Opinion
Docket No. 85059.
1962-03-21
CALVIN PARDEE ERDMAN, ESTATE OF ELEANOR D. ERDMAN, DECEASED, CALVIN PARDEE ERDMAN, CALVIN PARDEE ERDMAN, JR., EXECUTORS PETITIONERS, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
John E. McClure, Esq., for the petitioners. Jay B. Kelly, Esq., for the respondent.
John E. McClure, Esq., for the petitioners. Jay B. Kelly, Esq., for the respondent.
Upon the termination of a testamentary trust established by the father of Eleanor Erdman, the trustee filed suit in chancery court to determine the proper recipient of the property. Eleanor participated in the suit and asserted successfully that she was one of the persons entitled to the property. The chancery court then ordered that Eleanor be reimbursed from the trust corpus for her attorney's fees. The petitioners, Eleanor's executors and her husband, contend that the attorney's fees are a deductible expense to her and, in the alternative, that the trust is entitled to deduct them and thus Eleanor need not treat certain payments received from the trust as taxable income. Held, the payment of the attorney's fees is properly an expenditure of the trust and not an expenditure of Eleanor. Held, further, since these fees were chargeable to corpus rather than to income, they do not reduce the trust income distributed to and properly reported by Eleanor under sec. 162(b), I.R.C. 1939
The Commissioner determined a deficiency in the petitioners' income tax for 1953 in the amount of $6,377.65. The only issues for decision are:
(1) Whether the petitioners are entitled to an expense deduction for certain legal fees; and
(2) Whether, in the alternative, the petitioners are entitled to exclude from gross income a certain sum received during the taxable year from a trust.
FINDINGS OF FACT.
Some of the facts are stipulated and are found as stipulated.
At all times material in this proceeding Calvin and Eleanor Erdman were husband and wife. They filed their joint Federal income tax return and amended joint Federal income tax return for the taxable year 1953 with the district director of internal revenue at Los Angeles, California, on March 15, 1954, and April 9, 1954, respectively. Eleanor died on December 30, 1959, and her executors, Calvin Pardee Erdman and Calvin Pardee Erdman, Jr., filed the petitioner herein on behalf of her estate.
Eleanor was the daughter of Reuben Hamilton Donnelley. Reuben died on February 25, 1929, leaving a will which was admitted to probate on April 1 1929. In Article Six of his will he bequeathed $500,000 in trust. Three-fifths of the income of this trust was to be paid to his mother for life and the remaining two-fifths to his sister, Naomi Donnelley. If his mother died before Naomi, the entire income was to be Naomi's for her life and the principal would go to whomever Naomi appointed in her will. In the event that Naomi died before her mother, the entire income was to go to her mother for life and on her death the principal would go to Eleanor and her brother, Thorne Donnelley, equally.
In Article Fifteen of his will Reuben provided that the remainder of his estate after the payment of debts and specific legacies should be divided into two trusts, one primarily for the benefit of his son Thorn Donnelley and his issue and the other primarily for the benefit of Eleanor and her issue. Under the provision for Eleanor, if she were living (as she was at the time of the separation of the residue into two trusts), she would receive the income from her share for her life. If she left descendants at her death, the principal of her trust fund was to go to whomever she directed in her will. There was a gift provided in default of appointment. If Eleanor left no issue at her death, the principal was to become a part of the trust fund established for her brother. The provisions of the trust established for Thorne Donnelley were similar. Articles Sixteen and Seventeen of the will disposed of the property in the event neither Thorne nor Eleanor left issue upon their deaths.
Reuben Hamilton Donnelley's mother died on or about March 18, 1934, at which time his sister Naomi was living. On or about December 15, 1942, Naomi released the power of appointment given her by Article Six of the will. On July 2, 1951, Naomi died. On the death of Naomi, the trustee of the $500,000 trust created by Article Six of Reuben's will determined that an ambiguity existed with regard to who should receive the principal of the trust. The trustee, therefore, brought suit in the Circuit Court of Cook County, Illinois, in Chancery, to obtain a construction of Reuben's will. All known persons who could possible have had an interest in the trust were made parties defendant.
Thorne and Eleanor answered the complaint and contended that they were entitled to have the principal of the trust distributed to them immediately because the will displayed an intent on the part of the testator that they receive the property should the provisions for Reuben's mother and sister cease to operate. They also contended, in the alternative, that they were entitled to the property because, since the testator made no provision for the circumstances that occurred, he died intestate as to that property and they were his only heirs.
The trustees of the trusts established by Article Fifteen of the will also answered the complaint. They contended that Article Fifteen should be treated as a general residuary clause and that, therefore, all property not otherwise disposed of should be included in their trusts.
The Circuit Court decided that Thorne and Eleanor were entitled to the property and so decreed on March 25, 1953. In the decree that court also ordered that the trust pay the counsel fees and expenses of the parties but reserved judgment as to the amount of these fees and expenses. On May 18, 1953, the Circuit Court entered an order setting the amount of the attorney fees and expenses to be paid and ordered the trustee to pay them out of the principal of the trust. The total amount of these was $60,020. Thorne and Eleanor were allowed $25.005 to pay the attorneys who represented them. All of the attorneys were paid by the trustee from the trust fund.
