Opinion
Dockets Nos. 2496-67— 2499-67 5075-67 5076-67.
1970-01-27
JAMES T. PETTUS, JR., ET AL.,1 PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Donald E. Fahey and William A. Ens, for the petitioners. Charles B. Tetrick, for the respondent.
Donald E. Fahey and William A. Ens, for the petitioners. Charles B. Tetrick, for the respondent.
Petitioners established identical trusts for the benefit of each of their minor children. Each trust instrument provided that the income of the trust was to be paid to the beneficiary or accumulated as the trustee determined in his uncontrolled discretion. The principal of each trust could be invaded only if the trustee determined that the beneficiary was ‘in need of funds,‘ because of ‘illness, infirmity or disability, either mental or physical.’ The trustee was granted discretion to add accumulated income to the principal, and was also granted other extensive administrative powers. Disposition of the accumulated income and principal of the trusts satisfied the requirements of sec. 2503(c) (2), I.R.C. 1954. Held, petitioners' gifts to the trusts were gifts of present interests to the extent of the value of the income portions thereof and gifts of future interests to the extent of the value of the remainders. Held, further, petitioner June B. Pettus is not liable for additions to the tax under sec. 6651(a), I.R.C. 1954, for the years 1959 through 1963, since her failure to file gift tax returns for those years was due to reasonable cause.
FEATHERSTON, Judge:
Respondent determined deficiencies in petitioners' gift tax and additions to the tax as follows:
+------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦ ¦ ¦Additions to ¦ +-------------------+----------+-----+------------+----------------¦ ¦Petitioner ¦Docket No.¦Year ¦Deficiencies¦the tax, ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦ ¦ ¦sec. 6651(a) [2]¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦(1963¦$1,724.06 ¦$86.20 ¦ +-------------------+----------+-----+------------+----------------¦ ¦James T. Pettus, Jr¦2496-67 ¦(1964¦3,269.40 ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦(1962¦67.50 ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦Philip K. Crowe ¦2497-67 ¦(1963¦97.50 ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦(1964¦156.92 ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦5076-67 ¦1965 ¦215.16 ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦(1962¦675.00 ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦Irene Pettus Crowe ¦2498-67 ¦(1963¦675.00 ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦(1964¦672.52 ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦5075-67 ¦1965 ¦669.52 ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦(1959¦321.54 ¦80.38 ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦(1960¦971.68 ¦242.92 ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦(1961¦1,340.16 ¦335.04 ¦ +-------------------+----------+-----+------------+----------------¦ ¦June B. Pettus ¦2499-67 ¦(1962¦860.62 ¦215.15 ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦(1963¦1,240.76 ¦310.19 ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦(1964¦2,685.04 ¦ ¦ +-------------------+----------+-----+------------+----------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +------------------------------------------------------------------+
Respondent has conceded that no addition to the tax is due from petitioner James T. Pettus, Jr., for the year 1963. The issues remaining for decision are:
(1) Whether petitioners' gifts in trust for the benefit of their minor children were gifts of present interests in property under section 2503(b) and (c), so as to entitle each petitioner to an exclusion from taxable gifts of $3,000 per year for each donee.
(2) Whether petitioner June B. Pettus is liable for additions to the tax under section 6651(a) for failure to file gift tax returns for the years 1959 through 1963.
(3) Whether respondent, in the notice of deficiency, correctly computed the gift tax liability of petitioner James T. Pettus, Jr., for the years 1963 and 1964.
FINDING OF FACTS
James T. Pettus, Jr. (hereinafter referred to as Pettus), and June B. Pettus are husband and wife. Their legal residence at the time their petitions were filed was London, England. Pettus filed gift tax returns for 1959 through 1964, and June filed a gift tax return for 1964, with the district director of internal revenue, St. Louis, Mo. June did not file gift tax returns for 1959 through 1963.
Philip K. Crowe (hereinafter Crowe) and Irene Pettus Crowe are husband and wife. Their legal residence at the time their petitions were filed was R.D. 4, Easton, Md. Irene filed gift tax returns for 1962 through 1965 with the district director of internal revenue, St. Louis, Mo. Crowe did not file gift tax returns for those years.
Pettus and Irene made the gifts involved herein, but the gift tax liabilities of their spouses are also at issue because they consented to have the gifts considered as having been made one-half by each of them.
