*2998 1. Value of petitioner's interest in certain shares of stock surrendered to employees of a corporation in which he was a shareholder was a capital expenditure.
2. Payments for services of an agent of the executors of an estate are ordinary and necessary expenses incident to the production of the income thereof and, such estate keeping its books on a cash basis, are deductible from income in the year in which it is made.
3. During the period of administration of the estate here involved, and pursuant to an order of the probate court having jurisdiction over such estate, certain payments were made to the widow of the decedent, who was beneficiary of a trust created by the will of her husband. Held, that such payments were not deductible from the income of the estate in the respective taxable years in which they were made.
*1067 The respondent asserts an aggregate deficiency in income taxes for the years 1922 and 1923 in the amount of $3,869.87. All the issues raised relate to deductions from the income of the estate of Charles W. Ames*2999 claimed by the petitioner in the taxable years. Hereinafter the petitioner will be regarded as the estate of Charles W. Ames.
FINDINGS OF FACT.
Charles W. Ames died testate on April 3, 1921. In his will he disposed of a large and complicated estate made up for the most *1068 part of stocks and bonds representing investments in many widely separated and diverse enterprises. The bulk of the devised property consisted of stocks of the West Publishing Co., the American Law Book Co., and the Diamond Ranch, appraised for administrative purposes in the respective amounts of $264,000, $118,401, and $51,445.50. Other stocks, bonds, real estate and miscellaneous items made up the total appraised value of the estate in the amount of $711,289.34.
On November 2, 1916, certain shareholders of the American Law Book Co. of New York renewed an agreement under the terms of which a syndicate therein constituted, through one of its members as trustee, held 776 shares of the common and 2 shares of the preferred stock of the aforesaid company for purposes not disclosed by the record. Such agreement, inter alia, contained the following provision:
All interest and dividends to which*3000 said stock is entitled shall be paid by the said American Law Book Company to the Trustee of this syndicate, or at the Trustee's option to the members of the syndicate in proportion to their interests therein. Any expenses pertaining to the proper protection of said stock shall be paid by the Trustee from dividends or interest thus received. The balance of the dividends or interest received by said Trustee shall be divided among the members of the syndicate in proportion to their interests therein.
The stock interest of Charles W. Ames in the American Law Book Co. constituted 30 1/2 per cent of the holdings of the syndicate. On the death of Ames, the petitioner received such interest subject to the terms of a contract between the syndicate and certain employees of the company, which obligated the syndicate to deliver 10 per cent of its holdings to such employees at the expiration of a six-year period dating from November 4, 1916, if during that period the American Law Book Co. should declare and pay cash dividends to its stockholders equal to 500 per cent of the par value of its outstanding capital stock. Subsequent to November 4, 1916, and prior to the death of Ames, the company*3001 declared and paid cash dividends in the amount of 300 per cent of its outstanding capital stock, and subsequent to the death of Ames, but within the six-year period specified in the contract, it declared and paid cash dividends in the amount of 200 per cent of its outstanding stock.
On or about December 11, 1922, the syndicate surrendered 10 per cent of its holdings of American Law Book Co. stock to the employees of such company who were designated by the original and supplementary contracts as the beneficiaries thereunder. In proportion to its interest in the syndicate, the petitioner shared in such surrender and transfer of stock. The parties have stipulated that at December 1, 1922, the syndicate held 776 shares of the common and one share of the preferred stock of the American Law Book Co. *1069 and that such stock was worth $500 and $100 per share, respectively, at that date, or a total of $338,100. On such date the 30 1/2 per cent interest of the petitioner in such holdings was worth $118,370.50, and the 10 per cent thereof surrendered to the syndicate for transfer to the beneficiaries of the contract on or about December 11, 1922, was worth $11,837.05.
In his*3002 will the decedent appointed his son, Charles Lesley Ames, Cushing F. Wright, and Samuel Epes Turner, as executors and trustees of his estate, all of whom qualified and participated in the administration thereof. On account of the magnitude and diversity of the holdings of the estate and of the business situation, both as to it and in general, it was necessary to prolong the process of administration until May 13, 1925, when the estate was finally closed, and a decree of distribution in conformity with the terms of the will was made and entered by the Probate Court of Ramsey County, Minnesota. During such period of delay the executors and trustees, in order to conserve the property, operated the estate as a going business concern. Some time in May, 1921, they employed the Northwestern Trust Co. to act as their agent and agreed to pay such company the amount of $400 per month as compensation for its services. As agent of the executors and trustees, the Northwestern Trust Co. took care of all the business of the estate, kept the books of account thereof on a cash basis, handled its securities, looked after and advised with the trustees as to investments and reinvestments, collected*3003 all income and made all disbursements for the estate. Some time in 1923 the executors paid such Trust Company the amount of $5,000 for services rendered as their agent prior to the date of such payment.
