Opinion
Docket No. 3689.
1945-03-30
DANIEL J. FRY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Carl E. Davidson, Esq., for the petitioner. Byron M. Coon, Esq., for the respondent.
Petitioner, engaged in the operation and management of two farm properties, executed two documents assigning his interest therein to his 18-year old daughter and 15-year old son. Thereafter he continued to exercise the same command over the properties and income therefrom as before. No disbursements of cash were made to the children except small amounts for their own personal use. Held, the net income from the operation of the two farms was properly included in the gross income of petitioner. Carl E. Davidson, Esq., for the petitioner. Byron M. Coon, Esq., for the respondent.
The Commissioner made two adjustments to the net income disclosed by petitioner's return for the calendar year 1941 and determined a deficiency in income tax in the amount of $9,300.90. One of the adjustments is conceded to have been proper.
The sole issue is whether the Commissioner properly included in petitioner's gross income $21,342.68 representing the income from the operation of two farms near Long View in Cowlitz County, Washington.
FINDINGS OF FACT.
Petitioner is a resident of Salem, Oregon, filing his income tax return for the taxable year upon a cash basis with the collector of internal revenue for the district of Oregon. The gross income shown by the return was $22,056.87.
In January of 1941 petitioner's family consisted of his wife, an eighteen-year old daughter, Marylee, a fifteen-year old son, Daniel J., III, and himself. The daughter was attending college and the son resided at home.
Separate returns of income were filed by the children, each reporting gross income of $8,463.42 on line 9 of the respective returns as ‘Income (or loss) from partnerships; fiduciary income; and other income.‘ Schedule I of each return indicates that the name of the partnership was ‘M. & D. Fry.‘
The income referred to in the preceding finding resulted from the operation of two contiguous tracts of ground in Cowlitz County, Washington, one containing 257 acres and the other 121 acres, upon which peppermint (and possibly digitalis, belladonna, and other plants) had been grown.
Petitioner is a registered pharmacist. At an undisclosed period antecedent to the taxable year he had acquired a drug store in Salem, Oregon, which he operated. The drug store, prior to the taxable period, had been turned over to others to operate.
Petitioner had early become interested in the distillation of drugs. He had acquired a warehouse in Salem, Oregon, where he carried on a crude drug business. He did considerable traveling in the general community, purchasing leaves and plants to be processed primarily for digitalis, belladonna, and oil of peppermint. In later years the warehouse was leased to the Southern Pacific Railroad Co. for the storage of hops.
Petitioner had the territory composed of Oregon, Washington, California, and Idaho for buying crude drugs for wholesale distribution, mostly drugs indigenous to that particular locality.
Petitioner owned a farm of 515 acres near Aurora, Oregon, devoted principally to general farming and the raising of cattle.
On May 1, 1938, petitioner entered into a contract for the purchase of 257 acres of land in Cowlitz County, Washington, for an agreed consideration of $70,804.25. $7,080.42 was paid on the execution of the agreement and the balance was payable at the rate of $449.26 on or before the tenth day of each and every month thereafter until the entire balance of the purchase price, including interest at the rate of 6 percent per annum, should have been paid. The contract provided that it should not be assigned without the written consent of the owners, given directly or through the agent. Time was of the essence of the contract and failure to make any payment promptly at the time it became due entitled the seller to declare forfeiture and cancellation.
On September 1, 1939, petitioner entered into an agricultural lease with the National Bank of Commerce of Seattle for a term of 5 years, under which 121 acres of land contiguous to the land mentioned in the preceding finding were leased. The annual rental was $1,512.50, the first payment being due on or before October 1, 1940, and a like amount on or before the first day of October of each year during the term of the lease. Petitioner covenanted in the lease that he would farm the premises in a good and husbandlike manner and in accordance with the best farming methods and that he would ‘not assign this lease or any interest therein or underlet said premises or any part thereof without the written consent of lessor.‘ The lease granted petitioner an option to purchase the property during the term of the lease at a price of $36,300.
