Opinion
Docket No. 6001.
1946-01-9
ALFRED COWLES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
William N. Haddad, Esq., for the petitioner. Harold H. Hart, Esq., for the respondent.
Petitioner is a life beneficiary and a cotrustee of a trust created by his father. He also has a power of appointment over the remainder. Under article I, section 1 of the trust indenture the trustees are required to pay the entire net income of the trust to petitioner ‘if he demands it.‘ Under article II, section 4, the trustees may in their discretion take out policies of life insurance on petitioner's life and charge the premiums thereof ‘to the income of the Trust Estate.‘ In the taxable year the trustees exercised their discretion and took out a policy on petitioner's life and charged the premium paid thereon to the income of the trust and distributed the balance of the trust income to petitioner. Held, petitioner is taxable under section 22(a), I.R.C., on the income of the trust that was used to pay the premium on the policy in question. Edgar R. Stix, 4 T.C. 1140; affd., C.C.A., 2d Cir., Dec. 21, 1945, followed. William N. Haddad, Esq., for the petitioner. Harold H. Hart, Esq., for the respondent.
This proceeding involves the determination by the respondent of a deficiency of $1,535.89 in petitioner's income tax for the calendar year 1941.
The deficiency results from two adjustments made by the respondent to the net income as disclosed by petitioner's return. Petitioner does not contest these adjustments, but claims that instead of a deficiency he is due a refund of $578.99, and he assigns as error the following:
(a) The Commissioner erroneously refused to eliminate from petitioner's income $3,299.20 of income which was received by the trustees of a trust created by the petitioner's father, known as the Alfred Cowles III Trust of December 1, 1934, which income was used by the trustees to pay premiums on insurance policies owned by the trust and was never distributed to the petitioner. This resulted in an overstatement of the distributable income of said trust by $3,229.20.
FINDINGS OF FACT.
Petitioner is an individual, residing in Chicago, Illinois. The return for the period herein involved was filed with the collector at Chicago on or about March 14, 1942.
On December 1, 1934, petitioner's father, as ‘Grantor,‘ created the ‘Alfred Cowles III Trust‘ and named petitioner and petitioner's younger brother, Knight Cheney Cowles, as ‘Trustees.‘ Alfred Cowles III, referred to in the trust indenture, is the petitioner herein.
The corpus of the trust as listed in Exhibit A of the indenture consisted of 12 1/2 shares of the capital stock of the Tribune Co., and was, under article I, subject to a charge of $55,000 payable to the grantor on December 31, 1934. The body of the indenture consisted of article I, with 8 sections, and article II, with 13 sections. The first 3 sections of article I provide:
Section 1. The Trustees shall pay to Alfred Cowles III, if he demands it, the entire net income of said Trust Estate in convenient installments, and in any event as often as once in each year. Any part of the net income not so paid shall be accumulated and added at the end of each calendar year to the principal of said Trust Estate.
Section 2. Upon the death of the said Alfred Cowles III, the Trustees shall pay, transfer and deliver the Trust Estate, together with all unexpended accumulations thereon, to such person or persons and in such shares and proportions, and for such estate or estates, and in such manner and upon such trusts, as said Alfred Cowles III may by his last will and testament limit, direct and appoint.
Section 3. In default of such appointment by Alfred Cowles III, if Elizabeth Strong Cowles, wife of Alfred Cowles III, shall survive Alfred Cowles III as his widow, the Trustees shall pay to her, during her life, so much of the entire net income of the Trust Estate as she shall demand for the use of herself and the lineal descendants of Alfred Cowles III, and in addition so much of said net income for her own unrestricted use as the Trustees may in their absolute discretion determine after receipt of a demand by her for said additional income.
Sections 4 and 5 of article I ‘In default of such appointment by Alfred Cowles III,‘ deal further with the disposition of the remainder upon the death of petitioner's wife, if she shall have taken under section 3, supra, or upon the death of petitioner if his wife shall not have so taken. The beneficiaries were the children and grandchildren of petitioner, if any, if none, then the heirs at law of the grantor.
