5 T.C. 1112 (1945)

When a will bequeaths a portion of the income from a business interest to a beneficiary, that beneficiary has an interest in the property itself, and the payments are taxable to the beneficiary, not to the recipient of the business interest.

Summary

Frank P. Malloy bequeathed his interest in a partnership to his son, Frank R. Malloy, but stipulated that $250 per month be paid to his widow, Catherine, from one-half of the net income of the business. The payments were cumulative, ensuring Catherine would receive the funds when available. Catherine elected to take under the will. Frank R. Malloy took a corresponding deduction on his income tax returns, treating the payments as if they were not his income. The Commissioner disallowed the deduction, arguing it was income to Frank R. Malloy. The Tax Court held that the payments to the widow were income to her, as she had an interest in the business itself via the will, and were not income to her step-son. Therefore, Frank R. Malloy could exclude the payments from his gross income.

Facts

Frank R. Malloy and his father, Frank P. Malloy, operated an undertaking establishment as partners. Initially, Frank R. held a one-eighth interest, and his father held the remaining seven-eighths. By 1939, each held a one-half interest. Frank P. Malloy died testate in 1940. His will bequeathed $250 per month to his widow, Catherine, to be paid by his son, Frank R. Malloy, from half the net earnings of the partnership. The will also left Frank P. Malloy’s interest in the partnership to his son, Frank R. Malloy. Catherine elected to take under the will, foregoing any potential community property claim.

Procedural History

The Commissioner of Internal Revenue assessed deficiencies against Frank R. Malloy and his wife (filing separately on a community property basis), disallowing deductions taken for payments made to Catherine Malloy pursuant to Frank P. Malloy’s will. Malloy petitioned the Tax Court for review of the Commissioner’s determination.

Issue(s)

Whether payments made to a testator’s widow from the net income of a business, as stipulated in the testator’s will, are taxable income to the recipient of the business interest or to the widow.

Holding

No, because the bequest to the widow created an interest in the underlying property, making the payments income to her, not to the recipient of the business interest.

Court’s Reasoning

The court distinguished this case from situations where payments to a widow are considered capital expenditures made to acquire a deceased partner’s interest. Here, Frank R. Malloy acquired his father’s interest through bequest, not purchase. The payments were not Frank R. Malloy’s personal obligation but rather a fulfillment of the testator’s wishes. The court reasoned that the testator chose to give his son less than his entire business interest, granting his wife a portion of it through the income stream. Because the $250 monthly payment was to come directly from the business’ net income and in months where the net income was insufficient, the payment would be reduced, the Court reasoned that the bequest to the wife and the income from the partnership property were completely interdependent. The court stated that “[i]n substance, the bequest was a portion of the net income from that particular property, which, in equity, would ordinarily be treated as giving her an interest — a sort of life estate — in the property itself.” Therefore, the payments to the widow were income to her.

Practical Implications

This case clarifies the tax implications of bequests that direct income streams to specific beneficiaries. It establishes that when a will creates an interest in a business’ income, the recipient of that income, not the recipient of the business itself, is responsible for paying taxes on it. When drafting wills involving business interests, attorneys must clearly define the nature of any payments to beneficiaries to ensure proper tax treatment. This ruling affects estate planning, particularly in family-owned businesses, and guides how similar income-splitting arrangements should be structured and analyzed for tax purposes. The case emphasizes that the origin and nature of the payment, rather than its mere disbursement, dictates tax liability.