Opinion
Docket Nos. 3702 3703.
1946-02-20
ROY P. HARPER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.DOROTHY C. HARPER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Dana Latham, Esq., and Austin H. Peck, Jr., Esq., for the petitioners. B. H. Neblett, Esq., for the respondent.
Under section 172 of the Civil Code of California the husband has the management and control of the community personal property, with the power of disposition, but he can not make a gift of it or dispose of it without a valuable consideration except with the written consent of the wife. Where a gift is made without the written consent of the wife, she has the right to revoke it and reinstate the property as part of the community property, provided she exercises her right within the applicable period of limitations. With the oral agreement of the wife, but without her written consent, the husband in 1939 transferred by gifts in trust to himself, as trustee for the benefit of their two minor children, certain community property consisting of shares of corporate stock. Held, that throughout 1940 the wife had the right to revoke the trusts and reinstate the trust property as part of the community property and that under section 166 of the Internal Revenue Code the income from the trust property during that year was taxable to the husband and wife as community income. Dana Latham, Esq., and Austin H. Peck, Jr., Esq., for the petitioners. B. H. Neblett, Esq., for the respondent.
The respondent determined a deficiency of $3,603.35 in the income tax of each of the petitioners for the year 1940. The primary question presented is whether the respondent erred in determining that income of two trust created by petitioner Roy P. Harper in 1939 was taxable to petitioners as community income.
FINDINGS OF FACT.
The petitioners are husband and wife, and they filed their income tax returns for 1940 with the collector at Los Angeles, California. They were married in Los Angeles in June 1918, and have two children, Virginia L., born March 5, 1924, and Donald L., born January 26, 1930.
Van Camp Sea Food Co. is a California corporation, with an office at Terminal Island, and is engaged principally in the fishing business. Petitioner Roy P. Harper entered the employ of that company in 1923. During a period in 1924 he was in the employ of a firm of food brokers as a salesman on a commission basis. Upon termination of that connection he reentered the service of Van Camp Sea Food Co., sometimes hereinafter referred to as Sea Food, and since 1925 has been its vice president and one of its directors. His work as one of the executive officers is to determine its policies as to marketing, advertising, and new ventures in production.
Sea Food has three classes of capital stock, prior preferred, preferred, and common, with each class having a par value of $100 per share and one vote per share. Harper acquired his first stock in that company in 1924, acquiring $5,000 par value of the prior preferred stock with commissions received for his services as salesman for the food brokers. Subsequent stock, including prior preferred, preferred, and common, acquired by him in Sea Food was purchased with earnings from his personal services. The petitioners have no oral or written agreement separating their respective community property rights, but have always considered everything owned by them to be community property. The 500 shares of preferred stock in Sea Food covered by a trust instrument hereinafter described were community property of Harper and Mrs. Harper.
On March 28, 1932, Harper held 323 of the 6,550 outstanding shares of Sea Food's prior preferred stock, 208 of the 5,985 outstanding preferred shares, and 148 of the 8,011 outstanding common shares, or 679 of the total of 20,546 outstanding shares of all classes. Mrs. Harper held no stock of any class. On said date Harper, Bismark Houssels, and Frank Van Camp, the parties who started the business conducted by Sea Food and who then were in charge of its management, entered into an agreement respecting their stockholdings in the company whereby they created a voting trust, with themselves as trustees. The purpose of the agreement was to continue in office the directors and officers of the company holding the views of the then management. By its terms the agreement was to continue for a period of 21 years or until each of the trustees had retired from the active management of the company should that occur first. Both Van Camp and Houssels died prior to February 11, 1939. The voting trust continued in effect until about August 28, 1941, when it was voluntarily terminated and the stock held under the trust was distributed to those entitled to receive it.