Sections 6 and 7 of article I deal with matters not material to this proceeding. Section 8 is as follows:
Section 8. If at any time during the life of this trust the Trustees shall determine in their discretion that the income payable to any beneficiary hereunder is insufficient for the maintenance of such beneficiary in health and comfort, the Trustees may from time to time in their discretion pay to such beneficiary such sum or sums out of the principal of the fund, the income of which is payable to such beneficiary, as may be in the judgment of the Trustees necessary, in addition to the income from such fund, for the maintenance of such beneficiary in health and comfort.
Article II dealt with the powers and duties of the trustees. Section 4 thereof provided in part:
The Trustees may in their discretion take out, purchase, or otherwise acquire a policy or policies of life, health or accident insurance on the life or health of Alfred Cowles III or of any other beneficiary or beneficiaries or to the Trustees, and the Trustees may pay all premiums and other expenses and charges incurred in connection with said insurance, and charge the same to the income of the Trust Estate. Any amounts received by the Trustees on account of said insurance (whether upon maturity or surrender of the policies or otherwise) shall be added to the principal of the Trust Estate.
Section 8 of article II provided:
Section 8. The Trustee or Trustees for the time being under this Indenture shall have full power and authority from time to time, with the consent in writing of the person or persons entitled to receive not less than half the then net income of the Trust Estate, by an instrument in writing signed by all of the Trustees, to alter or amend this instrument, or to terminate the trusts hereby created as to the whole or any part of the Trust Estate, and in the event of such termination to pay over, transfer and deliver the portion of the Trust Estate affected as may be directed in said instrument of termination: provided, however, that no part of the principal or income of the Trust Estate shall be revested in the Grantor by virtue of any such alteration, amendment or termination.
Section 10 of article II provided that ‘There shall at all times be at least two acting trustees to execute the trusts herein provided for‘ and to that end made provision for the appointment of additional trustees. Section 11 provided in part:
Section 11. The Trustees may from time to time delegate their power and authority herein to one of their number who shall be designated as Managing Trustee. All acts of such Managing Trustee shall have all the force and effect of the acts of both Trustees, except that none of the capital stock or other property held hereunder by the Trustees shall be sold by the Managing Trustee, and the trusts hereby created shall not be terminated by the Managing Trustee, except with the written consent of all acting Trustees, and the amount of income payable to any beneficiary hereunder, when discretionary with the Trustees, shall in all cases be determined by all acting Trustees.
Petitioner's brother Knight was the original managing trustee. In 1939 petitioner's father died and petitioner became the managing trustee. Petitioner and his wife, Elizabeth Strong Cowles, have 2 children, aged 20 and 17, respectively.
Acting pursuant to section 4 of article II of the trust agreement, the trustees in 1941 applied for and took out with the Equitable Life Assurance Society of the United States an insurance policy on the life of petitioner in the amount of $60,000. The application for the policy was signed by the two trustees as such, the proceeds were payable to the trustees, and all rights of ownership were vested solely in the trustees.
The annual premium on the above mentioned policy, amounting to $3,229.20, was paid by the trustees in 1941 out of the income of the trust and was charged to the income account. The net income of the trust for the year 1941, before applying section 162(b) of the Internal Revenue Code, was $30,939.21. Out of this amount the trustees paid the premium of $3,229.20, leaving a balance of $27,710.01 which was distributed to petitioner as life beneficiary under article I, section 1, of the trust instrument.
In making their fiduciary income tax return for the year 1941 the trustees reported the amount distributed to petitioner as $30,939.21, instead of $27,710.01; and petitioner included the larger amount in his own return. Later, the trustees filed an amended return showing the amount distributed as $27,710.01, and petitioner filed a claim for refund of the tax paid by him on account of the difference between that amount and the $30,939.21 included in his return. This claim was filed with the collector of internal revenue at Chicago on June 9, 1943.
In a statement attached to the deficiency notice the respondent advised petitioner in part as follows:
In your claim for refund of income tax paid for the year 1941 you claim that you erroneously reported excessive income to the extent of $3,229.20 from the Alfred Cowles III Trust. It is held that under the provisions of Sections 162(b) and 22(a) of the Internal Revenue Code, the entire net income of said trust for the year 1941 is taxable to you as reported by you in your return, and, consequently, the contention made in your claim must be denied.
