Petitioners Brief — Pierce v. United States (No. 36)

BLANK PAGE:

2s ap RN TRIAL M 5 RELATE ALY REIT MD

Office Soprome Cour, 8. |

NOV 1 1940

OUAALES ELMORE CROPLEY

CLERK

IN THE

Supreme Court of the

Octoser Term, 1940

No. 113

CHESTER GAINES and THERESA GAINES,

Husband and Wife,

| Petitioners,

v.

GUY TJ. HELVERING, Commissioner of Internal

Revenue,

Respondent.

7

On Warr or Certiorakt To THe Unrrep States Omovrr

Court ur APPEALS FOR THE Seconp Creculr.

ed

BRIEF FOR THE PETITIONERS.

Freperick Baum,

Counsel for - Petitioners,

230 Park Avenue,

| New York, N. Y.

BLANK PAGE

INDEX.

PAGE

CRE EDI 05 oa ews cvevecvenncccuccovestesesesdcuccedctecicecs 1

eR CtL Wal ees yu ucbwie covedscaseccdte cea thas ewaweeer 1

Question presented ..............4. Sapa wou dssecaeevedcaen Code heases 2

Statute and Regt‘ations involved ................. ees AILEY 2

Ne av eamUia d eka ceeas oebicas 2

Specification of errors to be urged ..........ccccceeeeeeedeceeesece 3

I OU | ons tue cacck ncccvecepecneuasgeseeencsid Pee 4

Argument : a A

1, The petitioners’ contention is in accord with the evident inten-

MG MNO * Ccaducng cacdcUeninsevensetcensicutindenest 6

2. The reasons and authorities referred to in the majority

opinion in Pierce v. Commissioner, 100 F. (2d) 397, (C.C.A.

2d) do not support the decision ............cccccccececccces 13

3. The administrative construction does not support the Com-

TTD sh bccvancéuseccuusis daucébacetseavdebacs 21

SE See od cols 406 S00 0s 6 abbb SSSR ae raskubusdudeeunceneCoen 25

ST Matha awehd snveedas cucetesune ighisenbacuendwesbecabes ck 26

CITATIONS.

Cases:

ne We DS a ne coi eeeeuegha 20

Burnet v. Sanford & B. Co. 282 U. S. 359, 363, 75 L. &. 383,

ri i On. Ce he Webs cn ch ns nel seat wanes Gawnatihs 18

Commissioner v. Brumder, 82 F. (2d) 944 .........cc0005 16, 17, 22

Commissioner v. Rabenold, 108 F. (2d) 639, 641 ............ 24

Commissioner v. Thomas, 84 F. (2d) 562 ........ccncceeees 16, 17, 22

Commissioner v. Ujihlein, aff'd sub som Commissioner v.

ON, CMR Ge use eh acct cckonent wa 22

Crocker First Nat'l Bank of San Francisco, 26 B. T. A.

EE cans wel senk alee a0 eawe Cech rerber ened oacweew at 20

Demuth v. Commissioner, 100 F. (2d) 1012, certiorari denied,

PE EE is cu'e Cpe ck docosetion’ Judvabueediecctdrlexe 13, 24

Gummey, Frank B., 26 B. T. A. 894 .......ccceccccceees 16, 17, 21, 23

Hill v. United States, 12 F. Supp. 798 (C. Cls.) .......... 17

Janney v. Commissioner, 108 F. (2d), 564, 567 .............. 6, 23, 24

Kaiwiki Sugar Co. v. Burnet, 63 F. (2d) 822, 824 ......... 20

Nelson v. Commissioner, 104 F. (2d) 521 ............0005: 13

Pierce v. Commissioner, 100 F. (2d) 397 ............ 513,14, 15,2

Shelmerdine, William H., 24 B. T. A. 833 ...........0.0005-

Speer v. Cummissioner (decided November 3, 1934 unre-

ported), affirmed per curiam December 16, 1935 ........ 23

Sweet v. Commissioner, 102 F. (2d) 103, certiorari denied 307

BE EE ood kb oc ence abandon S48 Cob 2443 060.0% bn Chdackocke ek 13

Taft v. Helvering, 111 F. (2d) 145, No. 183 this Term, cer-

tiorari granted October 14, 1940 A......... cece cep eeeeeee 14

Uihlein v. Commissioner, 30 B. T. A. 399 now quniing on

Government’s appeal to C. C. A. 7th .............e eee = 23

United States v. Kirby Lumber Co., 284 U. S. 1, 3-.......... 8g

ea Tad

: ”

é Soca Sait pen ba a

po riwnen eh evaibhta bagel oP tae

TAS Pe Sees a ae

et ee

ii

PAGE

United States v. Pleasants, 305 U. S. 357, 360 .............. 10

Van Vieck v. Commissioner, 80 F. (2d) 217, certiorari denied,

ah ns res ued vest sad eheedine Oe aued iu tabsob en. 17, 19, 24

Woolford Realty Co. v. Rose, 286 U. S. 319, 326, 329 ....... 18

Statutes:

Revenue Act of 1921, c. 136, 42 Stat. 227:

OE aU ai pe lwmet fechewerereebsncercace 7.

EN ied AEE a i ceeded ewbdewihadeseseddductdas cces ° 6

Revenue Act of 1924, c. 234, 43 Stat. 253:

le Ne te teehee ee hee ube deekwebbenes 10

oe Oa ee ea oe aa en nates bee's 7

I a ae ceedwekace 6

Revenue Act of 1926, c. 27, 44 Stat. 9:

kt RRO EEA SORET ESS ESE Dns 2 SE Sn eee eae a ee 18

II i St ee cc cikeainécouhbesa ee 7

DCS? “SisndthehGesdeah ch baseeined cunttobnes nctvixtencac 6

ee iuebweybees 18

Revenue Act of 1928, c. 852, 45 Stat. 791

a i es ua céend babe eehece 7

a a eapees 6

Revenue Act of 1932, c. 209, 47 Stat. 169

ESAS ii gre tind oth gs a eens MER yey tae Fee 15

SE 2 nna 7b wih oO a oi Nea aaa are tod bbeh babes vaeanes 7,8, 15, 24

ee i Cee ees SaaS be kia keer en token’ 14

tr UES Séscéneseudenstete 5, 7, 8, 9, 10, 11, 12, 13, 15, 16, 17, 24

EUS © co cs bencbecadasokces seus chaseteaceweanuene 20

EEE =. Du deuudads E86GS6 on eeWete eddie seh Kees cbeeks tees 7

hE Gos we tedudie vacua renedantuteesvas das 4,7, 8, 11, 15,24

DE not caliusGcket Guetebachbaebedevcacevecneoey on 6 10

Revenue Act of 1934, ¢. 277, 48 Stat. 680:

