U.S. Supreme Court Commissioner v. P. G. Lake, Inc., 356
U.S. 260 (1958) Commissioner of Internal Revenue v.
P. G. Lake, Inc. No. 108 Argued March 11, 1958 Decided April 14,
1958 356
U.S. 260 CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE FIFTH
CIRCUIT Syllabus 1. In each of the five cases here considered together, the
taxpayer received present consideration for assignment of a
so-called oil payment right (or sulphur payment right) carved out
by the taxpayer from a larger mineral interest producing income
taxable as ordinary income, subject to a depletion deduction. Held: the consideration received for the assignment was
taxable as ordinary income, subject to a depletion deduction, and
not as a long-term capital gain under § 117 of the Internal Revenue
Code of 1939. Pp. 356 U. S.
261 -267.

															(a) The present consideration received by the taxpayer was paid
for the right to receive future income, not for an increase in the
value of the income-producing property. Pp. 356 U. S.
264 -267.

															(b) An earlier administrative practice (reversed in 1946)
contrary to this holding will not be presumed to have been known to
Congress and incorporated into the law by reenactment, because it
was not reflected in any published ruling or regulation. P. 265, n 5.

															(c) Moreover, prior administrative practice is always subject to
change through exercise by the administrative agency of its
continuing rulemaking power. P. 356 U. S. 265 ,
n. 5.

															2. In the Fleming case, the taxpayers exchanged oil
payment rights for fee simple interests in real estate. Held: this did not constitute a tax-free exchange of
property of like kind within the meaning of § 112(b)(1) of the
Internal Revenue Code of 1939. Pp. 356 U. S.
267 -268.

															241 F.2d 65, 69, 71, 78, 84, reversed. Page 356 U. S. 261 MR. JUSTICE DOUGLAS delivered the opinion of the Court.

															We have here, consolidated for argument, five cases involving an
identical question of law. Four are from the Tax Court, whose
rulings may be found in 24 T.C. 1016 (the Lake case); 24
T.C. 818 (the Fleming case); 24 T.C. 1025 (the Weed case). (Its findings and opinion in the Wrather case
are not officially reported.) Those four cases involved income tax
deficiencies. The fifth, the O'Connor case, is a suit for
a refund originating in the District Court. 143 F. Supp. 240. All
five are from the same Court of Appeals, 241 F.2d 71, 65, 78, 84,
69. The cases are here on writs of certiorari which we granted
because of the public importance of the question presented. 353
U.S. 982.

															The facts of the Lake case are closely similar to those
in the Wrather and O'Connor cases. Lake is a
corporation engaged in the business of producing oil and gas. It
has a seven-eighths working interest [ Footnote 1 ] in two commercial oil Page 356 U. S. 262 and gas leases. In 1950, it was indebted to its president in the
sum of $600,000, and, in consideration of his cancellation of the
debt, assigned him an oil payment right in the amount of $600,000,
plus an amount equal to interest at 3 percent a year on the unpaid
balance remaining from month to month, payable out of 25 percent of
the oil attributable to the taxpayer's working interest in the two
leases. At the time of the assignment, it could have been estimated
with reasonable accuracy that the assigned oil payment right would
pay out in three or more years. It did in fact pay out in a little
over three years.

															In its 1950 tax return, Lake reported the oil payment assignment
as a sale of property producing a profit of $600,000 and taxable as
a long-term capital gain under § 117 of the Internal Revenue Code
of 1939. The Commissioner determined a deficiency, ruling that the
purchase price (less deductions not material here) was taxable as
ordinary income, subject to depletion. The Wrather case
has some variations in its facts. In the O'Connor case,
the assignors of the oil payments owned royalty interests,
[ Footnote 2 ] rather than
working interests. But these differences are not material to the
question we have for decision.

															The Weed case is different only because it involves
sulphur rights, rather than oil rights. The taxpayer was the owner
of a pooled overriding royalty in a deposit known and Boling Dome.
[ Footnote 3 ] The royalty
interest entitled Page 356 U. S. 263 the taxpayer to receive $0.00966133 per long ton of sulphur
produced from Boling Dome, irrespective of the market price.
Royalty payments were made each month, based on the previous
month's production.

															In 1947, the taxpayer, in order to obtain a sure source of funds
to pay his individual income taxes, agreed with one Munro, his tax
advisor, on a sulphur payment assignment. The taxpayer assigned to
Munro a sulphur payment totaling $50,000 and consisting of
86.254514 percent of his pooled royalty interest, which represented
the royalty interest on 6,000,000 long tons of the estimated
remaining 21,000,000 long tons still in place. The purchase price
was paid in three installments over a three-year period. Most of
the purchase price was borrowed by Munro from a bank with the
sulphur payment assignment as security. The assigned sulphur
payment right paid out within 28 months. The amounts received by
the taxpayer in 1948 and 1949 were returned by him as capital
gains. The Commissioner determined that these amounts were taxable
as ordinary income, subject to depletion.

															The Fleming case is a bit more complicated, and
presents an additional question not in the other cases. Here, oil
payment assignments were made, not for cash, but for real estate.
Two transactions are involved. Fleming and others with whom he was
associated made oil payment assignments, the rights and interests
involved being held by them for productive use in their respective
businesses of producing oil. Each oil payment was assigned for an
interest in a ranch. Each was in an amount which represented the
uncontested fair value of the undivided interest in the ranch
received by the assignor, plus an amount equal to the interest per
annum on the balance remaining unpaid from time to time. The other
transaction consisted of an oil payment assignment by an owner of
oil and gas leases, held for productive use in the assignor's
business, for the fee simple title to business Page 356 U. S. 264 real estate. This oil payment assignment, like the ones
mentioned above, was in the amount of the uncontested fair market
value of the real estate received, plus interest on the unpaid
balance remaining from time to time. First, as to whether the proceeds were taxable as
long-term capital gains under § 117 [ Footnote 4 ] or as ordinary income subject to depletion.
The Court of Appeals started from the premise, laid down in Texas
decisions, see especially Tennant v. Dunn, 130 Tex. 285,
110 S.W.2d 53, that oil payments are interests in land. We too
proceed on that basis; and yet we conclude that the consideration
received for these oil payment rights (and the sulphur payment
right) was taxable as ordinary income, subject to depletion. Page 356 U. S. 265 The purpose of § 117 was

															"to relieve the taxpayer from . . . excessive tax burdens on
gains resulting from a conversion of capital investments, and to
remove the deterrent effect of those burdens on such
conversions." See Burnet v. Harmel, 287 U. S. 103 , 287 U. S. 106 .
And this exception has always been narrowly construed so as to
protect the revenue against artful devices. See Corn Products
Refining Co. v. Commissioner, 350 U. S.
46 , 350 U. S.
52 .

															We do not see here any conversion of a capital investment. The
lump sum consideration seems essentially a substitute for what
would otherwise be received at a future time as ordinary income.
The pay-out of these particular assigned oil payment rights could
be ascertained with considerable accuracy. Such are the
stipulations, findings, or clear inferences. In the O'Connor case, the pay-out of the assigned oil payment
right was so assured that the purchaser obtained a $9,990,350
purchase money loan at 3 1/2 percent interest without any security
other than a deed of trust of the $10,000,000 oil payment right, he
receiving 4 percent from the taxpayer. Only a fraction of the oil
or sulphur rights were transferred, the balance being retained.
[ Footnote 5 ] Except in the Fleming Page 356 U. S. 266 case, which we will discuss later, cash was received which was
equal to the amount of the income to accrue during the term of the
assignment, the assignee being compensated by interest on his
advance. The substance of what was assigned was the right to
receive future income. The substance of what was received was the
present value of income which the recipient would otherwise obtain
in the future. In short, consideration was paid for the right to
receive future income, not for an increase in the value of the
income-producing property.

