Dunkle, D. S.

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Taxation -- The Tax Benefit Rule of Perry Overruled

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NORTH CAROLINA LAW REVIEWVolume 46 | Number 4 Article 236-1-1968Taxation -- The Tax Benefit Rule of PerryOverruledD. S. DunkleFollow this and additional works at: http://scholarship.law.unc.edu/nclrPart of the Law CommonsThis Note is brought to you for free and open access by Carolina Law Scholarship Repository. It has been accepted for inclusion in North Carolina LawReview by an authorized editor of Carolina Law Scholarship Repository. For more information, please contact law_repository@unc.edu.Recommended CitationD. S. Dunkle, Taxation -- The Tax Benefit Rule of Perry Overruled, 46 N.C. L. Rev. 995 (1968).Available at: http://scholarship.law.unc.edu/nclr/vol46/iss4/23TAX BENEFIT RULETaxation-The Tax Benefit Rule of Perry OverruledIn Alice Phelan Sullivan Corporation v. United States' taxpayer,a California corporation, received two parcels of land, each of whichit had previously donated and claimed as a charitable deduction.'The first donation, valued at 4,243.49 dollars, was made in 1939;the second, valued at 4,463.44 dollars, was made in 1940. Underthe tax rates applicable in those years,' the claimed deductionsresulted in an aggregate tax benefit of 1,877.49 dollars to taxpayer.The conveyances, however, were made subject to the condition thatthe realty be used either for religious or educational purposes. In1957 the donee decided not to use the property and therefore re-conveyed it to taxpayer. The Commissioner of Internal Revenue,characterizing the reconveyances as taxable at the 1957 corporaterate,4 included in taxpayer's gross income the amount of 8,706.93dollars-the value of the charitable deductions previously claimedand allowed.6 Relying on Perry v. United States,7 taxpayer paidand sued for refunds in the Court of Claims on the theory thatthe reconveyances constituted a return of capital' and that a properassessment could require no more than payment to the governmentof the tax benefit originally obtained.Y0 The court held that recovery'381 F.2d 399 (Ct. Cl. 1967).'See INT. REv. CODE of 1954, § 170.8 The corporate tax rate in 1939 was 18 per cent; in 1940, 24 per cent.'The applicable corporate tax rate in 1957 was 52 per cent.'This resulted in a deficiency assessment of 4,527.60 dollars.Gross income normally includes only the amount of the previous de-duction regardless of any increase in value. See Buck Glass Co. v. Hoffer-bert, 176 F.2d 250 (4th Cir. 1949); Commissioner v. First State Bank,168 F.2d 1004 (5th Cir. 1948); Crabb v. Commissioner, 119 F.2d 772 (5thCir. 1941); Perry v. United States, 160 F. Supp. 270 (Ct. Cl. 1958)." 160 F. Supp. 270 (Ct. Cl. 1958). In this case taxpayers in 1944, 1945,1946, 1947, and 1948 made charitable gifts of cash and securities to a townfor the purpose of constructing an addition to a library. Taxpayers de-ducted the appropriate amount from their gross income each year. In 1953the gifts were returned to taxpayers. It was held that taxpayers shouldhave added to their income tax the amount by which their income taxes inprevious years had been decreased.'The amount of the refund sought was 2,650.11 dollars.' See Perry v. United States, 160 F. Supp. 270, 271 (Ct. Cl. 1958), inwhich the court stated: "As stated, the return to the taxpayer of the propertyhe had tried to give away cannot possibly be considered as income-hemerely got back his own property.""" That is, 1,877.49 dollars instead of the Commissioner's assessment of4,527.60 dollars,1968]NORTH CAROLINA LAW REVIEWof charitable contributions for which full tax benefit had been en-joyed is properly classified as income taxable at the current rateat the time of recovery. The Perry decision, with its new taxbenefit rule, 1 was expressly overruled.' However, Judge Collins,even though writing the opinion for the court, criticized the hold-ing.'3 Upon examination of the law and scrutiny of the court'sreasoning, it is justifiable to conclude that the decision is morelegally correct than equitably just.14The recovery of charitable contributions removes the equitablebasis' 5 upon which previous deductions were taken. The rule re-quiring taxation of such recoveries 16 or an appropriate adjustment 7in favor of the government is necessary to prevent the unjust en-richment of a taxpayer and to offset the tax benefit of deductionswhich subsequent