be used to discharge such bank loans and certain unsecured obligations for which the decedent was personally liable, and should decedent during should his lifetime liquidate said indebtedness or after his death should his estate pay said debts, the income of the trust should be used to reimburse either decedent or his executors as the case might be, The indebtedness remaining unpaid at the time of decedent's death was paid by the executors of his estate. Held that the amount of the indebtedness paid by the executors is deductible from the gross income of the estate as a claim against the estate, and that the claim of the executors against the trust arising out of the payment should be included in the gross estate at a value of $38,181.38.
2. The right of decedent's estate to share in the profits of a partnership for an agreed period subsequent to his death constitutes property subject*1290 to be included in the gross estate.
*533 This proceeding involves the redetermination of a deficiency of $35,164.94 in estate tax. The issues are (a) whether the sum of $381,813.77 paid by the estate to discharge debts contracted by the decedent for loans is deductible from the gross estate; (b) the value of a claim against a trust created by the decedent arising out of the payment; and (c) whether the right of the decedent to share in the profits of a partnership after his death constitutes an asset subject *534 to be included in the gross estate. It has been stipulated that the gross estate as determined by the respondent should be reduced by the sum of $5,837.39, representing an amount paid by the estate after the mailing of the deficiency notice.
FINDINGS OF FACT.
The petitioners are the duly qualified executors of the estate of their father, George Wood, who died February 17, 1926, a resident of the State of Pennsylvania.
On January 6, 1923, the decedent owned, among other assets, 15,557 shares*1291 of the 30,000 shares of stock of the Millville Manufacturing Company and 6,248 shares of the 12,500 shares of stock of the Mays Landing Water Power Company, corporations engaged in the cotton textile business. The remaining outstanding capital stock of the corporations was held by members of the decedent's family. The par value of the stock was $100 per share. On that date 7,845 shares of decedent's stock of the Manufacturing Company were pledged as security for bank loans amounting to $381,700. He was also indebted to the Manufacturing Company and the Power Company in the respective amounts of $96,626.61 and $43,544.99 for loans.
The decedent, on January 6, 1923, assigned and transferred to his wife, Mary H. Wood, and his son, Richard D. Wood, as trustees, 15,000 shares of stock of the Manufacturing Company, subject to the prior assignment of 7,845 shares as collateral security for the bank loans, and 5,000 shares of stock of the Power Company in trust, to apply the income or dividends from the stock as it might be received, first to the payment of the bank loans, and then to the indebtedness to the corporations. The trust instrument then provides that:
* * * should Settlor's*1292 estate be required, before or after Settlor's death, to pay said indebtedness for which the said stock is pledged, as above set forth, or any part thereof then remaining unpaid, thus releasing said stock so held as collateral, to apply the dividends and income from said stock thereafter to reimburse Settlor's estate for the amount so paid in liquidation of said indebtedness or any balance thereof, till the same with interest accruing thereon, shall have been paid and liquidated in full to Settlor's estate and also to apply said income and dividends after Settlor's death to the liquidation of said indebtedness to Millville Mfg. Co. and May's Landing Water Power Company, or should said indebtedness have been paid by Settlor's Estate, to the repayment thereof, with interest, to Settlor's estate until the same shall have been paid in full.
Upon the complete liquidation of the settlor's indebtedness to the banks and corporations, or his estate, if paid by it, three-fifths of the income and dividends received by the trust from the stock was to be distributed immediately upon its receipt to the settlor's wife and the *535 remaining two-fifths equally among his four daughters. In*1293 case of the death of any daughter leaving issue, her share was to go to her children and issue per stirpes, and should any of settlor's daughters die without issue, her share was to be distributed among the settlor's surviving daughters and the issue of any deceased daughter. Upon the death of settlor's wife part of her share was to be distributed to living daughters and issue of deceased daughters and the balance equally among settlor's grandchildren and great-grandchildren. Provision was also made in the instrument for the distribution to settlor's descendants of the corpus of the trust upon the death of the survivor of his then living children and grandchildren.