Under date of March 28, 1932, the date on which the voting trust agreement was entered into, there was issued to Harper a voting trust certificate for 504 shares of stock in Sea Food, representing 261 shares of prior preferred stock, 147 shares of preferred, and 96 shares of common and being only a part of the total of each class of stock held by him at that time. About 1934 or 1935 Houssels gave to his children the preferred and common stock owned by him in Sea Food. Van Camp gave certain shares of his preferred and common stock in Sea Food to his children and gave, in trust, to his two grandchildren certain other shares of the same classes of stock, naming his son and daughter as trustees for them. Harper began to think about making a like disposition of some of his stock to his two minor children, but did not know what form of trust agreement should be made. Although still not having reached any conclusion as to what sort of trust agreement should be made, Harper, on December 1, 1936, had separate voting trust certificates issued in his name as trustee for an unnamed person or persons for the 147 shares of preferred stock and the 96 shares of common stock represented by the above mentioned voting trust certificate. No trust instrument was executed at the time, but he intended that at some time in the future, when he had decided upon the terms thereof, he would execute such an instrument to show that the preferred stock was held for the benefit of his daughter Virginia and the common stock for the benefit of his son Donald. Thereafter Harper took up the matter with his bank and it sent an employee to talk with him about it. At Harper's request the bank in the early part of 1938 submitted to him a proposed form of trust agreement which it considered would serve the purpose he had in mind. In that form of agreement the bank was named as trustee and Harper and Mrs. Harper were named as trustors. The form contained an express provision that the trusts provided for therein were to be irrevocable. After examining the proposed form Harper concluded that it was long and cumbersome and that in view of the small amounts of stock involved he should be named trustee. He gave the form to his brother, Albert Harper, who is his and his family's adviser on taxes, as well as personal matters generally, and instructed him to simplify it, naming petitioner Roy P. Harper as trustee, and to have someone check it over to see that it was legal. Thereafter Albert Harper prepared a form of trust instrument which he presented to petitioner Roy P. Harper, who examined and signed it on February 11, 1939. Mrs. Harper was not named as grantor and was not asked to and did not sign the trust instrument because Harper had talked over with her the matter of making the gifts covered by the trust instrument and she had agreed to it. However, she did not execute any instrument purporting to give her written consent thereto.
The trust instrument recited that Harper transferred and gave to himself as trustee 300 shares of preferred stock in Sea Food, to be known as Virginia's trust, and 200 shares of preferred stock and 500 shares of common stock in Sea Food, to be known as Donald's trust; that said ‘stock includes 147 shares of Preferred Stock and 96 shares of Common Stock transferred to Virginia and Donald respectively, December 1, 1936, and held in trust by Van Camp, Houssels and Harper‘; and that Virginia's trust and Donald's trust were separate and distinct trusts held by the same trustee under common duties and powers. The instrument also recited that Harper, as trustee, was to hold the property in an irrevocable trust, to manage, invest, and reinvest the same and collect the issues, income, and profits and the principal thereof, and to use and dispose of the income, profits, and principal as therein indicated.
As to Virginia's trust, it was provided that the income should be added to principal until she reached 18 years of age, after which time all net income available for distribution, but not exceeding $100 per month, should be paid to her in monthly installments during her life. Should net income be insufficient to pay $100 per month, the deficiency is to be paid out of principal but the right with respect to such deficiency may be waived by her. Should the payments thus provided for be insufficient to provide her with reasonable funds for her own use, supplementary to the support and care furnished by her parents under their parental obligations, the trustee in his discretion may pay, apply, or expend for her use and benefit so much of the income or principal, up to and including the entire amount thereof, as deemed advisable. While it is provided that when Virginia reaches 30 years of age one-fourth of the trust estate is to be distributed to her and the remaining three-fourths is to distributed to her at the age of 35, the trustee may, if deemed advisable by him, convert the trust estate into a monthly annuity ‘in any amount reasonable under the circumstances.‘ Should Virginia die prior to becoming entitled to receive distribution of the entire trust estate, the undistributed remainder is to be distributed to her then living lawful issue, or should no such issue be then living, the trust estate is to become a part of the trust estate of Donald's trust and to be held, managed, and distributed as such.
The provisions respecting the distribution of the income and principal of Donald's trust are the same as in the case of Virginia's trust, except (1) that distribution of one-fourth of the principal is to be made to him at age 25 and three-fourths at age 30, with the trustee, if deemed advisable by him, similarly empowered to convert the trust estate into a monthly annuity, and (2) that, upon the death of Donald prior to his becoming entitled to receive distribution of the entire trust estate, the undistributed remainder is to be distributed to his living lawful issue or if no such issue be then living, the trust estate is to become part of the trust estate of Virginia's trust, and to be held, managed, and distributed as such.