facts have rendered unwarranted.' Recoverieshave been taxed as income under the theory that since deducteditems result in the non-taxation of a part of gross income, these'The Perry Case set forth what has been called the "new tax benefitrule" or the "tax dollar benefit rule." That is, a taxpayer who recoversgifts is required to add to his income tax in the year of recovery no morethan the amount of taxes saved in prior years due to charitable contributiondeductions. See 33 TuL. L. Rxv. 247 (1959)."2 Concluding its opinion, the court says:Since taxpayer in this case did obtain full tax benefit from its earlierdeductions, those deductions were properly classified as income uponrecoupment and must be taxed as such. This can mean nothing lessthan the application of that tax rate which is in effect during the yearin which the recovered item is recognized as a factor of income.381 F.2d 399, 403 (Ct. Cl. 1967)."In the words of judge Collins,This opinion represents the views of the majority and compiles withexisting law and decisions. However, in the writer's personal opinion,it produces a harsh and inequitable result. Perhaps, it exemplifies asituation 'where the letter of the law killeth; the spirit giveth life.'Id. at 403, n.5.1, In the instant case, the court says of Perry that "it achieved a resultwhich was more equitably just than legally correct." Id. at 403.13 See INT. REv. CODE of 1954, § 170.'6 See Rothensies v. Electric Storage Battery Co., 329 U.S. 296 (1946);Estate of Block v. Commissioner, 39 B.T.A. 338 (1939), aff'd sub liom.Union Trust Co. v. Commissioner, 111 F.2d 60 (7th Cir. 1940), cert. denied,311 U.S. 658 (1940).1? See Perry v United States, 160 F. Supp. 270 (Ct. Cl. 1958).18 See Plumb, The Tax Benefit Rule Today, 57 HARV. L. REV. 129, 176(1943).19 See National Bank of Commerce v. Commissioner, 115 F.2d 875 (9thCir. 1940); Estate of Collins, 46 B.T.A. 765 (1942). But see, Helveringv. State-Planters Bank & Trust Co., 130 F.2d 44 (4th Cir. 1942), whereanother theory relying on estoppel or implied waiver is set forth.[Vol. 46TAX BENEFIT RULEitems when recovered must stand in the place of the gross incomewhich previously escaped taxation.' " The lack of adequate statutorytreatment of recoveries, however, has lead to extensive litigation.20The only exception to the taxation of recoveries is found inthe equitable tax benefit rule"' whereby recovered items may beexcluded from income so long as their previous deduction did notprovide a tax saving.2" Initially, the rule was not accepted unani-mously, some courts adopting the view that a recovery of a deducteditem is includible in taxable income regardless of whether the de-duction resulted in a tax benefit.23 However, the tax benefit ruleachieved limited statutory recognition in 1942.4 Moreover, itsoverall equitable policy was guaranteed expanded recognition bythe Supreme Court in Dobson v. Commissioner.5 Today the taxbenefit rule has been broadened by both the Internal Revenue Codeof 195426 and by the Income Tax Regulations.27 The goal of thetax benefit rule has been regarded as commendable by both courts2 1and writers.2 9In denying taxpayer's claim in the instant case the court rightlydetermined that the present regulations on the tax benefit rule con-trolled the tax consequences of the recovery of charitable contribu-tions.3" The principle applies not only to bad debts, prior taxes and20 For collected cases see 1 J. MERTENS 1962 FEDERAL INCOME TAXATION§§ 7.34-7.37.2 See Dobson v. Commissioner, 320 U.S. 489 (1943).22 See Lassen, The Tax Benefit Rule and Related Problems, 20 TAXEs 473(1942) ; Plumb, The Tax Benefit Ride Today, 57 HARV. L. REv. 129 (1943);33 TUL. L. REv. 247 (1959); 44 VA. L. REv. 639 (1958)."'See Commissioner v. United States & Int'l Sec. Corp., 130 F.2d894 (3d Cir. 1942), modified, 138 F.2d 416 (3d Cir. 1943).2 INT. REV. CODE of 1939, § 22(b) (12), added by 56 STAT. 812 (1942).The statute applied to only bad debts, prior taxes and delinquency amounts.2320 U.S. 489 (1943)." INT. REV. CODE of 1954, § 111. See also INT. REV. CODE of 1954, §1016(a) (2), which makes the tax benefit rule applicable to excessive deduc-tions based upon wear and tear, amortization, obsolescence and depletion.2 TREAs. REG., § 1.111-1 (1956)."8 See Dobson v. Commissioner, 320 U.S. 489 (1943); California Ha-waiian Sugar Ref. Corp. v. United States, 311 F.2d 235 (Ct. Cl. 1962)." See Eustice, Cancellation of Indebtedness and the Federaf IncomeTax: A Problem of