1180 E. 63RD ST. BLDG. v. COMMR. OF INTERNAL REVENUE, 12 T.C. 437 (1949)


Docket No. 15731.United States Tax Court.
Promulgated March 25, 1949.

Petitioner, on accrual basis, in 1936 acquired fee title to a building and part of land on which it was erected, at which time real estate taxes on the property were delinquent; after acquisition further real estate taxes assessed against the property were not paid in full. In 1942 delinquent taxes, penalties, and interest exceeded $55,000. By agreement between the state’s attorney and petitioner, a tax foreclosure suit was brought and property was sold to petitioner’s nominee for $24,000, from whom petitioner redeemed at the same figure; and, in separate proceedings, petitioner enjoined the county from collecting the balance. Respondent increased petitioner’s gross income for 1942 by $6,340.42, being the portion of unpaid taxes and interest the deduction of which in 1939 and 1940 accorded petitioner a tax benefit. Held, under the facts, respondent’s action is approved, as there was practical extinguishment of petitioner’s liability for delinquent taxes as a result of the various court proceedings and the general practice, and such extinguishment was not voluntary and gratuitous cancellation of its indebtedness.

J. Roy Browning, Esq., for the petitioner.

Jackson L. Boughner, Esq., for the respondent.

Respondent determined income tax deficiencies for the years 1941 and 1942 in the respective amounts of $672.52 and $2,392.45. By stipulation, it has been agreed that there is a deficiency in income tax for 1941 in the amount of $529.87. All adjustments but one made by the respondent for the year 1942 have also been settled by stipulation. Consequently, only part of the deficiency for 1942 is in question.

The sole issue presented is whether respondent erred in increasing petitioner’s gross income for 1942 by $6,340.42, such adjustment having been made by the respondent under the tax benefit principle recited in Internal Revenue Code section22 (b) (12).

Respondent’s action was predicated on the proposition that, “as an incident to the foreclosure sale of * * * [petitioner’s] real property during that year to enforce tax liens thereon arising from delinquent taxes and interest for 1940 and prior years,” petitioner’s tax liability was finally settled for a sum less than the amounts accrued on its books for real estate taxes in the earlier years and claimed as deductions on its returns, by which accruals and deductions it received a tax benefit in the years 1939 and 1940.

Petitioner’s attack on respondent’s action is in the alternative. It first urges that as a result of the court actions only its in rem liability for unpaid taxes and interest was discharged, and that there still remained an enforceable personal liability. Secondly, it contends that,Page 438
even if its personal liability were also discharged, the discharge of the unpaid amounts was a voluntary and gratuitous cancellation of its indebtedness and hence nontaxable.

Petitioner apparently recognizes that if the two points it urges are decided adversely to it the tax benefit principle is applicable, and that the amount respondent seeks to add to its gross income for 1942 is correct.

Some of the facts have been stipulated.

The stipulated facts are hereby found accordingly and are incorporated herein by this reference.

Petitioner, an Illinois corporation, was incorporated on May 30, 1935, for the purpose of acquiring title to a building formerly owned by the Woodlawn Trust Savings Bank, title to which petitioner acquired on November 1, 1936. For the years 1936 to 1942 petitioner kept its books and records and filed its income tax returns on the accrual method of accounting. Returns were filed with the collector at Chicago, Illinois.

The building which petitioner acquired in 1936 was erected on lots 2, 3, and 4, in Wright’s Subdivision, Chicago, Cook County, Illinois. The legal title to lots 2 and 3, on which one-half of the building, in size and value rested, was acquired in fee at the same time as the building was acquired. Lot 4, on which the other one-half of the building was erected, had been leased to petitioner’s predecessor in title for 99 years, and at the time petitioner acquired title to the building and lots 2 and 3 it also acquired the lessee’s interest in the 99-year lease. The lease so acquired provided that the lessee pay all real estate taxes levied on the leasehold during the period of the lease. At a later time, in September 1941, petitioner did acquire by purchase the fee title to lot 4. The conveyance was made subject to all unpaid general taxes, special assessments, special taxes, and tax sales and forfeitures, and to all suits or proceedings pending in any court to enforce the payment of unpaid general taxes. At the time of the conveyance the lessors released petitioner from all claims under the lease.