On the dates indicated Pettus orally declared separate, identical, irrevocable trusts for the benefit of his minor children as follows:
+------------------------------------------------------------+ ¦Date of Declaration ¦Beneficiary ¦Date of Birth ¦ +---------------------+----------------------+---------------¦ ¦ ¦ ¦ ¦ +---------------------+----------------------+---------------¦ ¦Mar. 9, 1956 ¦Winston Albert Pettus ¦Oct. 6, 1955 ¦ +---------------------+----------------------+---------------¦ ¦Mar. 11, 1957 ¦Katherine Irene Pettus¦Nov. 13, 1956 ¦ +---------------------+----------------------+---------------¦ ¦May 26, 1958 ¦Ruth Eva Pettus ¦Oct. 27, 1957 ¦ +---------------------+----------------------+---------------¦ ¦July 22, 1960 ¦William W. Pettus ¦July 1, 1960 ¦ +------------------------------------------------------------+
At the time of the creation of each trust, and on various subsequent dates, Pettus transferred certain assets to the trustee of the various trusts.
On April 9, 1962, these trusts were reduced to writing and incorporated into one trust agreement, which provides, in pertinent part, as follows:
ITEM ONE: * * *
(B): Each child of Grantor shall enjoy his or her trust estate in the following manner, that is to say, that the net income of such child's trust shall be paid to and/or used and applied for the benefit of such child until the termination of such trust, in such amount or amounts and at such time or times, respectively, as the Trustee shall determine in his sole judgment and discretion. The decision of the Trustee as to the advisability and amount of any such disbursement shall be conclusive and binding on all parties in interest. Any income of the trust of a child of Grantor not disbursed as above provided shall at such time or times, respectively, as the Trustee determines be added to and administered as a part of the principal of such child's trust hereunder.
(C): If at any time or from time to time it shall appear to the satisfaction of the Trustee that a child of Grantor, shall be in need of funds in excess of the income, which may be then available for such child from his or her trust estate, and if it shall appear to the Trustee that such funds are needed because of illness, infirmity or disability, either mental or physical, of such child, then the Trustee may relieve in whole or in part any such need or needs of such child by paying to such child or using and applying for his or her benefit such sum or sums of the principal of such child's trust estate as the Trustee deems reasonable and proper under the circumstances.
(D): When a child of Grantor herein named reaches twenty-one (21) years of age the trust estate of such child shall terminate and the Trustee shall transfer, convey and deliver to such child, free of trust, all the income and principal of the trust estate of such child then on hand.
(E): If a child should die prior to attaining the age of twenty-one (21) years, such child's trust estate (both principal and income) shall be distributed to such person, firms or organizations as such child shall have appointed in his or her Last Will and Testament admitted to probate, or by written instrument filed with the Trustee prior to death and not revoked, or, if such child fails to exercise such power of appointment, then the Trustee shall transfer, convey and deliver all such property to the legal representatives of such deceased child to be administered as a part of the estate of such child. The Grantor, however, shall be excepted from any such distribution.
ITEM FOUR: * * *
The Trustee is further authorized to use all of the principal funds at any time or from time to time held hereunder and any income at any time or from time to time held hereunder or such portion or portions of such principal funds and/or income as the Trustee may determine, in the purchase of a policy or policies of insurance of such kind and character and in such amounts and with such benefits, respectively, as the Trustee may determine on the lives of such persons respectively, as the Trustee shall deem advisable under the circumstances, and to hold each such policy of insurance as assets of the trust estate. * * *
The Trustee shall determine whether any money or other assets received hereunder shall be considered part of the principal or income of a trust estate or apportioned between principal and income of the trust estate and the manner and extent of such apportionment, provided, however, dividends from Investment Trust Shares (commonly called Investment Trusts) held to be capital gains and all other gains from the sale or exchange of any assets of the trust estate and all commissions and fees due Grantor and received hereunder by assignment shall become principal; and all royalties from any oil, gas and mineral lease and all taxable stock dividends shall be income, except from investment trust shares as hereinabove provided, and in the allocation of other assets hereunder the Trustee shall resolve all reasonable doubts in favor of the then income beneficiary of the trust, excepting, however, the Trustee shall not make additions to income because of the purchase or acquisition for a trust estate of any stocks, bonds or other personal property at a discount. The Trustee shall determine whether any expenditure from a trust estate or loss to the principal of a trust estate arising from the sale of any assets thereof, or from the fact any such principal assets shall have become worthless, shall be charged to the principal or income of the trust estate or apportioned between principal and income of the trust estate and the manner and extent of such apportionment, provided, however, that each expenditure hereunder in payment of special taxes or benefit judgments which shall be a lien on real estate at any time held hereunder or subject hereto, shall be charged to the principal of the trust estate, and all other taxes shall be charged to the income, if any, otherwise to the principal of the trust estate, and provided further, that the Trustee shall out of income amortize premiums paid in the purchase or acquisition for the trust estate of any stocks, bonds, or other personal property.