Prior to the taxable year the two farms above referred to had been planted largely to peppermint. Other property on the farms consisted of tractors, trucks, and machinery for peppermint distillation. The last mentioned property represented a depreciated investment of petitioner in the amount of $4,931.36.
When petitioner's daughter Marylee was home from college during the Christmas vacation in 1940 petitioner discussed with her an assignment or conveyance of the two farms and the property thereon. He stated that he was going to assign it to her and her brother, but that he wasn't telling her brother anything about it because of his age. It was understood at that time that petitioner should receive a salary of $300 per month for managing the property.
‘ * * * (W)ithin the first 15 days of 1941‘ petitioner and his wife executed two documents as of January 1, 1941. One was captioned ‘Assignment of Lease‘ and the other ‘Assignment of Agreement for the Sale of Real Estate.‘ Exclusive of signatures, they are as follows:
ASSIGNMENT OF LEASE
FOR AND IN CONSIDERATION of the sum of ONE DOLLAR ($1.00) and other good and valuable considerations, the receipt whereof is hereby acknowledged, I hereby sell, assign, set over and transfer to Marylee Fry and Daniel J. Fry III that certain lease dated the first day of December, 1935 (sic 1939?) between the National Bank of Commerce of Seattle, a national banking association having trust powers, organized under the laws of the United States, as trustee, and Daniel J. Fry of Salem, Oregon, as Lessee.
This lease and assignment cover 121 acres more or less in Cowlitz County, Washington and more particularity (sic) described in the Agriculture Lease referred to dated December 1st, 1935 (sic 1939?) and is for a term of five years.
This assignment is given and is to be irrevocable as long as the terms and conditions contained in the lease remain in force and effect.
Dated at Salem, Oregon.
Jan. 1st, 1941.
ASSIGNMENT OF AGREEMENT FOR THE SALE OF REAL ESTATE.
For and in consideration of the sum of ONE DOLLAR ($1.00) and other good and valuable considerations, the receipt of which is hereby acknowledged, I hereby sell, assign, set over and transfer to Marylee Fry and Daniel J. Fry III that certain Agreement for the Sale of Real Estate dated May 1st, 1938, between the National Bank of Commerce of Seattle, a National Banking Association having trust powers, organized under the laws of the United States, as trustee, and Daniel J. Fry of Salem, Oregon as purchaser.
This agreement and assignment cover 257 acres more or less in Cowlitz County, Washington and are more particularity (sic) described in the Agreement for the Sale of Real Estate referred to Dated May 1st, 1938.
This assignment is given and is irrevocable.
Dated at Salem, Oregon.
Jan. 1st, 1941.
No written consent to either assignment was secured. Neither was filed for record in a public registry and both were retained by petitioner.
In the spring of 1941, when petitioner was having his books audited preparatory to filing his return of income for the calendar year 1940, he had his accountant make certain entries in his books in connection with the farms. An entry was made charging the children $4,931.36 representing the depreciated cost of the tractors, trucks, and machinery for peppermint distillation.
During the calendar year 1941 the $4,931.36 charged by petitioner to his children upon his books was paid over to him and he paid himself the sum of $3,600 for acting as superintendent. No disbursements of cash were made to the children ‘ * * * except small amounts for their own personal use. ‘ Disbursements were made for the cost of operating the farms, for rental on the one tract, for the payments on the purchase price of the other, $1,784 was paid for the purchase of new irrigation equipment, and the remainder was held by petitioner in his personal bank account. Books and records were kept by petitioner showing the receipts and disbursements.
The growing of the crops on the farms required very little supervision by petitioner, the work all being by hired help. He visited the farms approximately once a week.
Petitioner's daughter assisted in the keeping of books, when she was not in school, and had authority to sign checks. She occasionally signed a check for an employee when her father was absent and drew some checks to take care of her personal expenses while away at school. The boy drove a truck and performed other duties about the home during vacation.