Creeping Confwsion, 14 TAx L. REv. 225, 252 (1959),where it is said: "The role of the tax-benefit doctrine as an approach totaxability in the cancellation of indebtedness area has been far from clear.As a general proposition, the theory seems logical and fair. . . ." See alsoLassen, The Tax Benefit Rule and Related Problems, 20 TAXES 473 (1942);Plumb, The Tax Benefit Ride Today, 57 HARV. L. REv. 129 (1943).The court said:Drawing our attention to the broad language of this regulation1968]NORTH CAROLINA LAW REVIEWdelinquency amounts,3 but also "to all other losses, expenditures, andaccruals made the basis of deductions from gross income for prior tax-able years."32 In applying the principle the court rejected taxpayer'sargument that the reconveyances represented merely the return ofcapital. In doing so it relied upon the authority of numerous cases3"and also the reasoning expressed in the dissenting opinion of thePerry case to the effect that "[h]aving been written off, the laterrealization of the claim was, again for tax purposes, like a windfallto the taxpayer, and within the broad definition of taxable income." 4But for the fact that taxpayer deducted the value of the contributionsfrom his gross income, it is difficult to see why the return to taxpayerof property he had given away is income.Y5 In any event, the labelplaced on the reconveyances should not be controlling as to theequitable tax consequences.The primary point of controversy between the government andtaxpayer arises because the tax benefit statute 8 and the income taxregulations37 are silent as to the tax rate applicable to recoveries.38Taxpayer suggested that the fair solution would be to add theamount of tax saved in previous years due to the gift deductionsto its tax for the year in which the property was returned. Thus,the precise amount of the tax benefit enjoyed would be restored tothe government.39 This equitable solution was rejected by the court[TREAs. REG., § 1.111-1], the Government insists that the present re-covery must find its place within the scope of the regulation and, assuch, should be taxed in a manner consistent with the treatment pro-vided for like items of recovery, i.e., that it be taxed at the rate pre-vailing in the year of recovery. We are compelled to agree.381 F.2d 399, 402 (Ct. Cl. 1967)." INT. REv. CODE of 1954, § 111."2TREAS. REG. § 1.111-1 (1956)." Rothensies v. Electric Storage Battery Co., 329 U.S. 296 (1946);California & Hawaiian Sugar Ref. Corp. v. United States, 311 F.2d 235(Ct. Cl. 1962); Citizens Fed. Say. & Loan Ass'n v. United States, 290 F.2d932 (Ct. Cl. 1961) ; Estate of Block v. Commissioner, 39 B.T.A. 338 (1939),aff'd sub norn. Union Trust Co. v. Commissioner, 111 F.2d 60 (7th Cir.1940), cert. denied, 311 U.S. 658 (1940)." Perry v. United States, 160 F. Supp. 270, 273 (Ct. Cl. 1958).I51d. at 271."See note 32 supra.' See note 27 supra.28 See definition of "recovery exclusion" in INT. REV. CODE of 1954, §111(b) (4)."9 For a good discussion, see Pavenstedt, The United States Court ofClai4s as a Forum for Tax Cases, 15 TAx L. Rnv. 201 (1960).[Vol. 46TAX BENEFIT RULEon the ground that it exceeded the legal limits of both statutoryand judge-made law.4" In arriving at its decision to tax the re-coveries at the current rate in the year of recovery, the court reliedupon such policy considerations as annual accounting, 41 the statuteof limitations, 42 general administrative ease,43 and the lack of judicialpower to legislate.44 Strong as these policy considerations are, theyshould not outweigh the need for justice. The court's interpretationof the present tax benefit rule necessarily promotes injustice.4 ' Therecoveries, for example, may come in a year of high income so thatthe taxpayer pays a much greater tax on the recoveries than hesaved by the deductions. Also, the recoveries may come in yearswhen tax rates have increased. Moreover, the inclusion in one yearof deductions taken in several years inevitably pushes the tax-payer into a higher tax bracket. 