The opinion of the court was delivered by: CONNER
The above-captioned action for refund of federal income taxes, brought pursuant to 26 U.S.C. § 7422, has been the subject of two prior Memoranda and Orders of this Court, the first dated March 31, 1975, the second dated February 3, 1976. In its first decision, the Court denied the parties' cross-motions for summary judgment; in its second decision, the Court once again denied an application by plaintiff for entry of judgment in her favor, pending the parties' submissions with respect to a potentially critical question of law that had been newly raised by defendant. This most recent chapter in an unhappily protracted litigation follows the Court's review of those submissions.
A full exposition of the events at the base of plaintiff's summary judgment motion appears in the March 31, 1975 Memorandum and need not be recited anew. The factual setting of this case will be retraced only to the extent necessary to the discussion of legal issues that follows.
From the latter part of 1965 through 1967, plaintiff received a series of payments pursuant to her late husband's Last Will and Testament, which bequeathed to her, inter alia, a life interest in a portion of the net income generated by the residue of Mr. Lemle's estate. The checks representing those payments had been uniformly legended by the executors as "income distribution[s]," a characterization vigorously protested by plaintiff's attorney. Indeed, at the outset, the latter had advised the estate's representatives that his client's retention of the checks was, at least in his own view, without prejudice "to Mrs. Lemle's rights as a surviving spouse" and that those checks constituted
"payment * * * on account of the monies [Mrs. Lemle] will ultimately be entitled to receive out of the estate, whether by way of principal or income."
In February 1966, plaintiff filed a notice of election against the will, under then-effective Section 18-d of the New York Decedent Estate Law.
Maintaining that the terms of an antenuptial agreement disabled plaintiff from exercising her elective right, the executors refused to recognize plaintiff's statutory claim. Thus, the estate's federal tax returns reported the 1965, 1966, and 1967 payments to plaintiff as distributions from income to a will beneficiary, i.e., distributions deductible from the estate's taxable income under 26 U.S.C. § 661.
Plaintiff, for her part, treated the payments received by her during those years as distributions drawn from estate principal and thus excludible from gross income under 26 U.S.C. § 102(a).
The contest between plaintiff and the executors, culminating in a New York County Surrogate's Court proceeding, was ultimately resolved by the issuance of a consent decree in April 1971. The latter acknowledged plaintiff's right to a surviving spouse's elective share and provided for an adjustment of plaintiff's consequent claim against Mr. Lemle's estate. As this Court earlier noted, the 1971 settlement -- referenced in the Surrogate's confirming decree -- determined that payments to plaintiff, in satisfaction of her elective share, were to "consist of principal from the Estate" and further provided that "prior distributions would be considered as part payment of the total principal due" plaintiff. Lemle v. United States, 75-1 U.S. Tax Cas. (CCH) P9355, 35 A.F.T.R.2d (P-H) 1379, Docket No. 74 Civ. 77 at 4 (S.D.N.Y. March 31, 1975).
Prior to consummation of the above-outlined compromise agreement, the Internal Revenue Service had assessed deficiencies with respect to plaintiff's income tax returns for the years 1965, 1966, and 1967, those assessments representing the difference between Mrs. Lemle's tax liabilities as reported and her tax liabilities computed on the premise that her receipts from the executors had constituted income distributions. Plaintiff paid the Internal Revenue Service the amounts assessed and, at the same time, filed claims for refunds of those amounts. The refund claims, as well as the present action which followed their disallowance by the Service, were bottomed upon Mrs. Lemle's contention that the 1965, 1966, and 1967 payments had been distributed from estate corpus and thus were not properly included in her gross income.
In its decision of March 31, 1975, this Court concluded -- for reasons discussed at length in the Memorandum -- that the monies presently at issue had "constituted principal, not income," 74 Civ. 77 at 10, their character thus settled by the 1971 decree's vindication of plaintiff's claim as a surviving spouse. Plaintiff's motion was nonetheless denied in the light of defendant's contention that the 1971 settlement had been the product of collusion, a contention that raised material questions of fact foreclosing the entry of summary judgment. The Government thereafter conceded that it could supply no proof to support its allegation of collusion. Nevertheless, defendant urged the Court not to sign the proposed judgment order submitted by plaintiff in response to the Government's concession. In so doing, the Government has invited this Court to traverse a legal ground apparently discovered by defendant only after the Court's disposition of the parties' original cross-motions.
The Government's present position is founded upon the operation of Sections 102 and 662 of the Internal Revenue Code. According to the Government, a review of those sections and the regulations thereunder belies what earlier had been assumed by both the parties and the Court -- i.e., that plaintiff would have been entitled to exclude from her gross income all distributions from Mr. Lemle's estate if those distributions had been from corpus. Thus, defendant argues, principal distributions from an estate may be includible in gross income, within the meaning of Section 102(b) of the Internal Revenue Code, under circumstances described in Section 662(a).
Section 102(b)(2) prescribes that, "where [a] gift, bequest, devise, or inheritance is of income from property, the amount of such income" may not be excluded from gross income. The section further provides that "any amount included in the gross income of a beneficiary under subchapter J shall be treated for purposes of ...