Docket No. 75968 75969.
01-30-1936
F. COIT JOHNSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. F. COIT JOHNSON AND STUART HOLMES JOHNSON, EXECUTORS OF THE ESTATE OF FLORENCE D. JOHNSON, DECEASED, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Dean Emery, Esq., for the petitioners. Carroll Walker, Esq., for the respondent.
Dean Emery, Esq., for the petitioners.
Carroll Walker, Esq., for the respondent.
The petitioners request a redetermination of deficiencies in income taxes as determined by the respondent for the year 1931, as follows: F. Coit Johnson (Docket No. 75968), $2,264.45; estate of Florence D. Johnson (Docket No. 75969), $3,025.66.
Of the deficiency determined against Florence D. Johnson, $228.81 (all she conceded is due), it is stipulated, has been paid.
The questions involved in both cases arise out of the same state of facts, and by consent of counsel the cases were consolidated for hearing.
In Docket No. 75968, the only error assigned is the disallowance of a deduction of $24,000 which petitioner says he paid as interest to the City Bank Farmers Trust Co., trustee; and in Docket No. 75969, the error alleged is the addition to income of $21,035.09, being the part of the $24,000 used by said trustee in paying insurance premiums on the life of F. Coit Johnson, taken out for the benefit of Florence D. Johnson. Respondent contends that he should prevail in one proceeding, but not in both.
FINDINGS OF FACT.
F. Coit Johnson and Florence D. Johnson were husband and wife, and resided at Mill Neck, Long Island, New York. For convenience and brevity they will be hereinafter called Johnson and Mrs. Johnson, respectively. Mrs. Johnson died testate May 30, 1934, and Johnson and their son, Stuart Holmes Johnson, are executors of her estate under the will, and, as such, were substituted in her place as petitioners in proceeding No. 75969. Johnson is 71 years old and is and for many years has been engaged in the textile industry.
At all times herein material there existed 15 policies of insurance on the life of Johnson, aggregating in amount to $324,000. All of said insurance policies were either originally taken out for the benefit of Mrs. Johnson or duly assigned to her thereafter. The premiums were always paid by Johnson prior to the taxable year 1931, and he always recognized it as his duty to pay them. Mrs. Johnson herself was possessed of ample means to make the payments if it had been necessary or desired. The total net annual premiums on said policies amounted to about $21,000 or $22,000, but less than $24,000. Johnson and his wife were each possessed of large and ample means.
Sometime about 1929, an insurance man and an attorney suggested and recommended to Johnson a plan whereby he could reduce his income tax and the inheritance tax on his estate. Johnson, being impressed with the plan, told his wife fully about it, and they discussed it together at length and agreed to put it into execution. The action of Mrs. Johnson throughout was under suggestions and advice of Johnson, pursuant to the advice of the lawyer and insurance agent.
The plan called for the execution by Mrs. Johnson of two trusts, one a funded trust with $400,000 corpus, and one an insurance or unfunded trust. Prior to July 3, 1930, Johnson caused the trust instruments to be prepared for execution and on that day (July 3) they were executed and delivered at the time of the other transaction connected therewith. On the same day (July 3), carrying out further provisions of the plan, Johnson borrowed from the National City Bank of New York $400,000, on his unsecured demand note. He deposited the amount at once with said bank and executed his own check on the bank in the same sum in favor of Mrs. Johnson, who was present in the bank, and delivered the check to her. She at once deposited the same to her own credit in another bank and issued her check for the amount in favor of the City Bank Farmers Trust Co., trustee, in the funded trust above mentioned, and delivered it to said trustee.
The funded trust instrument provided, inter alia, that the trustee was to hold, manage, invest, and reinvest said $400,000, collect and receive the income therefrom, and, after deducting commissions and expenses and taxes, during the lifetime of Johnson (husband of the donor), apply the net income or so much thereof as "shall be necessary to the payment of the net premiums on" said policies of insurance on the life of Johnson, that any balance remaining in any one year after the premiums for said year had been paid should be paid to the donor, or her executors, etc., and that "the Trustee shall be under no liability whatever to anyone in case such premiums, dues, assessments or other charges are not paid, nor for any loss resulting from such failure."
Also, among the other numerous provisions of the funded trust, deemed material to the issues herein, were the following:
Upon the death of the said F. Coit Johnson, the Trustee shall assign and set over the principal of the Trust Estate to the Donor, if then living, otherwise to the executors, administrators or assigns of the Donor.
