Opinion
Docket Nos. 2801 2802.
1945-01-16
ALICE OGDEN SMITH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.LESTER A. SMITH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
J. Lee Boothe, C.P.A., for the petitioners. Paul A. Sebastian, Esq., for the respondent.
The petitioners were grantor-trustees of 3 irrevocable trusts for the sole benefit of their 3 children. The income of each trust was to be used for a college education of the beneficiary. The principal and undistributed income were to be paid to the beneficiary upon attaining the age of 30 years. Powers reserved to the grantor-trustees were solely for the benefit of the beneficiary. Held, that the petitioners are not taxable upon the income of the trusts. J. Lee Boothe, C.P.A., for the petitioners. Paul A. Sebastian, Esq., for the respondent.
These proceedings, consolidated for hearing, are for the redetermination of deficiencies in income tax as follows:
+------------------------------------+ ¦ ¦Alice Ogden ¦ ¦ +----+---------------+---------------¦ ¦Year¦Smith ¦Lester A. Smith¦ +----+---------------+---------------¦ ¦ ¦Docket No. 2801¦Docket No. 2802¦ +----+---------------+---------------¦ ¦1939¦$218.80 ¦$375.00 ¦ +----+---------------+---------------¦ ¦1940¦403.89 ¦908.96 ¦ +----+---------------+---------------¦ ¦1941¦351.85 ¦818.92 ¦ +------------------------------------+
The question in issue is whether the petitioners are taxable under the provisions of sections 166, 167, and 22(a) of the Internal Revenue Code upon the income of three trusts which they created for the benefit of their three minor children.
FINDINGS OF FACT.
The petitioners, husband and wife, are residents of Detroit, Michigan. They filed separate income tax returns for the years 1939, 1940, and 1941 with the collector of internal revenue at Detroit.
The petitioners have three children, namely, John R. Smith, born in 1922; Marilyn Alice Smith, born in 1928; and Myron E. Smith, born in 1934.
During the fall of 1935 Lester A. Smith, hereinafter referred to as petitioner, caused to be created the L. A. Smith Co. The company had an authorized capital stock of 5,000 shares, of which 1,000 shares were issued and outstanding. Of the 1,000 shares outstanding, 998 shares were issued to the petitioner at the inception of the corporation. One share was issued to the petitioner's wife and one share to the secretary of the corporation. Shortly thereafter petitioner transferred 400 shares to his wife. During the years in question the corporation was controlled by petitioner and his wife. From the inception of the corporation and throughout the years here in question petitioner was president and treasurer of the L. A. Smith Co.
Under dates of January 3, 1938, September 1, 1939, and January 6, 1941, respectively, petitioner and his wife created three separate irrevocable trusts in favor of their children, John, Marilyn, and Myron, each transferring to each of the trusts five shares of L. A. Smith Co. capital stock. They named themselves trustees of each trust. The provisions of the trust instruments were substantially alike. It was stated in each trust agreement that the principal purpose of the trust was to provide for the college education of the beneficiary and that the entire income and principal should be used by the trustees for that purpose and to give the beneficiary a start in life. The amount to be expended for educational purposes was within the absolute control of the trustees. It was further provided that all remaining trust funds were to be delivered to the beneficiary when he or she attained the age of 30 years.
The trust indentures contain, in addition to others, the following material provisions:
FIRST: To receive, hold and manage all of the property conveyed by this Indenture together with any investitures by said Donors hereinafter made a part of this trust; to sell, transfer and to exchange all or any part of said property as though the absolute owner thereof; * * *
SECOND: To invest and reinvest money coming into their possession under the terms hereof subject to any limitations or conditions hereinafter specifically imposed in such loans, stocks, bonds, securities and real estate as they may in their uncontrolled discretion deem proper or suitable for the investment of trust funds, without being restricted to a class of investment which a Trustee is or may hereafter be permitted by law to make.
THIRD: To retain by way of investment any property or securities transferred to them without liability for depreciation and in accepting title to real estate, said Trustee shall not be held to have assumed the payment of any encumbrances thereon nor any responsibilities as to the validity of the title conveyed to or held by them. All conveyances executed and delivered by them shall be without covenants of warranty except as against their own acts.