There was no written agreement between the daughter and son with reference to the operation of the farms. The boy was not told about the assignments until many months after they were executed. The whole situation was discussed with him about the time he became eighteen years of age and went into the military service.
Early in 1943 revenue agents, following examination of petitioner's books and returns, contended that the income which petitioner had shown on his books as belonging to his children actually belonged to him. Thereafter he consulted counsel and on July 16, 1943, an assignment of the contract for the purchase of the 257-acre tract was executed by petitioner and his wife to his daughter Marylee, she in the meantime having attained her majority. This assignment was consented to in writing by the seller and accepted by Marylee. In consideration of the seller giving its consent petitioner and his wife quitclaimed their interest in the property to it. On the same date an assignment of the lease was also made to the daughter and consented to in writing by the lessor. The latter document stated that the assignment was ‘as of January 1, 1941‘ and the former stated that ‘the rents which accrued and became due on and after January 1, 1941, shall belong to and shall be paid to the purchaser so long as this contract shall remain in full force and effect.‘
On August 9, 1943, the daughter, Marylee Fry, in a short ‘Declaration of Trust,‘ acknowledged and declared:
* * * that I do now hold and have held since the dates as of which the said assignments were effective, a one half (1/2) interest in each of the foregoing described contract and leases in trust for my brother Daniel J. Fry III and do agree to operate the said properties, to collect the income therefrom and to pay the said income therefrom to my said brother until he shall reach the age of twenty-one (21) years to thereupon convey to him a one half (1/2) interest in the said contract and leases as they may then exist.
After the execution of the trust no change was made in the handling of the property.
In January of 1944 a deed for the 257 acres to Marylee Fry was executed and filed for record in the office of the recorder of deeds on January 28, 1944. Thereafter, on March 15, 1944, Marylee Fry signed a note for $25,000 and a real estate mortgage upon the 257-acre tract of ground which was recorded in the office of the recorder of deeds on March 17, 1944. The last mentioned documents had been sent by petitioner to Marylee while she was at school, petitioner writing to her and advising her that he was sending them to her to be signed.
The notice of deficiency was mailed October 26, 1943. The amount of petitioner's net income from farming was determined to be $30,436.05 instead of $9,093.37, as reported in his return. The net income from the operation of the 257-acre farm and the 121-acre farm aggregated $21,342.66.
OPINION.
MELLOTT, Judge:
The basic facts, shown at length in our findings, are not seriously in dispute. The operation of the two farms resulted in net income of $21,342.68. It is includible in petitioner's gross income unless the action taken by him ‘within the first 15 days‘ of 1941 relieves him from the tax. Nor do counsel for the parties disagree as to the fundamental legal principles. Both recognize that under Lucas v. Earl, 281 U.S. 111, ‘anticipatory arrangements and contracts, however skillfully devised,‘ can not relieve the earner or producer of the income from tax upon it by attributing the fruits ‘to a different tree from that on which they grew.‘ Cf. Griffiths v. Commissioner, 308 U.S. 355; Gregory v. Helvering, 293 U.S. 465; Helvering v. Eubank, 311 U.S. 122; and Helvering v. Horst, 311 U.S. 112. If, however, the income-producing property be assigned, the assignee, rather than the assignor, is taxable upon the income. Blair v. Commissioner, 300 U.S. 5; Reinecke v. Smith, 289 U.S. 172. Cf. Harrison v. Schaffner, 312 U.S. 579, and Helvering v. Clifford, 309 U.S. 331.