The Grantor realizes that it is impossible to preserve and conserve the estate without selling securities from time to time and taking profits thereon and that there will be some assets held hereunder which must be sold at a loss. Therefore, for the purpose of preserving the corpus of each trust estate, the Trustee and his successors in trust hereunder is authorized to manage the trust estate held hereunder so as to increase the income and corpus of the estate, and may adopt and use such investment plan as, in their opinion, will be for the best interest of the Trust in carrying out said purpose, and the Trustee is further authorized to do everything and anything with respect to the trust estate, or any part thereof, as the Trustee would have the right to do if he were the individual owner thereof and as he deems best in the interest of the trust estate and the beneficiary hereunder.
The agreement appointed a professional trustee to administer the trusts.
Pettus established a trust for the benefit of his daughter, Rachael Anne Pettus, on February 28, 1964, the date of her birth. The provisions of this trust are substantially identical to those contained in the trust of April 9, 1962.
The following schedule shows the gifts made by Pettus (and considered by him and June as having been made one-half by each of them) to the trusts for his minor children during the year 1959 through 1964:
+-----------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+--------------------------------------------------¦ ¦ ¦Value of gift ¦ +--------------+--------------------------------------------------¦ ¦Date of gift ¦ ¦ +--------------+--------------------------------------------------¦ ¦ ¦Winston ¦Katherine¦Ruth Eva ¦William W.¦Rachael ¦ +--------------+---------+---------+---------+----------+---------¦ ¦ ¦Albert ¦Irene ¦ ¦ ¦Anne ¦ +--------------+---------+---------+---------+----------+---------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦6/15/59 ¦$5,987.85¦$5,987.85¦$5,987.85¦ ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦1/12/60 ¦5,940.00 ¦5,940.00 ¦5,940.00 ¦ ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦7/22/60 ¦ ¦ ¦ ¦$5,992.12 ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦1/10/61 ¦5,976.00 ¦5,976.00 ¦5,976.00 ¦5,976.00 ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦11/2/62 ¦3,187.50 ¦3,187.50 ¦3,187.50 ¦3,187.50 ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦3/22/63 ¦3,831.35 ¦3,831.35 ¦3,831.35 ¦3,831.35 ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦1/10/64 ¦3,981.25 ¦3,981.25 ¦3,981.25 ¦3,981.25 ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦1/10/64 ¦ ¦1,237.50 ¦1,236.25 ¦1,918.12 ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦2/28/64 ¦ ¦ ¦ ¦ ¦$3,360.00¦ +--------------+---------+---------+---------+----------+---------¦ ¦3/21/64 ¦ ¦ ¦165.90 ¦ ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦5/18/64 ¦ ¦ ¦ ¦ ¦2,762.50 ¦ +--------------+---------+---------+---------+----------+---------¦ ¦9/15/64 ¦ ¦213.20 ¦ ¦ ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦9/28/64 ¦ ¦ ¦212.00 ¦ ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦12/21/64 ¦ ¦207.50 ¦222.50 ¦ ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦12/23/64 ¦1,715.00 ¦ ¦ ¦ ¦ ¦ +--------------+---------+---------+---------+----------+---------¦ ¦Total for 1964¦5,696.25 ¦5,639.45 ¦5,817.90 ¦5,899.37 ¦6,122.50 ¦ +-----------------------------------------------------------------+
In each of the years 1959 through 1964 Pettus claimed an exclusion of $3,000 for each donee of the above gifts; in 1964 June claimed a $3,000 exclusion per donee. Respondent disallowed the exclusions for the years 1963 and 1964 on the ground that the gifts were of future interests. The exclusions taken for the years 1959 through 1962 were not challenged by respondent because the statutory period for assessment had expired for such years.
Each of the gift tax returns filed by Pettus for the years 1959 through 1963 was signed by June to manifest her consent to have the gifts reported therein considered as having been made one-half by her. However, she did not personally file gift tax returns for those years to report her one-half of the gifts. Pettus' returns for those years had been prepared, without consulting him and June, by the trustee of the children's trusts. The trustee
did not prepare returns for June, because in his opinion, after consulting with counsel, the gifts were of present interests, for which an individual return by her was not necessary. After each of Pettus' returns was prepared, it was sent to him and June in London for their signatures.
2. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise noted.The trustee is neither a lawyer nor an accountant, but has been a professional trustee since 1950 and a member of the board of directors and executive committee of the Guaranty Trust Co. in Missouri since 1952.
Irene established a trust by oral declaration on or about December 26, 1962, for the benefit of her minor daughter, Mary Bayard Crowe, who was born on November 3, 1947. The trust was reduced to writing on July 26, 1963, and contains provisions substantially identical to the trust agreement executed by Pettus on April 9, 1962, quoted in part above.
The following schedule shows the gifts made by Irene (and considered by her and Crowe as having been made one-half by each of them) to the trust for Mary during the years 1962 through 1965:
+-------------------------------+ ¦Date of gift ¦Value of gift ¦ +--------------+----------------¦ ¦ ¦ ¦ +--------------+----------------¦ ¦Dec. 6, 1962 ¦$6,000.00 ¦ +--------------+----------------¦ ¦Feb. 21, 1963 ¦6,000.00 ¦ +--------------+----------------¦ ¦Jan. 6, 1964 ¦5,978.00 ¦ +--------------+----------------¦ ¦Jan. 20, 1965 ¦5,951.25 ¦ +-------------------------------+
In each of the years 1962 through 1965 Irene claimed an exclusion of $3,000 from the above gifts. Respondent disallowed the exclusions on the ground that the gifts were of future interests.
In addition to disallowing the exclusions claimed by Pettus, June, and Irene, respondent determined taxable gifts of June for 1959 through 1963 and of Crowe for 1962 through 1965, the years for which they did not file gift tax returns, also on the ground that the gifts made by them were of future interests.
OPINION
Respondent determined that petitioners' gifts in trust to their minor children failed to meet the requirements of sections 2503(b) and 2503(c). The former
excludes from taxable gifts the first $3,000 of gifts made during a calendar year by a donor to any person,
SEC. 2503. TAXABLE GIFTS.(b) EXCLUSIONS FROM GIFTS.— In the case of gifts (other than gifts of future interests in property) made to any person by the donor during the calendar year 1955 and subsequent calendar years, the first $3,000 of such gifts to such person shall not, for purposes of subsection (a), be included in the total amount of gifts made during such year. Where there has been a transfer to any person of a present interest in property, the possibility that such interest may be diminished by the exercise of a power shall be disregarded in applying this subsection, if no part of such interest will at any time pass to any other person.
but provides that the exclusion does not apply to gifts of ‘future interests in property.’ That term— defined under the Federal gift tax law, regardless of the local law definition— refers to ‘any interest or estate, whether vested or contingent, limited to commence in possession or enjoyment at a future date.’ United States v. Pelzer, 312 U.S. 399, 403 (1941), quoting S. Rept. No. 665, 72d Cong., 1st Sess., p. 41 (1932); sec. 25.2503-3(a), Gift Tax Regs. ‘The question is of time, not when title vests, but when enjoyment begins.’ Fondren v. Commissioner, 324 U.S. 18, 20 (1945). Section 2503(c),
In the case of a trust, the donee to whom the exclusion applies is the beneficiary, not the trustee. Helvering v. Hutchings, 312 U.S. 393 (1941).
however, provides that no part of a gift to a minor ‘shall be considered a gift of a future interest’ if, inter alia, the property and income therefrom ‘may be expended by, or for the benefit of, the donee before his attaining the age of 21 years.’
SEC. 2503. TAXABLE GIFTS.(c) TRANSFER FOR THE BENEFIT OF MINOR.— No part of a gift to an individual who has not attained the age of 21 years on the date of such transfer shall be considered a gift of a future interest in property for purposes of subsection (b) if the property and the income therefrom—(1) may be expended by, or for the benefit of, the donee before his attaining the age of 21 years, and(2) will to the extent not so expended— (A) pass to the donee on his attaining the age of 21 years, and(B) in the event the donee dies before attaining the age of 21 years, bepayable to the estate of the donee or as he may appoint under a general power of appointment as defined in section 2514(c).
Section 25.2503-4(b)(1) of the Gift Tax Regulations
states that a transfer will not fail to satisfy the conditions of section 2503(c) merely because the trustee is given discretion to determine the amounts of trust income or property to be expended for the minor and the purpose for which the expenditure is to be made. This regulation contains a proviso, however, that there may be no ‘substantial restrictions under the terms of the trust instrument on the exercise of such discretion.’ This proviso forms the battleground for the present controversy.