															These arrangements seem to us transparent devices. Their forms
do not control. Their essence is determined Page 356 U. S. 267 not by subtleties of draftsmanship, but by their total effect. See Helvering v. Clifford, 309 U.
S. 331 ; Harrison v. Schaffner, 312 U.
S. 579 . We have held that if one, entitled to receive at
a future date interest on a bond or compensation for services,
makes a grant of it by anticipatory assignment, he realizes taxable
income as if he had collected the interest or received the salary
and then paid it over. That is the teaching of Helvering v.
Horst, 311 U. S. 112 , and Harrison v. Schaffner, supra; and it is applicable here.
As we stated in Helvering v. Horst, supra, at 311 U. S.
117 ,

															"The taxpayer has equally enjoyed the fruits of his labor or
investment and obtained the satisfaction of his desires whether he
collects and uses the income to procure those satisfactions, or
whether he disposes of his right to collect it as the means of
procuring them."

															There, the taxpayer detached interest coupons from negotiable
bonds and presented them as a gift to his son. The interest when
paid was held taxable to the father. Here, even more clearly than
there, the taxpayer is converting future income into present
income. Second, as to the Fleming case. The Court of
Appeals in the Fleming case held that the transactions
were tax-free under §112(b)(1), which provides:

															"No gain or loss shall be recognized if property held for
productive use in trade or business or for investment (not
including stock in trade or other property held primarily for sale,
nor stocks, bonds, notes, choses in action, certificates of trust
or beneficial interest, or other securities or evidences of
indebtedness or interest) is exchanged solely for property of a
like kind to be held either for productive use in trade or business
or for investment."

															53 Stat. 37.

															In the alternative and as a second ground, it held that this
case, too, was governed by § 117. Page 356 U. S. 268 We agree with the Tax Court, 24 T.C. 818, that this is not a
tax-free exchange under § 112(b)(1). Treasury Regulations 111,
promulgated under the 1939 Act, provide in § 39.112(b)(1)-1 as
respects the words "like kind," as used in § 112(b)(1), that "One
kind or class of property may not . . . be exchanged for property
of a different kind or class." The exchange cannot satisfy that
test where the effect under the tax laws is a transfer of future
income from oil leases for real estate. As we have seen, these oil
payment assignments were merely arrangements for delayed cash
payment of the purchase price of real estate, plus interest.
Moreover, § 39.112(a)-1 states that the

															"underlying assumption of these exceptions is that the new
property is substantially a continuation of the old investment
still unliquidated."

															Yet the oil payment assignments were not conversions of capital
investments, as we have seen. Reversed. [ Footnote 1 ]

															An oil and gas lease ordinarily conveys the entire mineral
interest less any royalty interest retained by the lessor. The
owner of the lease is said to own the "working interest," because
he has the right to develop and produce the minerals.

															In Anderson v. Helvering, 310 U.
S. 404 , we described an oil payment as

															"the right to a specified sum of money, payable out of a
specified percentage of the oil, or the proceeds received from the
sale of such oil, if, as and when produced." Id. at 310 U. S. 410 .
A royalty interest is "a right to receive a specified percentage of
all oil and gas produced" but, unlike the oil payment, is not
limited to a specified sum of money. The royalty interest lasts
during the entire term of the lease. Id. at 310 U. S.
409 .

															[ Footnote 2 ] See note 1 supra. [ Footnote 3 ]

															Boling Dome is a tract composed of various parcels of land. The
owners of the royalty interests in sulphur produced from the
separate parcels entered into a pooling agreement by which
royalties from sulphur produced anywhere in Boling Dome were
distributed pro rata among all the royalty interest holders. In
that sense was the interest of each "pooled."

															[ Footnote 4 ]

															Section 117(a)(1) provides in relevant part:

															"The term 'capital assets' means property held by the taxpayer
(whether or not connected with his trade or business), but does not
include stock in trade of the taxpayer or other property of a kind
which would properly be included in the inventory of the taxpayer
if on hand at the close of the taxable year, or property held by
the taxpayer primarily for sale to customers in the ordinary course
of his trade or business, or property, used in the trade or
business, of a character which is subject to the allowance for
depreciation provided in section 23(l), or real property used in
the trade or business of the taxpayer."

															53 Stat. 50, as amended, 56 Stat. 846.

															Section 117(a)(4) provides:

															"The term 'long-term capital gain' means gain from the sale or
exchange of a capital asset held for more than 6 months, if and to
the extent such gain is taken into account in computing net
income."

															53 Stat. 51, as amended, 56 Stat. 843.

															Section 117(b) provides:

															"In the case of a taxpayer, other than a corporation, only the
following percentages of the gain or loss recognized upon the sale
or exchange of a capital asset shall be taken into account in
computing net capital gain, net capital loss, and net income:"

															"100 per centum if the capital asset has been held for not more
than 6 months;"

															"50 per centum if the capital asset has been held for more than
6 months."

															56 Stat. 843.

															[ Footnote 5 ]

															Until 1946, the Commissioner agreed with the contention of the
taxpayers in these cases that the assignment of an oil payment
right was productive of a long-term capital gain. In 1946, he
changed his mind and ruled that

															"consideration (not pledged for development) received for the
assignment of a short-lived in-oil payment right carved out of any
type of depletable interest in oil and gas in place (including a
larger in-oil payment right) is ordinary income subject to the
depletion allowance in the assignor's hands."

															G.C.M. 24849, 1946�1 Cum.Bull. 66, 69. This ruling was made
applicable "only to such assignments made on or after April 1,
1946," I.T. 3895, 1948�1 Cum.Bull. 39. In 1950, a further ruling
was made that represents the present view of the Commissioner. I.T.
4003, 1950�1 Cum.Bull. 10, 11, reads in relevant part as
follows:

															"After careful study and considerable experience with the
application of G.C.M. 24849, supra, it is now concluded
that there is no legal or practical basis for distinguishing
between short-lived and long-lived in-oil payment rights. It is,
therefore, the present position of the Bureau that the assignment
of any in-oil payment right (not pledged for development), which
extends over a period less than the life of the depletable property
interest from which it is carved, is essentially the assignment of
expected income from such property interest. Therefore, the
assignment for a consideration of any such in-oil payment right
results in the receipt of ordinary income by the assignor which is
taxable to him when received or accrued, depending upon the method
of accounting employed by him. Where the assignment of the in-oil
payment right is donative, the transaction is considered as an
assignment of future income which is taxable to the donor at such
time as the income from the assigned payment right arises."

															"Notwithstanding the foregoing, G.C.M. 24849, supra, and I.T. 3935, supra, do not apply where the assigned
in-oil payment right constitutes the entire depletable interest of
the assignor in the property or a fraction extending over the
entire life of the property."

															The pre-1946 administrative practice was not reflected in any
published ruling or regulation. It therefore will not be presumed
to have been known to Congress and incorporated into the law by
reenactment. See Helvering v. New York Trust Co., 292 U. S. 455 , 292 U. S.
467 -468. Cf. United States v. Leslie Salt Co., 350 U. S. 383 , 350 U. S.
389 -397. Moreover, prior administrative practice is
always subject to change "through exercise by the administrative
agency of its continuing rulemaking power." See Helvering v.
Reynolds, 313 U. S. 428 , 313 U. S.
432 .

Summary:
Here is a summary of the Supreme Court case Commissioner v. P. G. Lake, Inc:

Issue: Whether the assignment of oil payment rights by a taxpayer is considered ordinary income or a long-term capital gain for tax purposes.

Holding: The Supreme Court held that the assignment of oil payment rights is taxable as ordinary income, subject to depletion deductions. This is because the consideration received by the taxpayer is for the right to receive future income, not for an increase in the value of the income-producing property. The Court also ruled that the exchange of oil payment rights for real estate interests does not qualify as a tax-free exchange of like-kind property.

