*3529 1. Where a petitioner, who owned certain shares of stock which had cost less than $250 a share, sold the shares of stock at $300 a share, he is not relieved from tax liability on the profit represented by the difference between $250 and $300 a share by the fact that a short time before the sale he told certain individuals that they should have all that he realized from the sale of the stock over and above $250 a share.
2. Where a petitioner purchased certain shares of stock three days prior to the declaration of a regular quarterly dividend, which dividend he expected would be declared and which influenced his bid for the stock, the dividend, when actually received by him, is nevertheless taxable to him as an ordinary dividend.
3. Life insurance premiums paid by the petitioner on policies insuring his own life in which his estate is named as the beneficiary and which he took out for the protection of a creditor are not deductible from income.
4. The deduction of an addition to a reserve to provide for possible future reduction in the market price of certain securities disallowed.
*439 The above cases were consolidated for hearing and decision.
In the case of Julius S. Rippel income taxes for the calendar years 1919 to 1923, inclusive, are in controversy. The Commisisoner determined deficiencies as follows:
| Deficiency | |
| 1919 | $1,762.36 |
| 1920 | 11,362.95 |
| 1921 | 33,691.81 |
| 1922 | 86,444.66 |
| 1923 | 12,731.15 |
| Total | 145,992.93 |
Certain portions of the above deficiencies are not contested.
The petitioner alleged and now contends that the Commissioner erred: (1) In determining the taxable profit realized in 1922 from the disposition of 48 shares of Fidelity Union Trust Co. stock; (2) in determining that the petitioner received a taxable dividend of $42,000 in the year 1922 from certain shares of Fidelity Union Trust Co. stock; (3) in disallowing as a deduction from net income the total amount of certain premiums paid on life insurance policies during the years 1921, 1922, and 1923; and (4) in refusing to permit the partnership firm of J. S. Rippel & Co. to deduct from income amounts set aside as a reserve to provide for losses or market reduction in the value of state, county, and municipal bonds.
*3531 In the case of Russell V. Adams, income taxes for the calendar year 1922, are in controversy. The Commissioner determined a deficiency of $1,113.13.
In the case of Joseph R. Mueller income taxes for the calendar years 1921 and 1922 are in controversy. The Commissioner determined a deficiency of $483.28 for 1921, and a deficiency of $1,022.49 for the year 1922. The only error alleged and now urged in the cases of Adams and Mueller is the last error set forth above in connection with the case of J. S. Rippel.
FINDINGS OF FACT.
The petitioners are all citizens of the United States, and are all partners in the firm of J. S. Rippel & Co., which has its principal office at Newark, N.J. This firm deals in investment securities, specializing in municipal bonds and bank stocks and in underwriting public service securities and other similar securities. This firm existed long before the years in controversy and during the taxable years was one of the largest dealers in the City of Newark, in state securities and local bank stocks.
