Opinion
Docket Nos. 111048 111049.
1944-11-6
CLAIR R. SAVAGE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.MARGARET D. SAVAGE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Thomas R. Dempsey, Esq., and Arthur H. Deibert, Esq., for the petitioners. Ralph E. Smith, Esq., and E. A. Tonjes, Esq., for the respondent.
Petitioners, husband and wife, each created two trusts in favor of their two minor children. In each trust the grantor's spouse, individually, has the power to amend, but not thereby to revoke or increase the interest of such spouse or the beneficiary, and, jointly with the beneficiary, has the power to revoke. The spouse has no present beneficial interest in the income or the corpus, but will take only if the trust continues and he or she survives the beneficiary and issue, if any, and then only if the similar, concurrently created trust for the other minor child has theretofore terminated by revocation or by the death of the beneficiary and issue, if any. Held, the person with the power to amend does not have a substantial adverse interest, and petitioners are taxable on the trust income under section 167, Revenue Act of 1938. Thomas R. Dempsey, Esq., and Arthur H. Deibert, Esq., for the petitioners. Ralph E. Smith, Esq., and E. A. Tonjes, Esq., for the respondent.
The petitioners in these consolidated cases contest income tax deficiencies determined by the Commissioner for 1938 in the amounts of $1,012.21 against Clair R. Savage and $1,003.08 against Margaret D. Savage. The issue involved is whether the income of certain trusts created by petitioners in favor of their minor children is taxable to petitioners.
FINDINGS OF FACT.
Petitioners are husband and wife. At all times material hereto they have resided in Pacific Palisades, California. Their income tax returns for the year in question were filed with the collector of internal revenue for the sixth district of California.
The facts are partially stipulated, and as so stipulated are incorporated herein by reference. On July 1, 1937, each petitioner orally created two trusts, one in favor of William Clair Savage, a son, then twelve years old, and one in favor of Marilyn Savage, a daughter, then fifteen years old. In each case the spouse of the trustor was made trustee. To each of these four trusts the respective trustor concurrently transferred the sum of $5,000 out of separately owned property. The trusts were reduced to writing on October 23, 1937.
The trust indentures are the same in all respects here material, except for the grantors, the beneficiaries and trustees. For convenience, reference will be made to the trust in which Clair R. Savage is grantor, Margaret D. Savage is trustee, and William Clair Savage is primary beneficiary.
The trustee is given the right, inter alia, to buy, sell, or encumber property for the trust; to allot and distribute the trust estate under prescribed conditions at values and by methods deemed by her to be proper; to invest principal and income without limitation to statutory securities; to determine what is principal and gross or net distributable income of the estate, with certain limitations; to reimburse herself for losses sustained in connection with trust property, except for those caused by reason of bad faith or failure to use ordinary care; and to exercise all rights connected with securities held in trust; and ‘The present Trustee and Clair R. Savage, if he shall succeed as such,‘ are authorized to participate freely in partnerships, pools, syndicates, etc., notwithstanding the trustee is a member thereof in her individual capacity.
All discretions conferred upon the trustee, unless specifically limited, are absolute and uncontrolled, bound only by the limits of good faith and ordinary care.
Section VI provides the only method for altering or revoking the trust. That section reads as follows:
Margaret D. Savage shall have the power at any time and from time to time, by written instrument duly signed, to alter, amend, and/or modify the terms, conditions and provisions of this instrument, provided, however, that no such alteration, amendment or modification shall entitle the said Margaret D. Savage or William Clair Savage, beneficiary herein, to any greater individual beneficial present or remainder interest in the principal or income of the Trust Estate than is hereby originally granted to them or either of them.
Margaret D. Savage and William Clair Savage shall have the power at any time/and from time to time after the said William Clair Savage reaches the age of majority, and during their several joint lives, by written instrument signed by both of them to revoke the trust hereby created. Said trust shall be irrevocable except as herein expressly provided. provided, further, that this section shall not be amended.
