Opinion
Docket No. 22160.
1950-06-30
ESTATE OF ALICE GWYNNE PRESTON, DECEASED, ALICE A. RUSSELL, ADMINISTRATRIX, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Jack Clareman, Esq., for the petitioner. Ellyn E. Strickland, Esq., for the respondent.
1. Held, that a decision of a court of New York on a question of property interests in a related case involving the same class of payments as are involved in this proceeding is binding on this Court. Commissioner v. Blair, 300 U.S. 5. Held, further, that the question of whether the income which petitioner's decedent received from a trust was taxable to petitioner's decedent is a Federal tax law question. Commissioner v. Blair, supra.
2. Held, that a trust of which petitioner's decedent was the beneficiary was not a revocable trust under section 166 of the Internal Revenue Code. Therefore, trust income is not taxable to settlor of trust and is taxable to petitioner's decedent under section 162(b) of the Internal Revenue Code. Jack Clareman, Esq., for the petitioner. Ellyn E. Strickland, Esq., for the respondent.
The respondent determined deficiencies in the income tax liability of Alice Gwynne Preston, deceased, as follows:
+---------------------------------+ ¦1943 ¦$3,020.81¦ +-----------------------+---------¦ ¦1944 ¦1,558.64 ¦ +-----------------------+---------¦ ¦1945 ¦1,539.12 ¦ +-----------------------+---------¦ ¦1946— Jan. 1 to Dec. 23¦1,270.82 ¦ +---------------------------------+
The complete notice of deficiency, including the statement which shows what adjustments were made, is not in evidence. This Court is not advised whether or not petitioner concedes that some adjustments of the respondent have been correctly made. Absent evidence to the contrary, we assume that all adjustments were made correctly in each return, if any, excepting the one which is contested in each of the taxable years.
The only question for decision is whether payments received by the decedent out of interest paid to a trustee for payment to the decedent during the taxable years is taxable to her.
Income tax returns for Alice Gwynne Preston, deceased, were filed on September 12, 1947, by the petitioner for all of the years involved in this proceeding with the collector for the third district of New York.
FINDINGS OF FACT.
The facts which have been stipulated are found as facts, and the stipulation is incorporated herein by this reference.
The decedent, Alice Gwynne Preston, suffered from mental disorders for several years prior to her death. She died intestate on December 23, 1946, in New York Count. Alice A. Russell, petitioner, is the duly appointed administratrix of the decedent's estate, having been appointed by the Surrogate for New York county, New York, on February 14, 1947.
For the years 1934 ro 1935 until 1943, Alice Gwynne Preston, the decedent, filed income tax returns in which she reported in her gross income each year payments which she received from the trustee of a trust created by William P. T. Preston, of which she was the beneficiary. No income tax returns were filed by or for the decedent for the years 1943, 1944, 1945, and for the period January 1 to December 23, 1946. Under date of September 12, 1947, the petitioner, Alice A. Russell, filed income tax returns for the aforesaid years with the collector for the third district of New York. There were omitted from each of the returns, payments which the decedent received in each year from United States Trust Company of New York.
The sums which were paid by the Trust Company to the decedent were as follows: $4,874.75 in each of the years 1943, 1944, and 1945; and $,906 in 1946.
William P. T. Preston is the brother-in-law of the decedent, Alice Gwynne Preston, deceased. On October 18, 1934, he executed a trust indenture with United States Trust Company of New York, as trustee, under which the trustee was directed to pay the net income of the trust to Alice Gwynne Preston, widow of the grantor's deceased brother, Jerome Preston, during her life; and to Doris Preston, wife of the grantor, for her life, upon the death of Alice Preston. If Doris Preston should predecease Alice Preston, then upon the death of Alice the trustee was to convey the trust corpus to the grantor, or to remaindermen if he should be deceased. Preston gave a check to the trustee for $125,000, receipt of which the trustee acknowledged in the trust indenture, and the schedule of trust assets attached to the trust indenture listed $125,000, cash as the only asset. On October 19, 1934, the following day, the trustee loaned Preston $125,000, for which he gave the trustee his note, or personal ‘bond‘ under seal, agreeing to repay the principal at the end of twenty years, in 1954, or before, and to pay 4 percent interest on the ‘bond,‘ i.e., $5,000 per annum. The trustee's cash ledger account for the Alice Gwynne Preston trust shows the following entries in 1934: October 18, 1934—Check from W. P. T. Preston $125,000, credited to principal; October 19, 1934— $125,000 bond of William P. T. Preston dated October 19, 1934, due to secure loan $125,000, debited to principal. The cash ledger account shows, also, credit of $2,179.17 on October 23, 1934, for a check of Preston for payment of gift tax on the gift to the trust.