Petitioner did not have the assistance of a lawyer in drafting the assignments in January 1941. He stated that he had consulted with some representative of the Bureau of Internal Revenue and with an accountant, both of whom, it inferentially appears, advised him of the principles to which reference has been made. The question which evolves, however, is the effect of what was done. Petitioner insists that the assignments ‘were legally sufficient to convey to the son and daughter * * * all of his interest in the * * * farm properties.‘ Citing American Savings Bank & Trust Co. v. Mafridge, 60 Wash. 180; 110 Pac. 1015, and Nelson v. Goodrich, 159 Wash. 189; 292 Pac. 406, he contends that a writing was not even necessary, inasmuch as his interest in the 121-acre tract was a tenancy for years, while his interest in the other was a mere chose in action— an executory contract to purchase land.
American Savings Bank & Trust Co. v. Mafridge merely held that a competent party who had entered into a contract, based upon a sufficient consideration, to purchase a lease from the lessee of property could not avoid the contract upon the theory that it was a lease, invalid because not acknowledged. In Nelson v. Goodrich an assignment of an executory contract of purchase, suit was instituted by the assignee. The issue before the Supreme Court of Washington was whether the lower court had erred in sustaining a demurrer to the answer in which recoupment had been sought because of violation of certain duties devolving upon the prior titleholder. The court pointed out that ‘since what was assigned was a chose in action only * * * the assignee stands in the shoes of his assignor.‘ It concluded that the lower court had erred in sustaining the demurrer. The cited cases furnish slight assistance or guidance in resolving the present question. Here the assignees were children, not sui juris, who signed nothing. One was too young even to be told what was happening or contemplated. Moreover, each contract required petitioner to perform specified obligations, which he could not escape by the simple expediency of assigning the contracts to his children. Each contract contained an express prohibition against assignment unless the written consent of the other party to it were secured. No such consent was given. Neither assignment was acknowledged and hence could not be recorded. If delivery was actually made, it has not been shown; nor is there any evidence of an acceptance by either child, especially the boy. Thus it is difficult to find upon this record that anything passed from petitioner merely by the signing of the two informal documents.
Passing the questions suggested in the preceding paragraph, we next examine the facts for evidence of a bona fide gift, asserted by petitioner to have been made. The use of the expressions ‘sell,‘ ‘good and other valuable considerations,‘ etc., belie the idea of a gift. Keeping in mind the fact that the documents were prepared by one unlearned in the law, however, no undue emphasis should be placed upon the terms used. But if a gift was made, what evidence is available? The property had a substantial value, although no evidence was adduced to prove the amount. The 378 acres had been planted largely to peppermint and a crop, which during the next twelve months yielded a net income of more than $21,000, was already in existence. Capitalizing the probable earnings, it would seem to be clear that the right to receive them would have a value greatly in excess of $8,000; yet no gift tax or donee information returns were filed. (Ch. 4, I.R.C., sec. 1,000, et seq.) Apparently, also, petitioner had paid more than $20,000 upon the purchase of the 257-acre tract— a circumstance entitled to some consideration in appraising the value of the property transferred.
The essential elements of a gift inter vivos have oft been stated. In Francis E. Tower, 3 T.C. 396, 402, they were said to be:
(1) A donor competent to make the gift; (2) a donee capable of taking the gift; (3) a clear and unmistakable intention on the part of the donor to absolutely and irrevocably divest himself of the title, dominion, and control of the subject matter of the gift, in praesenti; (4) the irrevocable transfer of the present legal title and of the dominion and control of the entire gift to the donee, so that the donor can exercise no further act of dominion or control over it; (5) a delivery by the donor to the donee of the subject of the gift or of the most effectual means of commanding the dominion of it; (6) acceptance of the gift by the donee. (See Edson v. Lucas, 40 Fed.(2d) 398, and authorities there cited.)
Many of the elements are lacking in the instant case, especially (3) and (4).