Facts: P. G. Lake, Inc., an oil and gas production company, assigned oil payment rights to its president as repayment for a debt. The company treated the income from this transaction as a long-term capital gain. The Commissioner of Internal Revenue disagreed, arguing that it should be taxed as ordinary income.

Reasoning: The Court reasoned that the consideration received by the taxpayer was for the right to receive future income from the oil leases, not for an increase in the value of the underlying property. Therefore, it should be taxed as ordinary income, subject to depletion deductions. The Court also noted that prior administrative practice, which treated such assignments as capital gains, was subject to change and had not been incorporated into law by Congress.

Conclusion: The Supreme Court reversed the lower court's decision and held that the assignment of oil payment rights is taxable as ordinary income, not as a long-term capital gain.


U.S. Supreme Court Commissioner v. Gillette Motor
Transport, Inc., 364
U.S. 130 (1960) Commissioner v. Gillette Motor
Transport, Inc. No. 359 Argued April 21, 1960 Decided June 27, 1960 364
U.S. 130 CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE FIFTH
CIRCUIT Syllabus Respondent trucking company ceased operations during World War
II because of a strike, and the Director of the Office of Defense
Transportation took possession and assumed control of its business
but left title to its properties in respondent, which resumed
normal operations and functioned under the control of a federal
manager until termination of possession and control by the
Government. The Motor Carrier Claims Commission determined that, by
assuming possession and control of respondent's facilities, the
Government had deprived it of the right to determine freely what
use was to be made of them, and it awarded to respondent as
compensation a sum representing the fair rental value of its
facilities during the period of government control. Held: under the Internal Revenue Code of 1939, this
award constituted ordinary income, and not a capital gain resulting
from an "involuntary conversion" of respondent's capital assets
consisting of real or depreciable personal property used in its
trade or business, within the meaning of §117(j). Pp. 364 U. S.
130 -136.

															265 F.2d 648, reversed.

															MR. JUSTICE HARLAN delivered the opinion of the Court.

															The question in this case is whether a sum received by
respondent from the United States as compensation for the temporary
taking by the Government of its business facilities during World
War II represented ordinary income or a capital gain. The issue
involves the construction Page 364 U. S. 131 and application of § 117(j) of the Internal Revenue Code of
1939.

															In 1944, respondent was a common carrier of commodities by motor
vehicle. On August 4, 1944, respondent's drivers struck, and it
completely ceased to operate. Shortly thereafter, because of the
need for respondent's facilities in the transportation of war
materiel, the President ordered the Director of the Office of
Defense Transportation to "take possession and assume control of"
them. The Director assumed possession and control as of August 12,
and appointed a Federal Manager, who ordered respondent to resume
normal operations. The Federal Manager also announced his intention
to leave title to the properties in respondent and to interfere as
little as possible in the management of them. Subject to certain
orders given by the Federal Manager from time to time, respondent
resumed normal operations and continued so to function until the
termination of all possession and control by the Government on June
16, 1945.

															Pursuant to an Act of Congress creating a Motor Carrier Claims
Commission, 62 Stat. 1222, respondent presented its claim for just
compensation. The Government contended that there had been no
"taking" of respondent's property, but only a regulation of it. The
Commission, however, determined that, by assuming actual possession
and control or respondent's facilities, the United States had
deprived respondent of the valuable right to determine freely what
use was to be made of them. In ascertaining the fair market value
of that right, the Commission found that one use to which
respondent's facilities could have been put was to rent them out,
and that therefore their rental value represented a fair measure of
respondent's pecuniary loss. The Commission noted that, in other
cases of temporary takings, it has typically been held that the
market value of what is taken is the sum which would be arrived at
by a willing lessor Page 364 U. S. 132 and a willing lessee. Accordingly, it awarded, and the
respondent received in 1952, the sum of $122,926.21, representing
the fair rental value of its facilities from August 12, 1944, until
June 16, 1945, plus $34,917.78, representing interest on the former
sum, or a total of $157,843.99.

															The Commission of Internal Revenue asserted that the total
compensation award represented ordinary income to respondent in
1952. Respondent contended that it constituted an amount received
upon an "involuntary conversion" of property used in its trade or
business, and was therefore taxable as long-term capital gain
pursuant to § 117(j) of the Internal Revenue Code of 1939. * Page 364 U. S. 133 The Tax Court, adopting its opinion in Midwest Motor
Express, Inc., 27 T.C. 167, affirmed, 251 F.2d 405,
which involved substantially identical facts, held that the award
represented ordinary income. The Court of Appeals, one judge
dissenting, in this instance reversed. 265 F.2d 648. We granted
certiorari because of the conflict between the decisions of the two
Circuits. 361 U.S. 881.

															Respondent stresses that the Motor Carrier Claims Commission,
rejecting the Government's contention that only a regulation,
rather than a taking, of its facilities had occurred, found that
respondent had been deprived of property, and awarded
compensation therefor. That is indeed true. But the fact that
something taken by the Government is property compensable under the
Fifth Amendment does not answer the entirely different question
whether that thing comes within the capital gains provisions of the
Internal Revenue Code. Rather, it is necessary to determine the
precise nature of the property taken. Here, the Commission
determined that what respondent had been deprived of, and what the
Government was obligated to pay for, was the right to determine
freely what use to make of its transportation facilities. The
measure of compensation adopted reflected the nature of that
property right. Given these facts, we turn to the statute.

															Section 117(j), under which respondent claims, is an integral
part of the statute's comprehensive treatment of capital gains and
losses. Long established principles govern the application of the
more favorable tax rates to long-term capital gains: (1) There must
be first, a "capital asset," and second, a "sale or exchange" of
that asset (§ 117(a)); (2) "capital asset" is defined as "property
held by the taxpayer," with certain exceptions not here relevant (§
117(a)(1)); and (3) for purposes of Page 364 U. S. 134 calculating gain, the cost or other basis of the property (§
113(b)) must be subtracted from the amount realized on the sale or
exchange (§ 111(a)).

															Section 117(j), added by the Revenue Act of 1942, effects no
change in the nature of a capital asset. It accomplishes only two
main objectives. First, it extends capital gains treatment to real
and depreciable personal property used in the trade or business,
the type of property involved in this case. Second, it accords such
treatment to involuntary conversions of both capital assets,
strictly defined, and property used in the trade or business. Since
the net effect of the first change is merely to remove one of the
exclusions made to the definition of capital assets in § 117(a)(1),
it seems evident that "property used in the trade or business," to
be eligible for capital gains treatment, must satisfy the same
general criteria as govern the definition of capital assets. The
second change was apparently required by the fact that this Court
had given a narrow construction to the term "sale or exchange." See Helvering v. William Flaccus Oak Leather Co., 313 U. S. 247 . But
that change similarly had no effect on the basic notion of what
constitutes a capital asset.

															While a capital asset is defined in § 117(a)(1) as "property
held by the taxpayer," it is evident that not everything which can
be called property in the ordinary sense and which is outside the
statutory exclusions qualifies as a capital asset. This Court has
long held that the term "capital asset" is to be construed narrowly
in accordance with the purpose of Congress to afford capital gains
treatment only in situations typically involving the realization of
appreciation in value accrued over a substantial period of time,
and thus to ameliorate the hardship of taxation of the entire gain
in one year. Burnet v. Harmel, 287 U.
S. 103 , 287 U. S. 106 .
Thus, the Court has held that an unexpired lease, Hort v.
Commissioner, 313 U. S. 28 , corn
futures, Corn Products Refining Co. v. Commissioner, 350 U. S. 46 , Page 364 U. S. 135 and oil payment rights, Commissioner v. P. G. Lake,
Inc., 356 U. S. 260 , are
not capital assets, even though they are concededly "property"
interests in the ordinary sense. And see Surrey,
Definitional Problems in Capital Gains Taxation, 69 Harv.L.Rev.
985, 987-989 and Note 7.