For real estate tax purposes the tax assessor for Cook County valued the building separately and apart from the land on which it was erected. Although petitioner owned only part of the land in fee, all real estate taxes on the premises were assessed in the name of petitioner as owner, and all such taxes were carried on petitioner’s books as a single account entitled “Real Estate Taxes.” The total real estate tax assessments against the property were considered as being divided as follows: Building, 89%; lots 2 and 3, 5 1/2%; and lot 4, 5 1/2%.

At the time of the acquisition of the building by petitioner in NovemberPage 439
1936, real estate taxes levied and assessed against the real estate were delinquent for 1936 and for certain prior years. Between November 1, 1936, and April 7, 1942, petitioner paid only a portion of the delinquent taxes and paid only a portion of the taxes levied against the real estate for the period between November 1936 and the end of 1940. As of April 7, 1942, the total amount of real estate taxes, interest, penalties, costs, and fees for the year 1940 and previous years aggregated $55,915.42.

As a result of the depression, there were over 1,000,000 parcels of real estate in Cook County which were delinquent in real estate taxes. The county officials, particularly the state’s attorney, who were charged with the enforcement of the collection of taxes, decided to invoke the foreclosure provisions of the applicable Illinois revenue laws and to foreclose the lien which the state had for taxes against the delinquent parcels. A procedure was devised whereby the owner, or others interested in a particular parcel, would guarantee that in the event a sale was ordered by the state court a minimum bid in an amount previously agreed upon between the owner and the state’s attorney would be made in order that the state could realize some remuneration for delinquent taxes, and further that the property could thereby be returned to the taxing rolls free of the state’s tax lien against it.

Prior to the establishment of this practice, the usual method of collecting delinquent taxes had been by an action of debt against the owner of the property.

In 1942 petitioner and the state’s attorney entered into an agreement under the foreclosure practice that was then being followed that it would cause a bid of $24,000 to be made if the state filed suit to foreclose its lien for the unpaid taxes, penalties, and other charges then totaling in excess of $55,000.

Pursuant to this agreement, the state’s attorney filed a complaint on behalf of the state in the Circuit Court of Cook County to foreclose its lien of $55,915.42. A decree was entered on April 7, 1942, determining, among other things, that the amount of the lien was $55,915.42, and ordering that the property be sold to satisfy such lien. It was further ordered that no bids in an amount less than $24,000 be accepted.

The property was thereafter sold for $24,000 to petitioner’s nominee, from whom petitioner redeemed on June 30, 1942. In connection with the foreclosure proceedings and the redemption therefrom, petitioner expended the sum of $5,923.64 for attorney’s fees and costs.

After the entry of the foreclosure decree and the sale, and as an apparent part of the procedure then in vogue, petitioner filed in the Circuit Court of Cook County a complaint in chancery for injunction against the county and the certain designated county officials, including the state’s attorney, to enjoin them from collecting or attemptingPage 440
to collect any additional general real estate taxes, interest, penalties, fees, and costs out of the real estate herein involved for the years 1931 to 1933, and 1935 to 1940. Petitioner prayed for a decree enjoining the county and county officials from attempting such collection. On June 23, 1942, a decree and injunction order, as prayed, was entered, in which it was recited in part, as follows:

That all of the liens for general taxes assessed against the above described real estate, together with interest, penalties, forfeiture fees and costs, for the years 1931 to 1933 both inclusive and 1935 to 1940, both inclusive, have been extinguished and discharged.

IT IS THEREFORE DECREED, that JOHN TOMAN, County Treasurer and Ex-Officio County Collector of Cook County, MICHAEL J. FLYNN, County Clerk of Cook County, THOMAS J. COURTNEY, State’s Attorney of Cook County, and THE COUNTY OF COOK, a Municipal Corporation, and all persons acting under them or in their behalf, are hereby perpetually enjoined and restrained for collecting or attempting to collect, in any manner whatsoever, any additional general real estate taxes, interests, penalties, forfeiture fees and costs, out of the real estate involved herein, or any part thereof for the years 1931 to 1933, both inclusive, and 1935 to 1940, both inclusive, and that a writ of injunction issue out of this Court in conformity with this decree.

