4 T.C. 34">*35 The Commissioner determined that petitioner is liable, as transferee of assets of Martin M. Pearlman, deceased, "for deficiencies of income taxes due from the Estate of Martin M. Pearlman, Deceased," as follows:

1944 U.S. Tax Ct. LEXIS 56">*58 In the answer it is alleged the Commissioner "erroneously and inadvertently failed to assert liability" for the additional amount of $ 1,755.15, this being the unpaid balance of the tax shown to be due by Pearlman's return for 1940. The aggregate amount in issue is therefore $ 25,713.57.

The principal question is whether petitioner, as the primary beneficiary of proceeds of insurance on the life of her deceased husband, Martin M. Pearlman, the annual premiums of which were paid by him during his lifetime, is liable in equity as transferee for his unpaid income tax for the calendar years 1934 to 1937, inclusive, and 1940, together with statutory interest thereon. A subsidiary question, in the event petitioner is liable as a transferee, is whether the liability of the deceased was less than the amount determined by the respondent

4 T.C. 34">*36 The facts are found to be as stipulated. Others shown in our findings are based upon admissions in the pleadings, documents received in evidence at the hearing, or concessions made by the parties.

FINDINGS OF FACT.

Petitioner is the widow of Martin M. Pearlman (hereinafter referred to as Pearlman), who died in Philadelphia, Pennsylvania, on March1944 U.S. Tax Ct. LEXIS 56">*59 11, 1941, insolvent and without any estate. Petitioner was born April 10, 1882.

In Pearlman's income tax returns for the calendar years shown below he deducted, as interest, the following amounts:

All of the deductions were disallowed except approximately $ 1,700 for the year 1940. The correctness of the disallowance of the amounts shown under the heading "Other interest" is not in issue. ¹

1944 U.S. Tax Ct. LEXIS 56">*60 The amounts shown in the column "Interest on business indebtedness" represented accruals of interest entered on books of account of M. M. Pearlman and Co. on notes to Tradesmen's National Bank & Trust Co. ($ 75,000) and to Philadelphia National Bank ($ 60,000), aggregating $ 135,000.

Pearlman did not maintain any books of account (other than a check book) at any time except those in the name of M. M. Pearlman and Co. M. M. Pearlman and Co. was a mere trade name. It "was conducted as a partnership until December 31, 1926." Thereafter it "was the trade name under which Martin M. Pearlman individually conducted an active business in the purchase and sale of metals * * * until 1931."

During the period from 1917 to 1931 the books of M. M. Pearlman and Co. were kept on a basis according to which all bills received for money owed by it were entered when the bills were received and deducted as expenses in such years, although a great many of these bills, both for materials and for expense items, were not paid until the following years. Similarly, merchandise sold was entered as an account receivable when the sales were made and reported in income for such years, although in many cases 1944 U.S. Tax Ct. LEXIS 56">*61 payment was not received 4 T.C. 34">*37 until the following year. In all cases the purchases, sales, and accounts payable and receivable were entered on that basis. In 1931 the company was inactive and so remained until 1937. From 1937 until Pearlman's death the activity of the company was on a much reduced scale.

On the books of account of M. M. Pearlman and Co. for the years 1934 to 1940, inclusive, there was accrued each year interest payable in the amount of $ 8,212.50 representing interest on the loans to the above named banks in the aggregate amount of $ 135,000. By December 31, 1929, Pearlman had withdrawn funds from M. M. Pearlman and Co. in excess of $ 135,000, which funds were charged to his drawing account on the books of M. M. Pearlman and Co.

During the period from 1931 to 1940, inclusive, each year there were accruals of interest entered on the books of M. M. Pearlman and Co. in the annual amounts of $ 8,212.50. These items appeared in an account designated "Interest and Discount" and a liability account designated "Accounts Payable." By December 31, 1932, the latter account was made up only of accrued interest on the two loans, and it so continued until December 31, 1937. 1944 U.S. Tax Ct. LEXIS 56">*62 On that date the credit balance in that account was split and credited to liability accounts in the name of each bank ($ 20,390 and $ 25,487.50). From then until December 31, 1940, the accrued interest was recorded each year in the new liability accounts.

"Prior to Dec. 31, 1926, interest on notes representing loans from the Philadelphia National Bank and the Tradesmen's National Bank and Trust Co. was charged to, paid by, and shown on the books of M. M. Pearlman and Co., a partnership. During the period from Dec. 31, 1926 to October 1, 1930, interest on notes representing loans from said banks was charged to, paid by, and shown on the books of M. M. Pearlman and Co. solely owned by Martin M. Pearlman during that period of time.

"Prior to the year 1927 the ledger of M. M. Pearlman and Co., a partnership, shows the repeated use of inventory accounts in the determination of the periodical profit or loss resulting from operations in the 'Zinc skimmings,' 'Salamoniac skimmings,' and 'Dross' accounts. Dealing in these commodities and in lead constituted the bulk of the business of M. M. Pearlman and Co. At no time did M. M. Pearlman and Co. have a warehouse for the storage of merchandise, 1944 U.S. Tax Ct. LEXIS 56">*63 and consequently contracted for its sales and purchases simultaneously, in all cases shipping the merchandise directly from its seller to its buyer. During the years 1927 to 1941, inclusive, M. M. Pearlman and Co. had no unsold merchandise on hand at the end of any year, and accordingly recorded no inventories on its books at the end of such years except in the year 1940, when an inventory of $ 478.02 was recorded. It was subsequently found that the merchandise so inventoried had 4 T.C. 34">*38 actually been sold prior to December 31, 1940, so that the entry was erroneous, and the inventory was eliminated by the Revenue Agent who examined the books for that year."