The following entry appears under date of October 10, 1922, in J. S. Rippel's day book, or journal, from which book postings were made to his ledger: *3532
| Sold to J. S. Rippel & Co. for a/c J. E. Bizzel 275 shrs. | ||
| Fidelity Union Trust Co's. stock @ 300 $82,500 | $82,500 | |
| Of this amount 250 shrs. were carried for the | ||
| account of R. V. Adams, 100 shrs.- J. R. Mueller 100 shrs. - | ||
| Ida M. Simcox 25 shrs. and Grace A. Fulton 25 shrs. | ||
| The understanding being that the profit on the above stock @ | ||
| $250 per share would be given to the above persons in the | ||
| above proportions. | ||
| Instead of taking cash profits R. V. Adams purchased of me 20 | ||
| shrs. Fidelity Union Trust Co. Stk. @ 300 | $6,000 | |
| Amt. due him as profit on trans | 5,000 | |
| Received his check Oct. 11 for | 1,000 | |
| Instead of taking cash profits J. R. Mueller purchased of me | ||
| 20 shrs. Fidelity Union Trust Co. Stk. @ 300 | 6,000 | |
| Amt. due him as profit | 5,000 | |
| Received his check Oct. 17 for | 1,000 | |
| Instead of taking cash profit Ida M. Simcox purchased of me | ||
| 4 shrs. above stock @ 300 | 1,200 | |
| Amt. of profit due her | 1,250 | |
| Gave her check Oct. 20 for dif | 50 | |
| Instead of taking cash profit Grace A. Fulton purchased of | ||
| me 4 shrs. above stock @ 300 | 1,200 | |
| Amt. of profit due her | 1,250 | |
| Gave her check Oct. 20 for dif | 50 | |
| Gave as donation the following: | ||
| Zella Robinson 1 shr. Fidelity Union Trust Co. Stk. | ||
| Helen Powers 1 shr. Fidelity Union Trust Co. Stk. | ||
| Edw. Hinckley 1 shr. Fidelity Union Trust Co. stk. | ||
| 51 shrs. @ 300 | ||
| Charge - Donations a/c $15,300 | 15,300 | |
| Credit - Fidelity Union Trust Co. Stk. a/c 51 shrs. stock @ | ||
| 300 as donation | 1,900 | |
| 17,200 | ||
| Credit 275 shrs. stock @ 300 as donation $82,500 | 82,500 |
*3533 *440 The credit side of J. S. Rippel's ledger account entitled "Fidelity Union Trust Company" contained the following entries and a reference to the above journal entry, under date of October 10, 1922:
| 51 shares as donation | $17,200 |
| 275 shares @ 300 | 82,500 |
Adams and Mueller, mentioned in the above journal entry, were partners with J. S. Rippel. Ida M. Simcox was employed as cashier of the partnership and Grace A Fulton was also employed by the partnership. At the time J. S. Rippel purchased the Fidelity Union Trust Co. stock described in the above entries he had no agreement with any of the four persons above named and none of these persons contributed anything toward the purchase price of these shares of stock. Shortly before J. S. Rippel sold the stock in question one of the four named persons asked Rippel for an interest in the stock. Rippel orally advised each of these four persons that he *441 or she would receive all of the selling price over and above $250 per share on a certain number of shares of this stock. Adams and Mueller were advised that so far as each was concerned this arrangement would apply to 100 shares and Simcox and Fulton*3534 were advised that so far as each was concerned this arrangement would apply to 25 shares. These four persons were not to share in any losses on the shares of stock and they did not put up any money on account on the purchase price of this stock or as collateral or otherwise.
On October 10, 1922, J. S. Rippel sold 275 shares of Fidelity Union Trust Co. stock at $300 a share. He considered that this gave Adams and Mueller a profit of $5,000 each and Simcox and Fulton a profit of $1,250 each. Instead of giving these individuals cash, Rippel transferred 20 shares of Fidelity Union Trust Co. stock to Adams at $300 a share and a like number of shares to Mueller at the same price and shortly thereafter received from each a check for the difference of $1,000. Likewise, he transferred 4 shares of the same stock at the same price to Ida M. Simcox and 4 shares at the same price to Grace A Fulton, and shortly thereafter gave his checks to each of these individuals for the difference of $50. At about the same time he gave 1 share of this same stock to each of three other individuals named in the journal entry and by mistake in the ledger entry the word "donation" was made to apply to 51*3535 shares instead of to the 3 shares only. The 48 shares of Fidelity Union Trust Co. stock thus transferred by J. S. Rippel were purchased by him from the Prudential Insurance Co. of America at $228.50 a share. He did not report any profit from the disposition of any of these 48 shares on his income-tax return.
Mueller did not report in his 1922 return any profit on account of the $5,000 benefit which he received from Rippel in the Fidelity Union Trust Co. stock transaction.
Grace A Fulton did not report any part of the $1,250 benefit which she received in the above transaction.
