The opinion of the court was delivered by: KNIGHT
Aaron F. Williams, the original plaintiff, filed his 1940 U.S. Individual Income and Defense Tax Return showing a net income of $ 9,796.92 and paid a tax of $ 619.10. The Commissioner then found that the net income was $ 22,331.28 and the correct income tax liability was $ 3,734.40. Crediting the $ 619.10 already paid, left a deficiency of $ 3,115.30, which this plaintiff paid to defendant on December 7, 1942, with $ 322.95 interest.
Plaintiff then sued defendant to collect $ 3,107.76 plus $ 322.17 -- total $ 3,429.93 -- which he claimed was wrongfully and improperly exacted and collected.
In his return, plaintiff had deducted $ 17,287.99 determined by him to be the net loss sustained from the sale of the A. F. Williams Hardware business on September 17, 1940, and $ 700 attorney fees paid in 1940 for obtaining a refund for losses sustained in 1936 on certain gas rights and lease holdings. The Commissioner disallowed both deductions.
This court dismissed the complaint, holding that the property sold by plaintiff was capital assets under the Internal Revenue Code and that he was not entitled to deduct the attorney fees. D.C., 58 F.Supp. 692. The Circuit Court by a divided Court reversed the judgment in both respects. 2 Cir., 152 F.2d 570. It allowed the $ 700 attorney fees (152 F.2d at page 571) and then said:
'Upon this sale Williams suffered a loss upon his original two-thirds of the business, but he made a small gain upon the one-third which he had bought from Reynolds' executrix; and in his income tax return he entered both as items of 'ordinary income,' and not as transactions in 'capital assets.' This the Commissioner disallowed and recomputed the tax accordingly; Williams paid the deficiency and sued to recover it in this action. The only question is whether the business was 'capital assets' under Sec. 117(a)(1) of the Internal Revenue Code, 26 U.S.C.A. Int.Rev.Code, § 117(a)(1). * * *
'Congress plainly did mean to comminute the elements of a business; plainly it did not regard the whole as 'capital assets.' * * * There can of course be no gain or loss in the transfer of cash; and, although Williams does appear to have made a gain of $ 1072.71 upon the 'receivables,' the point has not been argued that they are not subject to a depreciation allowance. That we leave open for decision by the district court, if the parties cannot agree. The gain or loss upon every other item should be computed as an item in ordinary income.'
The original plaintiff died and his two executors were substituted. They now claim, under the Circuit Court Decision, the same amount the original plaintiff claimed, to wit, a refund of $ 3,429.93, with interest from December 7, 1942. Defendant's answer contains this proposed conclusion of law: '5. Judgment may be entered for the plaintiff against the defendant for $ 2,294.76 with interest from December 7, 1942, and costs.'
Plaintiff's base their claim on the following computation:
Net income per Notice of Deficiency $ 22,331.28
Less: Additional loss on sale to
be reflected $ 11,734.37
Attorneys' fees allowed 700.00 12,434.37
*2 *Net taxable income $ 9,896.91
Less personal exemption 800.00
Surtax net income $ 9,096.91
Less Earned Income Credit:
Salaries $ 7,839.33
Period ending 1/31/40 $ 4,678.09
Partnership 2/1/40 to
20% of $ 6,423.73 1,284.75
10% of 9,124.08 912.41
Normal Tax Income $ 8,184.50
Normal Tax-4% of $ 8,184.50 $ 327.38
Surtax on $ 9,096.91 at 1940 Rates
$ 4,000.00 @ 0% $ 00.00
2,000.00 @ 4% 80.00
2,000.00 @ 6% 120.00
1,096.91 @ 8% 87.75
$ 9,096.91 $ 287.75 287.75
Defense Tax (10% of $ 615.13) 61.51
Less: Income Tax Paid Foreign Countries 50.00
Total Tax Liability $ 626.64
Original Assessment $ 619.10
Additional Assessment 3,115.30 3,734.40
Overasse ssment $ 3,107.76
Interest liability $ .78
Interest assessed 322.95 322.17
Total Overassessment of Tax and Interest $ 3,429.93