During the years M. M. Pearlman and Co. was active -- i. e., prior to 1931 -- its books and records showed substantial amounts in accounts receivable and payable. No accounts receivable existed after December 31, 1930. Accounts payable reflected only interest on the loans of Philadelphia National Bank and Tradesmen's National Bank & Trust Co. No part of such interest was ever paid by Pearlman or anyone else.

In Pearlman's returns for the years 1934, 1935, and 1936, line 9 -- "State whether your books are kept on cash or accrual1944 U.S. Tax Ct. LEXIS 56">*64 basis" -- is left blank. In his returns for 1937 and 1940 it is indicated they were "prepared on an accrual basis." Notwithstanding the fact that in some of the returns commissions earned rather than commissions received were reported in gross income, it can not be found that Pearlman's returns were made on other than a cash basis.

By notice dated February 27, 1940, the Commissioner determined deficiencies in Pearlman's Federal income taxes for the calendar years 1934, 1935, 1936, and 1937 in the respective amounts of $ 3,022.49, $ 2,633.84, $ 2,813.66, and $ 5,665.46. On May 18, 1940, Pearlman filed a petition with this tribunal requesting redetermination of the deficiencies. Motion to dismiss for lack of prosecution was granted on May 31, 1941, and deficiencies in the amounts shown above were determined. After Pearlman's death, but before the order of May 31, 1941, was entered, jeopardy assessments were made; but no portion of the taxes has ever been collected.

Pearlman's income tax return for the year 1940 was acknowledged by him on the date of his death (March 11, 1941) and filed in the office of the collector of internal revenue at Philadelphia on March 13, 1941. The tax1944 U.S. Tax Ct. LEXIS 56">*65 shown to be due thereon was $ 2,340.20. The first payment shown on the face of the return and transmitted to the collector was $ 585.05. The difference between the amount shown to be due and the amount received, or $ 1,755.15, is the amount sought in the respondent's answer in addition to that set out in the notice of liability herein. The net income shown to be due by Pearlman's return for 1940 was increased by the amount of interest shown above ($ 25,164.67). This resulted in a deficiency of $ 9,822.97 for that year. The total liability in controversy is therefore:

4 T.C. 34">*39 Numerous policies of insurance (apparently 24) were in effect at the time of Pearlman's death. Three, aggregating $ 150,000, according to the estate tax return, had been taken out by a company of which Pearlman was president. Five, aggregating $ 400,000, were payable to a creditor whose debt exceeded that amount. The proceeds of the 8 policies were paid over to the named beneficiaries and are not in issue here. The remaining 16 policies may be divided into three groups.

1944 U.S. Tax Ct. LEXIS 56">*66 The face amounts of the policies shown in this group were paid to petitioner after the death of her husband. No other details in connection with these policies are shown.

On February 2, 1934, Morris Wolf, as trustee, became the holder and owner of the debt of Pearlman and the Florence Realty Co., a real estate holding company to Wolf Bros. & Co., which debt on said date, including interest, amounted to about $ 450,000. The collateral for the debt, pledged some time prior to October 1, 1930, consisted of 585 shares of preferred and 1,550 shares of common stock of Superior Zinc Co.; two-thirds interest in premises at the northwest corner of Broad Street and Columbia Avenue; one-half interest in premises at 1726 and 1734 North Broad Street, represented by shares of stock of Barrie Realty Co.; one-third interest in premises 1736-1738 North Broad Street, in connection with which there was due one-third of $ 252,027.55, with interest from September 19, 1931; and the life insurance policy above referred to. The Superior Zinc Co. stock was carried as an asset on the1944 U.S. Tax Ct. LEXIS 56">*67 books of M. M. Pearlman and Co. from December 31, 1927, to December 31, 1940.

Pearlman and the Florence Realty Co. made default on the above obligation to Wolf Brothers & Co. On December 16, 1936, Morris Wolf, as trustee, declared the entire balance of approximately $ 500,000, including interest, due and payable. On December 24, 1936, all of the 4 T.C. 34">*40 above collateral was sold to Morris Wolf, as trustee, for $ 100,000. After Pearlman's death the face amount of the policy was paid to Wolf.

The proceeds of the policies shown in group III were, to the extent hereinafter shown, made available to petitioner by the death of her husband, as a result of which she is now receiving, and since March 11, 1941, has received, monthly payments aggregating $ 673.67. The following schedule shows the ten policies, the date each was issued, the face amount, the annual premium, the beneficiary named in the policy when issued, and the cash surrender value of each policy on the date of Pearlman's death.

The policies will hereinafter be referred to by the numbers shown on the left in the schedule above.

Pursuant to an agreement dated October 1, 1930, ² Pearlman (his wife joining) on or about that date assigned and transferred to J. William Hardt, trustee, for the benefit of his creditors, the assets listed on Exhibit A attached to the agreement. The property in Exhibit A was substantially the same as hereinafter shown. The creditors listed held claims against Pearlman aggregating approximately $ 548,000. Another, in the amount of $ 53,522.25, was1944 U.S. Tax Ct. LEXIS 56">*69 added on July 1, 1931. On the latter date a supplemental agreement was signed, the creditors waived default in payment then occurring, and agreed to accept new notes payable on or before December 31, 1931, with interest at 6 percent. The trust agreement was amended to provide that if $ 100,000 had not been paid on account by December 31, 1931, and if the trustee thought it would be advantageous to creditors, new notes, payable on or before July 1, 1932, should be accepted.