The state’s attorney has not attempted collection of any unpaid taxes, interest, penalties, and costs after a forfeiture foreclosure sale followed by a decree enjoining collection thereof, and has adopted the policy of not undertaking such suits.

The portions of the $24,000 paid by petitioner in 1942 allocable to the 1939 and 1940 real estate taxes and interest accruing in those years on delinquent taxes are $1,991.52 for 1939 and $2,776.32 for 1940. The unpaid balance of taxes and interest for 1939 was $2,648.47 and for 1940, $3,691.95.

On its tax returns for each of the years 1939 and 1940, petitioner reported a net loss. For 1939 it was in the amount of $4,507.20; for 1940, it was in the amount of $1,523. Petitioner actually had net income in 1939 of $2,138.35, and a net loss in 1940 of $701.32.[fn1]

In arriving at the net loss for 1939 as shown on its return, petitioner deducted from gross income the sum of $10,410.12 as real estate taxes on the real estate herein involved for the year 1939, and the sum of $4,530.65 for interest accrued during that year on delinquent real estate taxes on the same property for prior years. The amount deducted for real estate taxes was an estimate based upon the assessment for the prior year, inasmuch as the amount assessed for 1939 was not definitely ascertainable until after the income tax return was due. The original real estate tax assessment for 1939 amounted to only $9,216.50. This was protested by petitioner, with the result that it was reduced by the county’s board of tax appeals to $5,438.86, of whichPage 441
petitioner paid $3,980.39 during 1940. The interest deduction was likewise an estimate, and the actual interest accrued by the county was $3,198.48.

In arriving at its net loss for 1940 as shown on its return, petitioner deducted from gross income the sum of $5,438.86 for real estate taxes for the year 1940, and the sum of $4,380.79 for interest accruing in 1940 on delinquent real estate taxes levied and assessed against the premises for prior years. Both of these amounts were estimates, inasmuch as the actual amounts for the year 1940 were not ascertainable until after the income tax return was due. The amount of real estate taxes actually assessed for the year 1940 was $5,695.93. The actual interest accrued by the county was $3,644.16. In 1941 petitioner paid $2,841.42 on its 1940 real estate taxes.

In its balance sheet as of January 1, 1942, petitioner showed as assets land and building at a total cost of $254,100, and as a liability estimated accrued real estate taxes in the amount of $61,551.84. Included in this amount were taxes for the year 1941 of $6,341.82, leaving a balance consisting of delinquent taxes and interest thereon of $55,210.02. After the payment of the $24,000 in satisfaction of its then delinquent taxes, petitioner debited that sum to its account entitled “Estimated Accrued Real Estate Taxes.” There remained a balance of $31,210.02, exclusive of the $6,341.82 for 1941 taxes. Of this balance, $24,212.73 was credited to land and building, and the $6,997.29 to surplus, this latter figure being designated on petitioner’s books as “Real Estate Tax Savings.”

At the close of 1942 and thereafter petitioner carried on its books no liability for real estate taxes assessed for any year prior to 1941, or for interest, penalties, costs, or any other items in connection therewith, and it made no payments thereon after the payment of $24,000 in 1942.

The county records indicate that after the payment of $24,000 pursuant to the court proceedings in 1942 there were no taxes, interest, penalties, or costs due for the years 1939 and 1940. The real estate herein involved was not forfeited to the state on account of taxes for those years or for any previous years.

Petitioner received taxable income in the amount of $6,340.42 in 1942, this being the amount of unpaid real estate taxes and interest deducted by petitioner in 1939 and 1940 which gave rise to a tax benefit in those years.

[fn1] The parties stipulated that petitioner is entitled to a net operating loss deduction of this amount from its 1941 gross income.