CE. “sale cetstaevone ss suapadesudvscedabaabetecve 4,7, 8,24

DME: fac hecateececk whhateseneeaeyaestobsebeheetseua +

DEE a ook AUaGGiyGlebiavkbnes busca een bab aGuitase 7

i EE: ad biedd eekdvdinteeGhscseevechebscikeckeueden 4, 7,8, 24

SN MEE Gh Gees oes ieee ue aeomieees abba 4, 5, 8, 12, 17, 24

Internal Revenue Code, Section 20(s), 117(e), 122(d) (4) (5) .. 19

Miscellaneous :

ee ER os acdc vecwanewsbearess eden 22

IlI—1 Cum. Bull. 149, I.T. 1997 ............... ietine cca heas 22

AIV—2 Cum. Bull. 196.G6.C.M. 15438 2... cccccccccccccccess 21

1933 C. C. H. Federal Tax Service, Vol. TII, par. 6037 ......

Hearings before Senate Finance Committee, 72d Cong., Ist

a

iii a

ct PAGE i

Op. 90, 4 Cum. Bull. OR. cur ices ostiaunet adware 7

ep. No. 665, 72d Cong., Ist Sess., p. WD cidcsccccumesss? 11

tep. No. 665, 72d Cong., Ist See. 7 cccccncdcvcessse 9

sury Regulations 62, promulgated under the Revenue Act ®

1921:

Art 401 ..cccccccccccccccccvccccccccccccceserscsscssseess 16 :

sury Regulations 77, promulgated under the Revenue Act te

1932: .

Ast, BBL .cccccccccccccccccccccccecccccesccccvecscceses 5, 6, 15, 16

sury Regulations 86, promulgated under the Revenue Act

1934:

Art. Sled ccccccccccccccccccvcvcvcncccccccseccrsscsscenes 21

Ast, 11725 .cccccccvcccccccccccccccccccccaccvcesessccsers 6, 21, 22

|

/

$

PEASE Ve pate ayant ae <n

e ; a :

we seis ‘sammie aD ehNe

esl Nn!

=

cde ve ot art aestleACER SARI: ape

ca

fT AUT Pe oe

PREG SOE ISG TEN

bs ee RS ade a es Be eee Oe Pvt WY Po

ate i x

.

(BLANK PAGE

» Bitar le

Pott Ae Si

IN THE

Supreme Court of the United States

Ocroser Term, 1940

No. 113

cA

CHESTER GAINES and THERESA GAINES,

Husband and Wife,

Petitioners,

v.

GUY T. HELVERING, Commissioner of Internal

Revenue,

: Respondent.

er

On Wrir or Certionani to THe Unirep Srates Orcvuit

_ Court,or APPEALS For THE Seconp Circurrt.

BRIEF FOR THE PETITIONERS.

Opinions Below.

The memorandum opinion of the Board of Tax Appeals

(R. 15) is unreported. The opinion of the Circuit Court

of Appeals is reported at 111 F. (2d) 144.

Jurisdiction. *

The judgment of the Circuit Court of Appegls was en-

tered May 8, 1940 (R. 27). The petition for writ of cer- .

tiorari was filed May 29, 1940, and was granted October

2

14, 1940 (R. 29). The jurisdiction of this Court rests

upon Sectfon 240(a) of the Judicial Code, as amended by

the Act of February 13, 1925.

Question Presented.

Whether, under the Revenue Act of 1934, where a hus-

band and wife living together file a joint return, the

capital losses sustained by one spouse (in excess of $2,000)

may be deducted from the capital gains of the other.

Statute and Regulations Involved.

The pertinent provisions of the Revenue Act of 1934

and of the regulations promulgated thereunder will be

found in the Appendix, infra, pp. 26-30.

Statement.

The stipulated facts (R. 23-24) may be summarized as

follows:

The petitioners were married and living together

throughout the entire year 1934. During that year, the

husband, Chester Gaines, realized a net gain (excess of his

gains over his losses) from the sale of capital assets

of $18,466.41, the entire amount of which was to be taken

into account under Section 117(a) of the Revenue Act of

1934. The wife, Theresa Gaines, sustained a net loss

(excess of her losses over her gains) from the sale of

capital assets of $35,959.86, of which the amount to be

taken into aecount under Section 117(a) of the Revenue

Act of 1934 was $20,031.59 (R. 23-24).

The petitioners filed a joint income tax return for 1934.

In this return, they reported a capital loss of $1,565.18,

wo

;

/

j

3 aD

which represented the difference between the husband’s

net capital gains taken into account ($18,466.41) and the

wife’s net capital losses taken into account ($20,031.59)

(R. 24).

In auditing the return, the Commissioner held that the

losses sustained by the wife could not be applied to re-

duce the gains realized by the husband, and that the

wife’s losses accordingly could be deducted only to the

extent of her own gains, plus $2,000. By reason of this

holding, the Commissioner added $18,031.59 to the net

income reported by the petitioners (R. 24). On the basis

of this adjustment, the Commissioner determined a defi- :

ciency of $5,008.55 (R. 13).

The Board of Tax Appeals sustained the Commis-

sioner’s decision (R. 16). The Circuit Court of Appeals

affirmed the Board (R. 27). This Court granted certiorari

(R. 29).

Specification of Errors to be Urged.

The Cireuit Court of Appeals erred:

1. In holding that under the Revenue Act of 1934, a

loss sustained by one spouse from the sale of capital

assets is not deductible to the extent of the gain realized

by the other spouse from similar sales where a joint re-

turn is filed. ‘ gay: a

2. In holding that under the Revenue Act of 1934, the

excess of the losses of one spouse over his or her gains

from the sale of capital assets is not deductible from the

gains of the other spouse from similar sales when a joint

return is filed. |

Summary of Argument.