															In the present case, respondent's right to use its
transportation facilities was held to be a valuable property right
compensable under the requirements of the Fifth Amendment. However,
that right was not a capital asset within the meaning of §§
117(a)(1) and 117(j). To be sure, respondent's facilities were
themselves property embraceable as capital assets under § 117(j).
Had the Government taken a fee in those facilities, or damaged them
physically beyond the ordinary wear and tear incident to normal
use, the resulting compensation would no doubt have been treated as
gain from the involuntary conversion of capital assets. See,
e.g., Waggoner, 15 T.C. 496; Henshaw, 23 T.C. 176.
But here, the Government took only the right to determine the use
to which those facilities were to be put.

															That right is not something in which respondent had any
investment, separate and apart from its investment in the physical
assets themselves. Respondent suggests no method by which a cost
basis could be assigned to the right; yet it is necessary, in
determining the amount of gain realized for purposes of § 117, to
deduct the basis of the property sold, exchanged, or involuntarily
converted from the amount received. § 111(a). Further, the right is
manifestly not of the type which gives rise to the hardship of the
realization in one year of an advance in value over cost built up
in several years, which is what Congress sought to ameliorate by
the capital gains provisions. See cases cited ante, p. 364 U. S. 134 .
In short, the right to use is not a capital asset, but is simply an
incident of the underlying physical property, the recompense for
which is commonly regarded as rent. That is precisely the situation
here, Page 364 U. S. 136 and the fact that the transaction was involuntary on
respondent's part does not change the nature of the case.

															Respondent lays stress on the use of the terms "seizure" and
"requisition" in § 117(j). More specifically, the section refers to
the

															"involuntary conversion (as a result of destruction in whole or
in part, theft or seizure, or an exercise of the power of
requisition or condemnation or the threat or imminence thereof) of property used in the trade or business and capital
assets. . . ."

															(Emphasis added.) It is contended that the Government's action
in the present case is perhaps the most typical example of a
seizure or requisition, and that, therefore, Congress must have
intended to treat it as a capital transaction. This argument,
however, overlooks the fact that the seizure or requisition must be
"of property used in the trade or business [or] capital assets." We
have already shown that § 117(j) does not change the longstanding
meaning of these terms, and that the property taken by the
Government in the present case does not come within them. The words
"seizure" and "requisition" are not thereby deprived of effect,
since they equally cover instances in which the Government takes a
fee or damages or otherwise impairs the value of physical
property.

															We conclude that the amount paid to respondent as the fair
rental value of its facilities from August 12, 1944, to June 16,
1945, represented ordinary income to it. A fortiori, the
interest on that sum is ordinary income. Kieselbach v.
Commissioner, 317 U. S. 399 . Reversed. MR. JUSTICE DOUGLAS dissents.

															* Section 117(j) provides as follows:

															"Gains and losses from involuntary conversion and from the sale
or exchange of certain property used in the trade or business
--"

															"(1) Definition of property used in the trade or business."

															"For the purposes of this subsection, the term 'property used in
the trade or business' means property used in the trade or
business, of a character which is subject to the allowance for
depreciation provided in section 23( l ), held for more than
6 months, and real property used in the trade or business, held for
more than 6 months, which is not (A) property of a kind which would
properly be includible in the inventory of the taxpayer if on hand
at the close of the taxable year, or (B) property held by the
taxpayer primarily for sale to customers in the ordinary course of
his trade or business. . . ."

															"(2) General rule."

															"If, during the taxable year, the recognized gains upon sales or
exchanges of property used in the trade or business, plus the
recognized gains from the compulsory or involuntary conversion (as
a result of destruction in whole or in part, theft or seizure, or
an exercise of the power of requisition or condemnation or the
threat or imminence thereof) of property used in the trade or
business and capital assets held for more than 6 months into other
property or money, exceed the recognized losses from such sales,
exchanges, and conversions, such gains and losses shall be
considered as gains and losses from sales or exchanges of capital
assets held for more than 6 months. . . ."

Summary: The U.S. Supreme Court case, Commissioner v. Gillette Motor Transport, Inc. (1960), dealt with the question of whether compensation for a temporary government taking of a business's facilities during World War II was considered ordinary income or a capital gain for tax purposes. The Court held that the compensation was ordinary income, not a capital gain, as it did not meet the definition of "property used in the trade or business" or "capital assets" under the Internal Revenue Code of 1939, Section 117(j). This decision reinforced the longstanding meaning of these tax terms and had implications for how similar cases would be treated in the future.


U.S. Supreme Court Knetsch v. United States, 364
U.S. 361 (1960) Knetsch v. United
States No. 23 Argued October 17-18,
1960 Decided November 14,
1960 364
U.S. 361 CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE NINTH
CIRCUIT Syllabus In 1953, a 60-year-old taxpayer purchased single-premium 30-year
maturity deferred annuity savings bonds with an aggregate face
value of $4,000,000 from a life insurance company, paying only a
nominal sum in cash, giving nonrecourse notes secured by the bonds
for the balance, and paying a substantial amount as "interest" in
advance on that "indebtedness." A few days later, he borrowed from
the company nearly all of the excess of the cash surrender value
which the bonds would have at the end of the first contract year
over the amount of the existing "indebtedness," and again paid in
advance the "interest" on such additional "indebtedness." These
borrowings and "interest" payments were repeated in 1954 and 1955,
and the bonds were surrendered and the indebtedness was cancelled
in 1956. Held: the amounts paid as "interest" in 1953 and 1954
were not deductible from the gross income of the taxpayer and his
wife in their joint income tax returns for those years as "interest
paid . . . on indebtedness," within the meaning of § 23(b) of the
Internal Revenue Code of 1939 and §163(a) of the Internal Revenue
Code of 1954. Pp. 364 U. S.
362 -370.

															(a) On the record in this case, it is patent that the
transaction between the taxpayer and the insurance company was a
sham which created no "indebtedness" within the meaning of those
sections of the Codes. Pp. 364 U. S. 362 -366.

															(b) Congress did not authorize deduction of such payments by
enacting § 264(a)(2) of the Internal Revenue Code of 1954, which
expressly denies a deduction for amounts paid on indebtedness
incurred to purchase or carry a single premium annuity contract,
but only as to contracts purchased after March 1, 1954. Pp. 364 U. S.
367 -370.

															272 F.2d 200 affirmed. Page 364 U. S. 362 MR. JUSTICE BRENNAN delivered the the opinion of the Court.

															This case presents the question of whether deductions from gross
income claimed on petitioners' 1953 and 1954 joint federal income
tax returns, of $143,465 in 1953 and of $147,105 in 1954, for
payments made by petitioner, Karl F. Knetsch, to Sam Houston Life
Insurance Company, constituted "interest paid . . . on
indebtedness" within the meaning of § 23(b) of the Internal Revenue
Code of 1939 and § 163(a) of the Internal Revenue Code of 1954.
[ Footnote 1 ] The Commissioner
of Internal Revenue disallowed the deductions and determined a
deficiency for each year. The petitioners paid the deficiencies and
brought this action for refund in the District Court for the
Southern District of California. The District Court rendered
judgment for the United States, and the Court of Appeals for the
Ninth Circuit affirmed, 272 F.2d 200. Because of a suggested
conflict with the decision of the Court of Appeals for the Fifth
Circuit in United States v. Bond, 258 F.2d 577, we granted
certiorari, 361 U.S. 958.