4 T.C. 34">*41 "On January 1, 1934, Pearlman, as maker or as guarantor, was indebted to the following creditors in the following amounts, not including interest thereon:

1944 U.S. Tax Ct. LEXIS 56">*70 From October 1, 1930, to October 20, 1933, Hardt, as trustee, had cash receipts in the sum of $ 114,025.69. This represented the proceeds from liquidation of Pearlman's assets, plus interest on the trustee's bank account. From October 21, 1933, to the date of Pearlman's death, Hardt, as trustee, had cash receipts from liquidation of the remaining assets of the trust in the amount of $ 3,718.27.

No interest or any portion thereof was paid by Pearlman or anybody else on the obligations shown above after May 31, 1932. No part of the principal of said obligations was paid by Pearlman or anybody else prior to his death, other than as shown above in connection with the obligation of Pearlman and Florence Realty Co. to Wolf Bros. & Co.

Pursuant to the Trust agreement of October 1, 1930, and the supplemental agreement of July 1, 1931, Pearlman had executed and delivered to each of the creditors, other than Wolf Bros. & Co., promissory notes payable on December 31, 1931, with interest at 6 percent. On December 23, 1937, prior to the expiration of the period of limitations for collection of the notes, they were canceled and returned to Pearlman who in turn made, executed and delivered to1944 U.S. Tax Ct. LEXIS 56">*71 the creditors new notes dated December 23, 1937, in the same amounts, payable on demand, with interest at 6 percent.

As of January 1, 1933, Pearlman was insolvent to the extent of a sum in excess of $ 500,000, and he remained insolvent at least to that extent at all times subsequent thereto.

4 T.C. 34">*42 As of October 21, 1933, the assets remaining in the trust estate under the agreement of October 1, 1930, had the following values:

The antecedent history of the four policies shown on lines 5, 6, 7, and 8 is as follows: On December 10, 1928, Pearlman took out a policy of term life insurance in the face amount of $ 100,000. Medical examination was required and Ten Fifteen Chestnut St. Corporation was the named beneficiary. The insured had the right to change the beneficiary. The policy provided it might be exchanged, "not later than 5 years from the date on which it takes effect, upon written request from the insured * * * without medical examination" for insurance upon the ordinary life plan. Such request was made and on March 24, 1933, four such policies in the face amount of $ 25,000 each were issued, payable to "The Executors, Administrators or Assigns of the Insured or to the Duly Designated Beneficiary." Loans were made upon the policies as hereinafter shown.

The policies shown on lines 1, 2, and 3 were issued on the dates shown, 1944 U.S. Tax Ct. LEXIS 56">*73 Pearlman's wife, petitioner herein, being the named beneficiary. Pearlman had the right to change the beneficiary in each policy. On May 3, 1932, the beneficiary in each was changed to "The Executors, Administrators or Assigns" and endorsements to that effect were made on the policies. On May 5, 1932, the insurance company was named as trustee in each policy. The appointment was revoked January 30, 1933. On March 28, 1933, the insurance company was again appointed 4 T.C. 34">*43 trustee under each policy; but the appointments were revoked on May 25, 1933.

Under date of November 29, 1933, Pearlman filed with the insurance company a lengthy "Settlement Agreement," attached to and forming a part of each of the seven policies, designating his wife, petitioner herein, as first beneficiary, with several options, and his four daughters as second beneficiaries.

The policy shown in line 10 stems from a policy (No. 1107506) of $ 100,000 which was issued to Ajax Hosiery Mills by Sun Life Assurance Co. of Canada on February 7, 1929, on Pearlman's life. Policy No. 1107506 was assigned on September 8, 1932, and on April 24, 1934, by Ajax Hosiery Mills to Merchant's Transfer & Storage Co. On March1944 U.S. Tax Ct. LEXIS 56">*74 5, 1935, and on March 26, 1935, Merchant's Transfer & Storage Co. and Ajax Hosiery Mills, respectively, assigned it to Pearlman. On March 6, 1935, Pearlman requested the insurance company, without consideration, to change the beneficiary to his wife, petitioner herein. On March 25, 1935, he requested, without consideration therefor, that the beneficiary be changed in accordance with a settlement agreement. The settlement agreement provided that the proceeds, after deduction of indebtedness, should be left with the company and bear interest in accordance with option 1, and that Florence Pearlman should have certain options (election to receive five-twentieths or seven-twentieths in monthly payments, additional elections at age 65, etc.). At her death the remaining proceeds are to be divided into equal shares for the surviving children.

In a letter addressed to Sun Life dated June 14, 1935, Pearlman requested that a new policy be issued in place of Policy No. 1107506. The letter stated, inter alia:

* * * My reason is that I prefer not to have the Ajax Hosiery Mills appear on this policy since this policy has been assigned to me and I am paying the premiums, also having taken1944 U.S. Tax Ct. LEXIS 56">*75 over the loan that was on it, and I see no reason why this policy should not be rewritten direct to me, which, for personal reasons, I prefer to have done. * * *

On July 2, 1935, Pearlman agreed "to cancel and surrender to the Company the dividends that have been accumulated to the credit of this policy (No. 1107506) in consideration of the transfer of such dividends to the new policy." The "Amount of Discharge" was stated (in the special discharge form signed by him) to be $ 30,602, which he agreed should "be applied against the premium on a new policy on the life of the assured."