KERN, Judge:

Petitioner strenuously urges that, although by the various court actions its in rem liability for delinquent real estate taxesPage 442
was satisfied,[fn2] there still remained outstanding its personal liability for such unpaid amounts.[fn3] As a consequence, it argues that it should not be required to report as income that part of the amount of delinquent taxes for 1939 and 1940 which were accrued as deductions in each of those years and which resulted in tax savings, for until all liability therefore was extinguished[fn4] there could be no tax benefit under section 22 (b) (12) of the Internal Revenue Code.[fn5]

Respondent contends that by the foreclosure proceeding more than the petitioner’s in rem liability was extinguished. He argues that under applicable Illinois law petitioner could, under no circumstances, be liable for over one-half the taxes, since it was the fee owner of only one-half of the real estate; that it is extremely doubtful that any personal liability survived; that if it did survive the foreclosure proceeding it did not survive the injunction proceeding; and that, in any event, assuming that any personal liability is extant, the possibility of action for recovery being undertaken is so contingent, speculative, and remote that for all practical purposes it must be concluded that it does not exist.

The parties have not cited, nor have we been able to discover, any convincing authorities on whether in Illinois a personal action for delinquent taxes survives a foreclosure proceeding and redemptionPage 443
therefrom.[fn6] The problem here is further complicated by the subsequent injunction proceeding and court decree enjoining the collection of further delinquent taxes out of the property.[fn7]
Certain principles have, however, been established by the Illinois courts, and certain requirements under the statutes must be met which underscore the improbability of the existence of a right in the taxing body to bring a personal action for delinquent taxes under the facts presented to us. First, it has been held that section 275 of the Illinois Revenue Act[fn8]
“provides the exclusive methods of enforcing an owner’s personal liability for real estate taxes.” School District No.88 v. Kooper, 380 Ill. 68; 43 N.E.2d 542. Second, in the construction of the state taxing statutes, where doubt as to meaning and scope exists, “They must be construed strictly against the Government and in favor of the taxpayer, and will not be extended by implication.” French v. Toman, 375 Ill. 389;31 N.E.2d 801. And, third, the statute itself sets up certain conditions that must obtain before suit for personal judgment could be brought; there must be, under the statute, an “amount due for taxes * * * on forfeited property.”

The county records, to which reference would be made to determine whether there were unpaid taxes due, would reveal in this instance that there were no unpaid taxes due for 1939 and 1940. The county clerk “has the power to cause his records to show a tax paid. He is a public officer and is presumed to perform his duty. * * * He is conclusively presumed to have complied with the law * * *.” Jackson Park Hospital Co. v.Courtney, 364 Ill. 497; 4 N.E.2d 864. Moreover, there appears to be no compliance with the requirement that forfeiture must be established to sustain a suit in personam.Smith v. People, 3 Ill. App. 380. After its redemption by petitioner, this property was no longer “forfeited property.” Cf. People v. Henckler, 137 Ill. 580; 27 N.E. 602. Neither of the conditions precedent, as recited in the statute, appear to be established.

The absence of any controlling authorities on the point is explicable because of the policy of the state’s attorney in not essaying to commence actions for personal liability after foreclosure, sale, and issuance of an injunction decree.Page 444

Even if we were to assume, arguendo, favorably to petitioner, upon this murky question of law and consider that the extinguishment of in rem liability by the foreclosure and sale did not extinguish every vestige of personal liability, it is manifest that under Illinois law and practice whatever liability could be said to have remained was gossamer and flimsy, and for practical purposes was nonexistent.[fn9]
Particularly is this so where the state’s attorney has never attempted collection of unpaid taxes after a foreclosure sale followed by a decree enjoining collection, and has adopted the policy of not attempting such suits. It then must follow that in 1942 there was “enough objective probability that the amount would be retained to justify an accrual of the income involved.” Magill, Taxable Income (Rev. Ed.), p. 206. NorthAmerican Oil Consolidated v. Burnet, 286 U.S. 417. At best, only a remotely contingent liability to pay additional amounts for 1939 and 1940 real estate taxes could be said to remain; and income “subject only to an unliquidated contingent liability” must be returned for Federal income tax purposes. D.H. Byrd, 32 B. T. A. 568. See also George Hyatt,36 B. T. A. 121; Boston Consolidated Gas Co., 44 B. T. A. 793; affirmed on this issue, 128 F.2d 473.

