Opinion
Docket No. 5811.
1946-11-19
ARTHUR L. BLAKESLEE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Willis D. Nance, Esq., for the petitioner. Cecil H. Haas, Esq., for the respondent.
In 1934 and 1935 petitioner created trusts in which a bank was named trustee and petitioner's only daughter was the beneficiary. The corpus of the 1934 trust consisted of stock of the Kalamazoo Stove Co., of which petitioner was president but a minority stockholder, and other securities. The 1935 trust corpus was originally composed of other shares of the Stove Co. stock. The grantor reserved certain rights: (1) To vote the Stove Co. stock; (2) to veto the sale of the Stove Co. stock; (3) to consent to the investment of trust income; (4) to substitute trustees; and (5) to defer for a limited time the final distribution of the trust corpus to the beneficiary. All of these reservations were to meet potential emergencies or to conform to beneficiary's development in financial matters and were solely for her benefit. The trusts terminate when the beneficiary shall reach the ages specified therein. The trustee may expend from the income amounts necessary for the daughter's education (until she shall become 21 years of age). The unexpended income accrues until distribution. The trustee and its trust officer administered and managed both trusts. Petitioner never assisted or interfered therein. Petitioner never exercised his right to vote the Stove Co. stock, to veto its sale, or to veto investment of the trust income as made by the trustee. During the taxable year none of the trust income was expended by trustee for the beneficiary's education and hence all of it was accumulated. Held, that the trust income is not taxable to petitioner under either section 167 or section 22(a) of the Internal Revenue Code. Willis D. Nance, Esq., for the petitioner. Cecil H. Haas, Esq., for the respondent.
The respondent determined a deficiency of $6,595.78 in the petitioner's income tax for the year 1941.
The major issue is whether or not the petitioner is taxable on the income from two trusts created by him on August 1, 1934, and July 10, 1935, under the provisions of section 22(a) or section 167 of the Internal Revenue Code.
A collateral issue is whether or not the increment in value of certain United States savings bonds, series B, C, and D, held by the trusts, in the absence of an election by the petitioner in the taxable year to have such increment taxed to him, should be taxed to the petitioner. This issue is to be decided only if the first issue goes against the petitioner.
FINDINGS OF FACT.
Certain facts were stipulated. The portions thereof material to the issue are as follows:
The petitioner is an individual, residing in Kalamazoo, Michigan. He filed his income tax return for the year 1941 on the basis of cash receipts and disbursements with the collector of internal revenue for the district of Michigan.
On August 1, 1934, the petitioner created a trust, sometimes called the 1934 trust, by transferring to the First National Bank & Trust Co. of Kalamazoo, Michigan, in trust, for the benefit of the daughter of the petitioner, Mary Elizabeth Blakeslee, hereinafter called Betty; the following securities:
1,000 shares Kalamazoo Stove Co. stock
10 shares Chase National Bank stock
1 share Amerex Holding Corporation stock
$1,500 Gull Lake Country Club first mortgage bond
$450 United States HOLC bond
$50 City of Muskegon Heights school district bond
$50 Fourth Liberty Loan bond
The pertinent paragraphs of the trust instrument are as follows:
b. The Trustee is authorized to collect the dividends and interest accruing thereon, and to invest and reinvest the income in such securities as the Donor shall first in writing agree to.
c. Donor is the father of MARY ELIZABETH BLAKESLEE (sometimes hereinafter referred to as the Beneficiary), who was born August 21, 1921, and the object of this instrument is to provide a fund for the education of said Mary Elizabeth Blakeslee.
d. Donor hereby directs that so much of the income derived from said Trust Estate as may be necessary to furnish his said daughter with her education, shall be used for that purpose only until the Beneficiary shall attain the age of twenty-one (21) years, and that said Trustee shall account to and pay directly to the Beneficiary all income accruing on said Trust Estate after the said Beneficiary shall become of the age of twenty-one years.
e. It is mutually agreed, that the said Trustee will surrender to the Beneficiary, on her attaining her twenty-fifth (25th) birthday, the said shares of stock and any and all other securities that may be then remaining in its hands, unless notice has been served upon the Trustee in the manner provided in the following subdivision f.