The cash of $125,000 is the only property the trust has ever received. It was invested by the trustees making the loan thereof to Preston. The income of the trust has consisted at all times of the interest paid by Preston on his personal ‘bond‘ under seal. Up to the present time, Preston has not made any payment in reduction of the principal amount of his ‘bond,‘ but he has paid interest of $5,000 on the ‘bond‘ each year. After deducting its expenses, the trustee paid Alice Preston $4,874.75 in 1943, 1944, and 1945, and $4,906 in 1946. The trustee has filed fiduciary income tax returns for the trust each year, in which it has reported the trust income and deducted the amounts which it has distributed to Alice Preston, deceased. The trustee was not liable for any income tax on the trust income.
The trust indenture gave the trustee the power, in its absolute discretion, to sell upon such terms as it deemed proper any property in the trust, and to invest the proceeds of sales and any other money in securities and property which in its discretion it deemed proper, whether or not such investments were of the character or class generally regarded as proper as legal investments for trust funds. Also, the trustee was expressly authorized to make loans of funds in the trust to the grantor of the trust, William P. T. Preston, as follows:
* * * and the trustee is hereby expressly authorized in its absolute discretion from time to time to loan money to the grantor on either his unsecured note maturing not more than twenty years after the date thereof of his unsecured personal bond maturing as aforesaid or to purchase at par the unsecured note or notes or personal bond or bonds of the grantor in such amount or amounts and bearing interest at such rate or rates and maturing at such time or times but not more than twenty years after the date thereof and upon such terms and conditions as the trustee in its absolute discretion shall deem proper and to pay or exchange in payment therefor all or part of the property described in ‘Schedule 'a hereto annexed, and to renew any such notes or bonds for periods of not more than twenty years after the maturity thereof, and in case the trustee shall make any such loans or purchase any such bond or bonds, then the trustee is hereby expressly authorized to hold such note or notes, bond then the trustee is hereby expressly authorized to hold such note or notes, bond or bonds or renewals thereof until the maturity thereof and to accept such payments in reduction of the principal amount or amounts due thereunder as the grantor pursuant to the terms thereof shall make from time to time. The trustee is authorized to accept in lieu of cash in payment of part or parts or all of the principal amount due under any such note or bond securities or other property satisfactory to it at such valuations as it in its absolute discretion shall determine to be reasonable, and any such determination shall be binding and conclusive upon all persons interested herein. Any securities or other property so accepted may in the trustee's discretion be retained in part or in whole as part of the trust fund or varied or reinvested pursuant to the rights, powers and duties of the trustee herein elsewhere set forth. It is contemplated and expected that the trustee will from time to time loan money to the grantor on his unsecured bond or note and under no circumstances shall such action on the part of the trustee constitute a breach of trust and the trustee shall be under no liability except for actual or wilful fraud to any person or persons interested or claiming to be interest in the trust fund by reason of the purchase in its absolute discretion of any unsecured personal note or bond of the grantor and the trustee shall not be required to undertake the enforcement of any such note or bond in the event of any default thereunder unless (a) the trust fund shall then contain cash or property other than the said note or bond sufficient in the opinion of the trustee to meet the reasonable expenses of the trustee in undertaking such enforcement or (b) unless the trustee shall first be furnished with indemnity to it satisfactory in form and amount to meet the reasonable expense of the trustee in undertaking such enforcement. * * *
The trust, by its terms is to be construed in accordance with the laws of New York.
Preston took deductions in his income tax returns for the interest which he paid to the trustee on his personal ‘bond.‘ The Commissioner of Internal Revenue disallowed the deduction which was taken by Preston in his return for 1937. Preston filed a petition in the United States Board of Tax Appeals for redetermination of his 1937 income tax liability. The Board held that the ‘interest‘ was not deductible. See William P. T. Preston, 44 B.T.A. 973,reversed, 132 Fed.(2d) 763. Thereafter, Preston refused to pay interest on his bond, and the trustee filed suit in the Appellate Division of the Supreme Court of New York for payment of interest. See United States Trust Co. of New York v. Preston, 34 N.Y.S.(2D) 646 (1942). The Appellate Division of the Supreme Court of New York held that Preston's personal bond, being under seal, was a legally enforceable obligation upon which Preston was obligated to pay interest. Preston also appealed from the decision of the Board of Tax Appeals, and its decision was reversed. See Preston v. Commissioner, 132 Fed.(2d) 763. The Court of Appeals for the Second Circuit held that Preston's payments of ‘interest‘ on his bond were interest payments under section 23(b) of the 1936 Revenue Act and were deductible.
