Opinion
Docket Nos. 9819 9820.
1947-05-16
ERIK KRAG, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.DAGNY KRAG, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Lyman Henry, Esq., and A. Wallace Helvern, Esq., for the petitioners. T. M. Mather, Esq., for the respondent.
Taxpayers, husband and wife, in November 1941 each executed a so-called deed of gift and trust agreement for the benefit of their minor son and daughter. Section 2280, Civil Code of California, as amended in 1931, provides that ‘Unless expressly made irrevocable by the instrument creating the trust, every voluntary trust shall be revocable by the trustor.‘ The trusts were not expressly made irrevocable. In 1944, in a suit for reformation of the above instruments, a decree was entered reforming each trust so as to make it irrevocable as of its original date. Held, the trusts were, under section 2280, revocable during the taxable year, the decision of the California court notwithstanding, and that the income of the trust was therefore includible in the taxable income of taxpayer-grantors under section 166 of the Internal Revenue Code. Lyman Henry, Esq., and A. Wallace Helvern, Esq., for the petitioners. T. M. Mather, Esq., for the respondent.
The Commissioner determined a deficiency in the income tax of each petitioner of $3,120.74 for the year 1943. The petitioners assail the determination of the Commissioner that the trust created by each in 1941 was revocable and the inclusion of one-half of the income of the trusts in the taxable income of each.
FINDINGS OF FACT.
Erik Krag and Dagny Krag, husband and wife, reside in Mill Valley, Marin County, California. They filed separate income tax returns in the first district of California.
Under date of November 29, 1941, each petitioner executed a ‘DEED OF GIFT AND TRUST AGREEMENT,‘ each of which in part provides, as follows:
That the Donor, for and in consideration of the love and affection which he (or she) bears to the Donees and the beneficiaries hereinafter named, and each thereof, hereby conveys to ERIK P. S. KRAG, his (her) son, Seventy-five (75 shares of the capital stock of Interocean Steamship Corporation (a Nevada corporation) and to SALLY S. KRAG, his (her) daughter, Seventy-five (75) shares of the capital stock of Interocean Steamship Corporation (a Nevada corporation).
That the said Donor desires now and hereafter to transfer to ERIK KRAG, Trustee, the shares of stock hereinbefore described, to have and to hold in trust for the use and benefit of ERIK P. S. KRAG, the Donor's son, and SALLY S. KRAG, the Donor's daughter. Said trust shall continue until November 1, 1960. At the termination of said trust the said Trustee shall convey to each of said beneficiaries individually the property then so held in trust for him and her, free from any trust whatever and as and for his and her separate property.
Each instrument further provides that during the continuance of the trust the trustee shall apply the income and profits and such portions of the corpus as in his sole judgment he deems advisable for the best interests and welfare of the beneficiaries; that the payments made to or for each beneficiary shall be for his or her sole and exclusive use or benefit; that the trustee is not to recognize any order or assignment of either beneficiary by way of anticipation of any part of the income or principal; that the trustee shall have power to manage and operate all properties of the trust, to retain or to sell, assign, and transfer the same or any part thereof, and to invest and reinvest the proceeds thereof in any property of any kind whatsoever, whether or not such retention and/or such investment or reinvestment are permissible by law as investment for trust funds. In the event either beneficiary dies, his or her issue him or her surviving shall succeed and become entitled to the deceased beneficiary's interest, share and share alike, and if the deceased beneficiary leaves him or her no issue surviving, then his or her interest shall go to the surviving beneficiary. In the event both beneficiaries die during the existence of the trust and neither leaves any issue him or her surviving, then the property held in trust at the time of the death of the last surviving beneficiary shall go to the heirs at law of the last survivor according to the laws of succession of the State of California, share and share alike, and free from any trust whatsoever.
No right to change or revoke either trust was reserved. Neither trust was expressly made irrevocable by the instrument by which created.
At the time petitioners consulted their counsel for the preparation of the foregoing deeds of gift and trust agreements and when they signed the same they told their counsel that they desired that the trust thereunder be irrevocable.
On March 16, 1942 (the 15th falling on a Sunday) each of the petitioners filed a gift tax return in which each reported a transfer by the creation of an irrevocable trust of 150 shares of the capital stock of Interocean Steamship Corporation of the value of $7,500 in equal shares to Erik P. S. Krag and Sally S. Krag, son and daughter, respectively, of the donor. The specific exemption claimed in each return being equal to the stated value of the gifts, no tax liability was reported.