f. The Donor reserves the right to serve written notice upon the Trustee, extending the period of final delivery to the Beneficiary of said stock and securities, for the period of an additional ten (10) years, to-wit: until the Beneficiary shall attain the age of thirty-five years, and the Donor reserves the privilege, in the event of his death prior to the Beneficiary's attaining the age of twenty-five years, of permitting his wife, Guelda Blakeslee, the mother of the Beneficiary, to give written notice of the extension of time of distribution if she so desires.
g. If the Beneficiary should die prior to the period herein fixed for final distribution and delivery to her of the Trust Estate, and she shall leave issue her surviving, then the Donor directs that upon the death of the Beneficiary the Trustee shall immediately make delivery of said stock and other securities then constituting the Trust Estate, to the issue of the Beneficiary, and if more than one of said issue, then to said issue share and share alike.
h. If the Beneficiary shall die prior to the period herein fixed for final distribution and delivery to her of the securities, without issue surviving, the Donor directs the Trustee to make delivery of the stock and securities then in its hands to the Donor and his wife, the said Guelda B. Blakeslee, or to the survivor of them.
i. If the Beneficiary should die prior to the period herein fixed for final distribution and delivery to her of the securities, without issue surviving and neither the Donor or his wife should be living at the date of the death of the Beneficiary, the Trustee shall thereupon deliver to the personal representative of the estate of the deceased Beneficiary the stock and securities then constituting the Trust Estate in its hands, and under such circumstance the Beneficiary is given the power of alienation of said funds at any time after she become of lawful age to make a Last Will and Testament.
j. The Donor directs that no sale shall be made of any of the shares of the Kalamazoo Stove Company, excepting by and with his written consent, and that any stock dividends that may accrue on any of said stocks shall be treated as principal, and not as income, for the purpose of said distribution.
k. * * *
The Donor, during his lifetime, and prior to the time of distribution of said Trust Funds, reserves the right to vote the stock of said Kalamazoo Stove Company at all meetings of the stockholders of said Company, and the Trustee shall, on receipt of notice of such meetings, mail or deliver to Donor a proper proxy to vote said stock at all such meetings.
The Donor also reserves the right to substitute another Trustee in the place of the Trustee herein named, and the Trustee shall upon receipt of the written demand of the Donor forthwith account to and surrender the Trust Estate unto such succeeding Trustee as the Donor may in writing nominate.
The Donor also reserves the right to add other securities to said Trust Estate at any future time he may desire and if he does so, the Trustee shall administer such additional securities in the same manner as is herein provided for the administration of the securities enumerated in said Schedule A.
On July 10, 1935, the petitioner created a trust, sometimes called the 1935 trust, by transferring 2,000 shares of the capital stock of the Kalamazoo Stove Co. to the First National Bank & Trust Co. of Kalamazoo, Michigan, in trust, for the benefit of his daughter Betty. The 1935 trust was identical in language with the 1934 trust, except that in paragraph (F) the petitioner reserved the right to postpone the final distribution of the corpus to the beneficiary until she should reach the age of not more than 45 years and in paragraph (I) it was provided that if Betty should die prior to final distribution to her, without the survival of her issue, or of either the petitioner or his wife, the residue of the trust estate should go to Raymond D. Blakeslee and Tresa Blakeslee Anderson, brother and sister of the petitioner.
On October 30, 1936, the petitioner named his wife, Guelda B. Blakeslee, and C. H. Kleinstuck of Kalamazoo, Michigan, as additional trustees to serve with the First National Bank & Trust Co. of Kalamazoo in both the 1934 and 1935 trusts.
Under date of March 29, 1941, pursuant to paragraph (f) of the 1934 trust agreement, the petitioner served on the trustees in the 1934 trust a written notice relating to the time for distribution of the corpus of the 1934 trust to the beneficiary. By that notice the petitioner amended paragraph (e) of the trust instrument to provide that one-fourth of the trust corpus should be transferred to Betty when she should become 25 years of age, one-third of the remainder when she should become 30 years of age, and the residue thereof when she should become 35 years of age.
Under the same date, pursuant to paragraph (F) of the 1935 trust agreement, the petitioner served on the trustees in the 1935 trust a written notice relating to the time of distribution of the corpus of the 1935 trust to the beneficiary. The petitioner thereby amended paragraph (E) of the trust to provide that the final distribution of the corpus of the trust should be extended until Betty should become 40 years of age.
The beneficiary was born August 21, 1921, became 20 years of age during the year 1941, and was married during that year. After her marriage she lived with her husband and separate and apart from the petitioner. She has one child, born in January 1943.