Petitioner’s own actions in 1942 lend further support to this view. Although bookkeeping entries are generally not controlling in the determination of when an item of income is accruable, Helvering v. Midland Mutual Life Insurance Co.,300 U.S. 216, 223, they have been accorded vital significance in situations similar in principle to that presented to us. Book entries charging unclaimed wages, overcharges, and deposits to profit and loss or to surplus were given determinative effect in Chicago, Rock Island Pacific Ry. Co. v. Commissioner
(CCA-7), 47 F.2d 990; certiorari denied, 284 U.S. 618, inCharleston Western Carolina Railway Co. v. Burnet (App. D.C.), 50 F.2d 342, and in Boston Consolidated Gas Co.,supra. See 2 Mertens, Law of Federal Income Taxation, § 12.77. In 1942 petitioner wiped from its books its liability for delinquent taxes for 1939 and 1940, and increased its surplus account thereby. This was apparently done with the realization that for all practical purposes such liability ceased. Equally significant is the action of petitioner in expending approximately $6,000 in fees and costs in the court actions, seeking the settlement of its delinquent tax liability. If petitioner were not convinced that its liability was erased, it is improbable that it would have expended such sum in the court actions in 1942. The sum would have been better utilized in reducing the liability which it now seeks to have us find.Page 445

Petitioner next urges that, if all liability was actually extinguished, then under the doctrine of Helvering v. AmericanDental Co., 318 U.S. 322, the unpaid balance of real estate taxes was canceled or forgiven voluntarily and gratuitously, and, therefore, it was not taxable income. Assuming, contrary to petitioner’s argument under the principal issue, that the real estate tax debt was discharged in full, we are of the opinion that, under the facts, the principle of the AmericanDental case is inapplicable, and that this phase of the proceeding falls within the ambit of Commissioner v. Jacobson,336 U.S. 28. The only provision of the code under which the discharged tax debt could be excluded from petitioner’s income would be section 22 (b) (3), which formed the basis of the opinion in the American Dental case. The Jacobson case materially assists in assaying the meaning and scope of that section, particularly in its relationship to section 22 (a) of the code.[fn10] It was there observed:

* * * Both the general provision for taxation of income and this provision for the exclusion of gifts from gross income, for income tax purposes, have been in the Federal Income Tax Acts in substantially their present form since the Revenue Act of 1916. The contrast between the provisions is striking. The income tax is described in sweeping terms and should be broadly construed in accordance with an obvious purpose to tax income comprehensively. The exemptions, on the other hand, are specifically stated and should be construed with restraint in the light of the same policy. * * *

We learn further from the Jacobson case that, before there can be a discharge or cancellation cognizable under section 22 (b) (3), there must be discovered an “intent * * * to make a gift in contradiction of the natural implications arising” from the transaction under review, and that “The situation in each transaction is a factual one.”

Not only the “natural implications,” but the facts themselves buttress our conclusion that, if there was a complete discharge of liability, it was not a “release of something * * * for nothing” and it was not “gratuitous.” Helvering v. AmericanDental Co., supra. In addition, it may be pointed out that the ultimate discharge resulted not alone from negotiations between petitioner and the taxing authorities, but also from the court proceedings. Cf. Annis Van Nuys Schweppe, 8 T.C. 1224; affd.,168 F.2d 284. We also note thePage 446
unlikeliness of officials charged with the collection of state taxes having the intent of making a gift to taxpayers.

Respondent’s action in increasing petitioner’s gross income for 1942 by $6,340.42, under the provisions of section 22 (b) (12), is approved.[fn11] Cf. Hurd Millwork Corporation,44 B. T. A. 786.

Reviewed by the Court.

Decision will be entered under Rule 50.