Petitioner in his return for the calendar year 1941 reported a total tax liability of $35,760.12. This amount was paid by petitioner in four equal installments on March 16, June 4, September 5, and December 11, 1942. The deficiency notice was mailed to petitioner on June 15, 1944.
Petitioner is in the business of investment counsel and trust fund management. He has been in that business for about 15 years. He has an office in Chicago, in which he manages about 75 different investment accounts, including about 40 trusts. With the exception of 2 in which he has a personal interest, all of these trusts are managed by petitioner as trustee for others. He receives a management fee for his services. All of the trust agreements contain provisions for the appointment of a managing trustee with certain limited powers, in order to simplify the transaction of business in the trusts. The affairs of the Alfred Cowles III trust were handled in the same way as the other trusts managed in petitioner's office. The trust had its own bank account, its books were audited by certified public accounts, and annual audit reports were made covering all receipts and disbursements in the trust. Petitioner took no action with respect to the trust funds without the consent and approval of his cotrustee.
The insurance policy above referred to was taken out by the trustees for the sake of diversification, the only other investment in the trust at the time being the above mentioned 12 1/2 shares of stock which could not be sold on the market. The decision to take out the insurance was made by the trustees in the ordinary course of determining of what the trust investments should consist. The policy is still in force.
Petitioner is also the trustee of a trust created by his father in which his brother Knight was a beneficiary.
OPINION.
BLACK, Judge:
The sole issue in this proceeding is whether petitioner is taxable on that portion, $3,229.20, of the income of the Alfred Cowles III trust, of which petitioner was the life beneficiary, that was used by the trustees to pay the first premium on a life insurance policy taken out by the trustees on petitioner's life. During the taxable year 1941 the trust had a net income, before applying section 162(b) of the Internal Revenue Code, of $30,939.21. The trustees used $3,229.20 of this income to pay the above mentioned premium and distributed the balance of $27,710.01 to petitioner. Petitioner admits that he is taxable on the amount actually distributed to him, but contends that the trust, as a separate entity, is taxable on the balance of $3,229.20. The respondent contends that petitioner is taxable on the full $30,929.21.
Section 161 of the Internal Revenue Code provides in part that ‘The taxes imposed by this chapter upon individuals shall apply to the income of estates or of any kind of property held in trust‘ and that ‘The tax shall be computed upon the net income of the estate or trust, and shall be paid by the fiduciary, ‘ with certain exceptions not material here. Section 162 provides in part that:
The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that
(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 beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. * * *
Petitioner contends that the $3,229.20 used by the trustees to pay the premium in question is not ‘to be distributed currently by the fiduciary to the beneficiaries,‘ as that phrase is used in section 162(b); that, therefore, under section 162(b), the amount so used is not allowable as an additional deduction in computing the net income of the beneficiary; and that in any event there is no reason here for applying section 22(a) of the Internal Revenue Code. The material provisions of the latter section are set forth in the margin.
SEC. 22. GROSS INCOME.(a) GENERAL DEFINITION.— ‘Gross income‘ includes gains, profits, and income derived from salaries, wages, or compensation for personal services (including personal service as an officer or employee of a State, or any political subdivision thereof, or any agency or instrumentality of any one or more of the foregoing), of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *
The respondent's position as stated in his brief ‘is that the petitioner is taxable on all the trust income for the year 1941 under Section 162(b) of the Internal Revenue Code and/or under Section 22(a) of the Internal Revenue Code.‘
We shall consider first whether petitioner is taxable on all the trust income for the year 1941 under section 22(a). If we conclude that petitioner is so taxable, it will not be necessary to consider section 162(b).
The respondent, in contending that petitioner is taxable on all the trust income under section 22(a), cites Mallinckrodt v. Nunan, 146 Fed.(2d) 1; certiorari denied, 324 U.S. 871; rehearing denied Apr. 30, 1945, and Edgar R. Stix, 4 T.C. 1140. The respondent in this respect states his contention thus:
During the year 1941 petitioner, because of his control over the corpus and income of the trust, was in substance the owner thereof, and he is taxable upon the entire trust net income for the taxable year under Section 22(a) of the Internal Revenue Code.