On July 11, 1935, the policy shown on line 10 above (Policy No. 1475798) was issued. It recited it was being "issued in consideration of the application therefor and of a premium of $ 1,177 to be paid to 4 T.C. 34">*44 the company on the fourth of February 1929 and the payment to it of a like amount quarter yearly thereafter on the fourth day of May, August, November and February in every year during the continuance of this policy."

A policy loan agreement purporting to have been made on the 21st day of June 1935 recites that the Sun Life Assurance Co. had that date loaned to Pearlman, "the party assured under1944 U.S. Tax Ct. LEXIS 56">*76 the Policy No. 1475798," the sum of $ 12,500.72. The loan agreement was canceled February 29, 1936, upon the payment of $ 13,014.21.

Pearlman, except as otherwise shown above with reference to the Sun Life policy, paid all premiums on the policies from the dates taken out to the date of his death. Loans had been obtained upon most of them, some of which had been repaid prior to the dates and transactions shown below. Loans paid off on or about February 25, 1936, were:

1944 U.S. Tax Ct. LEXIS 56">*77 On February 24, 1936, Pearlman assigned the ten policies of insurance to the Market Street National Bank of Philadelphia as collateral security for a loan to him of $ 57,300. The proceeds of this loan were largely used in the payment of the outstanding loans on the policies.

Pearlman's income for the years 1933 to 1940, inclusive, consisted of salaries and commissions in the respective amounts of $ 32,570.09. $ 27,540.48, $ 25,689.70, $ 26,546, $ 41,356.75, $ 27,492.68, $ 35,842.74, and $ 47,214.16.

After Pearlman's death proofs were filed with the insurance companies under the ten policies. Settlement was made as follows: 4 T.C. 34">*45

The claim settlement certificates, though differing in form, provide for the payment of interest on the amounts held to Florence Pearlman unless she exercises the options -- i.e., to receive five-twentieths1944 U.S. Tax Ct. LEXIS 56">*78 of principal amount during 10, 15, or 20 years in accordance with a table; or some other amount (seven-twentieths) in monthly installments during 20 years; or after April 10, 1947, that she elects to receive installments, payable as long as she may live, in accordance with another table. Provision is made in each certificate for the disposition of the remaining amount, if any, to the daughters and grandchildren of Pearlman and his wife upon the death of the wife.

"During the period from March 11, 1941, to the present time, monthly payments have been made to Florence Pearlman, as beneficiary of the ten (10) policies of insurance on the life of Martin M. Pearlman * * * as follows:

The aggregate payments realizable by petitioner through the exercise of the options in the certificates of claim were:

1944 U.S. Tax Ct. LEXIS 56">*79 The value, on the date of the death of Pearlman, of petitioner's right to receive the annual payments under the policies shown in lines 5, 6, 7, 8, and 10 was in excess of the liability asserted herein. (See footnote 6, infra.)

4 T.C. 34">*46 OPINION.

As indicated at the outset, the issue is whether petitioner, under the facts, is liable in equity for the income taxes of her deceased husband. The applicable statute is shown in the margin. ⁴

1944 U.S. Tax Ct. LEXIS 56">*80 Although many cases have been decided under the transferee provisions of the statute, this is the first in which the precise question now before us has arisen. Beneficiaries under life insurance policies, however, have been held liable for the estate tax where the tax sought to be collected arose because of the inclusion in gross estate of the proceeds of insurance in excess of $ 40,000, Edna F. Hays et al., Executors, 34 B. T. A. 808; the widow of a deceased has been held liable, as a transferee, for the income tax of her husband where the proceeds of insurance policies on his life, payable to his estate, had been set aside to her by the probate court under a state statute, May R. Kieferdorf, 1 T.C. 772; affd., Kieferdorf v. Commissioner, 142 Fed. (2d) 723; and the Court of Appeals for the District of Columbia has reversed our holding ( John Hancock Mutual Life Insurance Co., 42 B. T. A. 809) that insurance companies with which the proceeds had been left pursuant to the terms of the policies and of settlement agreements were transferees under section 3161944 U.S. Tax Ct. LEXIS 56">*81 of the Revenue Act of 1926, pointing out that Congress had obviously intended "that the beneficiary alone was to be liable in the case of the insurance estate." John Hancock Mutual Life Ins. Co. v. Helvering, 128 Fed. (2d) 745.

The cited cases, while not determinative of the present issue, lend a modicum of support to respondent's contention, expressed upon brief in the following language:

Pearlman intended to make a most unreasonable provision for his wife and to wholly disregard the claims of his creditors. He was fully apprised of his inability to pay his debts which were in excess of $ 1,000,000 when he undertook to secure to her by the expenditure of his own means, an estate in the form of insurance on his life in an amount in excess of $ 300,000. In so doing, he converted to her benefit, in the payment of premiums, large sums of money in each year which in good conscience should have been paid to his creditors. The circumstances connected with the transactions that occurred during his insolvency * * * leave no doubt but that he had determined to provide for his wife and children in total disregard of the rights and claims of creditors. 1944 U.S. Tax Ct. LEXIS 56">*82 4 T.C. 34">*47 The premiums which secured the policies and kept them alive were part of his estate and were diverted from the payment of his debts to investments for his wife and children. He was hopelessly insolvent [when the beneficiaries were changed], his insolvency continued at all times subsequent * * * [and] the transfers were without consideration and void and fraudulent as against his creditors, including the United States Government. * * * At the death of Pearlman, petitioner, as donee beneficiary, acquired valuable property rights or choses in action against * * * [the insurance companies]. [She therefore became] the trustee of a constructive trust for the benefit of his creditors, was bound in equity to exercise the rights conferred upon her as primary beneficiary, * * * [and is therefore] liable for the full amount of his unpaid tax liability.