It shall be the duty of the Trustee and it is hereby directed, upon the written instructions of the said F. Coit Johnson (husband of the Donor) filed with the Trustee, to loan to said F. Coit Johnson at any time or from time to time and as often as said F. Coit Johnson shall desire, the whole or any part or parts of the principal of the trust estate, secured solely by his duly executed promissory note or notes, payable on demand and bearing interest at the rate of six per cent per annum, payable quarterly. * * * The trustee is hereby expressly prohibited from disposing of the aforesaid notes of said F. Coit Johnson or any of them during the life of said F. Coit Johnson and from taking any action whatsoever to collect or looking to the collection of the same or of the interest thereon, or to enforce any of the provisions thereof, or any rights whatsoever to which the Trustee is or may be entitled by the terms thereof, or by law in connection therewith, except as it shall be specifically directed in writing by the Donor during her lifetime, or after her death by her executor or administrator. * * *
Under no circumstances whatever shall the Trustee incur any liability, responsibility or accountability whatsoever for any depreciation or loss sustained or incurred by the trust estate or any beneficiary thereof, either on account of principal or income, by reason or in consequence of any loan or loans having been made to said F. Coit Johnson or by reason of the non-payment of said notes or any of them, or the failure of the Trustee to take any action whatever towards the collection or the disposition of the same, or for any matter or thing whatsoever in any way relating to or connected with said loans or notes. * * *
Upon the death of the said F. Coit Johnson the Trustee shall present for collection any or all of the aforesaid notes of F. Coit Johnson then outstanding and held by said Trustee, and when and if the same are collected and paid, in whole or in part, the proceeds shall be disposed of in the manner set forth in paragraph "2" as above quoted of this instrument, relating to the disposal of the corpus of the trust estate. In the event that the said notes shall not be paid in full upon their presentation by the Trustee as aforesaid, the Trustee shall transfer, pay over and distribute without recourse, said notes and any other property in its hands hereunder, to the Donor, if she be then living, or if she be then dead, to her executors, administrators or assigns.
* * * * * * *
The Donor hereby declares this Trust to be irrevocable.
The provisions of this instrument shall be governed by the laws of the State of New York.
The Trustee hereby acknowledges receipt of the funds constituting the trust estate and by joining in the execution of this instrument signifies its acceptance of the Trust.
On the same day (July 3, 1930) and occasion heretofore mentioned, Mrs. Johnson executed the insurance trust. Simultaneously with the execution of the insurance trust, she assigned and deposited with the trustee said 15 insurance policies on the life of her husband. In said insurance trust she agreed to pay any premium or other charges required to keep the policies in force. Upon the death of the insured, the trustee should collect the proceeds of the policies and divide them into five equal parts, but hold and invest the same, the net income to be paid to the donor during her life. At her death two parts should be paid to her son Stuart Holmes Johnson, two parts held for her daughter Florence Johnson Davenport, and the remaining part held for her son Donald Coit Johnson. There were also customary provisions in the trust as to contingencies and ultimate payments to remaindermen.
The laws of the State of New York were to govern with respect to all provisions of the trust instruments. The donor declared the trusts were irrevocable.
On July 8, 1930, Johnson, under the provisions of the funded trust, requested and obtained of the trustee therein, a loan of $400,000 upon his unsecured promissory demand note. He used the sum immediately to pay off and discharge his note to the National City Bank, paying $250 additional as interest thereon. On the hearing Johnson, testifying as to the note for $400,000 given to the trustee, said: "I knew there was no way the trustee could force payment."
No part of the principal of the $400,000 note given by Johnson to the trustee of the funded trust has been paid. But Johnson caused to be paid to said trustee during 1931 four quarterly payments of $6,000 each, which he claimed on his Federal income tax return for 1931 as deductible from gross income for the year as interest paid on said note. Respondent traverses this claim.
Of the $24,000 paid by Johnson to said trustee during the taxable year the trustee, under the direction of the trust instrument, paid the premiums on said life insurance policies amounting to $21,035.09, and the remainder, less commission and taxes, to Mrs. Johnson.
Mrs. Johnson's will, dated April 3, 1934, named her husband as one of the executors and Stuart Holmes Johnson, their son, as the other. After making some special bequests (which did not include the insurance policies, nor her husband's unpaid $400,000 note), she bequeathed and devised to her husband "for his sole use and enjoyment during his life, all the residue of my estate of every sort and description whatsoever", and said will further provided that "all income of every nature derived from the said property covered hereby shall be collected and received by him and applied by him to his exclusive use and enjoyment during the period of his life." The will contained this declaration: "whenever there be two acting executors, any action taken by both or either of them shall bind the estate."