Sec. 25.2503-4 Transfer for the benefit of a minor.(b) Either a power of appointment exercisable by the donee by will or a power of appointment exercisable by the donee during his lifetime will satisfy the conditions set forth in paragraph (a)(3) of this section. However, if the transfer is to qualify for the exclusion under this section, there must be no restrictions of substance (as distinguished from formal restrictions of the type described in paragraph (g)(4) of Sec. 25.2523(e)-1) by the terms of the instrument of transfer on the exercise of the power by the donee. However, if the minor is given a power of appointment exercisable during lifetime or is given a power of appointment exercisable by will, the fact that under the local law a minor is under a disability to exercise an inter vivos power or to execute a will does not cause the transfer to fail to satisfy the conditions of section 2503(c). Further, a transfer does not fail to satisfy the conditions of section 2503(c) by reason of the mere fact that—(1) There is left to the discretion of a trustee the determination of the amounts, if any, of the income or property to be expended for the benefit of the minor and the purpose for which the expenditure is to be made, provided there are no substantial restrictions under the terms of the trust instrument on the exercise of such discretion;
Pars. D. and E of the present trust instrument, relating to the disposition of the accumulated income and principal in the case of the death of the beneficiary before his attaining the age of 21 years, quite clearly meet the requirements of par. (2) of sec. 2053(c), and respondent does not contend otherwise.
Petitioners advance three contentions that the proviso is not applicable to the trusts involved here: (1) The language of section 2503(c) is so clear that an interpretative regulation is not permissible; (2) the regulation, as applied to the expenditure of the income and principal of a trust, is invalid; and (3) the proviso applies only to powers of appointment under section 2503(c)(2)(B) and not to the powers of a trustee. We disagree.
As to petitioners' first argument, the language of section 2503(c) is imprecise in several respects. For example, the phrase ‘may be expended’ can refer either to a mere grant of power to expend the trust funds or to a probability that the funds will be used by or on behalf of the minor. See Mueller v. United States, an unreported case (W.D. Mo. 1969, 23 A.F.T.R.2d 69-1864, 69-1 U.S.T.C.par. 12,592); compare Caplin, ‘Trusts for Minors,‘ 14th Ann.N.Y.U.Tax Inst. 361, 376 fn. 58 (1956), with Warren & Surrey, Federal Estate and Gift Taxation 671 (1961 ed.). Similarly, the word ‘benefit’ is not clear: does it mean merely a single, specified beneficial purpose, or does it denote a more general purpose which encompasses the overall needs of the donee? These ambiguities make section 2503(c) the kind of statutory provision that may properly be the subject of an interpretative regulation. See Koshland v. Helvering, 298 U.S. 441, 446 (1936); Brewster v. Gage, 280 U.S. 327, 336 (1930).
Petitioners' second argument— challenging the validity of the regulation—calls forth the observation that ‘The role of the judiciary in cases of this sort begins and ends with assuring that the Commissioner's regulations fall within his authority to implement the congressional mandate in some reasonable manner.’ United States v. Correll, 389 U.S. 299, 307 (1967). Taking this approach, a review of the history and language of section 2503(c) shows that the regulation must be sustained.
At the time the 1954 Code was adopted there existed great confusion as to the means of qualifying a gift to a minor for the annual exclusion without giving him immediate control over the property. S. Rept. No. 1622, to accompany H.R. 8300 (Pub. L. No. 591), 83d Cong., 2d Sess., p. 127 (1954) (hereinafter 1954 S. Rept.). In Fondren v. Commissioner, supra at 20-21, the Supreme Court had said that ‘Whatever puts the barrier of a substantial period between the will of the beneficiary or donee now to enjoy what has been given him and that enjoyment makes the gift one of a future interest.’ The result was that gifts to accumulation trusts were generally disqualified. Id.; Commissioner v. Disston, 325 U.S. 442 (1945); United States v. Pelzer, supra. Similarly, the exclusion was denied where the distribution was subject to contingent needs or events. George M. Street, 29 T.C. 428, 431 (1957), affirmed per curiam 261 F.2d 666 (C.A. 5, 1958); see Fondren v. Commissioner, supra at 24. A gift to a guardian who was already personally obligated to support the minor was regarded as a gift for the minor's future benefit. And a conflict had developed where a gift was made in trust for the benefit of a minor under provisions authorizing him or his legal guardian to terminate the trust at any time. Compare Stifel v. Commissioner, 197 F.2d 107 (C.A. 2, 1952), affirming 17 T.C. 647 (1951), with Kieckhefer v. Commissioner, 189 F.2d 118 (C.A. 7, 1951), reversing 15 T.C. 111 (1950), and Gilmore v. Commissioner, 212 F.2d 520 (C.A. 6, 1954), reversing 20 T.C. 579 (1953); cf. United States v. Baker, 236 F.2d 317 (C.A. 4, 1956); Rev. Rul. 59-78, 1959-1 C.B. 690. Thus, in many instances a gift to a minor was classified as a gift of a future interest even though a gift to an adult on the same terms would have been considered a gift of a present interest.
