Opinion
Docket Nos. 7402, 7403, 7404, 11020, 11021, 11022.
Promulgated June 26, 1947.
1. Decision of the Supreme Court of the State of New York construing trust deeds as creating multiple trusts, held, not binding upon the Tax Court, although affirmed by the Appellate Division, where the proceeding in the lower court was not adversary and no opposition was offered to the prayers of the complaint.
2. Certain trust deeds construed as creating single trusts in the absence of any provision for multiple trusts or any beneficial interests requiring more than one trust for each trust deed.
Alan L. Gornick, Esq., for the petitioners.
Thomas R. Charshee, Esq., for the respondent.
These proceedings involve income tax deficiencies for the years 1940, 1941, and 1942, as follows:
Docket No. Year Amount Garrard E. Kelly Trust #2 ................. 7402 {1940 $19,275.34 {1941 129,974.60 Do ...................................... 11020 1942 12,544.49 Lucy Gayle Kelly Trust #3 ................. 7403 1941 156,981.43 Do ...................................... 11021 1942 13,826.23 Garrard E. Kelly Trust #4 ................. 7404 {1940 820.15 {1941 18,996.60 Do ...................................... 11022 1942 1,004.74FINDINGS OF FACT.
The parties have filed a written stipulation of facts, which we adopt as our findings of fact herein.The petitioners filed fiduciary returns for the taxable years involved with the collector of internal revenue for the second district of New York.
The petitioners are the successor-trustees under three similar trusts, two of which were established by W. C. Kelly in 1927 and one by his son, Garrard E. Kelly, in 1926. The two trusts created by W. C. Kelly, one on April 2, 1927, and one on April 4, 1927, will be referred to hereinafter, as they are in the stipulation of facts, respectively as the "Garrard E. Kelly Trust #2" and the "Garrard E. Kelly Trust #4." The trust created by Garrard E. Kelly on April 2, 1926, will be referred to as the "Lucy Gayle Kelly Trust #3."
The three trusts were substantially alike in all respects here material. We therefore direct our discussion chiefly to the Garrard E. Kelly Trust: #2, created under the deed of trust referred to in the stipulation as "Trust Deed #2."
Under trust deed #2 the settlor, W. C. Kelly, transferred to the Central Trust Co. of Charleston, West Virginia, George S. Couch, and Lucy Gayle Kelly, as trustees, 4,666 2/3 shares of the common stock of the Kelly Axe Tool Co. to be held after the death of the settlor, together with any accumulation thereof from the investment of income:
* * * for the use and benefit of Garrard E. Kelly, the son of said W. C. Kelly during his life and after his death shall be paid one-half for the use and benefit of W. C. Kelly II and his successors in right, and one-half for the use and benefit of Lucy Gayle Kelly II and her successors in right, subject to the provisions hereof, the said W. C. Kelly II and Lucy Gayle Kelly II being the children of said Garrard E. Kelly; * * *
The trust was to be kept open for any later born children of Garrard E. Kelly, who were to share equally with W. C. Kelly, II, and Lucy Gayle Kelly, II. It was to continue for at least one year after the death of Garrard E. Kelly, but not later than twenty-one years after the death of the survivor of Garrard E. Kelly, Lucy Gayle Kelly and their children, W. C. Kelly, II and Lucy Gayle Kelly, II. The trust agreement further provided as follows:
12. (a) When any child of the said Garrard E. Kelly reaches the age of thirty (30) years, or as soon thereafter as may be under the provisions of section 11 (a) hereinbefore contained, the Trust as to such child shall be terminated, and his or her then share of the Trust property and funds shall be conveyed, delivered and paid over to him or her.
(b) If any such child shall die before the termination of the Trust as to him or her without lawful issue him or her surviving the interest of such decedent in the Trust Estate shall be held for the use and benefit of the survivors or survivor of such children, and the lawful issue, if any, of any of them who may have theretofore died, share and share alike, but per stirpes, such issue of any deceased child taking but one share.