The Commissioner's deficiency notice to J. S. Rippel contains the following:
It is noted that you also claimed as an additional cost of such securities, an amount of $10,968.00. As explained by you in conference, this $10,968.00 represents the cost of 48 shares at $228.50 per share; that you originally purchased a large part of this stock and immediately made an arrangement whereby certain stated individuals should receive a share of the profits realized on these sales.
When the sale in question was consummated, it was found that you were liable to these individuals in the following amounts: *3536
| R. V. Adams | $5,000.00 |
| J. R. Mueller | 5,000.00 |
| Ida M Simcox | 1,250.00 |
| Grace Fulton | 1,250.00 |
*442 You had some more of this stock which you considered worth $300.00 per share. To liquidate the above, you gave R. V. Adams and J. R. Mueller 20 shares each of this stock, said 20 shares being worth $6,000.00, and these individuals gave you $1,000.00 in cash. To Ida M. Simcox and Grace Fulton you gave 4 shares of stock each, said 4 shares being worth $1,200.00. As your liability to them was $1,250.00 each, you paid them $50.00 each additional in cash. In your brief you show that you disposed of these 48 shares for $1,900.00 and that their cost was $228.50 per share. After careful consideration, you are advised that the $10,968.00 has been disallowed as an additional cost for the reason that you apparently disregard entirely the fact that with these 48 shares you liquidated an indebtedness of $12,500.00 as well as received $1,900.00 in cash. Either the cost of 48 shares must be eliminated from the computation of the taxable profit or else the amount of the liquidated liability should be added to the amount received on these sales. The result in either instant*3537 will be the same. This contention, therefore, has been denied.
On March 14, 1922, J. S. Rippel received the following communication in duplicate, signed by Edward D. Duffield, acting president of the Prudential Insurance Co. of America:
MY DEAR MR. RIPPEL:
At the meeting of the Finance Committee of this Company, held this morning, I was authorized to make the following proposition to you on behalf of the Company.
In consideration of your purchase of 1,000 shares of the capital stock of the Fidelity Union Trust Company, owned by this company, at the price of 228 1/2, this company will grant you an option of thirty days from the 15th day of March to purchase the remainder of its holdings, i.e. 9,500 shares at the same price, i.e. 228 1/2, and in case you so desire, will make you a loan in which said shares will be pledged as collateral at the valuation of 200. Additional collateral to be furnished by you in sufficient amount to provide a satisfactory margin. Any dividends declared on the stock on which an option is given to you to be retained by the company, provided they have actually been declared prior to the exercise by you of said option, all dividends which may be*3538 declared on said stock subsequent to the exercise by you of said option to be your property. Said loan if granted to terminate on or before December 15, 1922, and to carry interest at the rate of 5 1/2% per annum. It is understood that you are to have the privilege of paying said loan at any time you may desire, either in whole or in part and releasing a proportionate amount of the collateral deposited as security therefor.
Very truly yours,
J. S. Rippel endorsed both copies of this letter as follows and returned one copy to the Prudential Insurance Co. of America:
I hereby accept the above proposition.
(Signed) J. S. RIPPEL.
In accordance with the foregoing agreement J. S. Rippel, on March 15, 1922, purchased 1,000 shares of Fidelity Union Trust Co. stock at $228.50 a share and on March 17, 1922, purchased 9,500 shares of the same stock at the same price, being all of the shares of this stock then owned by the Prudential Insurance Co. of America. During the five years preceding 1922, the Fidelity Union Trust Co.*443 had declared regularly a 4 per cent quarterly dividend. On March 17, 1922, this company had not declared a dividend. Shortly thereafter it did*3539 declare a regular quarterly dividend of 4 per cent, payable on April 1, 1922, to the stockholders of record on March 20, 1922. Rippel received his dividend on these 10,500 shares.