Both parties recognize that the transferee provisions create no new liability, but merely provide a new remedy for enforcing an existing liability at law or in equity. Phillips v. Commissioner, 283 U.S. 589">283 U.S. 589; Hulburd v. Commissioner, 296 U.S. 300">296 U.S. 300. Also that the liability1944 U.S. Tax Ct. LEXIS 56">*83 is to be tested primarily by the law of the state of the domicile, in this instance Pennsylvania.

The first charge made by the respondent, in our judgment, is without substance. "* * * the law does not prevent an insolvent from carrying insurance for the benefit of his wife, children, or other dependent relatives." Irving Bank v. Alexander, 280 Pa. 466">280 Pa. 466; 124 A. 634, 635. We pass, then, to consideration of the argument of the parties directed to what seems to be respondent's major contention, that the assignments of the policies -- i. e., the changes of beneficiaries to petitioner or to the insurance companies for her benefit -- were in fraud of creditors, including the Government. Before doing so, however, it should be stated that this contention is wholly without foundation as to the two Prudential policies ⁵ and it is at least doubtful whether it is sound as to the three New York Life policies, taken out by Pearlman in 1907 and 1916. ⁶ In the last mentioned, petitioner, or the insurance company as a trustee for her, was at all times the named beneficiary except for a two-day period in 1932 and two brief periods 1944 U.S. Tax Ct. LEXIS 56">*84 in 1933. Cf. Newman v. Newman, 328 Pa. 552">328 Pa. 552 (1938); 198 A. 30. In the Prudential policies, however, she was at all times either the named beneficiary or the one to whom payments were to be made during her life.

Briefly restating the facts with reference to the other five policies, four of them ⁷ stemmed from a $ 100,000 policy which had been issued1944 U.S. Tax Ct. LEXIS 56">*85 4 T.C. 34">*48 to the Ten Fifteen Chestnut St. Corporation. They were payable to Pearlman's executors, administrators, or assigns until long after he had become insolvent. The $ 100,000 policy issued by the Sun Life Assurance Co. of Canada to the Ajax Hosiery Mills Co. had been assigned by the latter company to one of its creditors as security for an indebtedness. Petitioner had no rights under it until March 25, 1935, when she was named as principal beneficiary, at which time the insured was hopelessly insolvent.

The first case relied upon by respondent to support his view that the changes of beneficiary were in fraud of creditors is Appeal of Elliott's Executors, 50 Pa. 75">50 Pa. 75 (1865). The deceased had effected four policies on his life, each for $ 10,000, three of which were assigned to a trustee for the benefit of his wife. The three assignments, the court pointed out, "were all voluntary, and would have been good against heirs, devises or legatees; but here the decedent1944 U.S. Tax Ct. LEXIS 56">*86 died insolvent, and the question is, are they good against creditors." Holding that they were not, the court said:

The testator was hopelessly insolvent in 1859 and for some time previous. The insurances were effected in February and March of that year, assigned on 10th September following, he dying two months afterwards, when the policies became due and payable. The assignments do not appear to have been known to the trustee or cestui que trusts, certainly not to his creditors, who were apparently first aware of his situation by the developments succeeding his decease. We can therefore have no difficulty in holding these assignments fraudulent and void, and that the proceeds of the policies belong to creditors and estate of the decedent.

The next case cited by respondent is In re McKown's Estate, 198 Pa. 96">198 Pa. 96 (1901). McKown had taken out a policy of $ 10,000 in the Manhattan Life Insurance Co. upon his life, payable to his executors, administrators, or assigns. Ten years later, while insolvent and at a time when he was largely indebted to the issuing company for defalcations while one of its agents, he assigned the policy to his1944 U.S. Tax Ct. LEXIS 56">*87 wife. The court held:

* * * At the time McKown made this voluntary assignment of the policy to his wife, he was admittedly insolvent. The burden of proof is, therefore, upon her to show the bona fide character of the transaction and to repel the presumption of fraudulent intent as to creditors. * * *

The third and principal case is Fidelity Trust Co. v. Union National Bank of Pittsburgh (1933), 313 Pa. 467">313 Pa. 467; 169 A. 209. The facts are quite involved. Briefly, a banker had engaged extensively in speculation, part of which had been unlawful. More than a half million dollars in insurance was paid after his death to trustees for his wife, the assignment of the policies having been made to the trustees at a time prior to his insolvency and no contention having been made that it was fraudulent. The major issue before the court involved three additional policies in the total amount of $ 275,000, taken out by the 4 T.C. 34">*49 insured in March and April 1929 and assigned to the same trustees in October 1929 after he had become insolvent. The court held that the latter assignments were made "with actual intent, as distinguished1944 U.S. Tax Ct. LEXIS 56">*88 from intent presumed by law (Section 7 [Uniform Fraudulent Conveyance Act]) to hinder, delay and defraud creditors. If, however, we did not reach that conclusion, we should be obliged by the record to find that the conveyances are condemned by Sections 4, 5 and 6 [of the same act]."