Section VII provides in part as follows:
All of the income of the Trust Estate * * * shall, in the absolute and uncontrolled discretion of the Trustee be either currently distributed to or for the benefit of William Clair Savage, if living, otherwise his lawful issue prior to the termination of this trust, or shall be accumulated by the Trustee and become a part of the corpus of this Trust Estate. * * *
Section VIII provides that the trust shall terminate upon the happening of any one of the following events (a), (b), (c), (d), or (e), whichever shall first occur, and the corpus be distributed as therein provided, unless subdivision (f) shall apply, in which event termination and distribution shall be in accordance therewith.
(a) In the case of the death of William Clair Savage without lawful issue surviving, the entire corpus is to be distributed to the trustees of the currently created Marilyn Savage trust and to be governed by the terms of that trust. If the Marilyn Savage trust shall have terminated, the corpus is to vest in and be distributed to Margaret D. Savage, if living, otherwise to Clair R. Savage, if living, otherwise it is to be apportioned in a manner provided to designated relatives of the trustor and his wife. If any of the named relatives shall die before becoming entitled to receive a distribution of his share, the heirs at law of William Clair Savage are to take.
(b) Upon the death of the survivor of Clair R. Savage, Margaret D. Savage, William Clair Savage and Marilyn Savage, or upon the expiration of a 25-year period next after the creation of the trust, whichever event shall last occur, the entire corpus of the estate is to go to the issue of William Clair Savage in equal shares, per stirpes. In the absence of living issue of William Clair Savage, the corpus of the trust estate is to be distributed as provided in (a) above.
(c) If William Clair Savage shall die leaving issue, and if such issue shall die prior to the happening of either of the events specified in (b) above, the corpus is to be distributed as provided in (a) above.
(d) The corpus is to be distributed to William Clair Savage should he attain the age of thirty years, and if his parents predecease that event, or, if either or both parents survive that event and both thereafter predecease him.
(e) Upon revocation of the trust as provided in section VI, the entire corpus of the trust estate is to go to William Clair Savage.
Subdivision (f) reads in part as follows:
This trust shall not terminate upon the happening of any one of the aforesaid events (a), (b), (c), (d) or (e) if the effect thereof would be to vest in and cause to be distributed to Clair R. Savage any part of the income of this trust which shall theretofore have been held or accumulated for future distribution to Clair R. Savage, or which, in the discretion of Clair R. Savage or of any person not having a substantial adverse interest in the disposition of such part of the income may have been held or accumulated for future distribution to Clair R. Savage; but this trust shall continue, the trust corpus thence forth shall consist of the accumulated income referred to above, and all income derived therefrom shall thereafter be currently distributable to Clair R. Savage. That portion of the trust corpus which shall not consist of the accumulated income referred to above shall, nevertheless, and in that event upon the happening of any one of the aforesaid events (a), (b), (c), (d) or (e) vest in and be distributed to Clair R. Savage should he otherwise be entitled to receive the whole of the trust corpus. This trust shall thereafter terminate only upon the death of Clair R. Savage and upon such termination the entire corpus of the Trust Estate shall vest in and be distributed to the persons next entitled to a distribution thereof as hereinabove provided in subdivision (a) of this Section VIII.
Margaret D. Savage, in June of 1938, executed an instrument by which she added subsection (g) of section VIII, providing for the conversion of the trust assets to cash and the purchase therewith of an annuity for William Clair Savage in case the grantor should die before William Clair Savage reaches the age of 21.
Section IX of the instrument provides:
The Trustee in her sole discretion may at any time and from time to time distribute and pay over to the said William Clair Savage the corpus of this trust, or any part thereof, in such amount or amounts as may be necessary in the case of illness, want or emergency affecting any beneficiary hereunder to provide reasonable support and care consistent with the station in life, financial means and other circumstances of such beneficiary.
Petitioners and respondent stipulated that, pursuant to certain provisions contained in the trust indenture authorizing her to do so, Margaret D. Savage, ‘as trustee,‘ executed the above described amendment to section VIII. By reference to the instrument itself we find that the power to ‘alter, amend, and/or modify‘ was given Margaret D. Savage as an individual and that it was so exercised.
The only power retained by the grantor was the right to add to the trust. The power to ‘alter, amend, and/or modify‘ the trust was vested in the grantor's spouse, a person not having a substantial adverse interest in the disposition of the trust income.