(c) If any child of said Garrard E. Kelly shall die before the termination of the Trust as to him or her, leaving lawful issue him or her surviving, the interest of such decedent in the Trust Estate shall be held for the use and benefit of such issue, share and share alike per stirpes.
(d) If any issue of a child of said Garrard E. Kelly shall die before reaching the age of twenty-one (21) years and before the termination of the Trust under the provisions of Section 11 (b) hereinbefore contained, leaving lawful issue him or her surviving, the interest, if any, of such decedent in the Trust Estate shall be held for the use and benefit of his or her issue, share and share alike per stirpes.
(e) If any issue of any such child shall die as aforesaid without leaving lawful issue the interest, if any, of such decedent in the Trust Estate shall be held for the use and benefit of such, if any, of his or her heirs at law as shall be the lawful issue of such Garrard E. Kelly otherwise for the use and benefit of such decedent's nearest of kin, if any, among the issue of said Garrard E. Kelly.
(f) Any interest in the Trust Estate passing hereunder to the issue of a child of said Garrard E. Kelly shall be held by the Trustee for such issue until, and conveyance, payment and delivery to such issue of his or her share of the Trust property and funds shall be made when, he or she reaches the age of twenty-one (21) years, or earlier upon the termination of the trust according to the provisions of said Section 11 (b), as the case may be. Any interest in the Trust Estate passing hereunder to a person, who shall have an interest hereunder then subject to the Trust shall be held by the Trustees for such person as if the interest thus taken had been directly taken and vested hereunder. Any interest in the Trust Estate passing hereunder to a former cestui que trust as to whom the Trust shall have terminated, or to an adult not a former cestui que trust, shall be conveyed, paid and delivered forthwith to such person.
(g) If said Lucy Gayle Kelly shall survive said Garrard E. Kelly and if during the life of said Lucy Gayle Kelly issue of said Garrard E. Kelly shall fail, the said Lucy Gayle Kelly shall be entitled to the net income of the Trust Estate until the termination of the Trust as hereafter provided, provided that the marriage between her and said Garrard E. Kelly shall not have been dissolved by process of law. At the end of one year after the death of said Gerrard E. Kelly if there shall be no living issue of him, and if the said Lucy Gayle Kelly shall have died, or in case she shall survive the said Garrard E. Kelly and be entitled to the net income of the Trust Estate for life, then at her death, the Trust shall terminate and the remaining property and funds of the Trust Estate shall be conveyed, paid and delivered to such persons as would have been the heirs at law of said W. C. Kelly according to the laws of West Virginia now in force if he had died at the date of such termination of the Trust. If issue of said Garrard E. Kelly shall fail after one year after his death, and after said Lucy Gayle Kelly if entitled to receive the income of the Trust Estate hereunder shall have died, but before the termination of the Trust according to said Section 11 (b), the Trust shall terminate and the remaining property and funds of the Trust shall be conveyed, paid and delivered to the persons who would have been the heirs at law of said W. C. Kelly according to the laws of West Virginia now in force if he had died at the date of such termination of the Trust.
The trust agreement further provided that the trustees could, at any time in their discretion, pay to any beneficiary of the trust, except Garrard E. Kelly and Lucy Gayle Kelly, his or her share of the trust estate. The trustees could also make such payment to any dependent member of the family of any of the beneficiaries. Any balance of the income of any beneficiary's share was to be reinvested for the use of such beneficiary.
The trust agreement further provided:
15. The Trustees shall keep the investments of each cestui que trust separate for the purpose of accounting and ultimate distribution, but this shall not prevent carrying the moneys belonging to the Trust Estate in one account, nor making joint investments for the benefit of any two or more cestuis que trustent. * * *
The deeds creating the other two trusts, the Garrard E. Kelly Trust #4 and the Lucy Gayle Kelly Trust #3, both contain provisions similar in all material respects to those of the Garrard E. Kelly Trust #2 described above.