The court's later recitation of the facts, which need not be repeated here, supports its conclusion. It said, inter alia:

The appellee beneficiaries contend that the donor withdrew nothing from his creditors to pay premiums, and that, as creditors had no claims to the loan or cash surrender values of the policies at the time of the conveyances, nothing was taken from them by changing the designation of beneficiary. This argument disregards the true nature of the transaction. Each policy was a chose in action, an obligation to pay the insured's legal representatives on his death if he complied with the conditions of the policy. That obligation was of value to the insured's creditors; he was able to borrow on the policies, and the proceeds, when received by his executors, would help pay his debts. In re McKown's Estate, 198 Pa. 96">198 Pa. 96, 47 A. 1111">47 A. 1111; In re Huff's Estate, 299 Pa. 200">299 Pa. 200, 299 Pa. 200">205, 149 A. 179">149 A. 179;1944 U.S. Tax Ct. LEXIS 56">*89 Burnet v. Wells, 289 U.S. 670">289 U.S. 670, 289 U.S. 670">679, 53 S. Ct. 761">53 S. Ct. 761, 77 L. Ed. 1439">77 L. Ed. 1439. By conveying that asset in fraud of creditors' rights, a constructive trust resulted for their benefit; on familiar principles, applied in tracing trust property, they may follow the asset in whatever form it takes, which, in this case, is the fund in the custody of the trustees.

In October, 1929, the donor could not, with reason, have considered that he had not provided adequate insurance for his wife and children, because they were then, under the trust agreement, the beneficiaries of insurance greatly in excess of $ 500,000 and his own affairs were in very precarious condition. In addition, his wife was the beneficiary of a $ 25,000 policy, not deposited under the trust agreement.

From the circumstances referred to, we think only one inference is permissible, and that is that the donor actually intended to deprive his creditors of their expectancies in the policies. No other inference will explain or reasonably account for the gift. The reservation of the right to deal with the policies as his own is some evidence of the actual intent to hinder, 1944 U.S. Tax Ct. LEXIS 56">*90 delay, and defraud his creditors. If he intended only to benefit his family, it was unnecessary to reserve power to revoke and to appoint to others. Cf. Mitchell v. Stiles, 13 Pa. 306">13 Pa. 306, 13 Pa. 306">309.

Petitioner expresses the view that the decision, "solely on the basis of the Fraudulent Conveyance Act, without any consideration of the later act of 1923, ⁸ which sets forth so definite and important an exception to the Fraudulent Conveyance Act, was completely ununderstandable." She sets out in considerable detail the antecedent history 4 T.C. 34">*50 of the act of 1923 and the decisions under the earlier acts in an attempt to prove that "the more than fifty years established policy of the state [is] that the transfer of insurance policies by an insolvent was to be an exception to the Fraudulent Conveyance Act." Whether that is so can best be determined by examining the later cases by the Supreme Court of Pennsylvania. Freuler v. Helvering, 291 U.S. 35">291 U.S. 35; Blair v. Commissioner, 300 U.S. 5">300 U.S. 5; Erie Railroad Co. v. Tompkins, 304 U.S. 64">304 U.S. 64; Helvering v. Stuart, 317 U.S. 154">317 U.S. 154.1944 U.S. Tax Ct. LEXIS 56">*91

Four cases have been decided by that court since the Fidelity Trust Co. case in which creditors have endeavored to seize the proceeds of insurance policies because the deceased, while insolvent, had named his wife as beneficiary in substitution for his estate. In Stutzman v. Fidelity Mutual Ins. Co., 315 Pa. 47">315 Pa. 47 (1934); 172 A. 302">172 A. 302, this had occurred under the following circumstances: Deceased was heavily involved1944 U.S. Tax Ct. LEXIS 56">*92 financially, but was carrying insurance on his life in an amount in excess of $ 100,000. Some of the policies were payable to his estate and some to his wife. A creditor, by threat of criminal proceedings, prevailed upon the insured to assign to him -- the wife of the insured joining -- policies in which his wife was named as beneficiary, having a cash surrender value of $ 700. "To restore to his wife the protection which she lost, the husband immediately * * * changed the beneficiary in the $ 25,000 Fidelity policy from his estate to her." The chancellor found that the purpose of the deceased in changing the beneficiary was not to defraud creditors and the Supreme Court of Pennsylvania affirmed, holding that the circumstances to which we have alluded "distinguish sharply this situation from that presented" in the cases cited, among which were In re McKown's Estate and 313 Pa. 467">Fidelity Trust Co. v. Union National Bank of Pittsburgh, supra.

In Potter Title & Trust Co. v. Fidelity Trust, 316 Pa. 316">316 Pa. 316 (1934); 175 A. 400, the court, in a per curiam opinion, said:

The wife and children 1944 U.S. Tax Ct. LEXIS 56">*93 of every man have an insurable interest in his life, and the law has always looked with favor on life insurance contracts made for their comfort and maintenance. From our earliest cases down to the present day this court has upheld and encouraged such provisions and protected them from claims of creditors. Stutzman, Admr., v. Fidelity Ins. Co., 315 Pa. 47">315 Pa. 47, 315 Pa. 47">49. In addition, the legislature has enacted laws for the protection of the wife and children, as beneficiaries of life insurance policies, from claims of creditors of the insured (Acts of April 15, 1868, P. L. 103 and June 28, 1923 P. L. 884), and this benefit inures to them whether the insured was solvent or insolvent, or had reserved the right to change the beneficiary: Schaeffer's Estate, 194 Pa. 420">194 Pa. 420; Irving Bank v. Alexander, 280 Pa. 466">280 Pa. 466.