Clair R. Savage has been engaged in the automobile business continuously since 1916. His experience has been successful and profitable and has given him a thorough understanding of the business.
In 1937, prior to the establishment of the subject trusts, petitioners were members of a copartnership doing business as the Savage-Haldeman Co., in which the interests were as follows:
+----------------------------------------------------------+ ¦ ¦Profit ¦ +------------------------------------------+---------------¦ ¦Members ¦Distribution, ¦ +------------------------------------------+---------------¦ ¦ ¦Percent ¦ +------------------------------------------+---------------¦ ¦Clair R. Savage ¦25 ¦ +------------------------------------------+---------------¦ ¦Henry F. Haldeman ¦25 ¦ +------------------------------------------+---------------¦ ¦Margaret D. Savage (Mrs. Clair R. Savage) ¦25 ¦ +------------------------------------------+---------------¦ ¦Clara B. Haldeman (Mrs. Henry F. Haldeman)¦25 ¦ +------------------------------------------+---------------¦ ¦ ¦100 ¦ +----------------------------------------------------------+
On July 1, 1937, the date on which the trusts were created, the above described partnership was dissolved and a new partnership agreement (reduced to writing on October 14, 1937) was entered into. The trustees invested the corpora of the trusts in this new partnership and were thereupon made partners. The Haldemans, as trustees of two similar trusts naming their daughter, Dayl Haldeman, as beneficiary, also became partners. The composition of this new partnership was as follows:
+----------------------------------------------------------------+ ¦ ¦Profit ¦ +------------------------------------------------+---------------¦ ¦Members ¦Distribution, ¦ +------------------------------------------------+---------------¦ ¦ ¦Percent ¦ +------------------------------------------------+---------------¦ ¦Clair R. Savage ¦19 ¦ +------------------------------------------------+---------------¦ ¦Henry F. Haldeman ¦19 ¦ +------------------------------------------------+---------------¦ ¦Margaret D. Savage ¦19 ¦ +------------------------------------------------+---------------¦ ¦Clara B. Haldeman ¦19 ¦ +------------------------------------------------+---------------¦ ¦Clair R. Savage, trustee for Wm. Clair Savage ¦3 ¦ +------------------------------------------------+---------------¦ ¦Clair R. Savage, trustee for Marilyn Savage ¦3 ¦ +------------------------------------------------+---------------¦ ¦Margaret D. Savage, trustee for Wm. Clair Savage¦3 ¦ +------------------------------------------------+---------------¦ ¦Margaret D. Savage, trustee for Marilyn Savage ¦3 ¦ +------------------------------------------------+---------------¦ ¦Henry F. Haldeman, trustee for Dayl Haldeman ¦6 ¦ +------------------------------------------------+---------------¦ ¦Clara B. Haldeman, trustee for Dayl Haldeman ¦6 ¦ +------------------------------------------------+---------------¦ ¦ ¦100 ¦ +----------------------------------------------------------------+
The Savage-Haldeman Co. was first organized as a corporation on August 2, 1935, to take over the Pontiac automobile franchise for Los Angeles. It had paid-up capital of $100,500, represented by 1,000 shares of 6 percent preferred stock issued to the Haldemans for $100,000, and 500 shares of common stock, 125 shares of which were issued to each partner for $1 a share. The 1,000 shares of preferred stock were retired and paid off at par about April 1936, and, when the first of the two partnership agreements was entered into on July 31, 1936, the company showed earnings of $91,065.60. The net worth of the first Savage-Haldeman partnership at the time of its dissolution on July 1, 1937, was $242,529.38, of which $150,963.78 represented earnings left in the business since July 31, 1936.
Petitioners consulted their attorney in connection with the establishment of the trusts and anticipated a saving in taxes therefrom. Their main object, however, was to provide for the comfort and security of the children in future years and, through the trusts, to create in the children an interest in the Savage-Haldeman business, with the plan that the son and the daughter's future husband, should he be so inclined, would ultimately take over petitioners' shares of the business.