Section 2503(c) was enacted in 1954 to eliminate this confusion. It ‘partially relaxes the ‘future interest restriction contained in’ section 2503(b). H. Rept. No. 1337, to accompany H.R. 8300 (Pub. L. No. 591), 83d Cong., 2d Sess., p. A322 (1954). It is intended to allow the exclusion for gifts to minors even though the gift is subject to restrictions which are designed to assure prudent management, provided the form stated therein is followed. The section appears to contemplate that the trustee or other person authorized to administer the gift may have discretion from the time the gift is made until the donee reaches 21 years of age to expend the property for the benefit of the minor to the extent that it is needed. The pattern appears to have been taken from the law relating to guardians. Indeed, one court has declared that the words ‘may be expended’ in section 2503(c) mean ‘may be expended within the limitations imposed on guardians by state law.’ Ross v. United States, 348 F.2d 577, 579 (C.A. 5, 1965).
Still another court has sustained a claim to the exclusion, reasoning that the trustee had at least as much discretion as a guardian under the law of the State where the gift was made. Williams v. United States, 378 F.2d 693, 696 (Ct. Cl. 1967).
It has been suggested that the Ross opinion implicitly repudiates the regulation, in that the Government relied heavily upon it and the opinion does not mention it. Note, ‘Federal Taxation: Gift to Minor Held a Present Interest Qualifying for Section 2503(c) Gift Tax Exclusion Despite State Laws Restricting Present Enjoyment,‘ 1966 Duke L.J. 578, 585-586. However, we interpret the opinion to hold merely that a gift will qualify for the exclusion if the restrictions placed on a trustee's discretion are no greater than a guardian's statutory restrictions.
The regulation merely provides that granting discretion to the trustee over the amounts of the trust funds that may be expended and the purpose of those expenditures does not disqualify the gift for the exclusion as long as that discretion is not subject to ‘substantial restrictions.’ The imposition of such restrictions on the exercise of the trustee's discretion may have the effect of postponing the ‘time * * * when enjoyment begins.’ Fondren v. Commissioner, supra at 20. We conclude that the regulation— even though the proviso itself requires line drawing— is a permissible interpretation of the statute and must be sustained. United States v. Correll, supra; Commissioner v. South Texas Co., 333 U.S. 496 (1948).
Petitioners' third argument is that the proviso applies only to powers of appointment under section 2503(c)(2)(B). Although petitioners' interpretation of the regulation is plausible at first blush because of the somewhat confusing structure of subsection (b) thereof, it cannot be adopted. It is true that the first three sentences of the subsection describe the type of power of appointment that will satisfy section 2503(c)(2)(B). But the remainder of the subsection, rather than referring to the donee's power of appointment, instead describes specific situations in which the three conditions set forth in regulations section 25.2503-4(a) will be satisfied. Compare each of the three paragraphs of section 25.2503-4(b) with its counterpart in section 25.2503-4(a) of the regulations. Although it would have been clearer had the fourth sentence and its paragraphs been set apart as a separate subsection, the present structure does not require a different interpretation. Furthermore, paragraph (1) of regulations section 25.2503-4(b), which contains the proviso in question, refers to the discretion of a trustee, not the donee, over expenditures of trust funds. Quite clearly, this paragraph of the regulation is an interpretation of the ‘may be expended by, or for the benefit of, the donee’ language of section 2503(c).
Other courts and a revenue ruling have applied the substantial restriction test to the quoted language. See Williams v. United States, 378 F.2d 693 (Ct. Cl. 1967); Duncan v. United States, 368 F.2d 98 (C.A. 5, 1966); Mueller v. United States, an unreported case (W.D. Mo. 1969, 23 A.F.T.R.2d 69-1864, 69-1 U.S.T.C.par. 12.592); Rev. Rul. 67-270, 1967-2 C.B. 349; see also 5 Mertens, Law of Federal Gift & Estate Taxation, sec. 38.20, pp. 521-522 (1959).