FOURTH: To cause securities which may from time to time comprise the trust fund, or any part thereof, to be registered in the names of said Trustees hereunder or in the name of their nominee, or to take and keep the same unregistered, and to retain them or any part thereof in such condition that they will pass by delivery.
FIFTH: To determine whether or not money or property coming into their possession shall be treated as principal or income and to charge or apportion expenses or losses to principal or income, according as they may deem just and equitable.
TENTH: To represent and vote any stock or securities in any corporation, joint stock company or other similar organization whatsoever at any time held by said Trustees hereunder; to attend any and all corporate meetings; and to act upon any and all questions that may come before such meetings and in their discretion to grant proxies to authorize others to vote any such stock or securities at any and all meetings.
TWELFTH: To employ suitable counsel and agents in the discharge of their duties and to determine and pay to them reasonable compensation and expenses. However, said trustees shall not be liable for any neglect, omission or wrongdoing of such counsel or agent, provided reasonable care shall have been exercised in their selection, nor shall they be liable except for their own neglect or wilful default, for any loss or damage.
THIRTEENTH: To require the Donors to make, execute and deliver in due form of law such other and further assignments, conveyances or other instruments as said trustees may deem requisite or necessary to effectuate the purposes hereof.
FOURTEENTH: To furnish to the Donors, during their lifetime and to the beneficiary after said Donors shall be deceased, whenever requested, a statement of the receipts and disbursements of said trust estate and at least once in each year to furnish the Donors and after their decease, said beneficiary, a full and complete schedule of all securities and other property comprising the subject matter of said trust.
FIFTEENTH: To do all acts and things in their judgment needful or desirable for the proper and advantageous control and management of the property held in trust hereunder to the same extent and to the same effect as might be legally done by an individual in absolute ownership and control of said property.
SIXTEENTH: Said Trustee shall in no event be liable for any mistakes in judgment in the making or retaining of investments so long as the same be made or retained in good faith.
SEVENTEENTH: Said Trustees may resign at any time or apply to any proper court for the settlement of their accounts and to be relieved and discharged from this trust.
EIGHTEENTH: In the event said Trustees or either of same shall resign, become disqualified or cease to act as Trustees, said Donors during their lifetime, or said beneficiary after their death, is hereby authorized and empowered by instrument in writing duly executed and acknowledged to select as successor to said trustees any qualified person or persons and the said successor trustee or trustees so selected are hereby appointed Trustees hereunder with all powers and duties herein conferred upon said Trustees.
TWENTY-SECOND: In the event of a division of said trust estate or any part thereof at any time, the trustees shall place such valuation upon the property to be divided as they may deem just and fair, and such valuation shall be binding upon all parties in interest under this agreement. The trustees in making distribution of principal hereunder, may do so in money, securities, or other property and the judgment of the trustees as to what shall constitute a just and proper division or apportionment among the beneficiaries hereunder, shall be binding and conclusive upon all parties in interest under this trust agreement.
TWENTY-THIRD: If at any time in the judgment of the said Trustees the income of said trust fund shall not be sufficient to provide for the proper maintenance, support, medical attention, care or education of said beneficiary hereunder, said Trustees may pay to or upon behalf of said beneficiary, or may expend for his benefit, such portion of the principal held for such beneficiary as said Trustees in their sole discretion shall deem advisable therefor.
In addition to the foregoing provisions the trust instruments also provided for the distribution of the corpus and income of each trust, in the event of the death of the named beneficiary, to his or her lawful issue per stirpes. In the event there were no surviving children, the share of the deceased beneficiary was to be distributed equally among the beneficiaries of the other trusts.