The following journal entry appears in the books of J. S. Rippel under date of December 30, 1922:
| Dividend received Apr. 1, 1922 on 10,500 shrs. | |||
| Fidelity Union Trust Co.'s Stock @ 4% | $42,000 | ||
| Transferred from Int. & Disc. a/c as of | |||
| this date to Stock a/c, as the dividend | |||
| had been entirely accrued at the date of purchase | |||
| Mch. 17, 1922 | |||
| Charge - Int. & Discount | 42,000 | 42,000 | |
| Credit - Fidelity Union Trust Co | 42,000 | 42,000 |
In the ledger of J. S. Rippel in an account entitled "Fidelity Union Trust Company" the following debit entries appear:
| 1922 | |
| Mch. 15. 1,000 shrs @ 228 1/2 | $228,500 |
| 16. 9,500 shrs @ 228 1/2 | 2,170,750 |
Edward D. Duffield had told J. S. Rippel prior to the sale of this stock that as the stock had cost the Prudential Insurance Co. of America about $228.50 a share the company did not feel that it ought to sell for less than this amount and the price would be the same regardless of who received the dividend which both parties then expected*3540 would soon be declared and paid. J. S. Rippel had offered $224.50 a share for the stock, the Prudential Insurance Co. of America to receive the expected dividend. This offer was refused and the agreement as above set forth was later entered into.
The Commissioner determined that J. S. Rippel had received a taxable dividend of $42,000 on April 1, 1922, as owner of 10,500 shares of Fidelity Union Trust Co. stock and refused to consider that this dividend represented a return of part of the cost of the stock, making the real cost of the stock $224.50 a share.
In 1921, J. S. Rippel purchased certain real estate from the Merchants & Manufacturers National Bank, of which he was a director. The purchase price of this property was $975,000, of which $100,000 was paid in cash. J. S. Rippel gave a purchase-money mortgage for the balance of $875,000. Thereafter, at his own suggestion and without solicitation on the part of the bank, he took out $500,000 of life insurance, payable to his estate. Prior to taking out these policies he had only carried $3,000 of life insurance. The new policies were taken out only because of the purchase of the property. On these policies J. S. Rippel*3541 paid premiums as follows:
| For 1921 | $12,844.00 |
| For 1922 | 16,311.44 |
| For 1923 | 14,799.50 |
*444 J. S. Rippel notified the bank that he had taken out this insurance, but he at all times retained the policies and never entered into any agreement with the bank in regard to them. The Commissioner disallowed the deduction of insurance premiums as a business expense in the case of J. S. Rippel.
The firm of J. S. Rippel & Co., a partnership, purchased state, county and municipal securities during the following years in the following amounts:
| 1919 | $3,649,000.00 |
| 1920 | 6,093,521.00 |
| 1921 | 8,914,900.00 |
| 1922 | 8,628,981.41 |
| 1923 | 7,474,902.28 |
The above amounts represent purchases of original issues by competitive bidding or otherwise. On the books of this firm an account was carried entitled "Reserve for Depreciation Account." This account contained the following entries:
| 1921 | |
| May 31. Balance carried forward to new ledger | $61,981.52 |
| 61,981.52 | |
| Dec. 31. Balance carried down | 154,438.11 |
| 154,438.11 | |
| 1922 | |
| Dec. 31. Balance carried down | 305,059.96 |
| 305,059.96 | |
| 1923 | |
| Dec. 31. Balance carried down | 353,587.90 |
| 353,587.90 | |
| 1924 | |
| Dec. 31. Balance carried down | 472,662.31 |
| 472,662.31 | |
| 1924 | |
| Dec. 31. Balance Fowd to new ledger | 472,662.31 |
| 472,662.31 | |
| 1919 | |
| Dec. 31. Cr. Balance as Day Book | $18,784.39 |
| Dec. 31. Cr. Balance as | |
| Dec. 31. Cr. Balance as Day Book | 43,197.13 |
| 61,981.52 | |
| 1921 | |
| May 31. Balance carried forward from old ledger | 61,981.52 |
| Dec. 31. Balance P & L a/c | 92,456.59 |
| 154,438.11 | |
| Dec. 31. Balance carried down | 154,438.11 |
| 1922 | |
| Dec. 31. Balance of Profit & Loss a/c | 150,621.85 |
| 305,059.96 | |
| Dec. 31. Balance carried down | 305,059.96 |
| 1923 | |
| Dec. 31. Balance of Profit & Loss a/c | 48,527.94 |
| 353,587.90 | |
| Dec. 31. Balance carried down | 353,587.90 |
| 1924 | |
| Dec. 31. Balance of Profit & Loss a/c | 119,074.41 |
| 472,662.31 | |
| Dec. 31. Balance carried down | 472,662.31 |
| 472,662.31 |
*3542 *445 The purpose of this reserve fund was to protect the firm in the event of a drop in price of the securities which it owned or which it had transferred to others for the purpose of resale. The Commissioner disallowed the deduction of the reserves set up on the books of J. S. Rippel & Co.
