Fox v. Commissioner

*895 Respondent determined a deficiency in petitioner's income tax for the year 1936 in the sum of $2,086.53. Prior to the hearing petitioner consented to the*1431 assessment of and paid $117.97 of the deficiency. Subsequent to the hearing petitioner abandoned an issue raised by the pleadings regarding a loss deduction and consented to $777.97 of the deficiency.

The sole issue before the Board is whether or not amounts paid to insurance companies by petitioner in the taxable year on policy loans which were made to petitioner's husband before assignment of the policies to petitioner are deductible as interest paid.

FINDINGS OF FACT.

The facts were stipulated substantially as follows:

In and prior to the year 1936 petitioner was the beneficiary of thirteen policies of insurance on the life of William J. Fox, husband of petitioner.

*896 On February 29, 1936, petitioner's husband executed a formal instrument, of which the following is material:

FOR VALUE RECEIVED, I hereby assign all right, title and interest in the following policies to AGNES I. FOX, my wife, said policies to be her sole and absolute property:

Company	No. of Policy
The Prudential Insurance Company of America	1,449,645
Aetna Life Insurance Company	N864,210
Aetna Life Insurance Company	N868,668
The Penn Mutual Life Insurance Company	1,471,398
	1,471,399
	736,540
The Union Central Life Insurance Company	539,751
	539,752
The Northwestern Mutual Life Insurance Company	2,117,530
	1,253,534
	1,402,262
	1,405,760
	1,405,761

*1432 During the year 1936 petitioner paid to the respective insurance companies sums totaling $6,889.09 in connection with loans which had been made prior to 1936 on the policies assigned to petitioner by the instrument executed by petitioner's husband on February 29, 1936. The apportionment of the sum of $6,889.09 to the interest periods covered by petitioner's checks aggregating that sum is as follows:

Paid on account of interest due* in 1934	$2,384.39
Paid on account of interest due* in 1935	1,208.13
Paid on account of interest due* in 1936, prior to 2/29/36	794.88
Paid on account of interest due* in 1936, subsequent to 2/29/36	2,501.69
Total payments made by petitioner in 1936	6,889.09

(*The word "due" employed in the above schedule is used only to indicate the point of time when the annual period for computing interest terminated and when the interest was payable.)

Each of the amounts aggregating $6,889.09, set forth in the above schedule, was paid by check in 1936. Each check bore the endorsement "in full payment of interest * * *" on the respective policy, to the dates specified.

The amounts included in the various checks paid by petitioner in*1433 1936 which pertained to interest that had become due and payable prior to February 29, 1936, aggregating the amounts shown above, had not been paid by cash or check at the time the interest payments became due and payable and the respective insurance companies had charged the amounts due to the principal of each respective policy's loan reserve.

*897 The following excerpts from letters are explanations of the insurance companies as to the manner of applying on their records the interest items enumerated in the schedule hereinbefore set forth:

THE PENN MUTUAL LIFE INSURANCE COMPANY

* * *

On November 30th, 1936 we sent to Mr. William J. Fox, 276 Fifth Avenue, New York City, a letter which reads as follows:

"Mr. A.V.Gartner has forwarded to us checks which we have applied in reduction of principal of loans on Policies Nos. 736540, 1471398 and 1471399, your life as below:

No. 736540 - Account of loan	$224.09
1471398 - Account of loan	46.70
1471399 - Account of loan	23.35

The above payments have been applied by the Company in reduction of principal, but each item set forth actually represents interest that was added to principal The following interest*1434 items were settled by addition to principal:

No. 736540 - Interest due 8/10/34	$78.96
Interest due 8/10/35	52.69
Interest due 8/10/36	92.44
		$224.09
No. 1471398 - Interest due 9/12/35	$46.70
1471399 - Interest due 9/12/35	23.35."

Today we have received from Mr. A.V.Gartner your three cancelled checks, Nos. 368, 369 and 370 which paid the above mentioned items and this letter is written to you acknowledging the items were paid by your checks. We are today returning to Mr. Gartner the three cancelled checks.

THE UNION CENTRAL LIFE INSURANCE COMPANY

* * *

Loan or advance on policy #539752 on the life of William J. Fox.
Loan or advance dated Oct. 26, 1931		$5,547.00
Interest due and unpaid to Oct. 26, 1933, added to principal		685.61
Total indebtedness Oct. 26, 1933		6,232.61
Interest due Oct. 26, 1934, added to principal		373.96
Total indebtedness Oct. 26, 1934		6,606.57
Interest to Apr. 8, 1935		178.38
Premium due on policy	$641.50
Dividend credit	103.00	538.50
		7,323.45
Credit by cash		223.00
Balance		7,100.45
Interest due Apr. 8, 1936, added to principal		426.03
Total indebtedness Apr. 8, 1936		$7,526.48
Interest to Nov. 27, 1936		288.26
Total indebtedness Nov. 27, 1936		7,814.74
Cash received Nov. 27, 1936		978.37
Balance indebtedness Nov. 27, 1936		6,836.37

*1435 *898 The above is a correct statement of the loan or advance on your policy No. 539752 and the cash payments made to date.