The total shares of stock of the Kalamazoo Stove Co., hereinafter called the Stove Co., outstanding on August 1, 1934, were 82,008, of which the petitioner owned 5,997 and other family interests 2,880, or an aggregate of 8,877 shares. On July 10, 1935, such total shares were 164,016, of which the petitioner owned 10,494 and other family interests 8,340, or an aggregate of 18,834 shares. From 1936 to 1944 the outstanding shares of the Stove Co. stock were 300,000. The Blakeslee family interests, including the petitioner's stock, varied from 31,382 in December 1936 to 23,342 in December 1944 and showed a gradual decrease during that period.
On January 1, 1944, the corpus of the 1934 trust consisted of bonds, chiefly United States savings series C and D; stocks, principally 1,728 shares of Stove Co. stock costing $37,868.33 but having a market value of $19,007; a one-fourth interest in the Kalamazoo National Bank Building, costing $62,508.65 but valued at $100,000; and an account receivable from the 1935 trust. The net cost of the assets of the 1934 trust was $126,944.01. On December 31, 1941, such assets were $139,496.66 at cost figures, and the corpus had been enlarged by the addition of mortgages and cash.
On January 1, 1941, the corresponding assets of the 1935 trust at cost consisted of United States savings bonds, $22,500; 3,459 shares of Stove Co. stock costing $34,866.53 (market value $38,049); 300 shares of Florence Stove Co. stock costing $10,998.19; cash, $3,808.90, and other small items, all aggregating $73,846.62. The 1935 trust owed $10,923.36 to the 1934 trust. On December 31, 1941, the cost of such assets was $67,850.53 and the trust owed the 1934 trust $3,329.77. Two hundred shares of Bendix Aviation Co. stock, cost $7,432, were substituted for the Florence Stove Co. stock. Otherwise, the items were practically the same as on January 1 of that year.
Fiduciary returns reflecting the income of the trusts for the year 1941 were filed by the trustees. Elections were made therein to include as income received in 1941 the increase for the current and prior years in the redemption price of the United States savings bonds and such increase was so reported as income.
The record discloses the following additional facts:
The petitioner has been president of the Stove Co. since 1927. In that year a Detroit investment company bought the company and registered as stock on the Chicago Stock Exchange. In 1936 the stock was registered on the New York Stock Exchange.
In the early 1930's the petitioner personally successfully defended several lawsuits involving more than $500,000. If judgment had been obtained against him he would have been ruined financially. The depression had also reduced the value of his holdings to a small percentage of their former market price. Many of his friends had lost everything during the depression and were unable to provide their children with an education, an advantage denied to the petitioner because of the financial reverses in his own family.
The petitioner was impelled by the foregoing reasons to create a trust for his only daughter Betty, then 13 years old, in order to insure her education and to provide a modest income when she should become 21 years of age. The petitioner knew nothing about trusts and decided to consult with Merrill W. Taylor, vice president and trust officer of the First National Bank & Trust Co. of Kalamazoo, hereinafter called the bank. They discussed the form and provisions of a trust required to accomplish the petitioner's purpose.
From 1933, the date of the bank moratorium, to 1945 the bank was operated by the receiver of the Guardian Detroit Union Group, Inc., with which the bank was affiliated. The bank was established in 1863. The people of Kalamazoo made every effort to dismiss the receivership and to recover control of the bank. Rumors were rife that eastern or ‘outside‘ interests would purchase the bank. In December 1941 citizens of Kalamazoo purchased the stock of the bank and still hold it.
Taylor became dissatisfied with the operation of the bank in receivership and threatened to leave its employ. Because of this situation and also for the reason that the Stove Co. stock constituted the major part of the corpus of the trusts, Taylor suggested and advised that the petitioner should reserve certain powers. These powers were the rights (1) to vote the Stove Co. stock; (2) to veto the sale of the Stove Co. stock; (3) to consent to the investment of trust income; (4) to substitute trustees; and (5) to extend the date of distribution of the corpus. All such suggestions originated with, and were made by Taylor, solely for the protection of the beneficiary, Betty. The petitioner desired to have the trust funds completely out of his control and free from his own benefit and interest. He adopted Taylor's suggestions in order to accomplish such purpose.