In that case the insured, while insolvent, had executed an insurance trust for the benefit of his wife, daughter, and sister. Prior to the execution of the trust the wife had been the named beneficiary in most 4 T.C. 34">*51 of the insurance policies and the daughter had been the1944 U.S. Tax Ct. LEXIS 56">*94 named beneficiary in the remainder. The court pointed out that "no change of beneficiary" had been made, with the exception that the sister had been made a contingent beneficiary at the death of the wife and daughter, and held that the creditors had no right to the fund created by the insured's death.

328 Pa. 552">Newman v. Newman, supra, was a controversy between a widow and the executors of her deceased husband's estate. Policy of insurance had been issued July 11, 1925, the wife being the designated beneficiary. On April 9, 1932, the beneficiary was changed to the executors, administrators, or assigns of the insured and on April 11 the policy was assigned to a bank as collateral security for a loan. On January 4, 1937, the loan was paid and the wife was restored as beneficiary. The executors claimed that the insured was insolvent when the wife was restored as a beneficiary and that such change was an effort, in the words of the affidavit of defense, "to cheat and defraud * * * creditors * * * in violation of the provisions of the Uniform Fraudulent Conveyances Act." The Supreme Court of Pennsylvania said:

The learned court below held that the affidavit1944 U.S. Tax Ct. LEXIS 56">*95 of defense was insufficient. The husband merely restored to the plaintiff the same policy benefit which she had relinquished so long as was necessary to secure the bank's loan to him; when the loan was repaid she was merely put in the position she had occupied before. There is nothing to show bad faith. See Stutzman, Administrator v. Fidelity Insurance Company, 315 Pa. 47">315 Pa. 47, 172 A. 302">172 A. 302. The situation is precisely what it would have been if, instead of formally changing the beneficiary, the wife had originally joined in the assignment as collateral and on payment of the debt the policy had been returned by the bank. Judgment affirmed.

In Provident Trust Co. v. Rothman, 321 Pa. 177">321 Pa. 177 (1936); 183 A. 793, the court, in an attachment proceeding brought by creditors against a surviving wife, discussed the Pennsylvania legislation, which culminated in the Act of June 28, 1923, of which the statute relied on by petitioner is a part, and distinguished the Fidelity Trust Co. v. Union National Bank case, supra, upon the ground that "there was not a fraudulent transfer," 1944 U.S. Tax Ct. LEXIS 56">*96 as there had been in the cited case.

Landreth v. First National Bank, 346 Pa. 551">346 Pa. 551 (1943); 31 Atl. (2d) 161, also cited by petitioner, although involving the right to proceeds of an insurance policy, turned upon the wife's right to stand upon the precise terms of a note which had been executed by her husband prior to his death. The court refused to construe the language making every "debt" or "obligation" of the pledgor due at his death applicable to corporate notes signed by him as a surety and which were not then due. It accordingly found that the widow was entitled to the insurance proceeds, reduced only by the amount borrowed by the insured and secured by the pledged insurance policy.

4 T.C. 34">*52 Each of the parties seems to take an extreme view of the Pennsylvania law. Petitioner argues that the act of 1923 means nothing unless it is construed to mean that it grants an absolute exemption of the insurance proceeds, even though the assignment may have been in fraud of creditors. Respondent appears to believe that the sole test is solvency or insolvency of the insured when the change in beneficiary is made. In our judgment1944 U.S. Tax Ct. LEXIS 56">*97 neither view is sound.

In the Fidelity Trust Co. v. Union National Bank case, supra, the court, upon another issue, made specific reference to the statute upon which petitioner relies. Contention was made that insurance policies which had been assigned to a bank as collateral were "within the statutory exemption saving family insurance from creditors." The chancellor had awarded to the plaintiff (administrator pendente lite) the difference between the note, with interest, and the stipulated value of the collateral. The court held that the donor had subordinated the contingent beneficial interest theretofore conferred on his family to the extent of the loan and interest; that while the statute exempts insurance payable to the family it does not exempt proceeds payable to a creditor or to creditors and the family; that the creditor's interest is not exempt; and therefore that the asset which the donor "had carved out of what was once an expectancy for his family" "remained where it was, an asset of the donor, which on his death passed to his personal representatives in such amount as the bank might have claimed."

The fact that the court considered and discussed the1944 U.S. Tax Ct. LEXIS 56">*98 1923 statute in that case is convincing evidence it did not deem it to be an insurmountable obstacle to the application of the Uniform Fraudulent Conveyance Act to policies of insurance assigned in fraud of creditors. The later cases, however, indicate that the court did not intend to lay down a rule making every change of beneficiary by an insolvent insured presumptively fraudulent. As we view the cases, the court has given a reasonable construction to both legislative enactments, holding that, while it is the policy of the state to protect a wife and children of an insured, it will not do so when he has been guilty of conduct interdicted by the Fraudulent Conveyance Act.

Was Pearlman guilty of such conduct in naming his wife beneficiary in the five policies under which approximately $ 200,000 is to be paid by the insurance companies? We are of the opinion he was. The courts of Pennsylvania would so hold in an action brought by creditors or by a representative of his estate. 313 Pa. 467">Fidelity Trust Co. v. Union Bank of Pittsburgh, supra.We are therefore of the opinion and now hold that petitioner is liable as a transferee for the income taxes of her1944 U.S. Tax Ct. LEXIS 56">*99 deceased husband.

