Kenan v. Commissioner of Internal Revenue
114 F.2d 217, 25 A.F.T.R. (P-H) 607, 1940 U.S. App. LEXIS 3097 (1940)
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Rule of Law:
The satisfaction of a pecuniary bequest (a fixed-dollar amount) with appreciated property constitutes a 'sale or other disposition' of that property, triggering the realization of a taxable capital gain for the distributing trust or estate.
Facts:
- Mrs. Bingham's will created a trust from her residuary estate.
- The will directed the trustees to pay her niece, Louise Clisby Wise, the sum of $5,000,000 when she reached the age of forty.
- The will granted the trustees the discretion to make this payment either in cash or in marketable securities of a value equal to the sum to be paid.
- Louise Clisby Wise turned forty on July 28, 1935.
- The trustees elected to satisfy the $5,000,000 obligation by distributing a combination of cash and securities.
- The securities distributed to the niece had appreciated in value during the time they were held by the trust.
Procedural Posture:
- The Commissioner of Internal Revenue determined a tax deficiency of $367,687.12 in the trust's 1935 income tax.
- The trustees (taxpayers) petitioned the Board of Tax Appeals (an administrative court, now the U.S. Tax Court) to contest the deficiency.
- The Commissioner moved to amend his answer before the Board to claim a much larger deficiency, arguing the gain was ordinary income rather than capital gain.
- The Board of Tax Appeals upheld the Commissioner's original deficiency determination but denied the Commissioner's motion to amend.
- The trustees, as petitioners, appealed the Board's decision to the United States Court of Appeals for the Second Circuit.
- The Commissioner, as a cross-petitioner, also appealed, challenging the Board's refusal to treat the gain as ordinary income.
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Issue:
Does a trust's distribution of appreciated securities to satisfy a pecuniary bequest for a fixed dollar amount constitute a 'sale or other disposition' of those securities, thereby creating a taxable gain for the trust?
Opinions:
Majority - Augustus N. Hand
Yes, a trust's distribution of appreciated securities to satisfy a pecuniary bequest is a 'sale or other disposition' that generates a taxable gain. The legatee, Louise Clisby Wise, did not have a right to any specific securities but rather a claim against the trust for a fixed sum of $5,000,000. Her right was to an unvarying amount of money or its equivalent, insulating her from the risk of the securities' value fluctuating. When the trustees used appreciated property to discharge this fixed monetary obligation, the trust realized the gain in the securities' value. This transaction is economically equivalent to the trust selling the securities on the open market and then using the cash proceeds to pay the legatee. The court found this situation analogous to its precedent in Suisman v. Eaton, reasoning that the discharge of the trust's monetary obligation served as the 'amount realized' in the exchange. Therefore, the difference between the trust's basis in the securities and their fair market value at the time of distribution is a realized capital gain, taxable to the trust.
Analysis:
This decision establishes a foundational principle in trust and estate taxation, clarifying that satisfying a pecuniary (fixed-dollar) bequest with appreciated property is a taxable realization event for the fiduciary. It draws a critical distinction between a bequest of a specific dollar amount and a bequest of specific property or a fractional share of a residue, the latter of which would not trigger a gain upon distribution. This ruling compels trustees and executors to consider the tax basis of assets when making in-kind distributions to satisfy monetary obligations, as their choices can have significant income tax consequences for the trust or estate. The case remains a cornerstone for understanding the tax implications of fiduciary distributions.