The income of each of the three trusts consisted of dividends on the L. A. Smith Co. capital stock during the years 1939, 1940, and 1941 as follows:
+-----------------------------------------------+ ¦ ¦ ¦Marilyn Alice¦ ¦ +----+-------------+-------------+--------------¦ ¦ ¦John R. Smith¦Smith ¦Myron E. Smith¦ +----+-------------+-------------+--------------¦ ¦Year¦Education ¦Education ¦Education ¦ +----+-------------+-------------+--------------¦ ¦ ¦Trust ¦Trust ¦Trust ¦ +----+-------------+-------------+--------------¦ ¦1939¦$3,000 ¦ ¦ ¦ +----+-------------+-------------+--------------¦ ¦1940¦2,000 ¦$2,000 ¦ ¦ +----+-------------+-------------+--------------¦ ¦1941¦1,000 ¦1,000 ¦$1,000 ¦ +-----------------------------------------------+
No separate books of account or records were kept by the trustees to reflect the corpus, income, or disbursements of the three trusts. No separate bank accounts were kept on behalf of or in the names of the trustees. All transactions relative to the trusts were handled through the books of account and records of the L. A. Smith Co. Ledger accounts were kept on the company's books in the name of each of the trusts, entitled ‘John R. Smith Education Trust,‘ ‘Marilyn Alice Smith Education Trust,‘ and ‘Myron E. Smith Education Trust.‘ In each of these accounts there was debited the purchase of Government bonds, series E, and there were credited the amount of certain cash dividends applicable to the L. A. Smith Co. stock in each trust and various amounts representing expenses.
It was a policy of the L. A. Smith Co. to declare and pay cash dividends during December of each year. The proportionate part of cash dividends during 1939, 1940, and 1941 applicable to the shares held in the three trusts was never at any time distributed to the trustees, but was carried in the L. A. Smith Co. cash accounts and intermingled with its other cash funds. There was never any segregation of the cash applicable to the trust stock. The cash was carried in this manner until it was used to purchase Government bonds, for which a corporation check was issued. All other disbursements for expenses of the trust were also made by check of the L. A. Smith Co.
There were purchased on behalf of John's trust, during 1940, eight Government bonds, series E, of the face value of $1,000 each at a cost of $6,000, and during 1941, one of the same type of bond, of a face value of $1,000, at a cost of $750. These purchases were charged to the account of John R. Smith Education Trust on the books of the L. A. Smith Co. Of the bonds purchased in 1940, one was in the name of John R. Smith, payable at death to Alice Ogden Smith, and the others were in the name of Alice Ogden Smith. The $1,000 bond purchased in 1941 was in the name of John R. Smith, payable at death to Myron E. Smith.
During 1940 three Government bonds, series E, of a face value of $1,000 each, were purchased at a cost of $2,250 and charged to the account of Marilyn Alice Smith Education Trust. The bonds were in the name of Marilyn A. Smith, payable on her death to Alice Ogden Smith. During 1941 there was purchased one Government bond, series E, of a face value of $1,000, at a cost of $750, also charged to the account of Marilyn Alice Smith Education Trust on the books of the L. A. Smith Co. The bond was in the name of Marilyn A. Smith, payable on death to John R. Smith.
During 1941 one Government bond, series E, of a face value of $1,000, was purchased at a cost of $750 and charged to the account of Myron E. Smith Education Trust on the books of the L. A. Smith Co. The bond was in the name of Myron E. Smith, payable at death to Marilyn A. Smith.
All of the above described Government bonds are still intact. None of the income of the trusts has been expended for the education of any of the children. Marilyn and Myron, during the years in controversy, were in high school and grade school, respectively. John began his college education during the year 1940 at the age of 18 years. He continued to attend college until 1943, when he was inducted into the armed services of the United States. The expenses incident to his attending college during the years 1940 to 1943, inclusive, were paid by the petitioner out of his personal funds and not from trust funds.
The stock of the L. A. Smith Co. issued in the names of the petitioner and his wife, as trustees, was voted by them at all meetings of stockholders and directors of the company in the same way as the shares which they owned.
The petitioners, as trustees, filed income tax returns for the trusts for the tax years here in question, reporting the correct amount of net income for such years and paying the taxes due thereon.
OPINION.