															On December 11, 1953, the insurance company sold Knetsch ten
30-year maturity deferred annuity savings bonds, each in the face
amount of $400,000 and bearing interest at 2 1/2% compounded
annually. The purchase price was $4,004,000. Knetsch gave the
Company his check for $4,000, and signed $4,000,000 of nonrecourse
annuity loan notes for the balance. The notes bore Page 364 U. S. 363 3 1/2% interest, and were secured by the annuity bonds. The
interest was payable in advance, and Knetsch on the same day
prepaid the first year's interest, which was $140,000. Under the
Table of Cash and Loan Values made part of the bonds, their cash or
loan value at December 11, 1954, the end of the first contract
year, was to be $4,100,000. The contract terms, however, permitted
Knetsch to borrow any excess of this value above his indebtedness
without waiting until December 11, 1954. Knetsch took advantage of
this provision only five days after the purchase. On December 16,
1953, he received from the company $99,000 of the $100,000 excess
over his $4,000,000 indebtedness, for which he gave his notes
bearing 3 1/2% interest. This interest was also payable in advance,
and, on the same day, he prepaid the first year's interest of
$3,465. In their joint return for 1953, the petitioners deducted
the sum of the two interest payments, that is $143,465, as
"interest paid . . . within the taxable year on indebtedness,"
under § 23(b) of the 1939 Code.

															The second contract year began on December 11, 1954, when
interest in advance of $143,465 was payable by Knetsch on his
aggregate indebtedness of $4,099,000. Knetsch paid this amount on
December 27, 1954. Three days later, on December 30, he received
from the company cash in the amount of $104,000, the difference
less $1,000 between his then $4,099,000 indebtedness and the cash
or loan value of the bonds of $4,204,000 on December 11, 1955. He
gave the company appropriate notes and prepaid the interest thereon
of $3,640. In their joint return for the taxable year 1954, the
petitioners deducted the sum of the two interest payments, that is,
$147,105, as "interest paid . . . within the taxable year on
indebtedness," under § 163(a) of the 1954 Code.

															The tax years 1955 and 1956 are not involved in this proceeding,
but a recital of the events of those years is Page 364 U. S. 364 necessary to complete the story of the transaction. On December
11, 1955, the start of the third contract year, Knetsch became
obligated to pay $147,105 as prepaid interest on an indebtedness
which now totalled $4,203,000. He paid this interest on December
28, 1955. On the same date, he received $104,000 from the company.
This was $1,000 less than the difference between his indebtedness
and the cash or loan value of the bonds of $4,308,000 at December
11, 1956. Again, he gave the company notes upon which he prepaid
interest of $3,640. Petitioners claimed a deduction on their 1955
joint return for the aggregate of the payments, or $150,745.

															Knetsch did not go on with the transaction for the fourth
contract year beginning December 11, 1956, but terminated it on
December 27, 1956. His indebtedness at that time totalled
$4,307,000. The cash or loan value of the bonds was the $4,308,000
value at December 11, 1956, which had been the basis of the "loan"
of December 28, 1955. He surrendered the bonds, and his
indebtedness was canceled. He received the difference of $1,000 in
cash.

															The contract called for a monthly annuity of $90,171 at maturity
(when Knetsch would be 90 years of age) or for such smaller amount
as would be produced by the cash or loan value after deduction of
the then existing indebtedness. It was stipulated that, if Knetsch
had held the bonds to maturity and continued annually to borrow the
net cash value less $1,000, the sum available for the annuity at
maturity would be $1,000 ($8,388,000 cash or loan value less
$8,387,000 of indebtedness), enough to provide an annuity of only
$43 per month.

															The trial judge made findings that "[t]here was no commercial
economic substance to the . . . transaction," that the parties did
not intend that Knetsch "become indebted to Sam Houston," that
"[n]o indebtedness of [Knetsch] was created by any of the . . .
transactions," and that Page 364 U. S. 365 "[n]o economic gain could be achieved from the purchase of these
bonds without regard to the tax consequences. . . ." His conclusion
of law, based on this Court's decision in Deputy v. du
Pont, 308 U. S. 488 , was
that,

															"[w]hile, in form, the payments to Sam Houston were compensation
for the use or forbearance of money, they were not in substance. As
a payment of interest, the transaction was a sham."

															We first examine the transaction between Knetsch and the
insurance company to determine whether it created an "indebtedness"
within the meaning of § 23(b) of the 1939 Code and § 163(a) of the
1954 Code, or whether, as the trial court found, it was a sham. We
put aside a finding by the District Court that Knetsch's "only
motive in purchasing these 10 bonds was to attempt to secure an
interest deduction." [ Footnote
2 ] As was said in Gregory v. Helvering, 293 U.
S. 465 , 293 U. S.
469 :

															"The legal right of a taxpayer to decrease the amount of what
otherwise would be his taxes, or altogether avoid them, by means
which the law permits, cannot be doubted. . . . But the question
for determination is whether what was done, apart from the tax
motive, was the thing which the statute intended."

															When we examine "what was done" here, we see that Knetsch paid
the insurance company $294,570 during the two taxable years
involved and received $203,000 back in the form of "loans." What
did Knetsch get for the out-of-pocket difference of $91,570? In
form, he had an annuity contract with a so-called guaranteed cash
value at maturity of $8,388,000, which would produce monthly
annuity payments of $90,171, or substantial life insurance proceeds
in the event of his death before maturity. This, Page 364 U. S. 366 as we have seen, was a fiction, because each year Knetsch's
annual borrowings kept the net cash value, on which any annuity or
insurance payments would depend, at the relative pittance of
$1,000. [ Footnote 3 ] Plainly,
therefore, Kentsch's transaction with the insurance company did
"not appreciably affect his beneficial interest except to reduce
his tax. . . ." Gilbert v. Commissioner, 248 F.2d 399, 411
(dissenting opinion). For it is patent that there was nothing of
substance to be realized by Knetsch from this transaction beyond a
tax deduction. What he was ostensibly "lent" back was in reality
only the rebate of a substantial part of the so-called "interest"
payments. The $91,570 difference retained by the company was its
fee for providing the facade of "loans" whereby the petitioners
sought to reduce their 1953 and 1954 taxes in the total sum of
$233,297.68. There may well be single premium annuity arrangements
with nontax substance which create an "indebtedness" for the
purposes of § 23(b) of the 1939 Code and § 163(a) of the 1954 Code.
But this one is a sham. [ Footnote
4 ] Page 364 U. S. 367 The petitioners contend, however, that the Congress, in enacting
§ 264 of the 1954 Code, authorized the deductions. They point out
that § 264(a)(2) denies a deduction for amounts paid on
indebtedness incurred to purchase to carry a single premium annuity
contract, but only as to contracts purchased after March 1, 1954.
[ Footnote 5 ] The petitioners
thus would attribute to Congress a purpose to allow the deduction
of pre-1954 payments under transactions of the kind carried on by
Knetsch with the insurance company without regard to whether the
transactions created a true obligation to pay interest. Unless that
meaning plainly appears, we will not attribute it to Congress. "To
hold otherwise would be to exalt artifice above reality and to
deprive the statutory provision in question of all serious
purpose." Gregory v. Helvering, supra, p. 293 U. S. 470 . We
therefore look to the statute and materials relevant to its
construction for evidence that Congress meant in § 264(a)(2) to
authorize the deduction of payments made under sham transactions
entered into before 1954. We look in vain.

															Provisions denying deductions for amounts paid on indebtedness
incurred to purchase or carry insurance contracts are not new in
the revenue acts. A provision applicable to all annuities, but not
to life insurance or endowment contracts, was in the statute from
1932 to 1934, 47 Stat. 179. It was added at a time when Congress
was Page 364 U. S. 368 developing a policy to deny a deduction for interest allocable
to tax-exempt income; [ Footnote
6 ] the proceeds of annuities were excluded from gross income up
to the amount of the consideration paid in by the annuitant. See H.R.Rep. No. 708, 72d Cong., 1st Sess., p. 11. The
provision was repealed by the Revenue Act of 1934, 48 Stat. 688,
when the method by which annuity payments were taken into gross
income was changed in such way that more would be included. 48
Stat. 687. See S.Rep. No. 558, 73d Cong., 2d Sess., p.
24.

