## Facts

- A California corporation donated two parcels of real property to charitable donees in 1939 and 1940, each conditioned on use for religious or educational purposes.
- The corporation claimed charitable contribution deductions of $4,243.49 (1939) and $4,463.44 (1940), totaling $8,706.93, producing an aggregate tax savings of $1,877.49 under the rates then in effect.
- In 1957 the donees chose not to use the properties as required and reconveyed both parcels to the corporation.
- The corporation did not include any amount for the reconveyed properties in its 1957 gross income.
- On audit, the Commissioner increased 1957 income by $8,706.93 (the full amount of the prior deductions) and assessed a deficiency computed at the 1957 corporate rate of 52%.
- The corporation paid the deficiency and filed a refund claim, asserting that any inclusion should be limited to its earlier tax benefit ($1,877.49); the claim was denied, and the corporation brought a tax refund suit.

## Issues

1. Under the tax benefit rule and 26 U.S.C. § 111, whether reconveyed property previously deducted as a charitable contribution must be included in income to the full extent of the prior deductions when the deductions produced a tax benefit.
2. Whether the inclusion is taxed at the rate in effect in the year the deduction was taken or the rate in effect in the year of recovery.

## Decision

- Judgment for the United States; the refund claim was dismissed.
- The corporation was required to include $8,706.93 in 1957 income, equal to the total charitable contribution deductions previously allowed.
- The applicable tax rate was the 1957 corporate rate, not the rates in effect in 1939–1940, even though the resulting tax exceeded the earlier tax savings.

## Legal Principles

- When a taxpayer recovers property (or an item) previously deducted and the deduction yielded a tax benefit, the recovery is includible in gross income to the full extent of the prior deduction.
- The “return of capital” concept does not prevent inclusion when the tax benefit rule applies; once a prior deduction has produced a tax saving, the size of that saving does not cap the later inclusion.
- Under 26 U.S.C. § 111 and the annual accounting system, the tax consequences of the recovery are determined in the year of recovery; the tax rate applied is the rate in effect for that year.
- Prior precedent limiting recapture by reference to the earlier year’s rates was rejected as inconsistent with § 111 and annual accounting.

## Conclusion

The court held that reconveyed charitable-contribution property must be included in income in the year of recovery for the full amount previously deducted, and the inclusion is taxed at the recovery-year rate rather than being limited to, or measured by, the taxpayer’s earlier tax benefit.


Alice Phelan Sullivan Corp. v. United States, 381 F.2d 399 (Ct. Cl. 1967)