Prior to July 10, 1935, the petitioner consulted again with Taylor, stating that he had decided to establish an additional trust for his daughter's benefit because the income received under the 1934 trust was inadequate. Taylor suggested that the same reservations be incorporated in the proposed trust, particularly since the conditions under which the bank was being operated, had become worse. After making appropriate notes, Taylor asked the petitioner to direct his own attorney to prepare such a supplemental trust instrument. The petitioner then consulted C. H. Kleinstuck, whom he instructed to prepare the new trust, with the additional provisions that he might reserve the right of distribution for a longer period and that if his daughter should die without issue and the petitioner and his wife should die before distribution, then the corpus would vest in the petitioner's brother and sister. Thereupon, the 1935 trust was so prepared and executed.
Just prior to October 30, 1936, the petitioner sought the counsel of his attorney, Kleinstuck, because of current rumors that the stock of the bank was to be sold to eastern interests and also because of Taylor's suggestion that he might withdraw from the bank. The attorney advised the petitioner to exercise his right to substitute trustees in order to prevent the sale of the Stove Co. stock in the event of his death. Accordingly, he made the substitution of trusts in both trusts, as heretofore mentioned.
The bank stock was not sold to ‘outside‘ interests and Taylor continued to act as its trust officer. Consequently, Mrs. Blakeslee and Kleinstuck have never acted as trustees and have had nothing to do with the management and administration of the trust, except on one occasion when a land contract required their formal signatures.
Early in 1941 Betty became engaged to be married. She had no business experience and her prospective husband had very little. She had been graduated from Miss Shipley's School at Bryn Mawr, Pennsylvania, and had attended Garland School in Boston for two years. Because of these circumstances, the petitioner exercised his right to defer the distribution of the corpus of the two trusts as heretofore set forth.
The administration and management of both the 1934 and 1935 trusts were accomplished solely by the trustee and Taylor as its trust officer. The petitioner never took any part in, or interfered with, their administration or management. He never received any income from the trusts, directly or indirectly. All diversification of the securities constituting their corpora was effected by Taylor. On September 25, 1937, the trustee paid out for the beneficiary $1,136.05 and on February 3, 1938, $1,119.72 for her first and second term tuitions, respectively, at Miss Shipley's School. These payments were occasioned by the petitioner's being short of cash at the time. All other income of both trusts, from their inception through the taxable year, was accumulated. The petitioner paid all living expenses and cost of education for Betty except the two payments just set forth, until her marriage on December 22, 1941.
The petitioner never exercised his right to vote the Stove Co. stock, to vote its sale, or to vote the investment of the trust income. Taylor secured the written consent of the petitioner to the sale of the Stove Co. stock. It is customary for the bank to obtain such consents, whether required or not. The bank received 3 per cent of the trust income for 1941 as compensation for its services as trustee. Kleinstuck and Mrs. Blakeslee received nothing therefor.
The number of shares of the Stove Co. stock owned by the 1934 and 1935 trusts ranged from 1,000 to 2,928 and from 2,000 to 3,659, respectively.
The consent agreements required by section 167, as amended by section 134 of the Revenue Act of 1943, have been filed by the petitioner with the Commissioner of Internal Revenue.
OPINION.
VAN FOSSAN, Judge:
The question posed in this case is whether the petitioner is taxable on the income of certain trusts under the provisions of section 167 or of section 22(a) of the Internal Revenue Code.
Much the same problem was before us on comparable facts in Frederick Ayer, 45 B.T.A. 146, where the grantor retained broad powers of management and the trust income could be used for the ‘support, education, comfort and happiness‘ of the grantor's children. There, as in the instant case, none of the income was so used in the taxable years. We held against the respondent and ruled that the income was not taxable to the petitioner under either section 167 or section 22(a).
Again, in David Small, 3 T.C. 1142, we had the identical question. We pointed out in that case that subsequent to the Ayer case, respondent acquiesced in the holding of that case and established its principles as binding administrative policy; that thereafter, the Supreme Court, in Helvering v. Stuart, 317 U.S. 154, repudiated the theory of E. E. Black, 36 B.T.A. 346, on which the holding in the Ayer case was based, thus casting doubt on the correctness of the Ayer case; that yet later, the Congress, by the adoption of section 134 of the Revenue Act of 1943, overruled the Stuart case and retroactively reinstated the rule exemplified by E. E. Black, supra. After reciting the above events, we stated in the Small case that ‘under these circumstances we view the result of the Ayer case as now reestablished and hence, as governing all similar situations, among which we place the present proceeding.‘ A concurring opinion was filed taking the position that section 134 alone was the proper authority for the ruling in the then instant case.
