Opinion
Docket No. 1845.
1945-01-8
ESTATE OF WILLIAM F. HOFFORD, DECEASED, MARKLE BANKING AND TRUST COMPANY, A CORPORATION, AND DONALD V. SMITH, EXECUTORS, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Joseph J. Brown, Esq., for the petitioners. Paul E. Waring, Esq., for the respondent.
1. In 1937 decedent, then 73 and in ‘very good‘ health, was the owner of all the stock and the sole manager of a corporation. He and the corporation entered into a contract whereby he was to remain the sole manager for the remainder of his life at a fixed salary, regardless of his physical condition or ability to serve. On the same day, as a result of promises made many years before, he created six irrevocable trusts, one for his wife, one for his daughter, and one for each of his daughter's four children, and within two weeks time transferred all of the stock of the corporation to the six trusts. He died about three years later. Held, the transfers to the trusts were not made in contemplation of death, but were nevertheless includible in decedent's gross estate under section 811(c), Internal Revenue Code, as transfers intended to take effect in possession or enjoyment at or after decedent's death.
2. In 1937 decedent purchased a life annuity for his wife, who was much younger than decedent. The annuity took effect immediately. The agreement provided that, if the wife should predecease the decedent before she had received amounts equal to the single premium, the balance would be paid to decedent unless, under a power given to the wife in the instrument to change the beneficiaries, she had designated otherwise. Held, decedent did not purchase the annuity in contemplation of death; held, further, the interest of decedent's wife in the annuity policy was irrevocable and complete on the date it was issued; the payment for the policy was not a transfer ‘intended to take effect in possession or enjoyment after decedent's death‘; and the amount of the single premium which decedent paid for the policy is not includible as a part of his gross estate under section 811(c), Internal Revenue Code, Helvering v. Hallock, 309 U.S. 106, is not applicable.
3. In 1939 decedent became liable as an endorser on a demand note. The primary obligor was an association of war veterans and the money thus obtained was used to buy uniforms for the members. The association paid some interest on the note, but paid nothing on the principal. After decedent's death the association was without funds and unable to pay the note, which was then paid by decedent's executors. Held, the amount of the note is deductible from the decedent's gross estate under section 812(b)(3), Internal Revenue Code. Joseph J. Brown, Esq., for the petitioners. Paul E. Waring, Esq., for the respondent.
This proceeding is for a redetermination of a deficiency of $44,446.65 in estate tax. In a statement attached to the deficiency notice the respondent made adjustments to the net estate of William F. hofford, deceased, as follows:
+-----------------------------------------------------------------------------+ ¦Net estate for basic tax as disclosed by return ¦ ¦($14,537.88)¦ +-----------------------------------------------------+----------+------------¦ ¦Additions to value of net estate and decreases in ¦ ¦ ¦ ¦deductions: ¦ ¦ ¦ +-----------------------------------------------------+----------+------------¦ ¦Real estate ¦$25,950.00¦ ¦ +-----------------------------------------------------+----------+------------¦ ¦Stock and bonds ¦7,524.15 ¦ ¦ +-----------------------------------------------------+----------+------------¦ ¦Other miscellaneous property ¦2,495.32 ¦ ¦ +-----------------------------------------------------+----------+------------¦ ¦Transfers during decedent's life ¦225,000.00¦ ¦ +-----------------------------------------------------+----------+------------¦ ¦Debts of decedent ¦571.50 ¦ ¦ +-----------------------------------------------------+----------+------------¦ ¦ ¦________ ¦261,540.97 ¦ +-----------------------------------------------------+----------+------------¦ ¦Net estate for basic tax as adjusted ¦ ¦$247,003.09 ¦ +-----------------------------------------------------+----------+------------¦ ¦Net estate for additional tax as adjusted ¦ ¦$307,003.09 ¦ +-----------------------------------------------------------------------------+
By appropriate assignments of error petitioner contested all of the above adjustments except the ‘other miscellaneous property‘ adjustment and $249.64 of the ‘stock and bonds‘ adjustment.
At the hearing the parties stipulated certain real estate values, the effect of which is to reduce the ‘real estate‘ adjustment from $25,950 to $13,450. At the hearing the parties also stipulated that the fair market value of 200 shares of Carbon Silk Co. stock as of the date of decedent's death was, as determined by the respondent, the amount of $7,275.51 instead of $1 as returned. The effect of this stipulation is that the ‘stock and bonds‘ adjustment of $7,524.15 is correct.