W. C. Kelly died on March 2, 1933. His son, Garrard E. Kelly, died on September 18, 1936, survived by his wife, Lucy Gayle Kelly and their two children, W. C. Kelly, II, age 14 years, and Lucy Gayle Kelly, II, age 12 years. W. C. Kelly, II, and Lucy Gayle Kelly, II, are the present beneficiaries of all three trusts. They are both married and each has one child, Lucinda Kelly Schaefer, daughter of Lucy Gayle Kelly, II, born July 7, 1945, and Patrick Lambert Kelly, son of W. C. Kelly, II, born April 6, 1946. Lucy Gayle Kelly, the widow of Garrard E. Kelly, was remarried on November 15, 1937, to Patrick Calhoun, Jr. She is now deceased, having died December 29, 1940.
The principal of the trust fund in the Garrard E. Kelly Trust #2, that is, the original corpus plus the accretions thereto and minus the losses chargeable thereto, was held "in solido" until about May 5, 1944, when it was physically divided into two equal parts, one of which was held for the benefit of W. C. Kelly, II, and one for Lucy Gayle Kelly, II. Until that time the principal of the trust was held in one account and the income in a separate account. During the lives of W. C. Kelly and Garrard E. Kelly the income was all distributed to them. After the death of Garrard E. Kelly on September 18, 1936, a portion of the current net income of the trust for each year was withheld from the beneficiaries and, together with some of the undistributed income of prior years, was set up in approximately equal amounts in separate accounts entitled "W. C. Kelly II Invested Income Account" and "Lucy Gayle Kelly II Invested Income Account." The net income of the trust for the period September 18, 1936, to December 31, 1942, and the amounts which were transferred to each beneficiary's invested income account were as follows:
The amounts shown in the table are those transferred to the account of W. C. Kelly, II. Where those amounts differ from the amounts transferred to the account of Lucy Gayle Kelly, II, the latter amounts are shown in parentheses.
The funds in the invested income accounts have always been kept separate and the investments of those funds have also been handled separately. The amounts of income transferred to the invested income accounts shown above were debited to the income account of the Garrard E. Kelly Trust #2.
In addition to the net income shown in the above table, Garrard E. Kelly Trust #2 realized a long term capital gain in 1941 of $363,269.87.
Since May 5, 1944, when the trust principal was divided, separate principal and income accounts have been maintained for each of the beneficiaries and all the income from the principal accounts has been transferred to their respective invested income accounts.
Since September 18, 1936, the date of death of Garrard E. Kelly, the trusts have filed separate fiduciary returns each taxable year, one for the fund held for W. C. Kelly, II, and one for the fund held for Lucy Gayle Kelly, II. The taxes shown to be due on those returns were paid and have never been refunded to the taxpayers. The amounts of such taxes for the taxable years 1940, 1941, and 1942 were as follows:
1940 1941 1942 W. C. Kelly, II, Trust #2 ............. $5,883.74 $60,836.88 $4,380.93 Lucy Gayle Kelly, II, Trust #2 ........ 5,909.43 60,876.92 4,421.13 On August 6, 1943, an action was commenced in the Supreme Court of the State of New York, County of New York, by the Chase National Bank and others, as trustees of the trusts here involved, asking the court to settle and allow their accounts for such trusts and to determine any and all questions relating to the trusts and other rights of the parties in interest. The defendants named in the action were W. C. Kelly, II, Lucy Gayle Kelly, II, and other beneficiaries under the several trusts. Guardians ad litem were appointed for Lucy Gayle Kelly, II, who had then not reached her majority, and other infant parties.The question as to the number of trusts created under the several trust deeds was not raised in the original complaint filed in the action referred to above, but was raised in a supplemental complaint filed in August 1945. The supplemental complaint is in part as follows:
3. Since the initiation of this action a question has been raised as to the construction and effect of those provisions of the Trust Deeds which created Trusts #1, 2, 3 and 4 referred to in the complaint herein, which provide for trusts for William Cody Kelly, II, and the said Lucy Gayle Kelly Schaefer. The question which has arisen is whether under each Trust Deed (1) one trust was created consisting of principal and accumulated income of which the said Lucy Gayle Kelly Schaefer and her brother, the said William Cody Kelly, II, are joint beneficiaries, or (2) whether separate trusts for each of the said children of Garrard E. Kelly were created by the said Trust Deeds consisting of principal and income (making two separate and distinct trusts under each of the Trust Deeds), or (3) whether two separate trusts of principal and two separate trusts of accumulated income were created for each of the said children of Garrard E. Kelly (making four separate and distinct trusts under each of the said Trust Deeds) by the said Trust Deeds dated the 31st day of March, 1927, the 2nd day of April, 1927, the 4th day of April, 1927, and the 2nd day of April, 1926, respectively.