OPINION.
SEAWELL:
Section 23 of the Revenue Act of 1928 provides:
In computing net income there shall be allowed as deductions:
* * * * * * *
(b) Interest. — All interest paid or accrued within the taxable year * * *.
Petitioner Johnson contends that he borrowed $400,000 from the City Bank Farmers Trust Co., trustee, and gave the trustee his demand note for that amount bearing 6 percent interest, and that during the taxable year paid said trustee $24,000, the amount of interest accrued on the note during the year.
Interest is defined to be "compensation which is paid by the borrower to the lender or by the debtor to the creditor for its use" — Bouvier.
Respondent contends on the other hand that there was no bona fide gift by Johnson to his wife and no bona fide borrowing by Johnson from the trustee; that the trustee had lent Johnson no money, and Johnson was not a debtor to the trustee on any account; and that the payment of $24,000 to the trustee was in no sense compensation for the use of money or for the postponement of a debt satisfaction. In short, respondent says the trustee was a mere agent or factor for the payment of the insurance premiums on Johnson's insurance; that Mrs. Johnson was a figurehead set to act her part in the drama set up for the benefit of her husband; and that the whole fabrication of the borrowing, pretended gift, and the setting up of trusts was simply a device to make payments of life insurance look like payments of interest whereby Johnson might escape payment of taxes on that much of his income.
Respondent insists further that all the acts and things done and performed by Johnson and his wife were the direct consequence of the suggestion of the lawyer and insurance man of a way for Johnson to escape tax in a sum equal to his insurance premiums; that the devious ways of these actions were merely to create appearances; that instead of actually borrowing $400,000 from the bank, and performing the other acts mentioned, Johnson could have handed over his unsecured demand note to the trustee and immediately upon demand borrowed it back and the trustee would have had a trust fund just as real and substantial as that which he secured. In either case, however, respondent contends, the provisions of the trust instrument effectually removed his note to the trustee from any negotiable instrument law.
These contentions of the parties have their application also to Mrs. Johnson's case. She did not testify as a witness in the proceedings.
The facts and circumstances herein make pertinent the comment of the Court in its opinion in Burnet v. Wells, 289 U. S. 670, wherein it is said: "The solidarity of the family is to make it possible for the taxpayer to surrender title to another and to keep dominion for himself, or, if not technical dominion, at least the substance of enjoyment." And in Willcuts v. Douglas, 73 Fed. (2d) 130, it is stated: "Among the devices employed to avoid income and estate taxes none has been more used than trusts dealing with members of a family, and the courts have been alert to prevent such avoidance by this means." In Corliss v. Bowers, 281 U. S. 376, Mr. Justice Holmes, delivering the opinion of the Court, said in part: "But taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed — the actual benefit for which the tax is paid."
In Elizabeth Bruce v. Helvering, 76 Fed. (2d) 442, the United States Court of Appeals of the District of Columbia, in reversing this Board, said:
The case we have would be wholly different if it appeared the plan was one designed to defeat the payment of taxes. In such a case it would be just as subject to condemnation as was the fictitious transfer of assets by one corporation to another, and thence to the sole stockholder, which, though accomplished in strict conformity with the statute, the Supreme Court denounced in Gregory v. Helvering (January 7, 1935).
The $400,000 delivered to Mrs. Johnson by her husband is shown to have been with the understanding of both that it was to be put in trust with the limitations and conditions attached, which made it exceedingly easy for him to have the amount immediately returned to him to use as he might wish, upon his merely agreeing to pay to the trustee 6 percent interest thereon, from which interest, if paid, the trustee was to pay insurance premiums on the aforesaid policies. It was understood by all three, his wife, the trustee, and himself, that the trustee was not to force collection of either interest or principal unless Mrs. Johnson should "specifically" so direct in writing during her life or such direction should be given by her executor after her death, and it was also a part of the trust agreement that the trustee was "expressly prohibited" from disposing of her husband's notes for such indebtedness except upon condition above stated. Under such limitations and conditions, so understood by all three, it is not surprising that Johnson in testifying felt justified in stating: "I knew there was no way the trustee could force payment." His alleged gift of $400,000 to his wife, therefore, does not appear to have been an absolute and unconditional bona fide gift, in view of the testimony taken in connection with the trust instruments themselves. He had complete confidence in his wife and was apparently warranted in feeling there would never be any specific direction on her part or by her executor to the trustee to enforce collection of either interest or principal of his note during her or his life. That his confidence in his wife as to her action with reference to the debt was not misplaced is further forcibly indicated by the fact that no demand for payment of the debt, so far as shown by the record, was ever directed by the wife during her life and the provisions made for her husband in her will — as quoted in our findings of fact — fully protect him against any demand for payments during his life.