Respondent, in contending that petitioner is taxable under section 22(a), relies upon the following: (1) The fact that petitioner was named by the grantor as one of the cotrustees of the trust; (2) the power of appointment given petitioner under article I, section 2, of the trust indenture; and (3) during the petitioner's lifetime he was given dominion and control over the trust income. Under (1) the respondent argues that petitioner as one of the two trustees could have blocked the purchase of the policy and thus left his right to demand all the trust income unimpaired. Under (2) the respondent argues that it was merely a matter of form whether petitioner received the entire trust income and individually entered into an insurance contract to protect his dependents, or, as one of the cotrustees, acted to take out a policy on his life payable to the trust, the corpus of which he could by his last will and testament limit, direct, and appoint. Under (3) the respondent calls our attention principally to section 1 of article I, the provisions of which we have set out in our findings and under which petitioner was given the right to demand the entire net income of the trust in ‘convenient installments.‘
We think our holding here must be for the respondent upon the authority of Edgar R. Stix, supra, and the cases there cited. The petitioners' mother in that case created two trusts having identical terms except for beneficiaries. The trustees under the two trusts were the same, namely, the two petitioners Edgar R. and Lawrence C. Stix. One trust was for the benefit of Edgar and his sons and the other for the benefit of Lawrence and his sons. In one case Edgar was named ‘primary beneficiary‘ and in the other Lawrence was so named. Each trust was to endure for the life of the primary beneficiary, and upon his death the corpus was distributable to the respective sons unless the primary beneficiary designated by will that the corpus was otherwise distributable. The income of each trust was payable to the primary beneficiary, except that the trustees could in their sole discretion, at any time or from time to time, pay all or any of the income to the sons of the primary beneficiary. During the taxable years there in question the trustees exercised their discretion and paid all of the income of the trusts to the sons of the petitioners. Notwithstanding the last mentioned fact, we held that the entire income of those trusts was taxable to the petitioners, namely, the primary beneficiaries. In so holding we said in part:
* * * Here, as we read the trust instrument, it was unnecessary for either petitioner to make a request in order for the income from his trust to be paid to him. Only by the affirmative action of the petitioners as cotrustees in exercising their discretion to pay the income to their children would there be the necessary conduct resulting in a failure on the part of the respective petitioners to receive the entire trust income. * * *
* * * The failure of either to concur was all that was necessary for him to obtain the income from his own trust. We need not, accordingly, resort to the reciprocal trust theory presented by the Lehman case, for the conclusion that I was within the unhampered power of each petitioner to obtain the current income of the trust if that suited his purpose. See also Edward E. Bishop, 4 T.C. 862.
Our decision in the Stix case was affirmed by the United States Circuit Court of Appeals for the Second Circuit on December 21, 1945, 152 Fed.(2d) 562.
In the instant case if article I, section 1, were the only provision of the trust instrument dealing with the disposition of trust income, we think it is clear that the entire trust income would be taxable to petitioner under section 22(a) as applied in Mallinckrodt v. Nunan, supra, and Blanche N. Hallowell, 5 T.C. 1239. We can see no difference in principle between the discretion exercised by the trustees in the Stix case in paying the income of the trust to the sons of the primary beneficiaries and the discretion exercised by the trustees in the instant case in using a part of the income to take out the insurance policy here in question. It is true, as petitioner contends, that section 4 of article II of the trust indenture authorized the trustees within their discretion to take out a policy of insurance on the life of Alfred Cowles III and pay the premiums on the policy out of trust income. It is also true that such a policy of insurance was taken out and was made payable to the trust and all elements of ownership were vested in the trust. However, it was within the power of petitioner as one of the two trustees to have blocked the taking out of such a policy and to have taken all of the net income of the trust for himself. The situation in this respect we do not think is distinguishable, in substance, from the discretion which existed in the Stix case.
We, therefore, think that petitioner did not err when he reported the entire net income of the trust in his original income tax return and we sustain the Commissioner in refusing to exclude from petitioner's net income the $3,229.20 insurance premium in his determination of the deficiency.
It thus becomes unnecessary to determine whether petitioner is taxable on the trust income in question under section 162(b).
Decision will be entered for the respondent.