The trust contained the following additional provisions:
IN TRUST, to permit Settlor's sons, Richard D. and Grahame Wood, to purchase from the trust at its par value, all, but not less than all, of the said Millville Mfg. Co. stock at any time; and all, but not less than all, of the said May's Landing Water Power Company stock at sixty dollars ($60.00) per share at any time, providing the stock of both Companies is purchased on the same date; and in the event of such purchase, to invest the purchase money and keep*1294 the same invested, and continue to distribute the income quarter-annually in the same manner, and to the same persons as would have been entitled to the income arising from dividends on the said stocks as hereinabove set forth; PROVIDED, HOWEVER, that distributions of income from such investments shall be made quarter-annually to the persons found to be entitled at the date of each quarter-annual distribution, January 1, April 1, July 1 and October 1 in each and every year.
* * *
IN TRUST, should said Trustees at any time find it advisable to sell the whole of said stock (it being Settlor's wish that it shall not be sold except as an entirety) that Settlor's said sons, Richard D. and Grahame, or the survivor of them, shall be given the first option by Trustees to purchase the same, at the prices above set forth, and should they not desire to purchase the same, them to sell the same to any other person or persons for such price or prices as may be reasonably obtainable therefor by Trustees, according to their best judgment and discretion, and to assign, transfer and set over the said shares unto the purchaser or purchasers thereof, without liability on the part of the said purchaser*1295 or purchasers to see to or be responsible for the application of the purchase money; and upon any such sale, to invest the proceeds thereof and hold the same upon the like trusts as the said stock theretofore had been held, and to distribute the income therefrom quarter-annually, January 1, April 1, July 1, and October 1, as hereinabove provided.
On July 30, 1924, the decedent notified the trustees in writing of payments made by him on the principal of his indebtedness to the banks and corporations and of his intention to make further payments and that these payments were gifts to the beneficiaries of the trust, without any obligation on the part of the trust to repay the sums so paid and to be paid to his estate. As of the date of decedent's death the indebtedness to the banks was $225,000, secured by 6,042 shares of stock of the Manufacturing Company, 1,803 shares having *536 been released by the payment in full of the debts owing to two banks, and the amounts owing the Manufacturing Company and Power Company were, respectively, $104,805.42 and $52,008.35. The total of $381,813.77 of the debts was paid by the petitioners out of the decedent's estate a short time after*1296 his death. The released stock was delivered to the trustees.
As of the date of decedent's death, the stock of the Manufacturing Company had a value of $75 per share and the stock of the Power Company $70 per share.
The Power Company was organized about 1860 and has never paid a cash dividend. It paid stock dividends of 200 per cent and 66 2/3 per cent on June 25, 1920, and December 29, 1922, respectively. It had net income in 1920, 1921, 1922, 1923, 1925 and 1927, aggregating $408,474.24 after deducting income taxes, and losses amounting to $476,620.21 in 1924, 1926, 1928, 1929 and 1930. Its capital stock and surplus at the close of 1926 was $1,250,000 and $386,255.69, respectively.
The Manufacturing Company did not pay any cash dividends between 1920 and 1926. It paid a stock dividend of 621.15 per cent on June 25, 1920. It had net income, after deducting income taxes, of $591,694.33 in the years 1921, 1922 and 1923, and losses amounting to $1,105,326.33 in the years 1920, 1924, 1925 and 1926. In the years 1927, 1928 and 1929, it had net income totaling $551,575.65 after deducting income taxes. In 1930 it sustained an operating loss. Its capital stock and surplus*1297 at the close of 1926 were $3,000,000 and $823,339.26, respectively. At the time of decedent's death the Manufacturing Company owed banks $1,400,000 for loans evidenced by notes endorsed by the decedent. The bills payable of the corporation at the close of 1926 amounted to $628,000. In that year the Power Company was not indebted to banks for any sum.
There was a steady decline in the business and earnings of the cotton textile industry from the middle of 1920 to the close of 1926. In 1920, thirty-five textile mills in the Fall River, Massachusetts, district paid very large dividends. In 1926 only twelve of these thirty-five mills paid dividends and the amounts paid by a majority of them were small. Due to the weak condition of the cotton textile industry, the necessity of the Manufacturing Company and the Power Company to have free credit with banks and maintain large reserves in liquid capital to meet changing business conditions, the large sum the Manufacturing Company owed banks in 1926, and the small earnings of the two corporations, it would have been disastrous for either corporation to have declared dividends in and after 1926. Many textile mills that did not maintain*1298 substantial liquid reserves after 1926 were compelled to discontinue business. Owing to the *537 condition of the textile industry, the plants and real estate of the Manufacturing Company and Power Company had had practically no value since the first of 1926.