Defendant's recomputation shows a 'total over-assessment of tax and interest' in the sum of $ 2,159.64. This recomputation is calculated as follows:
Net income -- statutory notice of
deficiency $ 22,331.28
Deduct: Additional loss on sale
of business -- as determined by
counsel $ 17,287.99
Less: Amount allowed in notice
of deficiency 11,888.84
Net $ 5,399.15
Attorney's fees 700.00 6,099.15
Net $ 16,232.13
Add: Short term gain realized on accounts
receivable not previously included in
Net income adjusted $ 16,589.70
Less: Personal exemption 800.00
Income subject to surtax $ 15,789.70
Less: Earned income credit 960.75
Income subject to normal tax $ 14,828.95
Normal tax at 4% on $ 14,828.95 $ 593.16
Surtax on $ 15,789.00 1,068.30
Total tax $ 1,661.46
Less: Income paid to a foreign country 50.00
Partial tax $ 1,611.46
Plus: Defense tax (10% of $ 1,661.46) 166.15
Total tax liability $ 1,777.61
Tax previously assessed:
Original $ 619.10
Additional 3,115.30 3,734.40
Overassessment $ 1,956.79
Interest liability $ 120.10
Interest assessed 322.95 202.85
Total overassessment of tax and interest $ 2,159.64
Both computations start with $ 22,331.28 and then make certain deductions. Both agree in deducting $ 700 for attorney fees allowed by the Circuit Court. 2 Cir., 152 F.2d 570, 571. They differ on the item of additional loss. Plaintiffs claim $ 11,734, while defendant allows only $ 5,399.15.
Plaintiffs arrive at the $ 11,734.37 item by the following computation:
Loss $ 23,777.69
50% allowed as a capital loss 11,888.84
Less short term capital loss
shown on original return 154.48
Additional loss $ 11,734.37
Defendant arrives at the $ 5,399.15 item by the following computation:
Additional loss on sale of business
as determined by counsel $ 17,287.99
Less amount allowed in notice
of deficiency 11,888.84
Net $ 5,399.15
This court found: '16. The taxpayer sustained a net loss of $ 23,777.69 on the sale of his original two-thirds interest in the A. F. Williams Hardware business.' Plaintiffs argue that this finding must stand because it was not reversed by the Circuit Court. They say: 'The Circuit Court did not reverse the Findings of the District Court as to the amount of the entire loss sustained by the sale. It merely reversed the conclusions of law which treated the results of this sale as a loss or gain on the sale of capital assets.'
Defendant urges that said loss was computed for February 1, 1940, whereas September 28, 1940, is the controlling date. He says: 'At the first trial the defendant objected to the consideration of what was transferred on September 28, 1940, on the ground that February 1 was the controlling date, and therefore what was transferred on September 28 was immaterial. However, under the mandate, September 28, 1940, is the controlling date and therefore the gain or loss must be determined by what was transferred on that date.'
Defendant says: 'Under the stipulation of facts * * * the taxpayer sold the inventory at an estimated liquidation value, which was 40% less than the cost of the inventory. Therefore, the loss sustained on the inventory transferred on September 28, 1940, was $ 65,103.93, and the loss sustained was $ 65,103.93 minus $ 39,062.36 or $ 26,041.57, on the entire inventory. But the taxpayer made a gain on the purchase and sale of Reynolds' one-third interest. His loss, therefore, was only on a two-thirds interest, or 2/3 of $ 26,041.57, which resulted in a loss on the inventory of $ 17,361.05.'
Defendant's recomputation fixed this loss at $ 17,003.48.
The original plaintiff Williams computed and entered it as $ 17,287.99.
The Circuit Court gave no specific 'mandate.' After mentioning a gain of $ 1072.71, it said: 'The gain or loss upon every other item should be computed as an item in ordinary income.' 152 F.2d at page 573. The court said that Williams entered his loss upon the sale of two-thirds of his business and his gain upon the purchase of one-third of the ...