															Congress then, in 1942, denied a deduction for amounts paid on
indebtedness incurred to purchase single premium life insurance and
endowment contracts. This provision was enacted by an amendment to
the 1939 Code, 56 Stat. 827, "to close a loophole" in respect of
interest allocable to partially exempt income. See Hearings before Senate Finance Committee on H.R. 7378, 77th Cong.,
2d Sess., p. 54; § 22(b)(1) of the 1939 Code (now § 101(a)(1) of
the 1954 Code).

															The 1954 provision extending the denial to amounts paid on
indebtedness incurred to purchase or carry single premium annuities
appears to us simply to expand the application of the policy in
respect of interest allocable to partially exempt income. The
proofs are perhaps not as strong as in the case of life insurance
and endowment contracts, but, in the absence of any contrary
expression of the Congress, their import is clear enough. There
is Page 364 U. S. 369 first the fact that the provision was incorporated in
the section covering life insurance and endowment contracts, which
unquestionably was adopted to further that policy. There is second the fact that Congress' attention was directed to
annuities in 1954; the same 1954 statute again changed the basis
for taking part of the proceeds of annuities into gross income. See § 72(b) of the 1954 Code. These are signs that
Congress' longstanding concern with the problem of interest
allocable to partially exempt income, and not any concern with sham
transactions, explains the provision.

															Moreover, the provision itself negates any suggestion that sham
transactions were the congressional concern, for the deduction
denied is of certain interest payments on actual "indebtedness."
And we see nothing in the Senate Finance and House Ways and Means
Committee Reports on § 264, H.R.Rep. No. 1337, 83d Cong., 2d Sess.,
p. 31; S.Rep. No. 1622, 83d Cong., 2d Sess., p. 38, to suggest that
Congress in exempting pre-1954 annuities intended to protect sham
transactions. [ Footnote 7 ] Page 364 U. S. 370 Some point is made in an amicus curiae brief of the
fact that Knetsch, in entering into these annuity agreements,
relied on individual ruling letters issued by the Commissioner to
other taxpayers. This argument has never been advanced by
petitioners in this case. Accordingly, we have no reason to pass
upon it.

															The judgment of the Court of Appeals is Affirmed. [ Footnote 1 ]

															The relevant words of the two sections are the same, namely that
there shall be allowed as a deduction "All interest paid or accrued
within the taxable year on indebtedness. . . ."

															[ Footnote 2 ]

															We likewise put aside Knetsch's argument that, because he
received ordinary income when he surrendered the annuities in 1956,
he has suffered a net loss even if the contested deductions are
allowed, and that therefore his motive in taking out the annuities
could not have been tax avoidance.

															[ Footnote 3 ]

															Petitioners argue further that, in 10 years, the net cash value
of the bonds would have exceeded the amounts Knetsch paid as
"interest." This contention, however, is predicated on the wholly
unlikely assumption that Knetsch would have paid off in cash the
original $4,000,000 "loan."

															[ Footnote 4 ]

															Every court which has considered this or similar contracts has
agreed with our conclusion, except the Court of Appeals for the
Fifth Circuit in the Bond case and one District Court
bound by that decision, Roderick v. United States, 59-2
U.S.T.C. � 9650. See Diggs v. Commissioner, 281 F.2d 326
(C.A. 2d Cir.), pending on petition for certiorari (later denied, post, p. 908); Emmons and Weller v. Commissioner, 270 F.2d 294 (C.A. 3d Cir.), certiorari denied, 347 U.S.
908; Haggard v. United States, 59-1 U.S.T.C. � 9299; Oliver L Williams, 18 T.C.M. 205. See also Rev.Rul. 54-94, 1954-1 Cum.Bull. 53, and the dissenting opinion of
Judge Wisdom in Bond. [ Footnote 5 ]

															Section 264(a)(2) provides:

															"(a) General rule -- No deduction shall be allowed for --"

															" * * * *" "(2) Any amount paid or accrued on indebtedness incurred or
continued to purchase or carry a single premium life insurance,
endowment, or annuity contract."

															" Paragraph (2) shall apply in respect of annuity contracts
only as to contracts purchased after March 1, 1954. "

															(Emphasis supplied.)

															The substance of the section without the italicized language was
added to the 1939 Code in 1942. 56 Stat. 827.

															[ Footnote 6 ] See § 23(b) of the Revenue Act of 1932, 47 Stat. 179,
which provided:

															"(b) INTEREST -- All interest paid or accrued within the taxable
year on indebtedness, except (1) on indebtedness incurred or
continued to purchase or carry obligations or securities (other
than obligations of the United States issued after September 24,
1917, and originally subscribed for by the taxpayer) the interest
upon which is wholly exempt from the taxes imposed by this title,
or (2) on indebtedness incurred or continued in connection with the
purchasing or carrying of an annuity."

															[ Footnote 7 ]

															The Reports are as follows:

															"Under existing law, no interest deduction is allowed in the
case of indebtedness incurred, or continued, to purchase a single
premium life-insurance or endowment contract. . . ."

															"Existing law does not extend the denial of the interest
deduction to indebtedness incurred to purchase single premium
annuity contracts. It has come to your committee's attention that a
few insurance companies have promoted a plan for selling annuity
contracts based on the tax advantage derived from omission of
annuities from the treatment accorded single premium life insurance
or endowment contracts. The annuity is sold for a nominal cash
payment with a loan to cover the balance of the single premium cost
of the annuity. Interest on the loan (which may be a nonrecourse
loan) is then taken as a deduction annually by the purchaser, with
a resulting tax saving that reduces the real interest cost below
the increment in value produced by the annuity."

															"Your committee's bill will deny an interest deduction in such
cases, but only as to annuities purchased after March 1, 1954."

															MR. JUSTICE DOUGLAS, with whom MR. JUSTICE WHITTAKER and MR.
JUSTICE STEWART concur, dissenting.

															I agree with the views expressed by Judge Moore in Diggs v.
Commissioner, 281 F.2d 326, 330-332, and by Judge Brown,
writing for himself and Judge Hutcheson, in United States v.
Bond, 258 F.2d 577.

															It is true that, in this transaction, the taxpayer was bound to
lose if the annuity contract is taken by itself. At least the
taxpayer showed by his conduct that he never intended to come out
ahead on that investment apart from this income tax deduction. Yet
the same may be true where a taxpayer borrows money at 5% or 6%
interest to purchase securities that pay only nominal interest; or
where, with money in the bank earning 3%, he borrows from the
self-same bank at a higher rate. His aim there, as here, may only
to be get a tax deduction for interest paid. Yet as long as the
transaction itself is not hocus-pocus, the interest charges
incident to completing it would seem to be deductible under the
Internal Revenue Code as respects annuity contracts made prior to
March 1, 1954, the date Congress selected for terminating this
class of deductions. 26 U.S.C. § 264. The insurance company
existed; it operated under Texas law; it was authorized to issue
these policies and to make these annuity loans. While the taxpayer
was obligated to pay interest at the rate of 3 1/2% per annum, the
annuity bonds increased Page 364 U. S. 371 in cash value at the rate of only 2 1/2% per annum. The
insurance company's profit was in that 1-point spread.