4. The plaintiffs desire to have this question resolved and to have a determination made in this action as to the construction and effect of the appropriate provisions of the said Trust Deeds for instructions.
5. The Trustees have separated the securities and moneys constituting the principal of each Trust Estate into two separate and distinct trusts; one for William Cody Kelly, II, and the other for Lucy Gayle Kelly Schaefer, and, in addition, have set up Accumulated Income Accounts for each separate trust.
One of the guardians ad litem, Arthur J. O'Leary, who represented Lucinda Kelly Schaefer, stated in a report submitted to the Court February 26, 1946, that:
The question (fourteenth cause of action) has arisen as to whether each deed of trust creating Trusts Nos. 1, 2, 3, and 4 in fact created one trust consisting of principal and accumulated income for the benefit of Lucy Kelly Schaefer and William Cody Kelly, II, or whether two separate trusts for the benefit of each of said beneficiaries were created, or whether two separate trusts of principal and two separate trusts of accumulated income were created for each of said named beneficiaries. * * *
* * * * * * *
In determining questions like this, Courts generally seek to give effect to an intention to set up separate trusts rather than one big one. The provisions quoted above definitely provide that one-half of the principal in such cases is to be held for W. C. Kelly, II, and one-half for the benefit of Lucy Kelly Schaefer. Accumulated income is also to be paid to each child as he or she attains the age of 30 years. I have given a great deal of thought to this matter, have discussed it with the attorneys for the plaintiff and am of the opinion that it was the grantor's intention in each one of these trust deeds creating Trusts Nos. 1, 2, 3 and 4 to create four separate trusts, or sixteen trusts in all.
A hearing was had before the New York Supreme Court, County of New York, on February 19, 1946, at which the parties plaintiff and defendants appeared in person. None of the defendants opposed any of the prayers of the complaint or supplemental complaint. William M. Wherry, counsel for the defendants, W. C. Kelly, II, and Lucy Gayle Kelly, II, stated to the court as follows:
Mr. WHERRY: I have examined these questions of law which are involved here. I do not think there is any question at all about the authority and power of the trustees in regard to investments. I think the question of the number of trusts gave me a little more difficulty, but the language of the trust instruments, that seemed to me clearly to indicate the intention of the creator of those trusts, convinced me, after examining the cases, that they are separate trusts.
The COURT: It is to the interest of the defendants that you represent to have them declared to be separate trusts.
Mr. WHERRY: Exactly. But I call your particular attention to that language where it speaks of the trusts or the income trusts, and there it says: "Any income belonging to any cestui que trust not paid to him or her shall, at the convenience of the special trustee, be reinvested for the use of such cestui que." It seems to me that that language makes it very clear what the intention was.
The lower court gave a decision from the bench and later entered a written decision, approving the accounts as filed and granting the relief prayed for in all of the fourteen counts of the complaint and supplemental complaint. The court ruled:
So far as the trusts deeds, which are set forth as Exhibits A, B, C and D, and attached to the complaint, the Court rules that there are four trusts for each of the Kelly children under each of these trust deeds, two trusts being constituted as principal, and the other two trusts accumulative income.