OPINION.
MURDOCK: The petition in the case of Julius S. Rippel alleges that the determination of the deficiency is based upon the following error:
Erroneous determination in 1922 of taxable profits arising from disposal of 48 shares of Fidelity Union Trust Co. securities.
As facts in support of this contention it alleges, inter alia, the following:
Taxpayer is being charged, for the year 1922, with a profit of $28,786.00, resulting from the sale of 410 shares of Fidelity Union Trust Co. (including these first referred to 275 shares) at a sale price of $126,658.00 and a cost price thereof of $97,872.00. In this sale price of $126,658.00 is included the full sum of $82,500.00, resulting from the sale of the above referred to 275 shares of said Fidelity Union Trust Co. stock in which four others had an individual interest therein upon the profit realized over and above a*3543 sale price of $250.00 per share upon 250 shares thereof.
Taxpayer liquidated this syndicated interest in the 250 shares by making payment therefor with 48 shares of Fidelity Union Trust Co. stock which had cost taxpayer 228 1/2 per share of $10,968.00, and for which net cash in the adjustment of the account was received by taxpayer in the amount of $1,900.00.
Taxpayer contends error on Commissioner's part by his failure to reduce taxpayer's profit upon sale of said 410 shares, by giving credit to taxpayer for the other "interests" share in the gross profit derived from sale of 250 shares thereof, and at the same time to consider that taxpayer, in the adjustment of the other interests, disposed of 48 additional shares owned by taxpayer of Fidelity Union Trust Co. stock, costing $10,968.00, for sole cash consideration of $1,900.00. The Commissioner, in his letter of November 20, 1925, states that taxpayer "apparently disregarded entirely the fact that with these 48 shares he liquidated an indebtedness of $12,500.00 as well as receiving $1,900.00 in cash." Taxpayer directs attention, however, to the fact that in the computation of the sale price of the 410 shares of stock, the*3544 entire gross sale price is charged against taxpayer which, however, includes the other "interests" share in the transaction in question.
The answer denies that the Commissioner committed any error in this connection and also denies all the material allegations of fact contained in these paragraphs. No proof has been offered that this petitioner sold in the year 1922, 410 shares of this stock at a sale price of $126,658, or that this sale price included $82,500 resulting from the sale of 275 shares of the stock, or that the petitioner is being charged with a profit of $28,786, resulting from the sale of this stock. In the absence of these facts we could not possibly say that the Commissioner committed error by failing to reduce the petitioner's profit *446 upon the sale of the 410 shares of stock by the share of the gross profits belonging to other "interests," or in failing to consider that in the adjustment of the other interests the petitioner disposed of 48 additional shares of stock, costing $10,968, for a cash consideration of $1,900.