Johnson desired to continue in force the policies of insurance on which he had been paying premiums, and the trusts created, while not directly established by him, were, in our opinion, created at his instance and by his direction and intended for his benefit by enabling him to take as a deduction in computing his taxable net income what he would pay on his obligations, which he still recognized, to the insurance companies. The situation makes applicable the principle enunciated by Mr. Chief Justice Hughes in Douglas v. Willcuts, 296 U. S. 1 (affirming 73 Fed. (2d) 130, supra), wherein he said: "The creation of a trust by the taxpayer as the channel for the application of the income to the discharge of his obligation leaves the nature of the transaction unaltered."
It is stated in both trust instruments that the laws of the State of New York were to govern their provisions. Numerous decisions of the courts of the State of New York are cited and relied on by counsel for the petitioners to sustain their contention that, notwithstanding the specific provision in the funded trust that the trustee therein was "expressly prohibited from disposing of" the notes of Johnson during his life or "taking any action whatsoever to collect or looking to the collection of the same or of the interest thereon, or to enforce any of the provisions thereof * * *", except as the trustee should be "specifically directed in writing by the Donor during her lifetime, or after her death by her executor or administrator", the trustee might disregard the provisions of the trust and enforce collection against Johnson, contrary to his wife's direction and desires. However, we do not think such conclusion, in the circumstances of the instant proceedings, justified by the authorities cited.
The facts and circumstances involved in the instant proceedings are distinguishable from those in the cases cited in behalf of the petitioners, and the decisions therein, therefore, are not controlling. None of those cases goes to the extent of holding that the trustee may disregard the mandatory provisions of the trust, as in the instant case, wherein the maker of the note is the husband of the donor of the trust, created after his explanation of the scheme to her and in accordance with his desires and interest. Where the provisions of the trust are not illegal and the powers of the trustee are defined and limited by clear and express language of the trust instrument, the trustee is bound thereby. See McArthur v. Gordon, 27 N. E. 1033; 126 N. Y. 597; In re Watson, 142 N. Y. S. 1058; affd., 148 N. Y. S. 1020.
We agree substantially with the contentions of the respondent as to the reasons for the denial to Johnson of a deduction of the $24,000 alleged interest payment. We hold that the alleged $400,000 trust fund in the ultimate reality was not to be provided from the assets or capital of either Johnson or his wife nor from any loan negotiated by either which was intended to constitute any binding obligation on either of them to repay. Johnson was to secure a temporary loan of $400,000, turn it over to his wife there in the bank where they were assembled with the other participants in this matter. She was to return the money immediately to her bank. She was then to give her check to the nominal trustee who was required upon Johnson's request (predetermined) as soon as practicable, to lend it to Johnson, under circumstances negativing any real obligation or intention ever to repay it. Johnson would then under the plan use the amount to pay off and discharge the original temporary loan from the National City Bank. The trustee, under the trust instrument, was forbidden to assign any obligation of Johnson given by him for the loan, or to enforce in any way the return of any part of the loan or interest to the trustee without the written direction of Mrs. Johnson or her executor. The executor was Johnson himself (albeit his son was co-executor) and he was also the legatee of the trust fund. It matters not that the executor was named later in a will thereafter executed. The facts, which speak clearly, indicate this circumstance was not overlooked. Under all the facts we find and hold that the transactions of the parties above detailed were all executed with the primary and dominating purpose and intention of avoiding or evading taxes, and there was no bona fide gift made by Johnson to his wife or loan secured by Johnson from the trustee; and the $24,000 paid by Johnson to the City Bank Farmers Trust Co. is not deductible. Accordingly, we affirm the determination of the respondent as to Johnson's case, Docket No. 75968.
It follows, in accordance with respondent's contention in the cause and his statement above noted, that we should sustain Mrs. Johnson, petitioner in Docket No. 75969, which we do.
Reviewed by the Board.
Judgment in favor of the respondent will be entered in Docket No. 75968, and in favor of petitioner in Docket No. 75969.
LEECH concurs in the result.