The opinion of the court was delivered by: LEIBELL
This is an action under the Internal Revenue Laws of the United States, 26 U.S.C.A. § 1 et seq., to recover income taxes paid by the estate of Edward J. Cornish, deceased. The case was submitted to the Court upon a stipulation of facts and certain exhibits therein referred to.
It appears from the stipulation that Edward J. Cornish died a resident of Putnam County, State of New York on May 3, 1938 leaving a last will and testament dated August 11, 1937, naming the plaintiffs herein as executors. The will was admitted to probate June 13, 1938. It devised his entire residuary estate to his wife, Selina C. Cornish, who survived him by about two weeks and died on May 18. 1938. His will was silent as to the disposition of any income earned or realized by his estate during the period of administration. The executors of the estate of Edward J. Cornish adopted an accounting period in the administration of the estate based upon a fiscal year commencing on May 3, 1938 and ending on April 30, 1939. During the fiscal year the executors, by a sale of certain of the assets of the estate, realized a net short-term gain in the sum of $ 504,378.95.
The executors maintained a separate bank account which was designated 'Cash Income Principal Account No. 2' in which they deposited the capital gains realized upon the sale of assets of the estate during the period from May 3, 1938 to April 30, 1939. On March 29, 1939, they paid to the estate of Selina C. Cornish, as residuary legatee of the will of Edward J. Cornish, the sum of $ 483,126.51 out of the aforementioned capital gain that had been deposited in said account. With this payment they sent a letter to the executors of the Selina C. Cornish estate in which they stated that seven months having elapsed since their appointment, Sec. 218 of the New York Surrogate's Court Act,
they were making distributions of income, capital gains, and on account of principal, to the residuary legatee. The second paragraph of the letter refers to a payment of $ 43,728.67 'cash income' from Account No. 2. The next paragraph deals with the above mentioned capital gain distribution as follows: 'In the administration of Mr. Cornish's estate since our appointment, we as executors have realized capital gains in the amount of $ 531,307.21 resulting from sales of assets and have incurred capital losses of $ 26,928.26 from sale of assets. The resulting net capital gain, therefore, amounts to $ 504,378.95. These capital gains have been segregated as realized and kept in an estate bank account designated Account No. 2. The commissions to which we as executors will be entitled upon the aforementioned gross capital gains amount to the sum of $ 21,252.44 and we are reserving in the Account No. 2 that amount. The net capital gains over and above said commissions and amounting to the sum of $ 483,126.51 we are hereby remitting to you as executors of the last will and testament of Selina C. Cornish, deceased, by our check drawn upon said estate Account No. 2.'
The fourth paragraph of the letter states: 'On account of distribution of the principal of Mr. Cornish's estate, we send you herewith our check as executors in the amount of $ 125,000.00 drawn upon the estate's account No. 1, constituting principal as distinguished from income and capital gains of the estate.'
The executors of the Edward J. Cornish estate filed in the Surrogate's Court, Putnam County, New York, in October 1940 an account of their proceedings in the estate from May 3, 1938 to September 30, 1940. In the summary statement thereof the capital gain of $ 504,378.95 is included in a figure of $ 532,523.83 which is stated to be 'Increase of Principal from sale or collection of assets, as shown in Schedule E', which is entitled, 'A Full and True Statement of all Principal Assets of the Estate Sold or Collected Resulting in Increases of Principal or on which There were Neither Increases or Decreases'.
The summary statement also lists under the heading of 'Principal Account' a credit of $ 2,995,944.45 opposite the statement 'Amount of Payments and Distributions to Estate of Selina C. Cornish, as shown in Schedule 'G'. Schedule G is entitled, 'A Full and True Statement of All Payments and Distributions of Principal Made to the Executors of the Estate of Selina C. Cornish' and lists the $ 483,126.51 in issue as a 'Distribution of net capital gains in cash'.
The account filed by the executors also contains separate heading and schedules with respect to 'Income'. The capital gain distribution is not included in any part of the account devoted to 'Income'.
The executors' account was judicially settled and allowed on November 4, 1940, upon a waiver of citation, receipt and release, and consent of all parties. The decree on the accounting included the same provisions, figures and headings set forth above which, appear in the executors' summary statement of account.