6 This is not to say, however,that the present tax benefit rule cannot work in favor of the tax-payer 47 although the odds are against it. To remedy this injusticethe taxpayer could file an amended return for the year in which"o See Bird v. United States, 241 F.2d 516 (1st Cir. 1957); FriehoferBaking Co. v. Commissioner, 151 F.2d 383 (3d Cir. 1945); Boehm v. Com-missioner, 146 F.2d 553 (2d Cir. 1945); Ben Bimberg & Co., Inc. v. Helver-ing, 126 F.2d 412 (2d Cir. 1942); Universal, Inc. v. Commissioner, 109F.2d 616 (7th Cir. 1940); National Forge & Ordnance Co. v. United States,151 F. Supp. 937 (Ct. Cl. 1957); United States v. Detroit Moulding Corp.,56 F. Supp. 754 (E.D. Mich. 1944); H. Sheldon Mfg. Co. v. Commissioner,13 B.T.A. 1296 (1928); Birmingham Terminal Co. v. Commissioner, 17T.C. 1011 (1951). See also S. SuRREY & W. WARREN, FEDERAL INCOMETAXATION 538 (1960); J. MERTENS, FEDERAL INCOME TAXATION § 7.37(1962); Rev. Rul. 59-141, 1959-1 Cum. BULL. 17." INT. REV. CODE of 1954, § 441. See also Burnet v. Sanford & BrooksCo., 282 U.S. 359, 365 (1931), where the court said:It is the essence of any system of taxation that it should producerevenue ascertainable, and payable to the government, at regular in-tervals. Only by such a system is it practicable to produce a regularflow of income and apply methods of accounting, assessment, and col-lection capable of practical operation.I2 TNT. REv. CODE Of 1954, § 6511."See cases cited in note 40 supra.""[T]he court cannot legislate and any change in the existing lawrests within the wisdom and discretion of the Congress." 381 F.2d 399, 403(Ct. Cl. 1967)." See Plumb, The Tax Benefit Ride Today, 57 HAumv. L. REv. 129, 176-77 (1943)."This, of course, is less likely in the case of a corporate taxpayer.The taxpayer would benefit if the deduction was taken in a profitableyear, while the recovery came in a loss year or a year of low income or in ayear when tax rates were lower. See Inland Prod. Co v. Blair, 31 F.2d867 (4th Cir. 1929).1968]NORTH CAROLINA LAW REVIEWthe deduction was allowed thereby making a fair adjustment withthe government. 48Although the remedy of an amended return would violate theconcepts of annual accounting and undoubtedly would cause someadministrative inconvenience, such drawbacks have never preventedchange.49 The tax benefit rule itself deviates from the concept ofannual accounting. 0 Congress, in the name of equity, has deviatedfrom the statute of limitations and annual accounting and has ac-cepted administrative inconvenience by enacting provisions coveringthe carryover-carryback of losses, 1 recoveries from unconstitutionalprocessing of taxes,52 inconsistently treated items, 53 and periods ofabnormally high income.5 4 To allow an amended return for re-coveries of charitable contributions would be no greater departure.If the court was correct in its holding that judicial legislation'5cannot go as far as the taxpayer wished, it is submitted that Con-gress should reevaluate the tax benefit rule. Legislation grantingthe taxpayer an option to account for the recovery of a charitablecontribution in the year of recovery or to file an amended returnfor a previous year would not only achieve substantial justice,50 butalso would promote public policy by encouraging taxpayers to makecontributions to charity.5" D. S. DUNIrE" See, Plumb, The Tax Benefit Rule Today, 57 HARV. L. REV. 129, 177(1943).4Id. at 178-79."0 See Hearings Before House Ways and Means Committee on RevenueRevision of 1942, 77th Cong., 2d Sess., Vol. I, 80, 87-88 (1942).1 See INT. REV. CODE Of 1954, § 172(b).11Id. § 1346.r"Id. § 1311."Id. at 1301-1304."See Commissioner v. Beck's Estate, 129 F.2d 243, 245 (2d Cir. 1942),where the court said:Judicial legislation is one of the facts of life, an inescapable and neces-sary one. But courts may not, as legislatures may, roam at large,confined only by the Constitution; their function, when dealing withlegislative legislation, does not go beyond that of filling in small gapsleft by the legislature-and to closing those gaps in accordance withwhat appears to have been the legislative purpose." Although some may not agree that granting an option to the taxpayerachieves substantial justice, this would be in accord with other sections ofthe Code, such as section 1341."' For additional discussions of the tax benefit rule, see Eustice, Cancel-lation of Indebtedness and the Federal Income Tax: A Problem of CreepingConfusion, 14 TAx L. REv. 225 (1959); Lassen, The Tax Benefit Rule andRelated Problems, 20 TAXES 473 (1942); Pavenstedt, The United StatesCourt of Claims as a Forum for Tax Cases, 15 TAx L. REv. 201 (1960) ;Plumb, The Tax Benefit Rule Today, 57 HARv. L. REv. 129 (1943); 33Tui. L. Rav. 247 (1959); 44 VA. L. REv. 639 (1958).1000 [Vol. 46

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Taxation -- The Tax Benefit Rule of Perry Overruled

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