SMITH, Judge:
It is the respondent's contention that the petitioner, as grantors of the trusts under consideration, are taxable on such net income under the doctrine of Helvering v. Clifford, 309 U.S. 331. In that case it was held that where ‘the bundle of rights‘ retained by the settlor ‘as a result of the terms of the trust and the intimacy of the familial relationship‘ resulted in the retention of ‘the substance of full enjoyment of all the rights which previously he had in the property‘ the income is taxable to him under section 22(a) of the Internal Revenue Code. The respondent submits that the rights retained by the petitioners in the trusts under consideration were so great as to make them in substance the owners of the income. He calls attention to the fact that by paragraphs first and fifteenth of the trust instruments the petitioners had the authority to manage, sell, transfer, and exchange trust property as though they were the absolute owners thereof; that the trust instruments gave them the further authority as trustees to invest the funds of the trusts in any securities they might in their uncontrolled discretion deem proper without restriction and to have any securities which were a part of the trust funds registered in their names as trustees or in the names of their nominees; that they were authorized to take and keep trust securities unregistered so that they could pass by delivery; and that they had the right, in the event of distribution of principal, to divide the principal in any manner they saw fit. He further points out that no books of account or records of the trusts were kept by the trustees, but that such accounts were kept on the books of the L. A. Smith Co.
After careful consideration of the provisions of the trust instruments and the operations of the trusts during the taxable years here in question, we are of the opinion that nothing could have been done or was done by the trustees in respect of the trusts contrary to the best interests of the beneficiaries. We think that the petitioners as grantors of the trusts retained no powers which would relieve them from their responsibilities as trustees. As trustees they were required to manage the trusts for the interests of the beneficiaries. There is nothing to indicate that they did not so manage the trusts during the taxable years. It was in no way detrimental to the trusts that their accounts were kept in the books of the L. A. Smith Co.
In Phipps v. Commissioner (C.C.A., 2d Cir.), 137 Fed.(2d) 141, it was held that, where a grantor-trustee established a trust for the benefit of his wife and daughter and could control the allocation of the trust income among the members of his family only through a total disregard of the purposes of the trust, which disregard would result in judicial intervention, the trust income was not taxable to the husband-grantor.
In Chandler v. Commissioner (C.C.A., 3d Cir.), 119 Fed.(2d) 623, the grantor-trustee provided in the trust instrument that:
During the lifetime of Grantor, Trustee shall make such sale, exchange or other disposition either to Grantor or to a third party or third parties designated by him of all or any part of the Trust Fund and for such considerations and upon such terms as to credit or otherwise as Grantor shall at any one time or from time to time direct. * * *
In its opinion the court stated:
In the present case there can be no doubt that the power to control reserved by Chandler was for his own benefit. In addition to broad powers of directing investments by the trustee, such as were present in the trust instrument in Carrier v. Carrier, supra (226 N.Y. 114; 123 N.E. 135), Chandler reserved to himself the right to sell to or buy from the trust estate at his own price and to direct the disposition to himself (other than by way of sale or exchange) of all or any part of the trust fund for such consideration and upon such terms as he might direct. We think that the reservation by the settlor of the power to deal with the trust assets for his own benefit is irreconcilable with the fundamental principle underlying all fiduciary relationships that the fiduciary must act solely in the interest of the cestui que trust and, therefore, may not have personal dealings with the trust property. Restatement, Trusts, Sec. 170 and comments thereto. As owner of the assets Chandler, of course, had the right to reserve such a power. His doing so clearly indicates that he did not intend to impose upon himself fiduciary restraints enforceable by the trust beneficiaries. We think that the Board was entirely justified in construing the power as a reservation by the settlor of the right to revoke the trust.
In the instant case the grantors retained no powers which gave them the right to acquire the trust principal or income at any time for their own benefit. We are therefore of the opinion that the facts disclosed by this record do not bring the case within the principle of Helvering v. Clifford, supra.
The respondent stated in his brief that:
It should be stated at the outset that it is the respondent's position that his determination in this case is controlled by Helvering v. Clifford, (1940) 309 U.S. 331, without regard to Helvering v. Douglas Stuart, (1942) 317 U.S. 154. However, if the Tax Court should hold that the Clifford decision is not controlling and that the respondent's determination is supported only by R. Douglas Stuart, supra, it is requested that the Court make specific findings of fact and of law in this regard so that the respondent may determine whether relief should be afforded petitioner under I.T. 3609, I.R.B. No. 10, May 25, 1943, page 40, upon application therefor, and upon compliance by petitioner with the terms of I.T. 3609.