After the decree in favor of Thorne and Eleanor was entered, the trustees of the trusts established by Article Fifteen of the will indicated that they intended to appeal. However, a settlement agreement was reached between these trustees and Thorne and Eleanor and no appeal was taken. Under the settlement these trustees were to receive 35 percent of the corpus of the Article Six trust and Thorne and Eleanor were to receive 65 percent. On May 18, 1953, the Circuit Court of Cook County entered a decree modifying its prior decree to conform to the settlement agreement.
In accordance with the court decree, as amended, the trustee under Article Six distributed the fund during 1953. On the Fiduciary income tax return of the trust for 1953 it showed $37,780.59 income from long-term capital gains and $8,329.73 in other income. Of this income Eleanor received $1,108.40 of the long-term capital gain and $2,062.08 of other income. The income other than capital gain was reported by Eleanor and Calvin on their return for 1953. This return did not reflect the long-term capital gains. The trustee did not take a deduction for any of the expenses of the litigation over the disposition of the Article Six trust. On the joint Federal tax return filed by Eleanor and Calvin for the year 1953 a deduction of $20,000 was taken for attorney fees in the trust litigation.
OPINION.
FAY, Judge:
The first issue is whether the petitioners are entitled to an expense deduction for any of the legal fees incurred in connection with the litigation to construe the will. The respondent contends that the payment of these fees should be considered an expenditure of the trust. We agree with the respondent.
The equity court, in its decree, determined that the amount of the attorney fees incurred by all the parties was properly a charge upon the trust. When the legal fees of a beneficiary involved in trust litigation are ordered paid from a trust, it is because the beneficiary has benefited the trust by his involvement in the suit. See 4 Bogert, Trusts and Trustees, 861, fn. 2a, p. 390. Thus, although the beneficiary himself may have been benefited by the outcome of the suit, the advantage accruing to the trust is considered of sufficient magnitude that the beneficiary should be relieved of the burden of paying the legal fees.
This transaction is similar to that which occurs when a corporation pays the legal expenses of a stockholder who brings a derivative suit. In several instances this Court has held the payments of these expenses are properly expenditures of the corporation. Charles Kay Bishop, 25 T.C. 969 (1956); Shoe Corporation of America, 29 T.C. 297 (1957); B. T. Harris Corporation, 30 T.C. 635 (1958). In several situations payment by a fiduciary of the legal expenses of other parties to litigation has been treated as a proper expenditure of the fiduciary. Loyd v. United States, 153 F.Supp. 416 (1957); Kohnstamm v. Pedrick, 66 F.Supp. 410 (1946); and Leonard A. Farris, 22 T.C. 104 (1954), reversed on other grounds 222 F.2d 320 (C.A. 10, 1955).
The petitioners, in seeking to show that the legal expenses of the beneficiaries are properly the beneficiaries' expenditures, have cited the Illinois case of Montgomery v. Dime Savings & Trust Co., 290 Ill. 407 (1919), 125 N.E. 309. This case holds that an allowance of attorney fees in a decree is made to the party and not to the attorney. However, the fact that under Illinois law the beneficiary is used as a conduit for the payment of these expenses is immaterial. The net effect of the transaction involved here is that the trust has paid for legal services that have benefited the trust.
The fact that Eleanor was entitled to receive the corpus of the trust at the time that it paid the expenses here in issue does not make its payment her expenditure. Charles F. Neave, 17 T.C. 1237 (1952).
Since we have decided that the payment of the legal fees is appropriately an expenditure of the trust rather than the petitioners, it is unnecessary to decide whether the petitioners could deduct this sum if it were their expenditure. However, even if the expenditure were that of the petitioners, it is not clear that it would be deductible under any section of the Internal Revenue Code of 1939; since the payment was made in an attempt to obtain title to property, it is more in the nature of a capital expenditure.
The second issue is whether the petitioners are entitled to exclude from their gross income a certain sum received from the trust during the taxable year in issue and reported by them as income on their income tax return for that year. The petitioners urge that if they are not entitled to an expense deduction for the payment of the legal fees the trust is. Further, they contend if the trust is entitled to a deduction then the amount of the trust's distributable income should be correspondingly reduced; therefore, they should be entitled to exclude from their income amounts reported as income received from the trust.
It is unnecessary to decide whether the trust is entitled to deduct the amount it paid in legal fees in order to have the will construed. Even if the trust is entitled to this deduction it would not reduce the amount of income distributed to the petitioners. Section 162(b) of the Internal Revenue Code of 1939, as amended by the Revenue Act of 1942, provides, in part, as follows:
(b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the legatees, heirs, or beneficiaries, but the amount so allowed as a deduction shall be included in computing the net income of the legatees, heirs, or beneficiaries whether distributed to them or not. As used in this subsection, ‘income which is to be distributed currently’ includes income for the taxable year of the estate or trust which, within the taxable year, becomes payable to the legatee, heir, or beneficiary. * * *
The word ‘income’ in the phrase ‘amount of the income * * * which is to be distributed currently’ means probate income, that is, the income of the trust under applicable local law and the governing instrument. Augusta Bliss Reese, 30 B.T.A. 1 (1934); Gertrude Libbey Anthony, 9 T.C. 956 (1947); United States v. Merrill, 211 F.2d 297 (C.A. 9, 1954), footnote 3 at 300. Here, the Illinois court ordered the fees paid from the principal and that order has not been reversed. That decree is conclusive as to matters regarding the distribution of the trust property. Augusta Bliss Reese, supra. Since the payment of these fees was made a charge upon the principal of the trust, it did not reduce the probate income of the trust distributable to the beneficiaries and includible in their income for Federal income tax purposes.
Decision will be entered for the respondent.