[fn2] Under Illinois law, the owner of property on the first day of April in any year is liable for the taxes of that year. The taxes upon real property, together with all penalties, interest, and costs that may accrue thereon, are a prior and first lien on the property, which lien may be foreclosed in equity, when taxes for two or more years on the property shall have been forfeited to the state. Jones, Illinois Stat. Ann., 119.525, 119.713, §§ 28, 216.

[fn3] Personal liability for unpaid real estate taxes and the state’s right to sue thereon arises out of Jones, op. cit.,supra, 119.772, § 275, which provides in part, as follows:

“The county board may, at any time, institute suit in a civil action in the name of the People of the State of Illinois in any court of competent jurisdiction for the whole amount due for taxes and special assessments on forfeited property * * *.”

[fn4] In Illinois, action of debt by the people to recover taxes is not barred by the statute of limitations. Greenwood v. Town ofLaSalle, 137 Ill. 225; 26 N.E. 1087; People v. HibernianBanking Assn., 245 Ill. 522; 92 N.E. 305.

[fn5] (b) EXCLUSIONS FROM GROSS INCOME. — The following items shall not be included in gross income and shall be exempt from taxation under this chapter:

* * * * * * *

(12) RECOVERY OF BAD DEBTS, PRIOR TAXES, AND DELINQUENCY AMOUNTS. — Income attributable to the recovery during the taxable year of a bad debt, prior tax, or delinquency amount, to the extent of the amount of the recovery exclusion with respect to such debt, tax, or amount. * * *

* * * * * * *

(B) Definition of Prior Tax. — The term “prior tax” means a tax on account of which a deduction or credit was allowed for a prior taxable year.

* * * * * * *

(D) Definition of Recovery Exclusion. — The term “recovery exclusion”, with respect to a bad debt, prior tax, or delinquency amount, means the amount, determined in accordance with regulations prescribed by the Commissioner with the approval of the Secretary, of the deductions or credits allowed, on account of such bad debt, prior tax, or deliquency amount, which did not result in a reduction of the taxpayer’s tax under this chapter (not including the tax under section 102) or corresponding provisions of prior revenue laws, reduced by the amount excludible in previous taxable years with respect to such debt, tax, or amount under this paragraph.

* * * * * * *

[fn6] Cf. 3 Cooley, The Law of Taxation (4th Ed.), p. 2633: “* * * it is generally held that the remedies are cumulative.”

But cf. People v. Courtney, 380 Ill. 171; 43 N.E.2d 382: “It is also complained that the State’s Attorney did not bring a suit for a personal judgment against defendant * * * or the prior owners of the property in the same proceeding in which the tax lien was foreclosed. We are not convinced from anythingpointed out in appellants’ brief that such an action could betaken, but even if possible, it was still a matter of discretion for the State’s attorney to bring one or several suits to enforce liens or obtain personal judgment to enforce tax delinquencies.” (Italics supplied.)

[fn7] The customary independent injunction suit [is] to clear title following redemption from an equity tax foreclosure.” 19 Chicago Kent L. Rev. 310.

[fn8] The applicable section is set out, in part, in footnote 2,supra.

[fn9] And “Taxation, as it many times has been said, is eminently practical * * *.” Tyler v. United States, 281 U.S. 497, 503.

[fn10] (a) GENERAL DEFINITION. — “Gross income” includes gains, profits and income derived from salaries, wages, or compensation for personal service * * * of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *

Section 22 (b) (3) is to the following effect:

“(b) EXCLUSIONS FROM GROSS INCOME. — The following items shall not be included in gross income and shall be exempt from taxation under this chapter:

“(3) GIFTS, BEQUESTS, DEVISES, AND INHERITANCES. — The value of property acquired by gift, * * *”

[fn11] Regulations 111, sec. 29.22 (b) (12)-1 (a) (2) provides, in part: “Recoveries result from the receipt of amounts in respect of the previously deducted or credited section 22 (b) (12) items, such as * * * refund or credit of taxes paid, or cancellation of taxes accrued * * *.” See H. Rept. No. 2333, 77th Cong., 2d sess., pp. 69, 70:

“The term ‘recovery of a tax’ includes * * * the cancelation of a purported tax liability which was accrued and deducted for a prior taxable year but never previously paid.”