This request is based upon section 134 of the Revenue Act of 1943, which amended section 167 of the Internal Revenue Code by adding thereto the following:
(c) Income of a trust shall not be considered taxable to the grantor under subsection (a) or any other provision of this chapter merely because such income, in the discretion of another person, the trustee, or the grantor acting as trustee or cotrustee, may be applied or distributed for the support or maintenance of a beneficiary whom the grantor is legally obligated to support or maintain, except to the extent that such income is so applied or distributed. In cases where the amounts so applied or distributed are paid out of corpus or out of other than income for the taxable year, such amounts shall be considered paid out of income to the extent of the income of the trust for such taxable year which is not paid, credited, or to be distributed under section 162 and which is not otherwise taxable to the grantor.
The request of the respondent is granted. See J. O. Whiteley, 3 T.C. 1265.
Reviewed by the Court.
Decision will be entered under Rule 50.
BLACK, J., concurring: I concur in the result reached by the majority opinion, though I doubt if it can be distinguished from our Court's recent decision in Joel E. Hall, 4 T.C. 506, in which the opposite result was reached. I dissented in the Hall case and pointed out the reasons why I did not think the income of the irrevocable trust involved in that case should be taxed to the grantor.
Another comparatively recent case by this Court which it might be thought is in conflict with the result reached in the instant case is Louis Stockstrom, 3 T.C. 255; now on review, C.C.A., 8th Cir. However, after carefully reading the facts in that case and comparing them with those present in the instant case, I do not believe the result reached in the instant case is in conflict with the Stockstrom case. In the Stockstrom case the three trusts which were made for the settlor's three adult children contained powers which enabled the settlor-trustee to shift income beneficiaries somewhat similar to the powers reserved to the grantor in Commissioner v. Buck, 120 Fed.(2d) 775. There are no such powers granted to the settlor-trustees in the instant case. In the Stockstrom case the seven trusts which were set up for the benefit of Stockstrom's seven grandchildren, while not granting to the settlor-trustee powers which were as extensive as those contained in the trusts for his three adult children, did grant to the settlor-trustee the discretion to either accumulate the income or distribute it to the beneficiary. These trusts were for the lifetime of the beneficiaries. We construed this power as being broad enough to enable the settlor-trustee to completely withhold the income of the trust from the grandchild beneficiary throughout his lifetime. To quote from the opinion itself in the Stockstrom case, the settlor-trustee ‘was not required to distribute any part of the income to any of the beneficiaries during his lifetime.‘ We held that this power over the income, when coupled with the broad administrative powers granted the settlor-trustee over the corpus in these several trusts, caused the income to be taxable to the settlor, Stockstrom.
In the instant case the primary purpose of the trusts is to provide for the education of the settlors' three minor children and any accumulated income and principal not used for that purpose is to be turned over to the beneficiary when he reached 30 years of age. Thus each of the three trusts here involved is to completely terminate when the beneficiary reaches 30 years of age and all the corpus and accumulated income is to be turned over to the beneficiary. The trusts in that respect are not unlike those present in J. O. Whiteley, 3 T.C. 1265, where we held that Helvering v. Clifford was not applicable.
The administrative powers granted to the trustees in the instant case are quite broad and are, I think, as broad as those present in the Stockstrom case, but I think the Supreme Court in Helvering v. Stuart, 317 U.S. 154, made clear that retention by the grantor of only broad administrative control over the corpus does not make the income of a long term family trust taxable to him.
For these reasons above stated, I concur in the result reached in the majority opinion.
DISNEY, J., agrees with the above.
LEECH, HILL, HARRON, KERN, and OPPER, JJ., dissenting: We can not fairly distinguish the facts in either Louis Stockstrom, 3 T.C. 255, or Joel E. Hall, 4 T.C. 506, from those here. In addition, there are features of the conduct and operation of these trusts which are comparable to those leading to nonrecognition of the trusts in such earlier cases as Benjamin F. Wollman, 31 B.T.A. 37, and William C. Rands, 34 B.T.A. 1107, the true forerunners of the Clifford case. We accordingly dissent.