We have not overlooked the several contentions made by petitioner 4 T.C. 34">*53 upon brief; but in our judgment none of them can change the result. Her reliance upon the state statute of limitations is unsound. The transferee provision of the revenue act contains its own limitation. The one applicable here is "one year after the expiration of the period for assessment against the taxpayer." (Sec. 311 (b) (1), I. R. C.) The liability asserted for the 1940 taxes affirmatively appears to be timely. We can not find on the present record that any of the others were barred. Nor is it material in the instant case that the change in beneficiary occurred before the liability for some of the taxes arose. If the transfer was in fraud of creditors, intended to defraud creditors, or devised as a scheme to defeat the collection of future income taxes, it would be within one or more of the sections of the Fraudulent Conveyance Act and void under the law of Pennsylvania. 313 Pa. 467">Fidelity Trust Co. v. Union Bank of Pittsburgh, supra.Cf. Harwood v. Eaton, 68 Fed. (2d) 12. Nor need we be concerned with whether the Commissioner, 1944 U.S. Tax Ct. LEXIS 56">*100 as a result of this proceeding, succeeds in collecting all of his claim while other creditors may not fare so well. Whether he may sequestrate the monthly payments, "compel her to exercise certain options under which she may receive portions of the principal of the insurance fund over a period of years," or distrain upon other property owned by her, is not within our jurisdiction. It may even be (as suggested by the court in John Hancock Mutual Life Insurance Co. v. Helvering, supra) that the insurance companies are not trustees and that the relationship between them and petitioner is that of debtor-creditor. As to that we express no opinion. Our task is complete when the question of liability is determined.

Since we have held that petitioner is liable as a transferee, the extent of such liability must be determined. In this connection the real question seems to be (see footnote 1) whether the deduction of $ 8,212.50 each year as accrued interest may be allowed.

Petitioner relies upon Berryman D. Fincannon, 2 T.C. 216. In that case the issue was whether commissions earned by an active business conducted by1944 U.S. Tax Ct. LEXIS 56">*101 the taxpayer were to be included in his gross income in the year earned by the business, its books being kept on an accrual basis, or in the year when they were paid, the taxpayer being on the cash basis. We recognized that two separate systems of accounting could be maintained by the taxpayer, one for his active business and one reflecting his other transactions, and that under the circumstances before us he should have included in his gross income the commissions accrued on the books of his business.

The Fincannon case was a practical solution of the problem there dealt with; but it can have no application under the present facts. Pearlman's business, long prior to the taxable years, had become a mere shell, transacting no business and having no real existence. True, 4 T.C. 34">*54 it continued to make postings to accounts which had been set up on its books to show the interest accruing upon the loans from the banks. That, however, in our judgment, was an idle gesture. Clearly, the creditors, at all times, had recognized they were extending the credit to Pearlman, trading as M. M. Pearlman and Co. He was individually liable for the debt. The creditors did not look to the "business" 1944 U.S. Tax Ct. LEXIS 56">*102 and it would have been futile for them to have done so. Taking the balance sheet of the business at its face, it was insolvent throughout the taxable years. Its principal asset was a "Drawing Account" of Pearlman, ranging from $ 112,681.76 in 1934 to $ 272,714.48 in 1940. If the books had been properly kept the amount owing by Pearlman to his business, during most of the period, would have been in excess of a quarter of a million dollars. The business had no net worth, the other property owned by it being furniture and fixtures carried at $ 2,309.30, a small amount of cash, and a "Loan Receivable" of 1015 Chestnut Corporation, another company of Pearlman, in the amount of $ 9,664.67. The value of the last mentioned is not shown; but the parties have stipulated that an account payable by the same company to Pearlman and his trustee in the amount of $ 24,500 had no value on October 21, 1933.

Looking realistically at the situation as it existed throughout the taxable years, the conclusion is inescapable that the interest was Pearlman's. He was on the cash basis and, although he had substantial income, no interest was ever paid. To allow the deduction of $ 8,212.50 during each 1944 U.S. Tax Ct. LEXIS 56">*103 of the five years merely because entries were made on the books of an inactive non-entity would be to exalt form above substance. Cf. Griffiths v. Helvering, 308 U.S. 355">308 U.S. 355, and Higgins v. Smith, 308 U.S. 473">308 U.S. 473. Whether the "business" could be said to have properly accrued the interest even if it had been active -- the other facts being as shown in our findings -- is at least debatable. With all due deference to the Circuit Court of Appeals for the Eighth Circuit, we adhere to the view expressed in Zimmerman Steel Co., 45 B. T. A. 1041, notwithstanding the reversal in Zimmerman Steel Co. v. Commissioner, 130 Fed. (2d) 1011. But the point need not be labored. We hold merely that petitioner has failed to prove that Pearlman was on other than a cash basis or that any amount in excess of that allowed by the respondent may be deducted from his gross income as "interest paid or accrued within the taxable years on indebtedness" within the purview of section 23 (b) of the applicable revenue acts.

Respondent's determination is approved and his request that $ 1944 U.S. Tax Ct. LEXIS 56">*104 1,755.15 additional tax for 1940 be included in petitioner's liability as a transferee is granted.

Decision will be entered under Rule 50.