Any portion of Virginia's trust or Donald's trust not disposed of as set out above is to be distributed one-half to the heirs at law of Virginia and one-half to the heirs at law of Donald, the identity and the respective shares of such heirs to be determined according to the laws of California relating to the succession of separate property and to vest as of the date of death of Virginia and Donald, respectively. It is also provided that the interest of beneficiaries in principal or income of both trusts is not to be subject to claims of creditors or others, nor to legal process, and may not be voluntarily or involuntarily alienated or encumbered.
For the purpose of carrying out the provisions of the trusts, the trustee was given, among others, the following powers: (1) To hold any property received in trust as long as deemed advisable; (2) to manage, sell, exchange, partition, subdivide, improve, and repair, to grant options and sell upon deferred payments, to lease for terms within or extending beyond the duration of the trust for any purpose, including exploration for and removal of gas, oil, and other minerals, to compromise or otherwise adjust claims in favor of or against the trust, to create restrictions, easements, and other servitudes, and to carry such insurance as deemed advisable; (3) to invest principal and accumulated income in such securities and properties as the trustee may deem advisable, whether or not authorized by law for the investment of trust funds; (4) to hold securities or other property in the name of the trustee or his nominee, with or without disclosure of the trust, the trustee being responsible for the acts of such nominee affecting such property; (5) to advance funds to the trust for any purpose, such advances with the interest thereon to constitute a first lien on and to be repaid out of principal or income; (6) to borrow money for any purpose upon such terms and conditions as may be determined by the trustee and to obligate the trust estate for the repayment thereof; (7) to have respecting securities all the rights, powers, and privileges of an owner; (8) upon any division or partial or final distribution of the trust estate, to distribute the trust estate at such valuation and according to such method as the trustee may determine and to sell such property as deemed necessary to make such division or distribution; (9) to budget the estimated annual income in order to equalize periodical income payments to the beneficiaries; (10) to determine in his discretion what is principal or income of the trust estate and what items shall be charged to each except (a) premiums paid on the purchase of securities shall be charged to principal, (b) stock subscription rights and the proceeds from the sale thereof together with corporate dividends are to go to income, (c) commissions and expenses on the purchase and sale of trust property, gain or loss resulting from the sale or retirement of any property or security or from the realization on or foreclosure upon mortgages or trust deeds shall go to principal, (d) income from real property acquired on foreclosure or conveyance in lieu thereof and all bonuses, royalties, rents, or other consideration received under any lease of mineral rights shall go to income, and (e) income accrued or unpaid on trust property when received into the trust shall go to income; and (11) unless specifically limited, all discretions conferred upon the trustee shall be absolute and their exercise conclusive on all persons interested in the trust, and the enumeration of certain powers of the trustee shall not limit his general powers, the trustee being vested with and having as to the trust estate and in connection with the execution of the trust all the rights, powers, and privileges which an absolute owner of the same property would have. Taxes, assessments, and expenses incurred in the administration or protection of the trust estate might, at the election of the trustee, be paid from principal or income or partly out of each. Other property acceptable to the trustee might be added to the trusts. Upon the death or incapacity of Harper prior to the termination of the trusts, or in event he should decline to act, Dorothy C. Harper, his wife, and Albert L. Harper, his brother, were named as trustees. All trustees subsequent to Harper succeed to all authority, powers, and discretions conferred upon him by the trust instrument.
On February 11, 1939, the date of the execution of the trust instrument, Harper held, including the shares transferred into his name as trustee on December 1, 1936, 289 shares of prior preferred stock in Sea Food, 623 shares of preferred, and 806 shares of common, or a total of 1,718 shares. Mrs. Harper's holdings were 147 shares of prior preferred stock, 377 shares of preferred, and 194 shares of common, or a total of 718 shares. Sea Food's outstanding stock at that time amounted to 4,950 shares of prior preferred, 5,985 shares of preferred, and 8,000 shares of common, or a total of 18,935 shares. At all the annual meetings of the stockholders for the election of directors of Sea Food since February 11, 1939, Harper has voted the 1,000 shares of stock covered by the trust instrument.