The holding of the Small case was reaffirmed in Estate of O. M. Banfield, 4 T.C. 29. We there held that such income not actually used for support of the beneficiaries was not taxable to the grantor.
Applying the above precedents to the present case, we are of the opinion that the facts here found bring the case squarely within the scope of the cited decisions and make them decisive. The rulings of the Ayer and Small cases are entirely apt and require the ruling that the income is not taxable to the petitioner under section 167 of the Internal Revenue Code.
If the position taken in the concurring opinion in the Small case, i.e., that section 134 and not the Ayer and Black cases should be held controlling, be advanced here, respondent can find no solace therein. The facts bring the case squarely within section 134 of the code. That section has been literally complied with and appropriate consents have been filed.
There remains for decision, therefore, only the question whether the facts of record bring this case within the scope of the decision of the Supreme Court in Helvering v. Clifford, supra. In the Clifford case it was stated that the ‘answer to the question must depend on an analysis of the terms of the trust and all the circumstances attendant on its creation and operation.‘ The rights reserved by the grantor were limited and for specific purposes. These rights were (1) to require his consent to the sale of Kalamazoo Stove Co. stock; (2) to vote the same stock; (3) to approve the investment of income by the trustee; (4) to substitute trustees; and (5) to postpone for a limited time the final distribution of the trust corpus to the beneficiary. All of those reservations were made by the grantor at the suggestion of Taylor and solely for the benefit of the beneficiary. In fact, when the grantor created the trusts and at all times during their existence under Taylor's management, he emphatically disclaimed any right to manage or control the trust funds or the income therefrom and insisted that such funds should be entirely free from his own interest or benefit. He retained no dispositive control over either income or corpus. See Hall v. Commissioner, 150 Fed.(2d) 304; David L. Loew, 7 T.C. 363. The reservations insisted on by Taylor were incorporated in the trusts to be used only in the emergency that the uncertain bank situation should become critical and in the eventuality that Betty should fail to show evidence of her ability to manage her own affairs.
As events proved, the anticipated bank emergency never arose. The control of the bank was obtained by citizens of Kalamazoo and Taylor remained as its trust officer. The petitioner never exercised his right to vote the Kalamazoo Stove Co. stock, to veto its sale, or to veto Taylor's investment of the trust income. He executed only formal required consents to the sale of Kalamazoo Stove Co. stock. He substituted trustees solely because of the precarious bank situation and he altered the period for the final distribution of the corpus to Betty only because of her early marriage and her own inexperience in financial affairs. Both acts were prompted by conditions which arose after the execution of the trusts but which, at that time, were anticipated as being possible. Both were wholly in the beneficiary's interest.
Under these circumstances, it is clear that the petitioner never actually realized, nor could he realize, any gain, profit, or economic benefit through the retention or exercise of any of the rights reserved to him in the trusts. See Hall v. Commissioner, supra; Cushman v. Commissioner, 153 Fed.(2d) 510.
The recent case of Ward Wheelock, 7 T.C. 98, contains some elements similar to those found here and presents a situation less favorable to the petitioner than here. There the petitioner transferred stock in a ‘family corporation‘; here the petitioner was only a minority stockholder in the Kalamazoo Stove Co. The trusts there and here were all irrevocable. There the income was payable to the grantor's wife, one of the trustees, for the maintenance, education, and support of the beneficiaries. All unexpended income was to be accumulated and paid to the beneficiaries at a definite time. In no event was the income to be paid to the grantor for his own use. After the beneficiary should become 25 years of age (21 if the settlor were deceased) the entire net income was to be paid currently to the beneficiary until he should become 35 years of age. The trustees were given the usual general powers to manage the trust property. None of the family corporation stock could be sold without the consent of the grantor or his wife, who was to hold the proxies to vote such stock, or could designate a holder.
In the Wheelock case we held that the grantor did not retain powers equivalent to ownership and hence was not taxable on the income from the trusts. Here, in view of the provisions of the trusts, the petitioner's purpose in establishing them, his actions subsequent thereto, and all other pertinent facts of record, we come to the same conclusion. See Kohnstamm v. Pedrick, 153 Fed.(2d) 506.
In view of our decision on the major issue, it is unnecessary to discuss or decide the collateral issue.
Reviewed by the Court.
Decision will be entered under Rule 50.