The Appellate Division of the Supreme Court of New York, held, also, that the trustee acted properly in loaning the funds of the trust to the grantor in return for his covenant under seal to repay the loan in full with interest; that the trustee gave consideration to Preston for his bond; that there is nothing illegal ‘in the creation of a trust by a person for a member of his family, with power explicitly given the trustee to lend him all or any part of the fund which he covenants to repay in full to the trustee with interest‘; that the trustee was under no obligation to lend the money that comprised the trust fund to the grantor (Preston), and had the right to invest the trust corpus in securities, but that once the trust funds were loaned to Preston, there was a financial obligation on his part, or on the part of his estate to make good in the event of his death; and that Preston had made a valid gift of $125,000 in cash to the trust.
The United States Circuit Court of Appeals for the Second Circuit, in Preston v. Commissioner, supra, held that Preston had made a completed gift to the trust; and the following was said in the concurring opinion of Judge Learned Hand (p. 766):
* * * Although the trustee had agreed to lend the money in exchange for the bond, Preston could not have reclaimed it without executing the bond, and the trustee would have been liable to the beneficiaries if it had returned the money gratis: being bound to lend is not being bound to give. Hence it seems to me that the transaction was like any other loan and that the interest was interest in the strictest sense.
Moreover I do not see how such a transaction could ever be made the means of tax evasion. If Preston had used as the trust res the securities, on whose pledge he raised the money in the first place, he need not have included any interest or dividends accruing upon them in his income tax; the beneficiary would have paid the tax. If the trustee— being authorized in its discretion to lend the money to Preston, but not being bound to do so— had nevertheless chosen to lend it to him, any tax on the interest would also have been payable by the beneficiary and Preston could certainly have deducted it. * * *
In this proceeding, the Commissioner has determined that the decedent, Alice Preston, was taxable upon the trust income which was distributed to her during the taxable years 1943 through December 23, 1946.
The parties have stipulated that Preston did not include the income of the trust in his income tax returns for 1943 through 1946.
OPINION.
HARRON, Judge:
Although the complete notice of deficiency is not before us so as to acquaint us with the reason which the Commissioner has given for his determination, we assume that he has included in the income of the petitioner's decedent the trust income which was to be distributed currently to her, and was distributed to her, because of the provisions of section 162(b) of the Internal Revenue Code. Under that section of the Code such income shall be included in the net income of the trust beneficiary.
But the petitioner contests the determination of the Commissioner upon the allegation that the trust was a revocable trust within the meaning of section 166 of the Code. In general, section 166 provides that where the power to revest in the grantor of a trust title to any part of the trust corpus is vested in the grantor, or in any person not having a substantial adverse interest in the disposition of the trust corpus or income, then the trust income shall be taxed to the grantor of the trust.
Although it is unnecessary to do so, it is pointed out that William P. T. Preston, the grantor of the trust, is not a petitioner in this proceeding. Also, the record in the proceeding of Preston before the Board of Tax Appeals, which is mentioned in the findings of fact, was not introduced in evidence in this proceeding. Accordingly, we do not take judicial notice of that record. See B. F. Edwards, 39 B.T.A. 735. However, the parties have cited the proceedings brought by Preston in the Board of Tax Appeals and in the United States Circuit Court of Appeals for the Second Circuit, and by the United States Trust Company in the appellate Division of the Supreme Court of New York. The decisions in those proceedings are relevant to an understanding of the question in this proceeding. The New York court, in its opinion, has ruled upon questions of interests in property under New York law, in construing some of the terms of the trust, and this Court is bound by the Appellate Division's decision upon the questions of property interests under local law which it decided. See Edward T. Blair, 31 B.T.A. 1188; reversed on another point, 83 Fed.(2d) 655; reversed, 300 U.S. 5 (affirming the Board of Tax Appeals). Therefore, in the findings of fact, facts have been found with respect to the decisions in the litigation which has involved the trust in question.
The only question to be decided is whether the trust is a revocable trust under section 166 of the Code. Petitioner cites William P. T. Preston, 44 B.T.A. 973, as authority in support of her contention that the trust was a revocable trust, and that therefore the trust income is taxable to the settlor of the trust. That question was not before the Board of Tax Appeals in Preston's case. And if petitioner stresses the rationale of the opinion in that proceeding, complete answer is found to such argument in Commissioner v. Sunnen, 333 U.S. 591, 68 S. Ct. 715, 723. The intervening litigation over the Alice Gwynne Preston trust has brought about ‘a change in the legal climate ‘ from that which existed when Preston's case was before the Board of Tax Appeals.