During the years 1937 and 1938 all of the income of each of the four trusts, after payment of Federal and state income taxes, was accumulated by the respective trustee. On December 31, 1938, each trust had value of $8,246.64.
It is stipulated that during the period from July 1, 1938, through December 31, 1938, the Savage-Haldeman Co. made certain sales upon which the California State Board of Equalization assessed additional retail sales taxes in the amount of $4,156.65, no part of which was claimed by the partnership, Savage-Haldeman Co., on its Federal income tax return for the year 1938, or allowed by the respondent, as a deduction from net income of said partnership or from the distributive shares of the partners thereof for the year 1938. Said $4,156.65 had not been paid to the State of California when these cases were tried. By reason of the assessment of the aforesaid sales taxes for the year 1938, each petitioner's distributive share of the net income of the Savage-Haldeman Co. for the year 1938, as determined by the respondent in his deficiency notices, was overstated in the sum of $789.77. A claim for refund of income taxes overpaid by virtue of the reduction in petitioner's net taxable income for the year 1938, resulting from the assessment of the said sales taxes, was filed on March 15, 1942, and no action thereon has been taken.
At all times material to these proceedings the Savage-Haldeman Co. has kept its books of account and filed its income tax returns on the accrual basis.
OPINION.
ARNOLD, Judge:
Respondent contends that the income of the four trusts created by the petitioners in favor of their two children is taxable to the respective grantors under section 22(a) of the Revenue Act of 1938 (wherein ‘gross income‘ is defined) as that section is applied in Helvering v. Clifford, 309 U.S. 331. He further urges that, if the income is not so taxable under the broad general language of section 22(a), it is rendered taxable to the grantors by the more precise language of section 167 of the 1938 Act as that language was applied in Helvering v. Stuart, 317 U.S. 154. The pertinent provisions of the 1938 Act are set forth in the margin.
Applicability of section 166, dealing with trusts as to which there is a power to revest corpus in the grantor, is not urged by the respondent.
SEC. 22. GROSS INCOME.(a) GENERAL DEFINITION.— ‘Gross income‘ includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities or the transaction of any business carried on for gain or profit, or profits and income derived from any source whatever. * * *SEC. 167. INCOME FOR BENEFIT OF GRANTOR.(a) Where any part of the income of a trust—(1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor; or(2) may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; then such part of the income of the trust shall be included in computing the net income of the grantor.
We have noted in our findings of fact that the only power to alter, amend, or modify each trust is lodged in the spouse of the respective grantor as an individual. This power of the spouse is limited only in that he or she may not, by amendment, increase his or her own or the primary beneficiary's beneficial present or remainder interest or alter the power of amendment or revocation. Section VI of the indenture, which grants this power, provides the only method by which the trust may be revoked, i.e., by the grantor's spouse and the primary beneficiary together after the beneficiary attains majority. If this power resides in a person ‘not having a substantial adverse interest in the disposition‘ of trust income and if it may be used as a means of accumulating for or distributing trust income to the grantor, the trust income, to the extent that it may be so applied, is taxable to the grantor.
We fail to see any substantial adverse interest in the respective grantor's spouse, as required by section 167, which would deter his or her use of the power to amend for the grantor's benefit. The spouses have no present beneficial interests whatever in the income or corpus of the trusts. The interest of the spouse is that of a contingent remainderman, and it will vest, if at all, only upon the termination of the trust under almost impossible circumstances. For example, as to the William Clair Savage trust created by Clair R. Savage, Margaret D. Savage has the power to amend. Assuming the trust will not be revoked jointly by Margaret D. and William Clair Savage, Margaret D. Savage must survive him. She then would take only in case the trust created by Clair R. Savage for Marilyn Savage had previously terminated, either by the death of Marilyn and her issue, if any, or by the revocation by Margaret D. and Marilyn Savage.
Since Margaret D. Savage's interest in each trust would be defeated if the trust were revoked, there is little likelihood of revocation during her lifetime. Thus, in order for her to benefit from either of these trusts she would have to outlive the survivor of the two minor children and their issue, if any. To hold that such a remote possibility of receiving benefit constitutes a ‘substantial adverse interest‘ would do violence to the meaning of the word ‘substantial‘ and to the intent of Congress, when, in enacting the Revenue Act of 1932, it added the requirement that the so-called adverse party must be more than a mere beneficiary ‘having a very minor interest‘
and that the interest must be substantial.