															Tax avoidance is a dominating motive behind scores of
transactions. It is plainly present here. Will the Service that
calls this transaction a "sham" today not press for collection of
taxes * arising out of
the surrender of the annuity contract? I think it should, for I do
not believe any part of the transaction was a "sham." To disallow
the "interest" deduction because the annuity device was devoid of
commercial substance is to draw a line which will affect a host of
situations now now before us and which, with all deference, I do
not think we can maintain when other cases reach here. The remedy
is legislative. Evils or abuses can be particularized by Congress.
We deal only with "interest" as commonly understood and as used
across the board in myriad transactions. Since these transactions
were real and legitimate in the insurance world, and were
consummated within the limits allowed by insurance policies, I
would recognize them tax-wise.

															* Petitioners terminated this transaction in 1956 by allowing
the bonds to be cancelled and receiving a check for $1,000. The
termination was reflected in their tax return for 1956. It might
also be noted that the insurance company reported as gross income
the interest payments which it received from petitioners in 1953
and 1954.

Summary: The Supreme Court held that a taxpayer's transaction with an insurance company was a sham and did not create any "indebtedness" for which interest deductions could be claimed under the Internal Revenue Code. The Court found that the taxpayer's purchase of annuity savings bonds with non-recourse notes and subsequent borrowings against the cash value of the bonds was a pretense to generate tax deductions, as the taxpayer had no intention of making a genuine investment. Justice Brennan delivered the opinion, while Justice Douglas dissented, arguing that the transaction was legitimate within the insurance context and should be recognized for tax purposes.


U.S. Supreme Court Commissioner v. Lester, 366
U.S. 299 (1961) Commissioner v.
Lester No. 376 Argued April 25, 1961 Decided May 22, 1961 366
U.S. 299 CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE SECOND
CIRCUIT Syllabus Section 23(u) of the Internal Revenue Code of 1939 permits a
husband to deduct from his gross income for income tax purposes
amounts includible under § 22(k) in the gross income of his
divorced wife, and § 22(k) provides that periodic payments received
by the wife after a decree of divorce in discharge of a legal
obligation imposed upon the husband under a written instrument
incident to such divorce shall be includible in the gross income of
the wife, but that

															"This subsection shall not apply to that part of any such
periodic payment which the terms of the . . . written
instrument fix, in terms of . . . a portion of the payment, as
a sum which is payable for the support of minor children of such
husband." Held: in order to come within this exception to §
22(k), the written agreement providing for the periodic payments to
the wife must specifically designate the amounts or parts thereof
allocable to the support of the children, and must not leave such
amounts to determination by inference or conjecture. Pp. 366 U. S.
299 -306.

															279 F.2d 354 affirmed.

															MR. JUSTICE CLARK delivered the opinion of the Court.

															The sole question presented by this suit, in which the
Government seeks to recover personal income tax deficiencies,
involves the validity of respondent's deductions Page 366 U. S. 300 from his gross income for the taxable years 1951 and 1952 of the
whole of his periodic payments during those years to his divorced
wife pursuant to a written agreement entered into by them and
approved by the divorce court. The Commissioner claims that
language in this agreement providing

															"[i]n the event that any of the [three] children of the parties
hereto shall marry, become emancipated, or die, then the payments
herein specified shall . . . be reduced in a sum equal to one-sixth
of the payments which would thereafter otherwise accrue"

															sufficiently identifies one-half of the periodic payments as
having been "payable for the support" of the taxpayer's minor
children under § 22(k) of the Internal Revenue Code of 1939 and,
therefore, not deductible by him under § 23(u) of the Code.
[ Footnote 1 ] The Tax Court
approved the Commissioner's disallowance, 32 T.C. 1156, but the
Court of Appeals reversed, 279 F.2d 354, holding that the agreement
did not "fix" with requisite clarity any specific amount or portion
of the periodic payments as payable for the support of the
children, and that all sums paid to the wife under the agreement
were, therefore, deductible from Page 366 U. S. 301 respondent's gross income under the alimony provision of §
23(u). To resolve a conflict among the Courts of Appeals on the
question, [ Footnote 2 ] we
granted certiorari. 364 U.S. 890. We have concluded that the
Congress intended that, to come within the exception portion of §
22(k), the agreement providing for the periodic payments must
specifically state the amounts or parts thereof allocable to the
support of the children. Accordingly, we affirm the judgment of the
Court of Appeals.

															Prior to 1942, a taxpayer was generally not entitled to deduct
from gross income amounts payable to a former spouse as alimony, Douglas v. Willcuts, 296 U. S. 1 (1935),
except in situations in which the divorce decree, the settlement
agreement, and state law operated as a complete discharge of the
liability for support. Helvering v. Fitch, 309 U.
S. 149 (1940). The hearings, Senate debates and the
Report of the Ways and Means Committee of the House all indicate
that it was the intention of Congress, in enacting § 22(k) and §
23(u) of the Code, to eliminate the uncertain and inconsistent tax
consequences resulting from the many variations in state law.
"[T]he amendments are designed to remove the uncertainty as to the
tax consequences of payments made to a divorced spouse. . . ."
S.Rep. No. 673 Pt. 1, 77th Cong., 1st Sess. 32. They "will produce
uniformity in the treatment of amounts paid . . . regardless of
variance in the laws of different States. . . ." H.R.Rep. No. 2333,
77th Cong., 2d Sess. 72. In addition, Congress realized that the
"increased surtax rates [ Footnote
3 ] would intensify" the Page 366 U. S. 302 hardship on the husband who, in many cases, "would not have
sufficient income left after paying alimony to meet his income tax
obligations," H.R.Rep. No. 2333, 77th Cong., 2d Sess. 46, and
perhaps also that, on the other hand, the wife, generally being in
a lower income tax bracket than the husband, could more easily
protect herself in the agreement and, in the final analysis,
receive a larger net payment from the husband if he could deduct
the gross payment from his income.

															The first version of § 22(k) was proposed by the Senate as an
amendment to the Revenue Act of 1941. The sums going to child
support were to be includible in the husband's gross income only if
the amount thereof was "specifically designated as a sum payable
for the support of minor children of the spouses." H.R. 5417, 77th
Cong., 1st Sess., § 117. The proposed amendment thus drew a
distinction between a case in which the amount for child support
was "specifically designated" in the agreement and one in which
there was no such designation. In the latter event, "the whole of
such amounts are includible in the income of the wife. . . ."
S.Rep. No. 673, Pt. 1, 77th Cong., 1st Sess. 35. Action on the bill
was deferred by the conference committee, [ Footnote 4 ] and hearings on the measure were again held
the following year. The subsequent Report of the Senate Finance
Committee on § 22(k) carried forward the term "specifically
designated," used in the 1941 Report (No. 673), with this
observation:

															"If, however, the periodic payments . . . are received by the
wife for the support and maintenance of herself and of minor
children of the husband without such specific designation of the
portion for the support of such children, then the whole of
such Page 366 U. S. 303 amounts is includible in the income of the wife as provided in
section 22(k). . . ."

															S.Rep. No. 1631, 77th Cong., 2d Sess. 86. As finally enacted in
1942, the Congress used the word "fix" instead of the term
"specifically designated," but the change was explained in the
Senate hearings as "a little more streamlined language." Hearings
before Senate Committee on Finance on H.R. 7378, 77th Cong., 2d
Sess. 48. As the Office of the Legislative Counsel reported to the
Senate Committee:

															"If an amount is specified in the decree of divorce attributable
to the support of minor children, that amount is not income of the
wife. . . . If, however, that amount paid the wife includes the
support of children, but no amount is specified for the support
of the children, the entire amount goes into the income of the
wife. . . ." Ibid. (Italics supplied.) This language leaves no room
for doubt. The agreement must expressly specify or "fix" a sum
certain or percentage of the payment for child support before any
of the payment is excluded from the wife's income. The statutory
requirement is strict and carefully worded. It does not say that "a
sufficiently clear purpose" on the part of the parties is
sufficient to shift the tax. It says that the "written instrument"
must "fix" that "portion of the payment" which is to go to the
support of the children. Otherwise, the wife must pay the tax on
the whole payment. We are obliged to enforce this mandate of the
Congress.