On November 6, 1944, a petitioner was filed with the Superior Court of the State of California in and for the County of Main, in which Harry Brown made application to the court for his appointment as guardian ad litem of petitioner's minor son and daughter for the purpose of instituting an action in their behalf against petitioners for the revision and reformation of the instruments executed by them November 29, 1941, so that the same should expressly provide that the trust thereby created be irrevocable. On the same date an order appointing Harry Brown guardian ad litem of petitioners' son and daughter was made by the court. A complaint, captioned ‘Sally S. Krag and Erik P. S. Krag, Plaintiffs, vs. Dagny Krag and Erik Krag, Defendants,‘ was filed on the same date, in which it was alleged that the defendants promised one to the other and in consideration of their mutual promises agreed to transfer and convey in equal shares to plaintiffs 150 shares of Interocean Steamship Corporation stock owned by Dagny Krag and 150 shares of the same stock owned by Erik Krag; that pursuant to such agreement the certificates representing 300 shares of the above mentioned stock were placed in the name of Erik Krag, as trustee, and each defendant executed a written deed of gift and trust agreement under date of November 29, 1941, evidencing the gift and transfer; that it was the intention of the donors that each trust be irrevocable; that it is uncertain whether the trusts as written are or may be considered as revocable; that the failure of each trust agreement expressly to state that the trust thereunder was irrevocable by the donor was due to a misapprehension of the law by all parties, all supposing that they knew and understood it, and all making the same mistake as to the law; and that accordingly, in so far as the trusts as so written may be considered as revocable, the same do not truly express the intention of the donors and they should be revised and reformed to express such intention. The prayer in the complaint is as follows:
* * * that each Deed of Gift and Trust Agreement be reformed to provide in accordance with the true intention of the parties, that the trust therein provided in said instrument be and the same always was irrevocable by the respective defendants and that there be written into each said instrument at the end thereof before the words ‘IN WITNESS WHEREOF‘ a paragraph reading as follows:
‘The trust hereunder is expressly made irrevocable by the Donor.‘
Petitioner Erik Krag filed an answer, subscribed and sworn to on November 8, 1944, in which he admitted the allegations of the complaint, except that he denied that the trusts as written were or could be considered revocable and alleged the same to be irrevocable. Under the same date petitioner Dagny Krag made answer to the complaint, in which she admitted all the allegations of the complaint and alleged that she had refused to make the reformation requested in the complaint for the reason that Erik Krag had refused to make such reformation, and, if she alone were to make such reformation, then Erik Krag might have the power in the future to revoke his trust agreement to the irreparable injury of herself and the plaintiffs and contrary to the agreement and intention of all the parties at the present time and at the time each deed of gift and trust agreement was executed. On file also in the office of the county clerk of Marin County, California, are findings of fact and conclusions of law, and a decree of reformation, both dated November 21, 1944, and signed by the superior court judge. The facts found by the court follow practically verbatim the allegations of the complaint. In the decree it was ordered that the deeds of gift and trust agreements involved:
* * * are and each is reformed as of its original date to express the true intention of all of the parties thereto, to provide that each trust in each said instrument be, and the same now is and always has been, irrevocable by said defendants or either of them.
To further evidence and confirm such reformation, each defendant was ordered to write in the original deed of gift and trust agreement at the end thereof and before the words, ‘IN WITNESS WHEREOF‘ a paragraph reading as follows: ‘The Trust hereunder is expressly made irrevocable by the Donor.‘
Immediately following the decree of the Superior Court in and for the County of Marin, the petitioners entered the language as ordered in the decree on their respective deeds of gift and trust agreement.
No appeal was taken from the above decree and the same has become final.
During the years 1942 and 1943 the income of the trust consisted of dividends paid on the Interocean Steamship Corporation shares, aggregating $12,079.54 and $174.59, respectively. This income has been considered by the Commissioner as taxable in equal shares to the donors of such shares.
OPINION.
VAN FOSSAN, Judge:
It is contended by the respondent that the trusts herein involved, having been executed after 1931 and not having been made expressly irrevocable by the instrument creating them, are revocable under section 2280 of the Civil Code of California as amended in 1931
(George S. Gaylord, 3 T.C. 281; affd. (C.C.A., 9th Cir.), 153 Fed.(2d) 408), and hence, the income of the trusts is taxable in equal shares to the petitioners under section 166 of the Internal Revenue Code. Respondent makes no claim that the income is taxable to petitioners under section 22(a), Internal Revenue Code.