Section 51(b) of the Revenue Act of 1934 entitles a hus-

band and wife, if they so elect, to make a single joint

return, in which case their tax is to be computed ‘‘on the

aggregate income.’’ Sections 23(e) and (j) and 117(d)

together provide that losses from the sale of capital assets

shall be allowed as deductions only to the extent of $2,000

plus the gains from such sales.

It is the petitioners’ position that when a joint retarn

is filed, the aggregate capital losses of both spouses. may

be deducted to the extent of the aggregate capital gains of

both spouses, without regard to whether the spouse who

sustained the loss was the one who realized the gain.

é => 1. Section 51(b), authorizing joint returns, had been

¢ Mpiformly construed from 1921 to 1932 as entitling married

e taxpayers to offset the net loss of one against the net in-

“come of the other in a joint return. Privr to 1932, the

revenue laws likewise contained a section entitling tax-

; _ payers to deduct the full amount of their losses in com-

0? puting net income. By virtue of this section and the ac-

‘eepted meaning of Section 51(b), it had become long

recognized that in 4 joint return, the losses of one spouse

could be offset against the gains (or other income) of ms

other spouse...

In the 1932 and 1934 Acts, Congress reenacted Section

51(b) without change. It also reenacted the section per-

‘mitting the full deduction of losses in computing -net in-

come, subject only to a later section which fixed a limita-

tion theredn. Congress thus indicated its intention to con-

tinue undiminished the pre-existing scope of the joint re-

’ \

\

——— —

»

‘

turn privilege (including the right to pool gains and

losses), except in so far as the limiting provisions, em-

bodied in Sections 23(r)(1) of the 1932 Act and 117(d) of

the 1934 Act, might specifically otherwise provide. :

Sections 23(r)(1) and 117(d) are devoid of any lan-

guage purporting to diminish the pre-existing marital :

privilege with respect to pooling gains and losses. Deduc-

tion of losses is allowed ‘‘to the extent of * * * the gains »

from such sales’’ (which is true when one spouse’s losses

are offset against the other’s gains in a joint return); it

is forbidden only if it would diminish ordinary income.

Moreover, the sole purpose given by Congress for en.ct-

ing Sections 23(r)(1) and 117(d) was to prevent capital

or security losses from reducing ordinary income. This

purpose is completely fulfilled if the deductibility of the

losses of both spouses is limited to the gains of both

spouses in a joint return.

9. All of the Circuit Court opinions upholding the Com-

missioner’s position rest solely upon the authority of

Pierce v. Commissioner, 100 F. (2d) 397 (C. C. A. 2nd),

construing Section 23(r)(1) of the 1932 Act. The majority

opinion there (Judge L. Hand dissented) is based upon a

supposed general rule that only such amounts may be de-

ducted in a joint return as would have been deductible

had separate returns been filed. The majority opinion

refers to Article 381 of Regulations 77 and judicial deci-

sions, but it is submitted that neither authority estab- -

lishes such general rule. “The petitioners contend that

when a deduction is limited to a specified typeof income,

no such general rule controls but each such deduction

must be considered in the light of its separate provisions

«

+

and purposes, as outlined in the preceding” paragraph

hereinabove.

3. The Commissioner relies upon Articles 381 of Regula-

tions 77 and 117-5 of Regulations 86 as establishing a

binding administrative construction. As stated in Judge

Hand’s dissent in the Pierve case, Article 381 is ambig-

uous; despite its inclusion in the regulations since 1921,

the Commissioner in December, 1932, answered the very

question here involved in favor of the petitioners. As to

Article 117-5, as late as February, 1936, the Commissioner

was following a practice and contending for a doctrine

diametrically opposed to the principle announced in that

article. Moreover, Section 51(b) was not reenacted in

the 1938 Act, but was changed in various respects. In any

case, as was pointed out in Janney v. Commissioner, 108

F. (2d) 564, 567 (C. C. A. 3rd), the Article is unwarranted

under Section 51(b) as reenacted in the 1932, and 1934

Acts.

Argument.

1. The petitioners’ construction is in accord with the evi-

dent intention of Congress.

The legislative background preceding the 1932 and 1934

Acts is important. In the revenue acts prior to 1932,

Congress included a provision entitling husbands and

wives. living together to file a single joint. return, if they.

so elected, in which case their tax was to be computed ‘‘on

- the aggregate income’’ (Sections 223 of the 1921, 1924,

and 1926 Acts, and 51(b) of the 1928-Act). As early«as

1921, the Commissioner ruled that this section entitled

ut

7

martied taxpayers to deduct the net loss sustained by

one from the net income of Na: other when a joint re-

turn was filed (Sol. Op. 90, 4 Cum. Bull. 236). Recog-

nizing that an inflexible rule requiring separate returns

might result in collecting taxes froma family in a year in

which, regarded as a single entity, it had sustained a net

loss, Congress thus conferred on husbands and wives the

right ‘‘in all cases to make a joint return and have the tax

computed on the combined income”? (H. R. No. 350, 67th

Cong., ist Sess., p. 13). ;

Congress also included in the revenue laws prior to

1932 a provision which entitled taxpayers to deduct the

full amount of their losses in computing net income (Sec-

tions 214(a)(5) of the 1921, 1924, and 1926 Acts, and

23(e) of the 1928 Act). By virtue of this provision and

the accepted meaning of the section permitting joint re-

turns, it had become long established by 1932, that the

losses of one spouse could be offset against the gains (or

other income) of the other in a joint return.

In the Revenue Acts of 1932 and 1934, Congress reen-

acted without change the provision w h respect to the

filing of joint returns (Section 51(b))."9 Likewise, Con-

gress reenacted the section permitting thé full deduction

of losses in computing net income (23(e) of the 1932 and

1934 Acts), subject only to a later section which fixed a

limitation upon such deduction (23(r)(1) of the 1932 Act”

and 117(d) of the 1934 Act). Congress thus indicated its

1 Congress also preserved in the 1932 and 1934 Acts

the differential in favor of husbands and wives by allow-

ing them a joint personal exemption of $2,500 while giv-

ing other individuals an exemption of $1,000 (§25<¢)

of 1932 Act and §25(b) of 1934 Act).