The business of Sea Food is of a hazardous nature and no dividends have ever been paid on its common stock. The company began paying dividends on its prior preferred stock sometime prior to 1936 and, so far as disclosed, any cumulated unpaid dividends thereon had been fully paid by the end of 1936. The dividend on the preferred stock is at the rate of 7 percent per annum and is cumulative. On February 11, 1939, no dividends had ever been paid on that class of stock and the dividend on the shares of that class of stock covered by the trust instrument executed by Harper on said date were 12 or 14 years in arrears. In 1939 and 1940 Sea Food's business was good. At the annual meeting of its stockholders in 1940 certain holders of preferred stock who were not participating in the management of the company insisted that the company begin paying dividends on that class of stock. Subsequently, during 1940, dividends in the amount of $8,400 were paid on the 300 shares of preferred stock set up in Virginia's trust and $5,600 on the 200 shares of preferred stock set up in Donald's trust, or a total of $14,000. Subsequent to 1940 and through 1944 dividends totaling $36,750 were paid on the preferred shares in Virginia's trust and $24,500 on the preferred shares in Donald's trust.
On or about May 18, 1940, Harper opened bank accounts with respect to each of the trusts, styled ‘R. P. Harper as Trustee For Virginia Harper a Minor‘ in the case of Virginia's trust and similarly styled in the case of Donald's trust. Dividends on the shares in the trusts were deposited in the respective bank accounts and separate check books were used for withdrawals from said accounts. The stubs of the check books were the only books of account kept for the trusts. From time to time Harper made loans of funds of the trusts to Sea Food, and he also invested some of the funds in U.S. Treasury bonds. Other disbursements were for Federal and state income taxes. During 1940 and 1941, on the advice of Albert L. Harper that such disbursements were permissible under the trust instrument, a total of $2,679.65 was disbursed from Virginia's trust for a riding horse for her, riding lessons, maintenance of the horse, etc. Shortly before the hearing in these proceedings Harper consulted counsel representing him herein. Upon advice received therefrom, he, on the day prior to the hearing, paid said sum with interest into Virginia's trust. Beginning March 5, 1942, when Virginia reached 18 years of age, Harper has paid her $100 a month, which she has deposited in a building and loan account, with the exception of $100 spent by her for her own use. No payments from Donald's trust have ever been made to him.
During the past 10 years the principal source of Harper's income has been his compensation for services rendered to Sea Food. His compensation is based upon an employment contract which has been in effect for more than 15 years and is subject to termination by Sea Food's president upon one year's notice. Said contract has never been considered as an item of business at any director's or stockholder's meeting from 1935 to date. Under the contract Harper receives a salary of $18,000 a year, plus 10 percent of the profits of the company, computed without deduction for taxes but with deduction for dividends on preferred stocks. His compensation for the years 1935 through 1940 averaged approximately $70,000 per year, and since 1940 it has amounted to as much as $125,000 to $150,000 in some years.
For 1940 Harper, as trustee, filed a fiduciary return of income for the two trusts on which the income reported was dividends in the amount of $14,000, of which $8,400 was shown as distributable to Harper as trustee for Virginia and $5,600 as distributable to him as trustee for Donald. Individual income tax returns for the children were filed by Harper as trustee, in which the respective amounts were shown as income. The tax shown by these returns was paid. Upon audit of the returns the respondent determined that the income of the trusts was not distributable to the children, but was taxable to the trusts. Refunds were made of the taxes paid on the returns for the children and taxes were assessed against the trusts. No part of the income of either of the trusts was reported by either of the petitioners in their respective income tax returns. In determining the deficiencies involved herein, the respondent determined that the total income of the trusts, $14,000, was taxable to the petitioners as community income and accordingly increased the taxable income of each by $7,000.
OPINION.