The effect of the court's ruling that there were sixteen separate trusts was to deny the contingent minor beneficiaries any rights in the accumulated income and to remove that income from the reach of the provisions of the several trust deeds.
On April 22, 1946, the minors in the above action, through their guardian ad litem, Arthur J. O'Leary, filed an appeal to the Appellate Division of the Supreme Court of the State of New York. The appeal was taken from that part, and that part only, of the lower court's ruling that four trusts rather than one single trust were created by each of the aforesaid trust deeds. Without an opinion the Appellate Court affirmed the ruling of the lower court. One judge dissented, stating that in his opinion each of the trust estate, after the death of the last surviving life tenant, should have been divided into two trusts, one for W. C. Kelly, and one for Lucy Gayle Kelly, II.
In determining the deficiencies herein the respondent treated the funds held under each of the trust deeds as constituting a single trust, stating in his deficiency notice in Docket No. 7402 as follows:
In making this determination of your income tax liability, careful consideration has been given to the reports of examination dated September 30, 1943 in respect of W. C. Kelly II Trust #2 and L. G. Kelly II Trust #2; to your protest dated December 5, 1943 and supplemental data and to the statements made at the conferences held on February 25, March 22, April 17, and May 18, 1944.
* * * * * * *
It is held that the trust created by W. C. Kelly on April 2, 1927 did not contemplate that separate trusts would come into existence after the death of the life beneficiaries but that it would continue as a single trust until its termination.
Substantially the same procedure as that described above with respect to the Garrard E. Kelly Trust #2 was followed by both the trustees and the Commissioner with respect to the Lucy Gayle Trust #3 and the Garrard E. Kelly Trust #4.
OPINION.
Our question here is whether during the taxable years 1940, 1941, and 1942 there was only one trust under each of the three trust deeds involved or whether there were two or more trusts.
The petitioners contend, first, that this Court is conclusively bound by the ruling of the Supreme Court of the State of New York, affirmed by the appellate division, that four separate trusts were created by each of the trust deeds for the years following the death of the last surviving life beneficiary. The petitioners further contend that, independently of the ruling of the state courts, we must so construe the trust deeds.
We do not agree that we are bound by the ruling of the state courts. That action was brought by the trustees, initially, for the purpose of settling their accounts and other matters not related to our question here. The original complaint contained no reference to the number of trusts created by the several trust deeds. That question was injected into the proceeding by a supplemental complaint filed after it had been put in controversy in this proceeding before the Tax Court. There was no controversy between any of the parties to the suit in the trial court. The complaint and the supplemental complaint contained fourteen separate counts, none of which was opposed by any of the parties defendant. The court's decision was, we think, in the nature of a consent judgment. See Charles S. McVeigh, 3 T.C. 1246. Cf. Freuler v. Helvering, 291 U.S. 35.
Notwithstanding the absence of any contest before the trial court, an appeal from that court's ruling was taken to the appellate division. The appellants, through their guardian ad litem, Arthur J. O'Leary, were the same minors who had appeared as defendants in the lower court. O'Leary had stated in his report to that court that he had given a great deal of thought to the matter and was of the opinion that it was the intention of the grantor to create four separate trusts under each trust deed. Before the appellate court, however, he contended that the grantors intended to set up a single trust and not four separate trusts under each trust deed. He stated in his brief to the appellate court:
As a result of applying the theory of separate, independent trust, Special Term has adjudicated that the appellants have no remainder interests in the eight so-called invested income trusts. But if the accumulated invested income, as the grantors intended, is a part of the whole, then it is clear that the remainder interests attached to the whole trust and to all of its parts, and it is erroneous to hold that the infant remaindermen have no interest in the so-called invested income trusts.
It is true, if these trusts are considered to be separate and independent, that the income may be reported separately from each trust and consequently the income will be taxed at lower brackets than if all of the income is included in a single return. That advantage is beneficial to the present life beneficiaries but results in a disadvantage to the infant remaindermen. The respondents save income taxes but the appellants are deprived of their remainder interests in the so-called invested income trusts.
