Before KALODNER and HASTIE, Circuit Judges, and LAYTON, District Judge.
Can the heirs of an estate, in computing their individual income taxes, assert the benefits of a carry-back of a net operating loss available to the estate under the Internal Revenue Code of 1939? Otherwise stated, is a decedent's estate a taxable entity separate and distinct from its heirs?
The issue is presented by this appeal from judgment of the District Court for the Eastern District of Pennsylvania in favor of the United States.*fn1
The undisputed facts may be summarized as follows:
Herman B. Mellott, a road contractor and strip-coal mine operator, who lived in Pennsylvania, died intestate on July 16, 1948.He was survived by his widow and three children. Under Pennsylvania law the widow inherited one-third of the deceased's estate and the three children the remaining two-thirds in equal shares.
The widow, Amy C., and oldest son, Paul C. were appointed administrators of Mellott's estate; the Valley National Bank of Chambersburg, Pennsylvania, was appointed guardian of the two minor children, Forrest R. and Kay Virginia.
The administrators continued to operate the business of the decedent pending final distribution of the estate. In September, 1949, they filed a fiduciary tax return on the cash basis for the period beginning July 16, 1948, the date of decedent's death, and ending June 30, 1949. The return reported a sizeable net income. Since the decedent died intestate, and under applicable Pennsylvania law there was no provision for the accumulation of income of an intestate, the net income reported in the fiduciary return was distributable to the heirs of the estate and they reported their distributive shares in their individual income tax returns for 1949. Since under Section 162 (b)*fn2 of the Internal Revenue Code of 1939, as amended, the estate was allowed a deduction for income currently distributable to the heirs, the estate itself had no taxable income for the period ending June 30, 1949.
In the latter part of 1950, a fiduciary income tax return for the fiscal year ending June 30, 1950, was filed on behalf of the estate by the administrators in which was reported a substantial net operating loss approximating something less than 75 per cent of the estate's net income for the prior year. The administrators, however, did not amend the June 30, 1949 fiduciary income tax return of the estate to include the carry-back of the net operating loss. Instead, each of the heirs in proportion to his or her share of the estate under the Pennsylvania Intestate Law, 20 P.S. § 1.1 et seq., claimed a part of the estate's 1950 net operating loss and each recomputed his or her 1949 individual tax return to reflect this loss. Timely claims for tax refunds were filed by the heirs which the Commissioner denied, and the heirs brought suit. Upon motions for summary judgment made by the heirs ("taxpayers"), and the United States, the District Court rendered judgment for the United States. The action of the District Court was premised on its holding that under Section 122 (b) (1) (A) of the 1939 Code "only the taxpayer sustaining the 'net operating loss' is to take advantage of the carry-back", and, "In the case before us, the 'taxpayer' sustaining the net operating loss is the estate and not the heirs." 156 F.Supp. at page 255.
On this appeal the taxpayers urge in substance that they are in effect the estate and thus, since the estate was entitled to a carry-back into 1949 of the net operating loss suffered in 1950, that they are entitled in their individual returns to the benefits of that carry-back. As an alternative argument they assert here, for the first time, that they were individual members of a de facto partnership engaged in the operation of decedent's business and as such they are entitled to offset the partnership loss in the later year against the profits of the preceding year.
The United States takes the position that "the relevant Code provisions treat the estate as an entity separate from its beneficiaries, and confine deductions to the estate which sustained the loss * * Here, taxpayers as beneficiaries of the estate, are not the same taxpayer as the estate and are not entitled to the estate's loss carry-back."
Applicable to the determination of the problem presented by this appeal are these provisions of the 1939 Code, as amended:
Section 23 (s)*fn3 which authorizes a deduction from gross income of a net operating loss to the extent provided in Section 122;*fn4 Section 170*fn5 which allows the benefits of this deduction to an estate; Section 122 (b) which provides if "the taxpayer has a net operating loss" for any taxable year he may carry-back the loss to each of the preceding two taxable years commencing with the second preceding year.
In applying the deduction provisions above stated we must adhere to this explicit instruction of the Supreme Court in New Colonial Ice Co. v. Helvering, 1934, 292 U.S. 435, 440, 54 S. Ct. 788, 790, 78 L. Ed. 1348:
"Whether and to what extent deductions shall be allowed depends upon legislative grace; and only as there is clear provision therefor can ...