TURNER, Judge:
The petitioners take the position that the evidence shows that the trusts set up by Harper for their children were valid, subsisting, and irrevocable and that under the circumstances presented all of the income of the trusts was taxable to the trusts and no part thereof was taxable to either of the petitioners. The respondent contends that the income of the trusts was taxable to petitioners in equal amounts under sections 22(a), 166, and 167 of the Internal Revenue Code.
The respondent bases his contention that the income of the trusts was taxable to the petitioners under section 166 on the ground that the trusts were revocable by Mrs. Harper, a person who did not under the trust have a substantial adverse interest in the trust corpus or the income therefrom.
Section 166 of the Internal Revenue Code provides that, where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, then the income of such part of the trust shall be included in computing the net income of the grantor.
The Civil Code of California (1937), section 172, provides as follows:
Management of Community Personal Property: Limitations: Consent of Wife. The husband has the management and control of the community personal property, with like absolute power of disposition, other than testamentary, as he has of his separate estate; provided, however, that he cannot make a gift of such community personal property, or dispose of the same without a valuable consideration, * * * without the written consent of the wife.
Where a husband makes a gift of community property without the written consent of the wife, section 172 does not make the gift void, but merely voidable at the option of the wife. The property vests immediately in the donee, but subject to the wife's right to revoke the gift and reinstate the property as part of the community property. Spreckels v. Spreckels, 172 Cal. 775; 158 Pac. 537; Blethen v. Pacific Mutual Life Ins. Co., 198 Cal. 91; 243 Pac. 431; Lahaney v. Lahaney, 208 Cal. 323; 281 Pac. 67; Ballinger v. Ballinger, 9 Cal.(2d) 330; 70 Pac.(2d) 629. The exercise of the wife's right must occur before the expiration of the period of limitations applicable thereto. Spreckels v. Spreckels, supra; Ballinger v. Ballinger, supra; Cooper v. Cooper, 3 Cal.App.(2d) 154; 39 Pac.(2d) 820. The wife may, at any time, give her written consent to the gift, and if she does the gift becomes absolute as to her. Such written consent may be in language other than a mere recital that her consent is thereby being given. Spreckels v. Spreckels, supra; Metzger v. Vestal, 2 Cal.(2d) 517; 42 Pac.(2d) 67.
Concededly, Mrs. Harper never signed the trust instrument of February 11, 1939, and the petitioners admit that, while they knew that under the California law a wife's consent was necessary to make a gift of community property, they were not advised of the provisions of section 172 of the Civil Code of that state requiring her written consent. Nevertheless, they urge that, since Mrs. Harper knew of the gifts, orally consented to them, and subsequently filed her 1940 income tax return omitting therefrom all income from the gifts, the law of California is not necessarily determinative and that for Federal income tax purposes it must be held that she was bound by the gifts. To concede the contention of the petitioners would defeat the will of Congress as expressed in section 166 of the Internal Revenue Code, if, under the law of California and the facts presented, Mrs. Harper had the power to effect a revocation of the trusts.
The petitioners contend that by reason of the gifts to trusts Mrs. Harper was benefited by being relieved of payment of the tax on the income therefrom and further that she accepted such benefit by reporting no part of the income in her 1940 income tax return. On the basis of that contention they urge that, if the law of California is held to be determinative, then under the holding of the Supreme Court of that state in Lahaney v. Lahaney, supra, we must hold that she was estopped from revoking the trusts on the ground that the gifts had been made without her written consent thereto. The facts in Lahaney v. Lahaney are not comparable to those presented here. In that case a husband, without the knowledge of the wife, executed and delivered to his sister a deed of gift conveying to her and the wife undivided one-half interests in certain community property. Following the death of the husband and in a proceeding to determine the rights of the sister and the wife, the court held that the wife, having received under the deed, and having accepted her undivided one-half interest in the property, was without right to attack the husband's contemporaneous gift to another of his own equal undivided interest in the same property. By the trust instrument involved herein, Mrs. Harper was given nothing and there was no such setting apart of interests in community property as in Lahaney v. Lahaney, supra.