The fifth paragraph of the testator's will provides as follows:
I bequeath all shares of the common stock of the West Publishing Company and all shares of the stock of the American Law Book Company which I may own or to or in which I may be in any way entitled or interested to my trustees, hereinafter designated, to have and to hold the same in trust for the uses and purposes and in the manner herein provided, that is to say: My trustees shall have power and authority to retain and hold under the trusts by this article created any or all of said shares of stock and rights and interests in shares of stock; and also, in their absolute discretion to enter into and execute any and all lawful agreements with respect to and to manage and control said shares, rights and interests as they shall deem best; and also to sell the whole or any portion thereof and to execute and deliver good and sufficient instruments to transfer the same; and also to invest and reinvest the said trust estate*3004 in such stocks, bonds or other securities or property suitable for the investment of trust moneys as they shall deem best: Provided, that in the event of any re-organization of either or both of the said West Publishing Company or the said American Law Book Company or in the event of any consolidation of either or both of said corporations with any corporation or corporations, then in either or any such event my trustees shall have power and authority in their discretion to exchange any of said shares of stock, rights and interests for *1070 shares of stock and securities in and of such reorganized or consolidated corporation as my trustees may deem best. For and during the period of ten years after my death my trustees shall collect and receive the dividends, profits and income of said trust estate, and shall pay the net income thereof as follows, to-wit: One-half of such income to my wife, Mary Lesley Ames, and one-half thereof in equal shares to and among my children who shall be living at my death, and if my said wife shall not survive me or shall die during said period then in either such event my trustees shall pay the whole of such income in equal shares to and among*3005 said children, but in any case so that the children of any child of mine who shall have died prior to my death or who shall die during said period shall be entitled to and shall take equally between them the share of such income which their parent would have taken if then surviving: Provided, that if any person entitled to a share of said income during said period shall not have attained the age of twenty-one years, my trustees in their absolute discretion shall pay the whole or any part of such share of income during his or her minority to his or her guardian, and if such person be a female to her after she shall have attained full age and until she shall have attained the age of twenty-one years. Upon the termination of said period of ten years my trustees shall transfer and deliver said trust estate as follows, to-wit: One half thereof to my said wife if she be then living, and one-half thereof, or in the event that my said wife be not then living then the whole thereof, to and among my children who shall be then living, but so that the children of any child of mine who shall have died prior to my death or who shall have died during said period shall take equally the share of said*3006 trust estate which their parent would have taken if then surviving.
On May 19, 1921, the probate court made and entered the following order:
WHEREAS, Mary Lesley Ames, widow of Charles W. Ames late of the County of Ramsey, in the State of Minnesota, deceased, has this day filed in this Court her petition praying, for reasons therein set forth, that the sum of Seven Hundred Dollars per month be allowed for the support and maintenance of the widow and children constituting the family of said deceased during the settlement of said Estate. And it appearing to the Court that said sum of Seven Hundred Dollars is a reasonable and necessary amount for the support and maintenance of said family of said deceased during the settlement of said estate. On motion of said petitioner, IT IS ORDERED:
That the sum of Seven Hundred Dollars per month be and the same is hereby allowed to the said widow for the support and maintenance of said widow and children constituting the family of said deceased during the settlement of said Estate, said allowance to commerce on the fourth day of April, 1921, and continue thereafter until said Estate shall be fully settled, unless said Estate shall be insolvent, *3007 in which case said allowance shall continue only for the period of one year from said fourth day of April 1921.
ORDERED, FURTHER, That the Representatives of the Estate of said deceased, be, and they are hereby directed and required to deliver and pay to the said widow the amount herein allowed for the purposes herein specified during the time allowed and limited by this order.
Pursuant to the order of the probate court, supra, the executors and trustees paid the widow of the testator the amounts of $8,400 and $3,900, in the years 1922 and 1923, respectively. In each of such years the net income of the estate was largely in excess of the amounts paid to the widow of the testator.
*1071 OPINION.
LANSDON: The first contention of the petitioner is that the estate is entitled to deduct the amount of $11,837.05 from its income for the year 1922 as an ordinary and necessary business expense. To do this it must show that the payment in question was an expenditure incident to business operations, and that it was paid or incurred in the taxable year. The facts are that the petitioner's decedent owned a 30 1/2 per cent interest in certain stocks of the American Law*3008 Book Co., which, for purposes not disclosed by the record, were held by a group of men known as the American Law Book Company Syndicate. It may be assumed, we think, that such holdings represented a controlling interest in the Law Book Co., and that the syndicate was formed for the purpose of unifying the control thereof.