The question of whether petitioner's decedent is taxable on the trust income which she received is a question of Federal law. Blair v. Commissioner, supra; Freuler v. Helvering, 291 U.S. 35, 45. The question turns upon another question, namely, whether the trust was a revocable trust under section 166. It is concluded that the trust was not a revocable trust under the provisions of section 166. In arriving at this conclusion, the following is recognized:
A court of the State of New York has held that Preston made a valid gift of cash in the amount of $125,000 to the trust; that the trustee made a valid loan, acting properly under the trust indenture, to Preston; that the loan was considered for Preston's ‘bond‘ under seal; and that Preston, or his estate, is legally obligated to repay the loan to the trustee. Since Preston, or his estate, is legal obligated to repay the loan to the trustee, he has not, either alone or in conjunction with any person not having a substantial adverse interest, revested the trust corpus in himself, and he may not do so. The holdings of the New York court constitute construction of certain provisions of the Alice Gwynne Preston trust under the law of New York which governs the construction of the trust.
Turning now to the trust itself, it is observed that Preston did not retain any power of revocation of the trust. He was not the trustee. The trustee was an independent corporate trustee. The broad powers of management and control granted to the trustee were for the benefit of the trust beneficiaries. The question in this proceeding is controlled by Estate of Benjamin, Lowenstein, 3 T.C. 1133, 1137-1142. See, also, William P. Anderson, 8 T.C. 921, 925. There it was noted that any attempt by the trustee (in that case the grantor and the trustee were the same person) to mulct the trusts or waste their assets for the personal advantage of the grantor would violate the trusts and would be prohibited by New York law, and the following cases were cited: Carrier v. Carrier, 226 N.Y.; 123 N.E. 135; Heyman v. Heyman, 33 N.Y.S.(2d) 235; Osborn v. Banker's Trust Co., 5 N.Y.S.(2d) 211. Reference has been made in this proceeding to the Appellate Division's decision in United States Trust Company v. Preston, 35 N.Y.S.(2d) 646, chiefly because there is a local court has construed the trust indenture which is involved here in a way which is in harmony with the above cited decisions of New York courts. The Alice Gwynne Preston trust stands on even firmer ground than Benjamin Lowenstein's trust.
In the Lowenstein case, we distinguished the Chandler case (p. 1138)— Chandler v. Commissioner, 119 Fed.(2d) 623, affirming 41 B.T.A. 165, on the ground that Chandler ‘specifically reserved the power to direct the trustee to buy from or sell to himself, as grantor, at prices fixed by him.‘ In the Alice Gwynne Preston trust, the trustee had complete discretion to determine how trust corpus should be invested, and it could decide either to purchase property— real or personal— or loan funds to Preston, the settlor; and, if it decided to make a loan to Preston, the terms thereof were within the discretion of the trustee, to be that which it deemed proper— not Preston. The Appellate Division of the Supreme Court of New York has so construed the terms of the trust. The Chandler case is distinguishable from this proceeding.
Petitioner relies upon William J. Garland, 42 B.T.A. 324, and Gordon M. Mather, 5 T.C. 1001, affd., 157 Fed.(2d) 680, certiorari denied, 330 U.S. 819. The Garland case followed the Chandler case. In the Garland case, it was found that there was ‘no requirement that loans made directly from the trust be repaid,‘ (p. 328). The Garland case is distinguishable from this proceeding. The New York court has held that the loan to Preston must be repaid. The Mather case also followed the Chandler case, and the Garland case, on the point that the settlor of the trust ‘could have required the trustee to sell the trust assets or lend the trust funds to himself upon any terms he might have named.‘ We made that conclusion in the Mather case after saying: ‘For all that the trust agreements show, and we have no other evidence before us * * *.‘ As stated above, it has been held by a New York court that the trustee of the trust involved here had uncontrolled discretion in the matter of investing trust corpus, or making loans to Preston; and Preston, or his estate, was legally obligated to repay the loan which was made, and pay interest. This proceeding is distinguishable from the Mather case.
It follows from the above holding that the Alice Gwynne Preston trust was not a revocable trust under section 166, and that the trust income was not taxable to Preston, the settlor. It follows that the provisions of section 162(b) are applied properly to the trust, and that, therefore, the trust income which was distributed in the taxable years is taxable to petitioner's decedent.
Respondent's determination is sustained.
Decision will be entered for the respondent.