Q

8

intention to continue undiminished the pre-éxisting scope

of the joint return privilege (including the established

right of pooling gains and losses), except in se far as the

limiting provisions in Sections 23(r)(1) and 117(d) might

specifically otherwise provide. |

Sections 23(r)(1) and 117(d) are devoid of any lan-

guage purporting to diminish the pre-existing marital

privilege with respect to offsetting one spouse’s losses

against the other’s gains in a joint (return. Section 23

(r)(1) provides that ‘‘Losses from sales or exchanges of

stocks and bonds * * * which are not capital assets (as de-

fined in Section 101) shall be allowed only to the extent

of the gains from such sales or exchanges.’’ Section 117(d)

provides: ‘‘Losses from sales or exchanges of capital

assets shall be allowed only to the extent of $2,000 plus

the gains from such sales or exchanges.’’

The deductibility of losses is thus limited in only one

respect—‘‘to the exfent of the gains from such sales or

exchanges’’. Deduction of losses is permitted if it de-

creases gains but not if it diminishes ordinary income.

Sections 23(r)(1) and 117(d) would permit the deduction

in a joint return of one spouse’s losses from the other’s

gains ‘‘if we take words in their plain popular meaning,

as they should be taken here’’. United States v. Kirby

Lumber Co., 284 U. S. 1, 3.

Not only are Sections 23(r)(1) and 117(d) devoid of

any language purporting to curtail the prior scope of

Sections 51(b) and 23(e), but the purpose of Congress i:

enacting the sections was entirely foreign to any such in-

tention. The only purpose given by Congress for intro-

ducing the limitation upon the deductibility of security

9

losses in the 1932 Act was to prevent such losses from

being offset agaist ordinary income. This was expressed

in the following words by both the Senate and the House

Committees which drafted the 1932 Act:

“There are no provisions in existing lgw corre-

sponding to Section 93(r) (s) and (t). Many tax-

payers have been completely or partially eliminating

from tax their income from salaries, dividends, rents,

ete., by deducting therefrom losses sustained in the

stock and bond markets, with serious effect upon the

revenue.’ (S. Rep. No. 665, 72d Cong., 1st Sess., p.

17; H. Rep. No. 708, 72d Cong., 1st Sess., p. 12.)

The same purpose was stated by the Secretary of the

Treasury in his testimony before the Senate Committee

in the hearings on the 1932 Act:

“In recent years income.from business profits,

from salaries, and from other sources, has in many

eases been offset by losses on security transactions.

* © * In other words, people have been. able through

the taking of losses on sales of securities to wipe out

any profits by way of dividends, or from business,

and so forth. * * *

‘‘Now the Ways and Means Committee felt, and

the Treasury agreed, that that abuse has grown to

such a point that something ought to be done about

it. * * * So the Treasury did agreeswith the Ways

and Means Committee that you ought to limit the

deduction of losses from the sale of securities to the

amount of profits made in that same year from the

sale of securities, and that the loss resulting fram

10

sale of securities should not be used to wipe out

other income.’’ (Hearings before Sen. Finance

Comm., 72d Cong., 1st Sess., p. 31.)

The House Subcommittee which worked upon the draft-

ing of the 1934 Revenue Act likewise stated:

‘‘The Revenue Act of 1932 was enacted during a

' period of depression when the need for revenue was

acute. It was known that the ‘yevenue from the in-

come tax had greatly declinéd and a part of this

decline was correctly ascribed to the wiping out of

ordinary income by the deduction therefrom of both

classes of losses previously described. The Congress

therefore provided that the losses from sales of stocks

and bonds held two years or less could only be taken.

to the extent of the gain from similar sales. This

prevented the reduction of ordimary net income from

other sources by these losses.’’ (Hearings before

Ways and Means Comm., 73d Cong., 2d Sess., p. 46.)?

*The same purpose that moved Congress to insert

§23(r) (1) in the 1932 Act had caused Congress to intro-

duce §208(c) into the 1924 Act (§101(b) of the 1932 Act).

That section provided that capital net losses (the excess

of losses over gains from sales of assets held over two

years) could not decrease the tax (otherwise payable) by

an amount in excess of 1242% of such capital net losses.

The section was introduced into the revenue law because

‘‘the opportunity to minimize taxes by the practice of

taking capital losses to offset ordinary net income con-

stituted a particularly serious problem’’. United States

v. Pleasants, 305 U. S. 357, 360. In fact, §23(r) (1) com-

plemented §101(b) in the 1932 Act, for the former fixed

the limitation with respect to losses from,sales of non-

capital stocks and bonds, while the latter fixed the limi-

tation with respect to losses from capital assets.

11

This purpose of Congress, to prevent security losses

from diminishing ordinary income, is fulfilled if the de-

ductibility of security losses of both spouses is limited to

the security gains of both spouses in a joint return. To

permit one spouse to offset his or her security loss

against the security gain of the-other in a joint return

would not and could not diminish the full taxability of the

income of both spouses ‘‘from salaries, dividends, rents,

etc.”’

The Commissioner’s contention, however, requires the

extension of the limitation prescribed in Section 23(r) (1)

beyond the intention of Congress. It would not merely

prevent a spouse from offsetting his or her security losses

against ordinary imeome ‘(which was all that Congress in-

tended), but it would also deprive the spouse of the privi-

lege (which had always been previously recognized under

Sections 51(b) and 23(e)) of offsetting his or her secur-

Yet the Commissioner has always recognized that under

§101, the capital losses of one spouse may be offset against

the capital gains of the other in a joint return, That Con-

gress intended to make no distinction between the two

sections in so far as the joint return privilege is concerned

is shown by the fact that the draft of the 1932 Revenue

Act adopted by the House (H. R. 10236) provided for the .

application of the limitation in §23(r) (1) to all securities.

The Senate Committee eliminated this, stating: ‘‘The ex-

isting limitation, that capital losses cannot reduce the tax

by more than 121%, is adequate protection against ex-

cessive deductions.’’? (S. Rep. No. 665, 72d Cong., “1st

Sess., p. 10). At no time did the Committee or Congress

refer to the proposed change as affecting the privilege of

husband and wife to pool their gains and losses. It was

apparently assumed that the privilege was the same under

both §§101 and 23(r) (1).

s

—~

12

ity losses against the other’s security gains in a joint re-

turn.