On April 24, 1939, prior to filing an income tax return for the estate of Edward J. Cornish for the fiscal year ending April 30, 1939, Charles Simon, one of the executors, requested a ruling from the Commissioner of Internal Revenue as to whether any part of the capital gain of $ 504,378.94 paid to the estate of Selina C. Cornish ($ 483,126.51) or to other persons entitled thereto, constituted income taxable to the estate of Selina C. Cornish. (Ex. P) By a letter dated June 9, 1939 (Ex. Q) the office of the Commissioner of Internal Revenue ruled that the capital gains realized by the estate of Edward J. Cornish from the sale of assets were taxable to that estate and no deduction for the distributions thus made was allowable under Section 162 of the Act, 26 U.S.C.A. 162.
The executors of the estate of Edward J. Cornish thereupon filed a Federal fiduciary income tax return for the fiscal year May 3, 1938 to April 30, 1939. The return included, pursuant to the ruling of the Commissioner, the capital gain of $ 504,378.95 without any deduction of the $ 483,126.51 paid to the estate of Selina C. Cornish. A tax of $ 308,591.34 was paid under protest. The Commissioner assessed a deficiency of $ 8,475.11 plus interest of $ 345.96, which was also paid under protest. A claim for refund was filed February 7, 1941 for the tax, $ 316,583.95 and interest, $ 345.96, within three years of the time the return was filed and within two years of the time the total amount of the tax was paid. A refund of $ 1,651.29 tax and $ 67.41 interest was made June 9, 1944, pursuant to a certificate of overassessment. But the claim for refund was disallowed July 6, 1944, to the sum of $ 315,211.21, made up of a tax of $ 314,932.66 and interest in the amount of $ 278.55.
On December 19, 1945 the plaintiffs, as executors of the will of Edward J. Cornish filed a complaint in this court to recover the said sum of $ 315,211.21 and interest. They contend that the capital gain of $ 504,378.95 realized in the fiscal year ending April 30, 1939 was income to the estate of Edward J. Cornish, and that the payment of the sum of $ 483,126.51 to the executors of the residuary legatee, Selina C. Cornish, was deductible in computing the taxable income of the estate of Edward J. Cornish, and was taxable to the estate of the said residuary legatee under Section 162(c) of the Revenue Act of 1938.
The defendant answers that the payment of the sum of $ 483,126.51 to the estate of the residuary legatee, Selina C. Cornish, out of the capital gains realized, constituted a payment of principal or corpus to the legatee rather than income, that it could not be 'properly paid' as income under the law of New York, and that it therefore was not deductible under Section 162(c) of the United States Revenue Act of 1938 (26 U.S.C.A. 162(c)) in calculating the Federal income tax on the estate of Edward J. Cornish.
Section 162(c) provides: '(c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.'
Section 162(c) of the Act permits the deduction, if the capital gains were 'properly paid' to the residuary legatee. The New York Tax Law, McKinney's Consol. Laws, c. 60, in effect at the time, although it contains in Section 365(3) a provision very similar to Section 162(c) of the Federal Internal Revenue Act, nevertheless in Section 365(7) specifically provides that 'the tax on income arising from net capital gain realized by an estate or trust shall be imposed upon the estate or trust whether or not distributable to beneficiaries, or paid or credited to any legatee, heir or beneficiary' and that the 'Income of an estate or trust with respect to which the tax is imposed upon the estate or trust shall not be included in the gross income of a beneficiary when distributed.'
If the issue here involved only the conflict between the State and Federal tax laws as to the incidence of the tax, the Federal law would of course be controlling. But there is a holding by the Appellate Division, Third Department Bank of Richmondville v. Graves, 259 App.Div. 4, 18 N.Y.S.2d 133, 138, (affirmed (4 to 3) by the New York Court of Appeals, 284 N.Y. 671, 30 N.E.2d 720, without opinion) that 'capital gain received by an estate becomes a payment of corpus, rather than of income, when distributed to a residuary legatee' and that 'the amount distributed * * * could not have been properly paid as income; on the contrary, it was rather the payment of a legacy or bequest, exempt from tax by section 359, subdivision (2)'.
In Lyeth v. Hoey, 1938, 305 U.S. 188, 59 S. Ct. 155, 158, 83 L. Ed. 119, 119 A.L.R. 410, when the United States Supreme Court considered the question of what was an 'inheritance' within the terms of the Revenue Act, the court held, Chief Justice Hughes writing the opinion:
'In the instant case, the Court of Appeals applied the Massachusetts rule, holding that whether the property was received by way of inheritance depended 'upon the law of the jurisdiction under which this taxpayer received it'. We think that this ruling was erroneous. The question as to the construction of the exemption in the federal statute is not determined by local law. * * * the question whether what the heir has thus received had been 'acquired by inheritance' ...