															One of the basic precepts of the income tax law is that

															"[t]he income that is subject to a man's unfettered command, and
that he is free to enjoy at his own option, may be taxed to him as
his income, whether he sees fit to enjoy it or not." Corliss v. Bowers, 281 U. S. 376 , 281 U. S. 378 (1930). Page 366 U. S. 304 Under the type of agreement here, the wife is free to spend the
monies paid under the agreement as she sees fit. "The power to
dispose of income is the equivalent of ownership of it." Helvering v. Horst, 311 U. S. 112 , 311 U. S. 118 (1940). Including the entire payments in the wife's gross income
under such circumstances, therefore, comports with the underlying
philosophy of the Code. And, as we have frequently stated, the Code
must be given "as great an internal symmetry and consistency as its
words permit." United States v. Olympic Radio &
Television, 349 U. S. 232 , 349 U. S. 236 (1955).

															It does not appear that the Congress was concerned with the
perhaps restricted uses of unspecified child support payments
permitted the wife by state law when it made those sums includible
within the wife's alimony income. Its concern was with a revenue
measure and with the specificity, for income tax purposes, of the
amount payable under the terms of the written agreement for support
of the children. Therefore, in construing that revenue act, we too
are unconcerned with the variant legal obligations, if any, which
such an agreement, by construction of its nonspecific provisions
under local rules, imposes upon the wife to use a certain portion
of the payments solely for the support of the children. The Code
merely affords the husband a deduction for any portion of such
payment not specifically earmarked in the agreement as payable for
the support of the children.

															As we read § 22(k), the Congress was, in effect, giving the
husband and wife the power to shift a portion of the tax burden
from the wife to the husband by the use of a simple provision in
the settlement agreement which fixed the specific portion of the
periodic payment made to the wife as payable for the support of the
children. Here, the agreement does not so specifically provide. On
the contrary, it calls merely for the payment of certain monies
to Page 366 U. S. 305 the wife for the support of herself and the children. The
Commissioner makes such of the fact that the agreement provides
that as, if, and when any one of the children married, became
emancipated or died, the total payment would be reduced by
one-sixth, saying that this provision did "fix" one-half (one-sixth
multiplied by three, the number of children) of the total payment
as payable for the support of the children. However, the agreement
also pretermitted the entire payment in the event of the wife's
remarriage, and it is as consistent to say that this provision had
just the opposite effect. It was just such uncertainty in tax
consequences that the Congress intended to, and, we believe, did
eliminate when it said that the child support payments should be
"specifically designated" or, as the section finally directed,
"fixed." It does not say that "a sufficiently clear purpose" on the
part of the parties would satisfy. It says that the written
instrument must "fix" that amount or "portion of the payment" which
is to go to the support of the children.

															The Commissioner contends that administrative interpretation has
been consistently to the contrary. It appears, however, that there
was such a contrariety of opinion among the Courts of Appeals that
the Commissioner was obliged as late as 1959 to issue a Revenue
Ruling which stated that the Service would follow the rationale of Eisinger v. Commissioner, 250 F.2d 303 (1957), [ Footnote 5 ] but that Weil v.
Commissioner 240 F.2d 584 Page 366 U. S. 306 (C.A. 2d Cir. 1957), [ Footnote
6 ] would be followed "in cases involving similar facts and
circumstances." Rev.Rul. 59-93, 1959-1 Cum.Bull. 22, 23.

															All of these considerations lead to the conclusion that, if
there is to be certainty in the tax consequences of such
agreements, the allocations to child support made therein must be
"specifically designated," and not left to determination by
inference or conjecture. We believe that the Congress has so
demanded in § 22(k). After all, the parties may, for tax purposes,
act as their best interests dictate, provided, as that section
requires, their action be clear and specific. Certainly the
Congress has required no more and expects no less. Affirmed. [ Footnote 1 ]

															Section 22(k) of the Internal Revenue Code of 1939, 56 Stat.
816-817, provided in part that

															". . . periodic payments . . . received [by the wife] subsequent
to [a decree of divorce] . . . in discharge of . . . a legal
obligation which, because of the marital or family relationship, is
imposed upon or incurred by such husband under . . . a written
instrument incident to such divorce . . . shall be includible in
the gross income of such wife. . . . This subsection shall not
apply to that part of any such periodic payment which the terms
of the . . . written instrument fix, in terms of . . . a
portion of the payment, as a sum which is payable for the support
of minor children of such husband."

															(Emphasis added.) Section 23(u), 56 Stat. 817, stated in
pertinent part that there shall be allowed as a deduction

															"[i]n the case of a husband described in section 22(k), amounts
includible under section 22(k) in the gross income of his wife,
payment of which is made within the husband's taxable year."

															[ Footnote 2 ]

															Both Metcalf v. Commissioner, 1959, 271 F.2d 288, and Eisinger v. Commissioner, 1957, 250 F.2d 303, have arrived
at conclusions contrary to those of the court below.

															[ Footnote 3 ]

															Sections 22(k) and 23(u) were enacted as part of the Revenue Act
of 1942, which provided for greatly increased tax revenue to meet
the expenses of World War II.

															[ Footnote 4 ]

															H.R.Rep. No. 1203, 77th Cong., 1st Sess. 11.

															[ Footnote 5 ]

															The court there approved the rule that,

															"when the settlement agreement, read as a whole, discloses that
the parties have earmarked or designated . . . the payments to be
made, one part to be payable for alimony, and another part to be
payable for the support of children, with sufficient certainty and
specificity to readily determine which is which, without reference
to contingencies which may never come into being, then the 'part of
any periodic payment' has been fixed 'by the terms of the decree or
written instrument'. . . ."

															250 F.2d at 308.

															[ Footnote 6 ]

															In that case, the agreement provided for reduction only in the
event the divorced wife remarried. The court stated that

															"[t]he fortuitous or incidental mention of a figure in a
provision meant to be inoperative, unless some more or less
probable future event occurs, will not suffice to shift the tax
burden from the wife to the husband."

															240 F.2d at 588.

															MR. JUSTICE DOUGLAS, concurring.

															While I join the opinion of the Court, I add a few words. In an
early income tax case, Mr. Justice Holmes said "Men must turn
square corners when they deal with the Government." Rock
Island, A. & L. R. Co. v. United States, 254 U.
S. 141 , 254 U. S. 143 . The
revenue laws have become so complicated and intricate that I think
the Government, in moving against the citizen, should also turn
square corners. The Act, 1939 I.R.C. § 22(k), makes taxable to the
husband that part of alimony payments "which the terms of the
decree or written instrument fix, in terms of an amount of money or
a portion of the payment, as a sum" payable for support of minor
children.

															I agree with the Court that this agreement did not "fix" any
such amount. To be sure, an amount payable in Page 366 U. S. 307 support of minor children may be inferred from the proviso that
one-sixth of the payment shall no longer be due, if the children
marry, become emancipated, or die. But Congress, in enacting this
law, realized that some portion of alimony taxable to the wife
might be used for support of the children, as the opinion of the
Court makes clear.

															The present agreement makes no specific designation of the
portion that is intended for the support of the children. It is not
enough to say that the sum can be computed. Congress drew a clear
line when it used the word "fix." Resort to litigation, rather than
to Congress, for a change in the law is too often the temptation of
government, which has a longer purse and more endurance than any
taxpayer.

Summary: The Supreme Court held that a written agreement must explicitly designate the amounts or portions of periodic payments to a divorced spouse that are for child support, and cannot leave such amounts to inference or conjecture, in order for those amounts to be excluded from the spouse's gross income under the Internal Revenue Code.