With respect to the 1934 Act, the sole reason given for

inserting the limitation (Section 117(d)) was the same as

in the case of the 1932 Act. The House Committee ex-

plained the proposed restriction (Section 117(d)) by stat-

ing:

‘“‘The method proposed is safe from a revenue

standpoint, inasmuch as capital losses cannot be used

to reduce ordinary income * * *.’’ (H. Rep. No. 704,

73d Cong., 2nd Sess., p. 10.)

The House Committee which worked on the 1938 Reve-

nue Act referred to Section 117(d) in the 1934 and 1936

Acts as follows:

‘‘The Committee believes that the principle adopted

in the Revenue Acts of 1934 and 1936 which denied

~~ the privilege of using capital net loss as an offset

against ordimary income, save within very narrow

limits, should be adhered to at this time as a neces-

sary and salutary safeguard of the income tax reve-

nue.’’ (H. Rep. No. 1860, 75th Cong., 3rd Sess., p. 37.)

Although there are additional statements declaring that

the purpose in inserting Sections 23(r)(1) and 117(d)

was to prevent security or capital losses from being de-

ducted from ordinary income, nowhere in the record of

the congressional committee reports or the debate ,on the

floor of Congress ia there any statement of any purpose

to diminish in any sae the pre-existing marital privilege

of pooling gains and losses in a joint return. +4

13

®. The reasons and authorities referred to in the major-.

ity opinion in Pierce v. Commissioner, 100 F. (2d) 397

(C. C. A. 2d) do not support the decision.

All of the Circuit Court decisions upholding the Com-

missioner’s position are based upon the precedent of

Pierce v. Commissioner, 100 F. (2d) 397. There the Cir- ©

cuit Court of Appeals for the Second Circuit held that,

under Section 23(r)(1) of the 1932 Act, the losses of one

spouse from sales of securities constituting non-capital

assets could not be offset against the gains of the other

spouse from similiar sales in a joint return. Judge

Learned Hand dissented. The same court ruled likewise

in Demuth v. Commissioner, 100 F. (2d) 1012, certiorari

dered, 307 U.S. 627.

The Pierce case was followed by the Courts of Appeals

for the First and Fourth Circuits solely in deference to its

prior precedent and not because of independent reason-

ing impelling the same conclusion.

Thus in Nelson v. Commissioner, 104 F. (2d) 521, the

Court of Appeals for ni Boarth Circuit indicated that a

majority agreed with Judge Hand’s dissent:

‘‘While a majority of this Court are much im-

pressed with the reasoning of Judge Learned Hand

in his dissenting opinion in the Pierce case, the legal

question involved is a _elose one and we feel that we

should follow the decisions of the First and Second

Cir aits, particularly in view of the denials of cer-

tiorari by the Supreme Court.”’

And in Sweet v. Commissioner, 102 F. (2d) 103, certiorari

denied, 307 U. S. 627, the Court of Appeals for the First

Circuit stated:

- 14

‘*While the decision of the Court of Appeals for

the Second Circuit may involve some doubt we do

not regard it as clearly wrong and, being squarely

in point, we follow it.’’

Likewise, in the instant case, the per curiam decision be-

low of the Court of Appeals for the Second Cireuit af-

firmed the Board upon the authority of /the Pierce case

(R. 27). And in Taft v. Helvering, 111 F. (2d) 145, No.

183 this Term, certiorari granted, Octaber 14, 1940, the

same court held per curiam on the authority of the Pierce

case, that the limitation on the deduction for charities to

15% of the taxpayer’s net income (Section 23(0) of the

1932 Act) must be computed with reference to the hus-

band’s and wife’s separate net income, and may not be

computed on their combined net income, even though a

joint return is filed. ,

Since the Pierce case constituted the sole authority re-

lied upon by all of the lower court decisions in upholding

the Commissioner’s position, it is important to examine

the reasons and authorities referred to in the majority

opinion to see whether they support the decision.

The majority opinion in the Pierce case holds that

the regulations and decisions

‘‘contradict the petitioners’ theory that husband and

wife become a single taxable entity when they file a

joint return; on the contrary each is treated as a

separate individual who can carry deductions into

the joint return only in his or her own right’’ (100

F. (2d) at 398).

The petitioners do not claim that there is any general

- rule that spouses filing joint returns are to be treated as __

EN sO Tae Pu A ME GT PETE CEE SI

15

a single taxable entity; they base their case upon the

considerations set forth under caption 1 hereinabove. But

petitioners do contend that, contrary to the premise up-

on which the Court based the Pierce decision, there is

no general rule that only such amounts may be deducted

in a joint return as would have been deductible had sepa-

rate returns been filed. ‘

The majority opinion in the Pierce case bases this

® veneral rule not upon any provision of the revenue law,

for there is none such, but upon Article 381 of Regula-

tions 77 and judicial decisions.

Article 381 of Regulations 77 states that if a joint re-

turn is filed, ‘‘all deductions and credits to which either

[spouse] is entitled shall be taken from such aggregate

income.”’ To determine the deductions to which either

spouse is entitled, we must refer to the section defining

the deductions to which an individual is entitled, which is

Section 23 of the Revenue Act of 1932. This brings us

_right back to the correct meaning of Section 23(r)(1) of

the 1932 Act—whether it limits the deductibility of se-

curity losses solely to the extent of requiring that their

allowance should dimiffish security gains, or whether it

extends further and abolishes che pre-existing privilege

of spouses, embodied in Sections 51(b) and 23(e), to offset

one’s losses against the other’s gains in a joint return.

The answer to this question is to be found in the con-

siderations set forth under caption 1 hereinabove. It is

not supplied by referring to Article 381 (supra), for this

merely directs us back to the original question of the cor-

rect meaning of Section 23(r)(1). As stated by Judge

Hand in his dissenting opinion in the Pierce case, ‘‘* _

16

it begs the question to say that the extent of the deduction

under a separate return must be taken as a condition upon

its existence’’ (100 F. (2d) at 398).