See Senate Report No. 665, 72d Cong., 1st sess., pp. 34-35.
The main support for petitioners' contention that the interest of the spouse here is substantial is found in Meyer Katz, 46 B.T.A. 187; affd. (C.C.A., 7th Cir.), 139 Fed.(2d) 107. There the grantor and his wife jointly could terminate the trust and revest the corpus in the grantor. In that case the wife would benefit from the trust only if the minor beneficiary should predecease her and the grantor, leaving no issue. We held that this right gave her a ‘substantial adverse interest.‘ The Second Circuit did not determine independently that the interest involved in the Katz case was a substantial adverse interest, but accepted the finding of the Board of Tax Appeals as one which should not be disturbed.
The Katz case, in our opinion, approaches the twilight zone in the interpretation of ‘substantial adverse interest.‘ In our opinion it is less likely that both children in the trusts before us will die without issue before their mother in two trusts and their father in the other two than that the one minor child in the Katz case will die without issue before either parent. We do not feel that the doctrine of the Katz case should be extended to cover the facts before us, since a fair, independent analysis discloses only a remotely contingent interest, the value of which, if any, is negligible. Such a remote possibility of benefiting from a trust falls far short of the ‘substantial‘ interest required by the statute.
The Circuit Court of Appeals for the Second Circuit, in Loeb v. Commissioner, 113 Fed.(2d) 664; certiorari denied, 311 U.S. 643, made the following holding with respect to the term ‘substantial adverse interest,‘ as used in section 167:
* * * The statute presupposes that a trustee clothed with discretion to dispose of the income will be amenable to the wishes of the grantor of a trust, as he is likely to be, particularly in family trusts. That is the basis for treating the trust income as the grantor's, if the disposition of it lies in the discretion of any person who has not ‘a substantial adverse interest‘. This means, in our opinion, an interest sufficiently direct and adverse to rebut the presumption that the grantor can control in fact the exercise of discretion by such person.
In Commissioner v. Caspersen, 119 Fed.(2d) 94, the Circuit Court of Appeals for the Third Circuit, emphasizing the requirement of substantiality, reversed the holding of the Board of Tax Appeals that a ‘substantial adverse interest‘ existed.
* * * It is not sufficient that the trustee have merely an adverse interest. Sec. 167 of the Revenue Act of 1934 specifically requires that it be a substantial adverse interest. It was therein, we believe, that the Board of Tax Appeals primarily fell into error. In our opinion the Board failed to ascribe to the word ‘substantial‘ the import which its considered use in the statute demands, and thereby, the Board treated as substantial an interest which was not only lacking in substance but which was no more than technically adverse. * * *
See also Mary A. Cushing, 38 B.T.A. 948, and May v. United States (U.S. Dist. Ct., W. Dist. Pa., Oct. 23, 1940).
It remains to be determined, therefore, whether this power can be used as contemplated by section 167. We believe that it can. Certainly, there is no fiduciary duty to hinder its use, for it is not a power in trust, and under the broad powers vested in the spouse the income of the trust may at any time be made distributable to the grantor. The very creation of the power adequately rebuts any possible argument that its use was not intended. See Reinecke v. Smith, 289 U.S. 172; Sterling Morton, 38 B.T.A. 1283; Estate of Flora W. Lasker, 47 B.T.A. 172, 178.
It is evident, therefore, that the interests created for the beneficiaries were granted subject to the most exhaustive use to which the power to amend might validly be put by one with no fiduciary relationship to the beneficiaries. We see nothing in the indentures to prohibit their amendment to provide for complete diversion of income to the grantors.
We conclude that the respondent correctly attributed the income of the subject trusts to the petitioners. We further hold, in accordance with the stipulation of the parties, that the petitioners are entitled to an additional income tax deduction for 1938 by reason of the accrued California sales tax.
Decision will be entered under Rule 50.