In the estate-tax return filed by petitioners the claims of the estate against the trustees for the payment of the indebtedness of $381,813.77 were included in the gross estate at a value of $38,181.38, and a deduction was claimed for the full amount of the payment. In his determination of the deficiency the respondent allowed the deduction and increased the value of the claim to its face amount.
The claim of the estate against the trust for liquidating the debts of $381,813.77 to the banks, Manufacturing Company and Power Company had a value of $38,181.38 at the time of decedent's death, for estate-tax purposes.
At the time of his death the decedent was a member of the partnership of George Wood, Sons & Company. Article seven of the partnership agreement reads as follows:
In case any of the partners shall die before the expiration of said partnership it shall not work a dissolution of the firm.
The deceased*1299 partner's interest and share in the profits shall either continue to the end of the partnership term, viz., December 31st, 1926; or, if his executors elect to withdraw his contribution to the capital, his balance shall have determined at the end of the month in which he died and the firm shall have a year to make final settlement, but his executors may draw whatever amount is necessary for the living expenses of his dependent heirs, and his account shall bear six per cent. (6%) interest, and an advertisement that his responsibility as to the debts of the firm has ceased with his death shall be made in two Philadelphia daily papers; and the surviving partners shall divide the said deceased partner's interest proportionately to their respective shares as provided in Paragraph "Third" of this agreement.
The decedent's right to share in the profits of the partnership for the period in 1926 subsequent to his death was of the value of $91,876.36.
OPINION.
ARUNDELL: Section 303(a)(1) of the 1924 Act, which is the applicable taxing statute, provides that in determining the value of the net estate there shall be allowed as a deduction from the value of the gross estate such amounts*1300 for "claims against the estate" to the extent that they "were incurred or contracted bona fide and for an adequate and full consideration in money or money's worth * * * as are allowed by the laws of the jurisdiction * * *." Our first consideration then is to determine whether the sum of $381,813.77 sought to be deducted constitutes "claims against the estate." The items making up the indebtedness consisted of amounts loaned to the decedent by banks and the Millville Manufacturing Company and *538 the Mays Landing Water Power Company, for the payment of which he was personally liable. On this statement it would appear that the deductions sought were clearly allowable.
The respondent urges, however, that the trust, the pertinent provisions of which are set forth in our findings of fact, had been impressed with the obligation of paying the debts and that the collateral should have been used to satisfy the liabilities. In creating the trust, provision was made for the liquidation of the debts from income earned by the corpus of the trust. The bank loans were to be paid off first and then the debts owed the corporations. Provision was also made for reimbursing decedent's*1301 estate from the same source in case it paid all or any part of the obligatiovs. None of the creditors of the decedent were parties to the trust instrument and there is no evidence of an agreement on the part of any of them to look to the trust for payment. Nothing appears contrary to the fact that the decedent's primary liability for the debts continued until his death. Had he made provision in the declaration of trust for the payment of the debts by the trust alone, unless the arrangement was agreed to by his creditors, his primary liability for the obligations would nevertheless have continued.
In paying the claims the executors were liquidating liabilities that could have been enforced against the decedent during his life, and they being obligations for which he was primarily liable at the time of his death, the estate was not subrogated to the rights of the banks against the collateral. ; ; ; *1302 ; . The decedent's interests in these shares passed with his transfer of them to the trust, and the latter became their owner subject only to such rights as the bank had pending the liquidation of the indebtedness.
So far as the record discloses the agreements entered into with the banks for the loans did not confine their right of recovery to the value of the stock deposited as security. In the absence of such an agreement, a creditor holding security for his claim may, in case of default, proceed against the debtor personally in preference to the security, ; ; ; , and after the debtor's death he may file a claim as a general creditor of the estate. 24 C.J. 276; ; 28 Atl; 1109; *1303 ; . The debts owing the Manufacturing Company and Power Company were unsecured and as to them the creditors had no election of remedies.
*539 The debts were claims against the estate within the meaning of the statute and are deductible from the value of the gross estate.
The case of , is not controlling. There, the contracts under which the loans were made provided that in making settlement under the life insurance policies, any indebtedness to the company respecting them would be deducted from the amounts payable to the beneficiaries. Here, there has been no showing that the banks ever agreed to look to the value of the collateral alone for payment.