That the provisions of Article 381 constitute no bar to

the petitioners’ construction of Section 23(r)(1) is fur-

ther shown by the fact that, despite their inclusion in the

same form in all of the prior Treasury Regulations back

to Article 401 of Regulations 62 (1921), the Commissioner

en December 29, 1932, when this very question was sub-

mitted to him, expressed the opinion in a letter to the

Commerce Clearing House that ‘‘The loss sustained by

the husband would offset the same amount of ggin real-

ized by the wife from such source.’’ (1933 C. C. H. Federal

Tax Service, Vol. III, par. 6037). At the very least, this

letter, signed by the Commissioner and bearing the sym-

bols ‘*RR’’ standing for the Rules and Regulations Sec-

tion which draws up the treasury regulations, serves to

indicate that the provisions of Article 381 constitute no

clear statement that only such amounts may be deducted

in a joint return as would have been deductible if sepa-

rate returns had been filed.

Moreover, despite the inclusion of these provisions in

the Regulations since 1921, the Commissioner in 1932

(Frank B. Gummey, 26 B. T. A. 894) and as late as 1936

(Commissioner v. Brumder, 82 F. (2d) 944 (C. C. A. 7th);

Commissioner v. Thomas, 84 F. (2d) 562 (C. C. A. 5th))

was contending that the acts of husbands and wives should

always be regarded as those of one person when a joint

return is filed—a doctrine which goes beyond the peti-

tioners’ contention here and-which would have auto-—

matically resolved the question in the instant case in

favor of the petitioners.

17

The judicial decisions referred to in the majority opin-

jon in the Pierce case likewise do not support the assumed

general rule, that only such amounts may be deducted in

a joint return as would have been deductible if separate

returns had been filed. These cases allow one spouse to

deduct in a joint return losses realized from sales to the

other (Commissioner v. Brumder, supra; Commissioner

vy. Thomas, supra; Hill v. United States, 12 F. Supp. 798

(C. Cls.)); and to deduct losses on securities though the

other spouse buys similar securities immediately there-

after (Frank B. Gummey, 26 B. T, A. 894). They merely

recognize that the filing of a joint return does not auto-

matically convert the transactions of husband and wife

into those of one person, but the transactions continue to

be given legal effect as those of separate persons. In the

instant case, the acts of each spouse are recognized as

, “producing separate legal results—the one spouse sustains

losses and the other derives gains. After these acts are

given their separate legal effect, the question in the in-

stant case arises: does the limitation upon the deductibil-

ity of losses, embodied in Sections 23(r) (1) and 117(d),

merely require that losses must offset gains (as peti-

tioners contend that Congress intended) or does it go

further and require that the same spouse who sustained

the loss must have received the gain (as the Commissioner

contends) ? ee

Nor does the decision in Van Vleck v. Commissioner, 80

F. (2d) 217 (C. C. A. 2d), certiorari denied, 298 U. S.

656, lay down any such general rule. There the Court

held that the net loss sustained by the husband in a year

in which he filed a separate return might not be carried

over and deducted from the income of the wife in a joint

18 ”

’

return for the following year. The opinion relies upon

the Supreme Court cases which declare that a carry-over

deduction is an extraordinary right, not to be allowed un-

less the statute specifically so states:

‘‘The general principle underlying the income tax

statutes ever since the adoption of the 16th Amend-

ment has been the computation of gains and losses

on the basis of an annual accounting for the trans-

actions of the year. Burnet v. Sanford & B. Co., 282

U. S. 359, 363, 75 L. ed. 383, 386, 51 S. Ct. 150. A taa-

payer who seeks an allowance for losses suffered in

an earlier year, must be able to point to a specific

provision of the statute permitting the deduction and

must bring himself within its terms. Unless he can

do this, the operations of the current year must be

the measure of his burden. * * * The points of differ-

ence between the allowances under §206(b) upon the

one hand and those under $234 upon the other are im-

portant and obvious. The deductions allowable under

§234 represent expenses paid or accrued or losses

suffered during the same taxable year covered by the

return. They are thus included in the net income ac-

cording to the fundamental concept of such income

reflected in the statute, instead of falling within an

exception which, irrespective of its precise extension,

is a departure from the general scheme.’’ (Woolford

Realty Co. v. Rose, 286 U. S. 319, 326, 329.) (Italics

supplied. )

It is the position of the petitioners that where deducti-

bility is limited to the amount of a specific type of income,

Cee es

|

19

no general rule controls the question whether such deduc-

tion may be offset by one spouse against the other

spouse’s specified type of income in a joint return. In-

stead, each such deduction must be considered in the light

of its separate provisions and purposes, as was done in

the instant case in the discussion hereinabove under cap-

tion 1. Thus, the decision in Van Vleck v. Commissioner

(supra) rested upon the peculiar provisions and purposes

of the net loss carry-over deduction, ‘‘an exception * * *

which is a departure from the general scheme”’. There

was no background of construction, as in the instant case,

under which husbands and wives had been entitled for

years to offset the deduction in question against the

other’s income in a joint return; nor was the limitation

subsequently enacted, as in the instant case, with the sole

purpose of remedying a particular mischief, not touching

in any respect the pre-existing privilege of spouses with

respect to pooling such deduction in a joint return.

The adoption of any such general rule, that the filing

of a joint return may not change the amounts which

would have been deductible had separate returns been

filed, may have repercussions upon a ‘number of other sec-

tions of the/revenue law, in some cases to the detriment

of maximum revenues: :

(1) Under the net loss carry-over deduction, which

was contained in the revenue acts prior to 1932 and has

been reinstated in the present law (Sections 23(s) and

122 of the Internal Revenue Code), the Commissioner has

heretofore céntended and it has been held, that where

a joint return is filed, the income of the wife must be

included in computing the net loss carry-over deduction

®

‘ 20

of the husband, thereby diminishing or wiping out the

carry-over deduction to which the husband would have

been entitled if he had filed a separate return el G.

Adams, 19 B. T. A. 781; William H. Shelmerdine, 24

B. T. A. 833).8

(2) In computing the net loss carry-over deduction,

capital losses are deductible only to the extent of cap-

ital gains and non-business deductions only to the extent

of non-business gross income (Section 122 (d)(4)(5) of

the Internal Revenue Code).