In these circumstances it is difficult to understand why any appeal was taken from the trial court's ruling. The respondent here suggests that it was for the sole purpose of strengthening the petitioners' position in these proceedings by making it appear that the action of the state courts was adversary. He points out that the appeal was taken after the promulgation of our opinion in James S. Reid Trust, 6 T.C. 438, in which we called attention to the fact that no appeal had been taken from a state court case construing the trust agreement there involved.
However that may be, we do not think that in the circumstances here the affirmance by the appellate division makes the trial court's ruling any more binding upon us. If the action was not adversary in the trial court, neither was it in the appellate court. The appellate court did not change, and could not have changed, the fundamental character of the action. Although there was a dissent by one of the appellate judges, we do not think that there was ever any real contest in the state courts of the question which we must now decide, or that the decisions of those courts are binding upon us here.
Looking to the trust deeds themselves, we do not find any provisions which required the construction contended for by the petitioners, that it was the grantor's intention to create more than one trust under each trust deed. Throughout each of the trust deeds the grantor repeatedly referred to the "trust" in the singular. At no time did he use the plural of the term in referring to any of the trusts. This is an important factor in determining the real intention of the grantor and one that has been stressed in many of the cases involving questions like that presented here.
We do not overlook the fact that under each trust deed there was admittedly a single trust which was to continue at least until the death of the last surviving beneficiary. Consequently, some of the references to the trusts would properly have been in the singular, regardless of the intention of the grantor to creat multiple trusts after the death of the last surviving life beneficiary. If Garrard E. Kelly had lived until W. C. Kelly, II, and Lucy Gayle Kelly, II, both reached the age of 30 years, then upon his death the original single trusts would have all terminated and no question of multiple trusts would ever have arisen. However, the fact is that the plural of the term trust was not used in any of the trust deeds in reference to the trusts for any period of their existence, either before or after the death of the last surviving life beneficiary.
It was provided in section 12 (a) of trust deed #2 that when any child of Garrard E. Kelly reached the age of 30 years, after the death of Garrard E. Kelly, "the Trust as to such child shall be terminated, and his or her then share of the Trust property and funds shall be conveyed, delivered and paid over to him or her." This language clearly indicates that there was intended a single trust with separate or severable shares for W. C. Kelly, II, and Lucy Gayle Kelly, II. The same is true of the provisions of paragraph 12 (c) that "If any child of said Garrard E. Kelly shall die before the termination of the Trust as to him or her, leaving lawful issue him or her surviving, the interest of such decedent in the Trust Estate shall be held for the use and benefit of such issue, share and share alike per stirpes."
The trust deeds not only fail to provide expressly for more than a single trust, but they establish no beneficial interests that can not be served as well by single trusts as by multiple trusts. There is nothing uncommon about a single trust having two or more beneficiaries with different interests and rights in both principal and income. Even if the trust deeds must be construed as conferring upon the present beneficiaries, W. C. Kelly, II, and Lucy Gayle Kelly, II, complete ownership of all of the income of the trusts, to the exclusion of any claims of the contingent minor beneficiaries, we do not see that separate trusts are necessarily required for handling the income. Separate income accounts in the single trusts would serve the same purpose.
It is not within the province of trustees, for matters of convenience or for the purpose of saving taxes, to establish trusts which are neither expressly provided for nor intended by the grantor. In United States Trust Co. v. Commissioner, 296 U.S. 481, the grantor and the beneficiaries converted a single trust into several trusts, one for each of the beneficiaries, by exercising a power to amend which the grantor had expressly reserved to them. For that reason the Court held that the several trusts were properly established and must be recognized for Federal income tax purposes. Here, there was no reserve power to amend any of the trusts. In setting up the multiple trusts the trustees acted upon what, we think, was an erroneous construction of the trust deeds.
For the reasons stated the respondent's determination that there was only one trust entity under each of the three trust deeds involved is sustained.
Decisions will be entered for the respondent.