The returns filed on behalf of the children indicate that they were in partnership. If an information return for the partnership was filed, it has not been shown in evidence. Manifestly no real partnership existed. The children were incapable of entering into such a relationship. Moreover, the evidence deemed it advisable to expend nearly $1,800 in the taxable year for new irrigation equipment for the two farms, he did so. All of the details of the enterprise— the hiring of horses and labor, the planting, harvesting, processing, and selling of the crops— were looked after by petitioner just as he had done in the past. As he expressed it, there was not a great deal of difference in the handling of the property after the assignments were executed. ‘There was no reason why there should be. The bookkeeping was different; the accounting was different.‘ Apparently that was the only difference.
In support of his determination respondent suggests there was ‘merely a pretended reallocation of farm income within a family group‘ and therefore that the rationale of Helvering v. Clifford, supra, is applicable. The suggestion is not without merit. Cf. A. R. Losh, 1 T.C. 1019; affd., Losh v. Commissioner, 145 Fed.(2d) 456. ‘It is hard to imagine that * * * (petitioner) felt himself the poorer after * * * (the assignments) had been executed or, if he did, that it had any rational foundation in fact. ‘ Helvering v. Clifford, supra. Taxation is concerned ‘with actual command over the property taxed— the actual benefit for which the tax is paid. ‘ Corliss v. Bowers, 281 U.S. 376. ‘ * * * (I)t makes no difference that such 'command’ may be exercised through specific retention of legal title or the creation of a new equitable but controlled interest, or the maintenance of effective benefit through the interposition of a subservient agency. Cf. Gregory v. Helvering, 293 U.S. 465.‘ Griffiths v. Helvering, supra. It is clear that petitioner had as much command over the property and the income from it after the execution of the assignments as he had before. Thus, even if it be assumed, contrary to what we believe to be the fact, that a gift was actually made to the children in the taxable year, petitioner retained such substantial control over the property and the income that we can not say the Government erred in treating it as his income.
Petitioner places more reliance upon a group of cases in which it was held that a parent was not required to include in his gross income the profit resulting from operating brokerage accounts in the name of his minor child or children. Emil Frank, 27 B.T.A. 1158; Herbert L. Dillon, 32 B.T.A. 1254; H. C. Priester, 33 B.T.A. 230. See, however, Harry F. Canelo, 41 B.T.A. 713, (appeal, C.C.A., 9th Cir., dismissed) where the duties incumbent upon a parent under such circumstances are discussed at length. All of the cases were decided prior to the Clifford, Griffiths, Eubank, and Horst cases, cited at the beginning of this opinion. Whether they have lost any of their value as precedents need not now be decided. Each is distinguishable from the instant case upon its facts. The distinguishing characteristics may be gleaned from the following excerpts from the Priester case:
In the present case the evidence is that petitioner declared to all who might be interested that the accounts were established for the benefit of his children. It is his testimony that that was the purpose of the accounts and in this he is corroborated by his wife, the office manager of the firm, and the accountant of the firm. * * * The statements made by petitioner to all who had any connection with the accounts, his scrupulous maintenance of them as separate accounts in the names of the beneficiaries, and his representations of trusteeship in Federal tax returns, in our opinion, amount to the ‘unequivocal acts or declarations‘ which under the decisions above cited will convert what would otherwise be a tentative trust into a present trust.
None of the circumstances stressed in the above quotation is present here. Petitioner made no declarations from which it could be determined that the farm account was being handled for the benefit of his children. No showing has been made that the manager or employees of the Washington farms, the representatives of the owner of the 257-acre tract, the agents of the lessor of the other tract, bankers, or anyone else had any knowledge of the execution of the documents. Petitioner made no representation of trusteeship in Federal tax returns, nor did he scrupulously maintain separate bank accounts for his children. The funds were all deposited in his individual account. True, he kept records showing the receipts and disbursements from the two farms; but that is frequently done by one desiring to compare the profitableness of separate operations. Petitioner does not urge that under the present facts there were such ‘unequivocal acts and declarations‘ as to transmute a tentative trust into a present one. His theory is that a completed gift of the property was made. This, we believe, has not been proved.
The respondent committed no error in determining the deficiency in tax.
Decision will be entered for the respondent.