(3) Section 117(e) of the Internal Revenue Code pro-

vides that a net short-term capital loss may be carried

over as a deduction in the following year, but limited to

‘‘an amount not in excess of, the net income” for the

current year. The 1932 Act contained a similar provision

(Section 23(r)(2)). Where H has $100,000 net short-

term capital loss in 1940 and $100,000 net income, con-

sidering his transactions alone, but files a joint return re-

- porting no net income, he would be entitled to carry ove

into 1941 his net short-term capital loss if there were

a general rule that deductions are to be allowed as though

+ separate returns had been filed.

’ The same principle has been followed with respect to

the consolidated returns of corporations, in cases in which @

the Adams decision (supra) was cited as authority. See

Kawwiki Sugar Co. v. Burnet, 63 F. (2d) 822, 824 (C. C. A.

D. ©.); Crocker First Nat’l Bank of San Francisco, 26

B. T. A. 1078, 1088.

21

» The administrative construction does not support the

Commissioner’s position.

The Commissioner’s contention with respect to the ad-

ministrative cbnstruction is based upon Articles 51-1 and

117-5 of Regjilations 86, promulgated under the Revenue

Act of_1934.

Article 51-1 provides that when a joint return is filed,

«# © ® all deductions and credits to which either [spouse }

is entitled shall‘be taken from such aggregate income’’.

As pointed out (supra, p. 15), this provision is ambigu-

ous and fails to state the answer to the question here

involved; despite its inclusion in the Regulations since

1921, the Commissioner has contended in numerous cases

ince 1921 that the acts of husbands and wives are to be

treated as those of one person when a joint return is -

filed, which is directly opposed to the interpretation now

stated to have been expressed by this provision of the

Regulations (E. g. Frank B. Gummey, 26 B. T. A. 894). -

Moreover, in December, 1932, the Commissioner answered

the very question here involved in favor of the petitioners

(supra, p. 16). ©

It was not until 1935, after the close of the ‘taxable

year here involved, that the Commissioner first gave

notice through issuance of Article 117-5 of Regulations

86 and G. C. M. 15438, XIV-2, Cum. Bull. 156, that the

earlier ruling would not be followed. Thus, taxpayers

were lulled through the years 1933 and 1934 into the

belief that the losses of one spouse could be offset against

the gains of the other. :

22

But even after the issuance of Article 117-5 (which

specifically ruled in favor of the Commissioner as to the

question: at issue), the Commissioner continued to con-

strue the law_as requiring the transactions of husbands

and wives to be rettleded as those of one person when

a joint return is filed. In February, 1936, the Commis-

sioner filed afprief in the Fifth Circuit Court of Appeals

in the case of Commissioner v. Thomas, 84 F. (2d) 562,

and in the Seventh Circuit Court of Appeals in the case of

Commissioner v. Uihlewn, affirmed sub nom. Commissioner

v. Brumder, 82 F, (2d) 944. The question involved in

both cases was whether a loss sustained by one spouse

from a sale made to the other was deductible in a joint

return. In identical language, the Commissioner argued

in both briefs as follows:

‘“We submit that in providing for a ‘single joint

return’ and a reporting of ‘aggregate income’, Con-

gress intended to disregard the separate entities and

to treat husband and wife, for tax purposes, as one.

Their two incomes are brought together in a joint

return as a unit, and their aggregate income is

treated as though it were one income earned by one

individual. * * * The Treasury Department at an

early date so construed the statute. In I. T. 1575,

II-1 Cum. Bull. 144, it was held that a joint return

of husband and wife ‘is one return of a taxable’ unit

and not two returns of two units on one sheet of

paper.’ And in I. T. 1997, III-1 Cum. Bull. 149, infra,

p. 18, it was held that ‘such return is treated as the

return of a taxable unit and the income disclosed by

WNL ——aiOE aera ee A A NN LCE

23

. the return is subject to both normal tax and surtax

as though the return were that of a single individual.’*

‘The decision of the Board to the contrary is based

on the previous Board decision in Gummey v. Com-

missioner, 26 B. T. A. 894, and was followed in the

later Board decision in Uihlein v. Commissioner, 30

B. T. A. 399 (now pending on the Government’s ap-

peal to the Circuit Court of Appeals for the Seventh

Circuit), and Paul Speer v. Commissioner (decided

November 3, 1934, unreported), affirmed per curiam

(C. C. A. 2nd), December 16, 1935. * * * In none of

these cases did the Board answer the contentions here

advanced by the Government. We submit the deci-

sions are erroneous.”’

Thus in February, 1936, years after the issuance of the

regulations under Section 51(b) and about a year after

their issuance under Section 117(d), the Commissioner

was following a practice and was urging a doctrine en-

tirely inconsistent with that which he now states had been

laid down and long continued under those regulations.

Moreover, as was pointed out in Janney v. Commis-

sioner, 108 F. (2d) 564, 567 (C. C. A. 3rd), Section 51(b)

was not reenacted in the 1938 Act, but various changes

were made in the section, including a provision attach-

*Footnote in brief: ‘‘The above rulings were made in

1923 and 1924, respectively, following the adoption of the

Revenue Act of 1921. Since that time, five revenue acts

have been passed without change in the provision there

interpreted. The rule of implied legislative approval would

seem applicable.’’

j

—_—

24

ing joint and several liability to married taxpayers if

they filed joint returns. In Commissioner v. Rabenold, 108

F. (2d) 639, (C. C. A. 2nd), the majority opinion held

that the amendment of Section 51(b) in the Revenue Act

of 1938 did not constitute merely a restatement in ampli-

fied form of the pre-existing, law, and denied the joint

and several liability of métried taxpayers under the

Revenue Act of 1933, basing its decision upon the av-

thority of Van Vleck v. Commissioner, Pierce v. Commis-

sioner and Demuth v. Commissioner (supra, pp. 13, 17),

all of which cases are relied upon by the Commissioner in

the instant case.