The record indicates that the American Law Book Co. was an exceedingly prosperous concern. The owners of its stocks very naturally desired the continuance of that prosperity and they decided in 1916 that one way to assure such a result was to make certain of the more able and responsible employees participants in any profits that might be earned as a result of their services. For this purpose the members of the syndicate entered into an agreement, subsequently modified in minor particulars, with certain employees of the Law Book Co. By the terms of that agreement such employees, at the end of a term at first fixed at 5 years and later extended to 6 years, were to have surrendered to them 10 per cent of the stock of the company, which was held by the syndicate, conditioned upon the payment of dividends equal to 500 per cent of outstanding stock within the 6-year*3009 period. This was an agreement well calculated to inspire the proposed beneficiaries with zeal, enthusiasm and industry in their work for the company. Before the employees could receive any benefit from the contract the company must within 6 years first distribute 5 times the par value of its outstanding stock to its shareholders. That condition doubtless served as a stimulus to the employees. At any rate the conditioned distributions were made and 10 per cent of the stock held by the syndicate was delivered to the beneficiaries in 1922 at a cost to this petitioner of $11,837.05, which, it is contended, should be regarded as a business expense deductible from income for that year.
The distribution of dividends in the amount of 500 per cent of the par value of the Law Book Co.'s outstanding stock was completed in 1922. In that year the liability of the petitioner to surrender stock of the value of $11,837.05 was incurred under the terms of the contract and in that year such liability was met by the surrender of 10 per cent of its stock. There is no doubt, therefore, that the liability in question was both incurred and paid in the taxable year. It remains, then, only to determine*3010 whether it was a *1072 business expense. The single basis for the taxpayer's contention is that at the time of the surrender of the stock the estate was a going business concern. That may be true, but we are unable to see that the surrender of the stock to the beneficiaries was incidental to any of the operations through which the estate earned income. It was not in the law-book-publishing business, except in its capacity as one of the joint owners of the stock held by the syndicate. Any additional profits of the American Law Book Co. that resulted from increased efficiency of the benefited employees was not the income of the petitioner. We are of the opinion that the surrender of the stock in question was a capital transaction designed permanently to increase the value of the stock remaining in the petitioner's hands rather than an expense incidental to the production of income in the taxable year 1922.
The Northwestern Trust Co. was employed by the executors to act as their agent in conducting the business operations of the estate. The services rendered were many and varied. There is no showing that the compensation was unreasonable or that it was payment of purely*3011 administrative expenses and so deductible from corpus rather than from income. The books of the estate were kept on the cash basis. The amount of $5,000 paid to the Trust Company in 1923 is an allowable deduction from the income of the estate in that year for Federal tax purposes. . Cf. ; ; .
The petitioner contends that the amounts paid to the widow for the maintenance of herself and children during the period of administration should be deducted from gross income of the estate in the two respective years in which such payments were made. Paragraph 3 of section 8726 of the Revised Statutes of Minnesota provides as follows:
The widow or children or both, constituting the family of the decedent, shall have such reasonable allowances out of his personal estate as the probate court shall deem necessary for their maintenance during the settlement of the estate according to their circumstances, which in case of an insolvent estate shall not be longer*3012 than one year after administration is granted, nor in any case after the distributive share of the widow in the residue of the personal estate has been assigned to her; and such reasonable allowance may be made by the court when the husband or father has left a will, as well as when he dies intestate.
It is obvious that the probate court authorized the payments to the widow in conformity with the statutory provision above. Throughout the time involved the estate was in process of administration, which was not completed until May 13, 1925. Although *1073 the will creates a trust and provides for the payment of a part of the income thereof to the widow of the testator, from the date of his death, it is clear that such trust was not effective until the estate was closed and the property delivered to the trustees. The payments in question, therefore, could not have been made from the income of a trust not yet effective, and as there were no testatementary provisions for such payments from the income of the estate at regular intervals or otherwise, we think it is clear that section 219(a) of the Revenue Act of 1921 has no application to the situation here. The statute provides*3013 reasonable allowances for a widow out of the personal estate of the decedent. The probate court could act only in conformity with the law and, as the decree indicates, made no order that such payments should be from income. We conclude, therefore, that the amounts paid to the widow were distributions by the executors from the funds of the estate, that they were not such payments as are specified in subdivision (c) of section 219 of the Act, and that there is no authority for the deduction of such amounts from the income thereof in the respective years.
Reviewed by the Board.
Decision will be entered under Rule 50.
SMITH and MILLIKEN dissent on the first and third points.
PHILLIPS dissents on the first point.