Sec. 2280. Revocation of trusts. Unless expressly made irrevocable by the instrument creating the trust, every voluntary trust shall be revocable by the trustor by writing filed with the trustee. When a voluntary trust is revoked by the trustor, the trustee shall transfer to the trustor its full title to the trust estate. Trusts created prior to the date when this act shall become a law shall not be affected hereby. (Amendment approved June 15, 1931; Stats. 1931, p. 1955).
The petitioners admit that the law of California is determinative as to the nature of the trusts and as to the property rights created thereunder. They contend that the trusts were expressly made irrevocable by the instruments creating them. In support of their contention it is argued that each trust agreement is not a mere declaration of trust, as in the Gaylord case, supra; that the title of each instrument contains the words ‘Deed of Gift‘; that the opening paragraph of each instrument refers to ‘This Deed of Gift‘ between the donor and donees; that the following paragraph states that the donor ‘hereby conveys to each donee‘ the shares of stock mentioned; and that under section 1148 of the Civil Code of California
a gift can not be revoked. It is further argued that the words ‘now and hereafter,‘ in the phrase ‘the said donor desires now and hereafter to transfer to Erik Krag, Trustee, the shares of stock hereinbefore described,‘ constitutes an express statement that the trusts are to be irrevocable.
Sec. 1148. Gift not revocable. A gift, other than a gift in view of death, can not be revoked by the giver.
Such arguments are without merit. The language of section 2280, Civil Code of California, is not ambiguous. It provides that ‘unless expressly made irrevocable by the instrument creating the trust, every voluntary trust shall be revocable by the trustor.‘ Their intentions to make irrevocable trusts are not determinative under the statute unless ‘expressly‘ stated in the instruments creating the trusts. What is required by the statutory phrase ‘unless expressly made irrevocable by the instrument creating the trust‘ is well illustrated by the directive in the reformation suit decree requiring each defendant, petitioners herein, to insert in the trust agreement executed by them the sentence: ‘The trust hereunder is expressly made irrevocable by the Donor.‘ This directive was in accordance with the prayer of the complaint in that action. The trusts herein involved were not ‘expressly made irrevocable by the instrument creating‘ them and hence were revocable by the trustors. Title Insurance & Trust Co. v. McGraw, 164 Pac.(2d) 846; Gaylord v. Commissioner, supra. See also Hughes v. Commissioner (C.C.A., 9th Cir.), 104 Fed.(2d) 144, 147.
The petitioners intended to make and they made gifts in trust and not gift intervivos, the subject of section 1148, supra. This appears from the trust agreements wherein each donor expressed his or her desire to transfer the shares to the trustee named. It also appears from the allegations in the complaint in the suit for reformation, admitted by each petitioner, that the certificates representing the 300 shares were placed in the name of Erik Krag as trustee. There are well recognized differences between gifts inter vivos and gifts in trust, and a transaction cannot be both. In the case of a gift intervivos, title, possession, and control must pass to the donee, whereas in the case of a gift in trust, legal title is retained by the donor or transferred to a third person to hold for the purposes of the trust, the equitable title only passing to the cestui que trust. Hyman v. Tarpler, 149 Pac.(2d) 453; In re Alberts' Estate, 100 Pac.(2d) 538; 38 Cal.App.(2d) 42; Murdock v. Murdock, 194 Pac. 762; 49 Cal.App. 775; 39 C.J.S., GIFTS, sec. 8, pp. 785-6. Where a gift inter vivos of stock is made there must be a present vesting of title by endorsement or separate assignment and delivery of the certificate. Klein v. Farmer, 160 Pac.(2d) 30, 330; Field v. Mollison, 123 Pac.(2d) 603; 59 Cal.App.(2d) 585; sec. 330.1, Civil Code of California.
Neither is it determinative that in the gift tax returns the trusts were reported as irrevocable. ‘These returns were simply a report to the Government required by law and did not purport to change the nature of the trust. Any effective changes had to be in the instrument itself.‘ Gaylord v. Commissioner, supra.
Petitioners further argue that the trusts were not ‘voluntary trusts‘ under the rule of Touli v. Santa Cruz County Title Co., 67 Pac.(2d) 404, for the reason that each trust was not ‘an obligation arising out of a personal confidence reposed in, and voluntarily accepted by, one for the benefit of another‘ (sec. 2216, Civil Code of california), but each evidenced an obligation arising out of, and created pursuant to, a binding contract. Similar arguments were made In Gaylord v. Commissioner, supra. The statements made by the Circuit Court in that regard are equally apposite herein, as follows:
* * * the trust here created was a voluntary trust. It was the free act of the grantors and not affected by any form of compulsion. It reflected their desires to make a gift to their daughters to provide them with financial security. * * * Taxpayers did owe the duty of support and education to the younger daughter who was 19 when the trust was created (see Sections 25, 196 and 197, Civil Code of California) but even this obligation did not oblige them to create a trust for her benefit.