The parties are in agreement that the claim of the estate against the trust, created by the payment of the decedent's indebtedness to the banks and corporations, should be included in the gross estate at some value. The petitioners are asking us to confirm their valuation of $38,181.38, as returned, and the respondent insists that the evidence establishes no value less than the face amount of $381,813.77, *1304 the valuation determined by him.
The provisions of the declaration of trust clearly show an intention that the debts, whether paid to the original creditors or the estate, should be paid from income alone, without resorting to the principal. We find no reason to question the limitations thus placed upon the collection of the claim. The decedent was dealing with his own property and could have forgiven the trust of any liability to reimburse his estate, as he did in the case of payments made by him prior to his death. By requiring the trustees to repay his executors out of income from the corpus, he gave his estate the benefit of whatever value such a claim would have at the time of his death.
The uncontradicted testimony of five of petitioners' witnesses fully supports their claim. The petitioners, who have been identified with the two corporations for many years as officers, testified that a payment of dividends in and after 1926 would have seriously affected the future of the corporations, due to insufficient current earnings and the necessity of maintaining at all times large reserves of capital to meet market conditions in the industry and obsolescence of machinery resulting*1305 from new inventions. They further testified that they have never been interested in acquiring the stock of the trust at the prices at which it was offered to them, and because of the state of the cotton textile industry since the decedent's death there has been no market for the stock as an entirety at substantial prices. The liquidating value of textile mills, they testified, was very small in 1926 and since has decreased to practically nothing.
Their opinions are confirmed by the testimony of Charles H. Pope, a large cotton broker, with intimate knowledge of the financial affairs of corporations engaged in the textile business before and after 1926, a bank director and president of the Penn Mutual Life Insurance *540 Company, and the president of the bank with which the corporations had accounts and transacted business. The two latter witnesses placed a valuation on the claim at the basic date of not in excess of 10 per cent of its face amount. The opinions of these witnesses convince us that the claim in question had a value for estate-txa purposes of $38,181.38, and we have so found as a fact.
Under the agreement creating the partnership of George Wood, Sons & *1306 Company it is provided that in case any partner shall die before the termination of the firm the deceased partner's interest and share in the profits shall continue to the end of the partnership term or his executors may elect to withdraw his capital contribution. The petitioners decided to pursue the former course, with the result that they received at the close of 1926 the share of firm profits the deceased would have received had he survived the life of the partnership.
The parties have stipulated the issue to be whether the "right to share in the profits of the partnership * * * constitutes an asset of the estate subject to the Federal estate tax." Without objection, the proceedings were submitted by the respondent, with the understanding that if the right to participate in future profits of the partnership is taxable as a part of the gross estate, the figure to be used is the stipulated present worth of $91,876.36. Such appears to have been the purpose of the stipulation and the case will be decided on the theory that the parties are in agreement as to the value of the right at the time of decedent's death.
*1307 In the case of , we had the question of whether the taxpayers were liable for income tax on such portions of the earnings of a partnership as were included in the value of the gross estate. The fair market value of the right of the estate of the decedent to profits of the partnership was stipulated to be $49,346.15 as of the date of the decedent's death. In holding that only the profits received by the estate in excess of this figure were taxable income to the beneficiaries of the estate as gain, we remarked that the right of the estate to future partnership earnings "was a valuable contractual right or chose in action constituting a part of the assets of William Blodget which passed on his death to the executors of his estate." The same conclusion was reached in .
In the case of , there was no proof of the value of the right to future profits of the partnership and all of the earnings were held to be taxable to the estate as income.
The holding of the court in *1308 , is to the same effect. There, the Government sought to impose an income tax on the difference between the estimated amount at *541 which a right similar to the one here was returned for estate-tax purposes and the amount subsequently received. In deciding that the excess amount did not represent a profit or gain on the right, taxable as income to the estate, the court pointed out that the amount received by the executors from that source "came to them as part of the corpus of the estate of the deceased," and that the item "was an integral part of the corpus of the estate, received and retained by the executors, not a gain or profit issuing and severed from a capital asset."
We think these cases control the question and accordingly decide the issue in favor of the respondent.
Decision will be entered under Rule 50.