Pointing to section 338 of the California Code of Civil Procedure, which provides that an action for, among other things, the specific recovery of personal property must be brought within three years, the petitioners state that the right of Mrs. Harper to revoke gifts made on December 1, 1936, was barred prior to 1940, the taxable year involved herein, and that her right to revoke the gifts made on February 11, 1939, was barred not later than February 11, 1942. They contend that, in view of this and because the 1939 gifts were merely the consummation of a plan initiated in 1936, it should be concluded that at all times during 1940 Mrs. Harper's right to revoke was barred.
From the evidence presented, we are unable to find that Harper made any gifts of stock to the children in 1936. It is true that on December 1, 1936, he had separate trust certificates for 147 shares of preferred stock and 96 shares of common stock in Sea Food issued in his name as trustee, but the certificates fail to disclose any name or names of the person or persons with whom the intimated trust relationship existed. The evidence shows that no trust instrument was executed at the time, but that Harper intended that at some time in the future, when he had decided upon the terms thereof, he would execute an instrument to show that the preferred stock was held for the benefit of his daughter and the common stock for the benefit of his son. The most that we can spell out of that is that in 1936 he intended at some future time to give the stock in trust to the children on such terms as he might determine upon after further consideration of the matter. At one point in his testimony Harper stated that on December 1, 1936, when the shares were transferred into his name as trustee, he intended at that time to make his daughter and his son a gift of that stock at that time. The trust instrument executed on February 11, 1939, described said shares as having been ‘transferred to Virginia and Donald respectively, December 1, 1936.‘ If Harper had intended to make and had made present and completed gifts of shares of stock to the children on December 1, 1936, as now contended, they became the owners of the stock at that time and he was thereafter without any right to set the stock up in trust on such terms as are contained in the instrument of February 11, 1939. The petitioners make no attempt to, nor are we able to, reconcile his action in 1939 with his testimony that present gifts were made in 1936.
If it be assumed that the transfers of the shares into Harper's name as trustee on December 1, 1936, constituted present gifts to the children, we could not sustain the contention of the petitioners that prior to 1940 limitations had run against Mrs. Harper's right to revoke as to such shares. Where the wife has knowledge of a gift or is put on inquiry concerning it, limitations begin to run immediately, but where she does not know of it at the time it is made, limitations begin to run as soon as she discovers the fact or in the exercise of reasonable diligence should have discovered it. Spreckels v. Spreckels, supra. There is nothing in the record to indicate that in 1936 Mrs. Harper had knowledge of the transfers on December 1, 1936, or was put on inquiry concerning them. So far as disclosed, the earliest date she learned of them or had occasion to learn of them was at or about the time the trust instrument was executed on February 11, 1939.
Finding no basis for according treatment to the shares covered by the transfers on December 1, 1936, different from the treatment accorded to the remaining shares covered by the trust instrument of February 11, 1939, and being of the opinion that throughout 1940 limitations had not run against Mrs. Harper's right to revoke as to all the shares, we think the contention of the petitioners that limitations had so run must be denied.
Finally, the petitioners contend that, when in 1941 Mrs. Harper filed her 1940 income tax return in which she reported none of the income of the trusts, she thereby ratified the gifts and that in filing her petition against the deficiency involved herein as to her she definitely ratified and expressed her consent that at all times the gifts were effective as to her as well as to Harper. The end sought by the argument of petitioners is similar to that sought in George S. Gaylord, 3 T.C. 281; on appeal to the Circuit Court of Appeals for the Ninth Circuit. In that case the taxpayers, relying on an instrument executed by them subsequent to the close of the taxable years there involved, sought to have us hold that said instrument rendered irrevocable during the taxable years a trust instrument that was otherwise revocable under California law during the taxable years. We rejected the contention of the taxpayers there, and accordingly reject the contention of the petitioners here.
It is our conclusion that Mrs. Harper had the right throughout 1940 to revoke the trusts involved here and reinstate as part of the community property the property held in the trusts, and that the respondent correctly determined that the income from the trust property was taxable to petitioners as community income.
Having concluded that the income from the trust property was taxable to petitioners under section 166, it becomes unnecessary to determine whether it was also taxable to them under sections 22(a) and 167, or to determine an alternative affirmative issue raised by the respondent and to be considered in event we should find from the evidence that the property transferred to trust was not community property.
Reviewed by the Court.
Decision will be entered for the respondent.