In any case, as the Court in Janney v. Commissioner,

supra, likewise stated, Article 117-5 is not a construction

warranted by the words of Section 51(b) authorizing the

joint return. When Congress carried forward Sections

51(b) and 23(e) into the 1932 and 1934 Acts, it preserved

the full scope of the pre-existing privilege of spouses to

pool their gains and losses in a joint return, and the

insertion of Sections 23(r) (1) in the 1932 Act and 117(d)

of the 1934 Act, which neither in language nor in purpose

purported to diminish this prior privilege, constituted no

justification for the issuance of a regulation which im-

paired the established purview of Section 51(b).

TE

25

Cenclusion.

For the reasons stated, it is respectfully submitted that

the decision of the Court below should be reversed.

Freperick Baum,

Counsel for Petitioners,

230 Park Avenue,

New York, N. Y.

Of Counsel:

Frank E. KareE.seEn, JB.

October, 1940.

APPENDIX

Revenue Act of 1934, c. 277, 48 Stat. 680:

Sec. 23. DEDUCTIONS FROM GROSS INCOME.

ry

In computing net income there shall be allowed

as deductions:

. a 4 . *

(e) Losses by Individuals. In the case of an in-

dividual, losses sustained during the taxable year

and not compensated for by insurance or other-

wise—

(2) if incurred in any transaction entered

into for profit * * *

(j) Capital Losses—Losses from sales or ex-

changes of capital assets shall be allowed only to

the extent provided in section 117 (d).

P

é * 7 * * .

[U. S. C., Title 26, Sec. 23.]

Sec. 51. INDIVIDUAL RETURNS.

(b) Husband and Wife.—If{ a husband and wife

living together have an aggregate net income for

the taxable year of $2,500 or over, or an aggre-

gate gross income for such year of $5,000 or over—

(1) Each shall make such a return, or

+o.

*

27

(2) The income of each shall be included in a

single joint return, in which case the tax shall be

computed on the aggregate income.

[U. S. C., Title 26, Sec. 51.]

Sec. 117. CapiTaL GAINS AND LOSSES.

@

(a) General Rule—In the case of a taxpayer,

other than a corporation, only the following per-

centages of the gain or loss recognized upon the,

sale or exchange of a capital asset shall be taken

into account in computing net income:

100 per centum if the capital asset has been held

for not more than 1 year;

80 per centum if the capital asset has been held

for more than 1 year but not for more than 2

years;

60 per centum if the capital asset has been held”

for more than 2 years but not for more than 5)

years ;

40 per centum if the capital asset has been held

for more than 5 years but not for more than 10

years ; : ;

30 per centum if the capital asset has been held

for more than 10 years.

(b) Definition of Capital Assets.—For the pur-

poses of this title, ‘‘capital assets’? means prop-

erty held by the taxpayer (whether or not con-

nected with his trade or business),” but does not

‘nelude stock in trade of the taxpayer or other

property of a kind which would properly be in-

cluded in the inventory of the taxpayer if on hand

28

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,

(ad) Limitation on Capital Losses.—Losses from

sales or exchanges of capital assets shall be allowed

only to the extent of $2,000 plus the gains from

such sales or exchanges. If a bank or trust con-

pany incorporated under the laws of the United

States or of any State or Territory, a substantial

part of whose business is the receipt of deposits,

sells any bond, debenture, note, or certificate or

other evidence of indebtedness issued by any cor-

poration (including one issued by a government or

political subdivision thereof), with interest coupons

or in registered form, any loss resulting from such

sale (except such. portion of the loss as does not

exceed the amount, if any, by which the adjusted

basis of such instrument exceeds the par or fare

value thereof) shall not be subject to the foregoing

limitation and shall not be‘ included in determin-

ing the applicability of sucht itation to other

losses.

[U. S. C., Title 26, See. 101.]

Treasury Regulations $6, promulgated under the Rev-

enue Act of 1934:

ArT. 51-1. Individual returns—For each tax-

able year every single person and every married

person not living with husband or wife for any

part of the taxable year, whose gross income «@s

defined in sections 22 and 116 is $5,000 or over,

or whose net income as defined in section 1 is

29

$1,000 or over, must make a return of income.

Every married person living with husband or wife

for any part of the taxable year, but not at the

close of the taxable year, must make a return if

his gross income for the taxable year is $9,000 or

more, or his net income is equal to, or in excess of,

the credit allowed him by section 25 (b) (1) and

(3) (computed without regard to his status as {he

nead of a family). (See article 25-7.) A husband

and wife living together for the entire year need

make no returns unless their aggregate gross in-

come for the taxable year is at least $5,000, or their

aggregate net income is at least $2,500. If their

aggregate net income for the iaiaag tl. is $2,500

or more, or their aggregate gross income is $5,000

or more, either each must make a return) or the in-

come of each must be included in a single joint

return. A husband and wife living together at the

close of the taxable year but not during the entire

taxable year must make a return or returns if their

aggregate gross income for the taxable year is

$5,000 or more, or their aggregate net income is

equal to, or in excess of, the credit allowed them

by section 25 (b) (1) and (3) (computed without

regard to the status of either of them as the head

of a family)./ (See article 25-7.) If the income of

each is included in a single joint return, the tax is

computed on the aggregate income and all deduc-

tions and credits to which either is entitled shall be

taken from such aggregate income. A joint return

of husband and wife may be filed only if they were

living together at the close of their taxable year.

If one spouse dies prior to the last day of the tax-

able year, the surviving spouse may not include the

income of the deceased spouse in a joint return

for such taxable year.

a

30

Art. 117-5. Application of section 117 im the case

of husband and wife.—In the application of section

117, a husband and wife, regardless of whether a

joint return or separate returns are made, are con-

sidered to be separate taxpayers. Accordingly, the

imitation under section 117 (d) on the allowance of

losses of one spouse from sales or exchanges of

capital assets is in all cases to be computed with-

out regard to gains and losses of the other spouse

upon sales or exchanges of capital assets.

BLANK PAGE

ROR tere

30

Art. 117-5. Application of section 117 in the case

of husband and wife.——In the application of section

117, a husband and wife, regardless of whether a

joint return or separate returns are made, are con-

sidered to be separate taxpayers. Accordingly, the

limitation under section 117 (d) on the allowance of

losses of one spouse from sales or exchanges of

capital assets is in all cases to be computed with-

out regard to gains and losses of the other spouse

upon sales or exchanges of capital assets.

BLANK PAGE