THE PRUDENTIAL INSURANCE COMPANY OF AMERICA

* * *

This is to inform you that the Company will be willing to issue an interest receipt for interest due on the outstanding loan principal as charged against the above numbered policy, for 1935.

The interest on interest of $6.50 which we quoted in our letter of October 22nd, as having been added to the outstanding loan in 1935 will be waived and instead there will be added $4.21 representing the interest on interest from March 12, 1936 to November 2, 1936.

In addition it will be necessary for Mr. Fox to send us his check for $130.00 representing a 5% of the loan principal of $2,600. It will therefore be necessary for Mr. Fox to send us his check for a total of $134.21.

* * *

Petitioner made payments aggregating $3,296.57 to the insurance companies on account of interest becoming payable in 1936 before and after February 29, 1936. Respondent determined that $2,736.87 of the sum of $3,296.57 was applicable to interest periods preceding February 29, 1936. He determined that $559.70 of the*1436 sum of $3,296.57 was applicable to the interest period subsequent to February 29, 1936.

On her income tax return for the year 1936 petitioner claimed an interest deduction in the sum of $6,889.09. Respondent disallowed $6,329.39 of the claimed deduction.

OPINION.

VAN FOSSAN: The only issue for our determination is whether or not petitioner is entitled to a deduction for interest paid in the taxable year on sums paid to insurance companies which were denominated by petitioner as interest accrued on policy loans prior to assignments to petitioner of the policies upon which the loans had been made.

Petitioner contends that the mere fact that she paid more than the current year's interest to the insurance companies in the taxable year is immaterial, since she was on the cash basis. She maintains that by virtue of being a beneficiary under the policies she had an equity in the policies before they were assigned to her and hence was entitled to deduct interest due but not paid in prior years but paid as indicated *899 in the facts in the taxable year. She urges that in any event respondent erred in limiting her deduction for interest paid to those amounts accruing after*1437 assignment of the policies to her. In regard to this contention she asserts that she is entitled to deduct at least those amounts of interest paid which became payable after her acquisition of the policies. Respondent argues that petitioner's payment of interest which accrued prior to the assignment of the policies to her is not deductible because it was paid upon the obligations of another. He contends that the overdue interest which the insurance companies had added to principal of the various loans ceased to be interest and became principal so that neither petitioner nor her husband can obtain a deduction for interest paid by payment in a later year of the amounts which had previously been added to the principal by the insurance companies. We sustain the respondent.

Upon the addition of the overdue interest to the principal of the loans by the insurance companies the interest due lost its character as interest and became principal. This was not a mere bookkeeping device since interest immediately began to run upon the amounts added to principal. We are of the opinion that amounts paid by petitioner during the taxable year claimed to represent past-due interest which had*1438 been added to principal of the policy loans did not constitute "interest paid" within the meaning of the statute. Nor is it material that several of the insurance companies issued statements to petitioner in the taxable year indicating that the companies had withdrawn "interest" from principal and again treated it as interest. After the amounts have been added to principal the fact that the insurance companies are willing to designate payments as interest will not give such payments the characteristics necessary for deductibility under the statute. We hold that petitioner is not entitled to deduct the amounts paid upon the policy loans which had been added to the principal of the loans by the insurance companies.

There remains the question of the deductibility of those amounts paid by petitioner to the companies in the taxable year which related to interest on the policy loans becoming payable after February 29, 1936, the date on which the policies were assigned to petitioner. Respondent has allowed petitioner a deduction for interest on the loans which accrued after February 29, 1936, and which was paid by petitioner in the year 1936. He denies that petitioner may deduct interest*1439 which became due after February 29, 1936, but which is allocable to the period before the date of assignment of the policies to petitioner.

Petitioner argues that she may deduct interest which accrued before the date of assignment because she had an equity in the policies by virtue of being the named beneficiary before the policies were assigned to her. She urges that under New York law the interest of a beneficiary of a policy of life insurance is protected and that *900 she had acquired sufficient ownership in the policies before the assignment to permit her to treat the policy loans as her obligations. Whatever petitioner's equity in the policies before their assignment to her may have been, we can not ignore the fact that petitioner's husband was the person who borrowed on the policies. It was he who had the obligation to pay interest and the obligation continued until the date of assignment to petitioner. Proration must be made as of that date.

In , we stated:

The statutory deduction for interest (Revenue Act of 1928, sec. 23(b), supra ) is limited to amounts chargeable against the taxpayer qua interest (*1440 ) upon his indebtedness. . * * *

The quoted statement is applicable here. Only those amounts which may be considered interest on petitioner's indebtedness are deductible. The amounts paid by petitioner in the taxable year which were allocable to the period during which the loans were clearly the obligations of her husband are not deductible by petitioner as interest paid. ; ; certiorari denied, .

We hold that respondent was correct in disallowing petitioner's deduction of amounts paid to the insurance companies which were attributable to interest accrued on the loans prior to February 29, 1936.

Decision will be entered for the respondent.