This brings us to the question whether the discretion of the trustee of the present trusts is subject to ‘substantial restrictions'— an application of the regulation to the facts of this case. This issue must be resolved separately for the principal and income components of the trust; if either portion satisfies the requirements of the proviso, it will qualify for the annual exclusion. Commissioner v. Thebaut, 361 F.2d 428, 431 (C.A. 5, 1966); Rollman v. United States, 342 F.2d 62, 67 (Ct. Cl. 1965); Arlean I. Herr, 35 T.C. 732, 736 (1961), affd. 303 F.2d 780 (C.A. 3, 1962), acq. 1968-2 C.B. 2; cf. Fondren v. Commissioner, supra at 21.
Sec. 2503(c) is not exclusive; a gift to a minor which fails to comply with the statutory form still may qualify as a present interest under the more general provisions of sec. 2503(b) and decisional law. Sec. 25.2503-4(c), Gift Tax Regs.; see Caplin, ‘How to Treat Gifts to Minors,‘ 13th Ann. N.Y.U. Tax Inst. 193, 218 (1955); Warren & Surrey, Federal Estate and Gift Taxation 672, 678 (1961 ed.). However, the gifts involved here do not satisfy the conditions of sec. 2503(b), and petitioners do not argue otherwise, because the present enjoyment of both the income and principal is subject to the discretion of the trustee. See Lowndes & Kramer, Federal Estate and Gift Taxes, sec. 33.7 (2d ed. 1962), and cases cited therein at 711 fn. 56. But compare Caplin, supra at 209.
As to the principal of the Pettus and Crowe trusts, respondent contends that the provision of paragraph C of the trust instruments, quoted in our finding, limiting the trustee's use of the principal to the beneficiary's medical care (i.e., ‘illness, infirmity or disability, either mental or physical’), represents a ‘substantial restriction’ within the meaning of the proviso. Paragraph C imposes no restrictions as to the amounts of the principal that can be expended. However, while not cast in terms of a restriction, the permissible purposes for which the principal can be used are limited to the donee's medical care; this is an implied restriction on the trustee's discretion— a much more severe restriction than is generally imposed on guardians. Since there is no evidence that any beneficiary was in special need of medical care when the gifts herein were made, there existed at those times only a bare technical possibility that any part of the principal would benefit the donee before he reached age 21. This is not enough, in our view, to prevent the gifts of principal from being classified as future interests. See Warren & Surrey, supra at 672.
The provision of paragraph B of the trust instruments, quoted in our findings, authorizing the net income to be ‘paid to and/or used and applied for the benefit’ of the minor beneficiary, clearly meets the requirements of section 2503(c). See Arlean I. Herr, supra, wherein we held that the income interest of a trust qualified for the exclusion, even though the trustee had discretion to accumulate income, since the accumulated income was payable to the beneficiary at age 21 or earlier to his estate if he died. Respondent does not seriously argue to the contrary, but maintains that paragraph B requires the income not currently distributed to be added to the principal, expenditure of which is, as discussed above, subject to a substantial restriction. For this reason, respondent maintains, the income interests do not qualify as present interests.
We do not so read paragraph B. The language of that provision is that ‘Any income * * * not disbursed as above provided shall at such time or times, respectively, as the Trustee determines be added to and administered as a part of the principal.’ The timing of any such addition is thus left to the unrestricted discretion of the trustee. The facts are, in substance, analogous to Duncan v. United States, 368 F.2d 98 (C.A. 5, 1966), where the trustee was directed to apply ‘any and all available funds and assets' of the trust toward the payment of premiums due on the life insurance policies comprising the trust corpus. The court reasoned that this direction was not a substantial restriction on the trustee's discretion as to the use of the funds, in that it gave the trustee discretion to determine what funds were ‘available’ for payment of the premiums. Similarly, the trustee here has discretion to determine the timing of any addition of undistributed income to the principal.
Respondent argues, further, that the gifts of income do not qualify in any event for the exclusion because they are not subject to valuation. He contends that the administration powers given the trustee— to sell the trust property and reinvest the proceeds, to invest in life insurance policies, to borrow money and use the trust assets as security, and, under stated rules, to determine whether receipts will be classified as income or principal— render a determination of the value of the gifts of income impossible.
Respondent does not argue that the trustee's authority to invade the principal renders the income and principal components incapable of valuation. See the last sentence of sec. 2503(b), added in 1954, which in effect overruled Sylvia H. Evans, 17 T.C. 206 (1951), affd. 198 F.2d 435 (C.A. 3, 1952); 1954 S.Rept.at 478; J. J. Newlin, 31 T.C. 451 (1958).