J. S. Rippel told certain of his business associates and employees that if he sold certain shares of stock for more than $250 a share, *3545 they should have the amount realized in excess of $250 a share. Shortly thereafter he sold the shares of stock for $300 a share. Had it not been for his statements to these four persons, all of the difference between $250 and $300 a share would have been included in his profit from the transaction, inasmuch as the stock had cost him less than $250 a share. We are unable to find from the record that there was any consideration for Rippel's promise or agreement in regard to the profits which he expected to make and which he subsequently did make, or that there were any circumstances which might have made an enforcible obligation of Rippel's promise. Under such circumstances the profits, when realized, were his to do with as he pleased and he was not bound to give them to the four individuals in accordance with his unilateral promise. Therefore, despite his statement to these four persons his profits from the sale of the 250 shares of stock should not be reduced by the difference between $300 and $250 a share. , and cases there cited.
Since he was under no obligation to pay these individuals a total of $12,500 on account of the*3546 sale of these shares of stock, his action in transferring 48 shares of stock to them was, in effect, a gift of these shares, except as affected by the cash which changed hands at the same time. We have heretofore pointed out that we are unable to determine how the Commissioner has treated this transaction. The petitioner wants to concede that the transfer of the 48 shares resulted in a profit of at least $3,432 to Rippel, which has never been charged against him by the Commissioner. No such profit resulted. We will not disturb the determination of the Commissioner in regard to this entire transaction.
At the time J. S. Rippel bought the Fidelity Union Trust Co. stock from the Prudential Insurance Co. of America, the 4 per cent dividend in question had not been declared. The trust company was under no obligation to the petitioner to declare and pay such a dividend. We are not certain as to the method used by Rippel in reporting his income and in keeping his books, but so far as we can judge from the record, he kept his books and reported his income on the cash receipts and disbursements basis. We therefore see no reason why the $42,000 received by him as a dividend from the*3547 Fidelity Union Trust Co. was other than an ordinary dividend subject *447 to surtax when received by him. The situation is quite different from that where a taxpayer on an accrual basis accrues interest, the difference being that there is an obligation to pay interest and none to pay a dividend until it is declared and the one taxpayer accrues certain items, the other does not.
The petitioner, J. S. Rippel, claims that under section 214(a)(1) of the Revenue Act of 1921 he is entitled to deduct the premiums which he paid on certain life insurance policies insuring his own life, where his estate is the beneficiary. He testified that his sole purpose in taking out these policies of insurance was to give additional security to a bank from which he had bought a piece of property and to which he had given a relatively large purchase-money mortgage. We agree with the views of the Circuit Court of Appeals for the Third Circuit and the District Court for the Western District of Pennsylvania, that section 215(a)(4) of the Revenue Act of 1921 inhibits such a deduction. *3548 ; affirming , promulgated February 23, 1928; .
There remains for our consideration one alleged error raised by all three petitions, it being the only error alleged by the Adams and Mueller petitions which this Board is now urged to consider. This is the refusal of the Commissioner to permit the partnership firm of J. S. Rippel & Co., of which all three of the petitioners were members, to set aside from its profits a reserve to provide for losses or market reduction in the value of state, county, and municipal bonds. Counsel for the petitioner practically concedes that under the Revenue Act of 1921, additions to such a reserve are not authorized deductions from income. No satisfactory explanation of the purpose of this reserve has been given. In his opening statement counsel stated that the reserve was "to protect the firm against an unexpected break in the municipal security market, which would immediately occur if, for instance, the Federal income tax would be declared unconstitutional, or a drastic tax rate reduction took place in the higher surtax brackets*3549 during the time that the taxpayer was obligated to take up these particular securities under the conditions under which it made purchase or transacted its business."
No provisions of the Revenue Acts of 1918 or 1921, have been called to our attention, and we know of no provisions of these acts, which permit the deduction of additions to a so-called reserve of the character involved in this proceeding, as is contended for by this petitioner. Therefore, the Commissioner properly refused to permit the deduction of the amounts in question.
Judgment will be entered for the respondent.