The argument that there was consideration for the trust in that each of the trustors agreed to make the declaration in consideration of the agreement of the other to make a contribution to the trust corpus, is not persuasive. The trust instrument recites no consideration * * *
The consideration recited in the trust agreements herein is the love and affection which each donor bore to the two beneficiaries named.
It is contended by petitioners that if the original trust instruments are not by their terms expressly irrevocable, then by reason of their judicial reformation the trusts were at all times irrevocable, citing Blair v. Commissioner, 300 U.S. 5; Helvering v. Stuart, 317 U.S. 154; Hugh D. Rhodes et al., Administrators, 41 B.T.A. 62; affd., 117 Fed.(2d) 509; George N. Spiva, 43 B.T.A. 1174; Trust A #3586, 46 B.T.A. 846; and Eva V. Townsend, 5 T.C. 1380.
It is true that the decree in the reformation suit ordered that each trust agreement ‘be reformed as of its original date to express the true intention of all of the parties thereto.‘ It is also true, as contended by petitioners, that the cited cases hold that decisions of state courts determining property rights are binding upon Federal courts. However, such rule applies only to a decision entered in a proceeding presenting a real controversy for determination. The decision must be on issues ‘regularly submitted and not in any sense a consent decree.‘ Freuler v. Helvering, 291 U.S. 35, see also Francis Doll, 2 T.C. 276; affd., 149 Fed.(2d) 239; certiorari denied, 326 U.S. 725; Tatem Wofford, 5 T.C. 1152, 1161-1163; Leslie H. Green, 7 T.C. 263, 274. In the suit herein involved there was no real controversy. The purpose of the suit was to reform and amend the trust agreements so as to bring them without the purview of section 2280, i.e., to make them irrevocable. All the parties to the suit were in agreement in that respect. The petitioners, in so far as the records disclose, may have initiated the reformation suit, and probably did, since the beneficiaries were minors and there is no evidence of any controversy. The cases cited by petitioners are distinguishable and hence not applicable. They involved decisions of state courts or competent jurisdiction rendered in adversary proceedings after a hearing upon the merits, all of which decisions were in no sense consent decrees or ‘collusive in the sense that all the parties joined in a submission of the issues and sought a decision which would adversely affect the Government's right to additional income tax.‘ Freuler v. Helvering, supra. In Sinopoulo v. Jones (C.C.A., 10th Cir.), 154 Fed.(2d) 648, the taxpayer executed declarations of trust for the benefit of his two daughters. Thereafter, effective as of August 1, 1941, Oklahoma passed a statute providing that every trust created under the laws of Oklahoma ‘should be revocable by the trustor unless expressly made irrevocable by the instrument creating the same. ‘ Because of the statute and of a doubt as to the construction that might be attempted to be placed upon the declarations of trust, taxpayer's daughter Mary, who had married against his will, brought suit for herself and as the next friend of her minor sister against taxpayer, asking for a construction as to the revocability of the trusts and a reformation thereof. The court reformed the trust instruments by striking out a certain paragraph therein and inserting in lieu thereof another paragraph reading in part, as follows: ‘The trusts hereby created shall be and are irrevocable.‘ The judgment of the court made the reformation retroactive and effective as of December 14, 1939, the date of the execution of the written declarations of trust. As to the effect of such judgment, the Circuit Court stated:
The liability of appellant for the income tax chargeable to the income of the trusts for the years in question (1939, 1940, and 1941) must be determined from the provisions of the trusts prior to their reformation by the state court. While the judgment of the state court made the reformation of the trusts retroactive and effective as of the date of the execution, this could not affect the rights of the government under its tax laws.
The court held that the tax liability of Sinopoulo for the three years in question was to be determined from the provisions which he included in the declarations of trust which he executed, and not from what he intended to include therein.
Under section 2280 each trust was revocable by its trustor during the years herein involved. Under section 166 of the Internal Revenue Code, the income derived from a revocable trust must be included in computing the net income of its grantor. The action of the respondent in including the income of the trusts in the income of petitioners in equal shares must be approved.
Decisions will be entered for the respondent.