The method for valuing an income interest for a term of years is the same under section 2503(c) as under 2503(b). Carl E. Weller, 38 T.C. 790 (1962). Where a gift is made of income-producing property for a term of years the regulations assign a value computed according to a formula. Here the parties have stipulated the birth date of each of the beneficiaries, thus permitting a calculation of the time span over which the income interests are to be distributable. They have also agreed on the total value of each of the gifts. Employing the actuarial table in section 25.2512-5(f) of the Gift Tax Regulations, the values of the income interests of the gifts to each donee can be computed.
The trustee's powers, in our view, are not so extensive as to disqualify the income interests for the exclusion. Only two of them require mention; the others are similar to standard provisions. The ‘payment of premiums on life insurance policies is not an expenditure for the future interest of the minor or his estate * * * . It is an expenditure for the present and immediate benefit of the minor, because * * * the trustee may at any time surrender for cash, transfer, cancel or otherwise dispose of any or all of the insurance policies.’ Duncan v. United States, supra at 102. As to the power to classify receipts as income or principal, the trust instruments, as detailed in our findings, lay down explicit standards under which the classification is to be made; these standards severely limit the items as to which the trustee may exercise this power. In this respect, the facts are different from Fischer v. Commissioner, 288 F.2d 574 (C.A. 3, 1961), affirming a Memorandum Opinion of this Court, and Van Den Wymelenberg v. United States, 397 F.2d 443 (C.A. 7, 1968), certiorari denied 393 U.S. 953 (1968), on which respondent relies. Additionally, there is a tendency of the courts to circumscribe the situations in which a trustee's discretion to allocate receipts may properly be exercised. See Doty v. Commissioner, 148 F.2d 503, 506-507 (C.A. 1, 1945), affirming 3 T.C. 1013 (1944); Commissioner v. O'Keeffe, 118 F.2d 639, 642-643 (C.A. 1, 1941) (trustee's discretion exercisable only where the proper allocation ‘is a matter of honest doubt’); also see Raffety v. Parker, 241 F.2d 594, 608, 610 (C.A. 8, 1957) (applying Missouri law); American Security & Trust Co. v. Frost, 117 F.2d 283, 285-286 (C.A.D.C. 1940), certiorari denied 312 U.S. 707 (1941); Old Colony Trust Co. v. Silliman, 352 Mass. 6, 223 N.E.2d 504, 507 (1967). The present trustee's limited discretion as to a power granted to facilitate administration of the trusts does not render the income interests incapable of valuation. Cf. Frances Carroll Brown, 30 T.C. 831, 837 (1958); Sec. 2503(b).
Nor do we think the additions to the tax under section 6651(a)
can be sustained. Section 6019(a) provides that any individual who makes any transfer by gift ‘except those which under section 2503(b) are not to be included in the total amount of gifts for such year’ shall file a gift tax return. Sections 25.2513-1(c) and 25.6019-2 of the Gift Tax Regulations, read together, provide that a gift tax return is required of each spouse for a gift of a future interest in property where the spouses consent to have the gift considered as having been made by each of them. See True v. United States, 354 F.2d 323 (Ct. Cl. 1965).
SEC. 6651. FAILURE TO FILE TAX RETURN.(a) ADDITION TO THE TAX.— In case of failure to file any return required under authority of subchapter A of chapter 61 * * * on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate.
In the instant case the Pettuses signed and filed a single return for each year 1959 through 1963. June did not file a return for these years. Under section 6651(a) the question is whether her failure each year to file a return was due to ‘reasonable cause.’ We think it was.
The donors quite obviously intended to qualify the gifts made in trust as gifts of present rather than future interests. They prudently named as their trustee an individual who has made serving as a trustee his profession for almost 20 years. The trustee prepared the gift tax returns for them— they were residing in London at the time— and testified, without any cross-examination on this point, that he consulted a qualified attorney who advised that returns by June were not required because the gifts did not constitute future interests. We think this set of facts discharges petitioners' burden of showing reasonable cause.
We agree with respondent that, in determining the 1963 and 1964 deficiencies of Pettus, the statute of limitations on the assessment and collection of gift tax does not preclude inclusion of the value of gifts made in preceding, barred years in the computation of the correct aggregate sum of prior taxable gifts. Sec. 2504; 1954 S.Rept.at 479; Commissioner v. Disston, supra at 449.
Decision will be entered under Rule 50.