These stipulations leave for our consideration only the last two adjustments, which the respondent explained in a statement attached to the deficiency notice as follows:
+----------------------------------------------------------+ ¦Transfers During Decedent's Life ¦Returned ¦Determined ¦ +----------------------------------+----------+------------¦ ¦Trusts #1,#2, #3, #4, #5 and #6 ¦None ¦$200,000.00 ¦ +----------------------------------+----------+------------¦ ¦Annuity contract ¦None ¦25,000.00 ¦ +----------------------------------+----------+------------¦ ¦ ¦ ¦ ¦ +----------------------------------+----------+------------¦ ¦Totals ¦None ¦$225,000.00 ¦ +----------------------------------------------------------+
The capital stock of W. F. Hofford, Inc., transferred in trust by the decedent in 1937 and 1938, is held to be a transfer within the purview of section 811 (c) of the Interal Revenue Code, and, therefore, includible in the gross estate. The fair market value of the stock at date of death is held to be $100.00 per share.
The annuity purchased by the decedent in 1937 for his wife, Cora L. Hofford, at a cost of $25,000.00 is held to be a transfer within the purview of section 811 (c) of the Internal REvenue Code, and therefore, includible in the gross estate.
+--------------------------------------------------------------------+ ¦Debts of Decedent ¦Returned ¦Determined ¦ +--------------------------------------------+----------+------------¦ ¦Item 13—Note, Lehighton American Legion Home¦$571.50 ¦-0- ¦ +--------------------------------------------------------------------+
The deduction claimed under Schedule K of the estate tax return as a debt of the decedent in the amount of $571.50 is disallowed, in the absence of proof that it was contracted for adequate and full consideration in money or money's worth.
At the hearing the parties also stipulated that as of the date of decedent's death the fair market value of the stock of W. F. Hofford, Inc., transferred in trust by the decedent in 1937 and 1938 was $75 per share, instead of $100 per share as determined by the respondent. This stipulation, however, still leaves the question whether the said transfers are includible in decedent's gross estate.
Effect will be given to all of the above stipulations in the recomputation under Rule 50.
The petitioner, Donald V. Smith and Markle Banking & Trust Co., are the executors of the will of William F. Hofford, hereinafter sometimes referred to as the decedent, who died a resident of Carbon County, Pennsylvania, on September 16, 1940, at the age of 76 years.
Petitioners, as executors, filed a Federal estate tax return for the estate of the decedent within the time required by law with the collector for the twelfth district of Pennsylvania at Philadelphia.
Decedent was born April 27, 1864. His first wife died in 1930. He remarried on May 29, 1930. His second wife, Cora L. Hofford, was born August 9, 1891, and survived the decedent.
Donald V. Smith, one of the petitioners herein, is the son-in-law of decedent. He was born May 18, 1895. His wife, Helen Hofford Smith, was born in 1898 and was adopted by the decedent in 1900. The couple became engaged in June 1917, at which time Smith was in the insurance business at Indianapolis, Indiana.
During the fall of 1917 decedent repeatedly requested Smith to give up his insurance business and to associate himself in business with the decedent in Pennsylvania, in order that after her marriage to Smith the decedent's adopted daughter could remain near decedent and his first wife. The decedent's business was that of managing W. F. Hofford, Inc., hereinafter sometimes referred to as the Hofford Co., a corporation organized by decedent in 1909 for the purpose of engaging in the business of throwing silk. The entire outstanding capital stock of Hofford Co. consisted of 2,000 shares, all of which prior to December 28, 1937, was owned by decedent. Smith was entirely satisfied with his o business, and refused to comply with these repeated requests of the decedent until the latter part of December 1917, when such compliance was induced by decedent's promise to give Smith a substantial interest in the Hofford Co. as soon as a then existing mortgage on its property was paid off. As a result of decedent's promise, Smith became associated with him in the business of the Hofford Co. on January 1, 1918.
On June 15, 1918, Smith and Helen Hofford were married. Four children were born of this marriage, namely, Donald V. Smith, Jr., on September 20, 1919; Helen H. Smith on September 25, 1922; Samuel E. Smith on March 20, 1931; and Jo Ann Smith on March 23, 1933. This entire family survived the decedent.
The mortgage upon the property of Hofford Co. was paid off in 1919 or 1920 and Smith then asked decedent for the interest in the Hofford Co. which had been promised. Decedent then proposed that, before Smith should be given any such interest, decedent should first be permitted to accumulate $100,000 for himself, and he promised that Smith should then be given a one-half interest in the Hofford Co. This was agreed to by Smith.
About 1921 Smith and the decedent organized the A & H Silk Co., which name was later changed to the Berwick Yarn Mills. About the same time they also organized the Hazleton Silk Co. Smith acquired about five or six percent of the stock of the latter company with money that he had inherited. In 1923 Smith and decedent organized the Vertex Hosiery Mills. In 1923 or 1924 Smith bought a one-third interest in the Carbon Silk Mill Co. and the decedent bought a one-third interest therein. The other one-third interest was owned by one Abrams. Thereafter Smith and decedent organized the H & S Silk Co. and the H S & G Silk Co., with Smith obtaining a one-half interest in the former and a one-third interest in the latter. During the years 1918 to 1930, inclusive, the maximum salary received by Smith from Hofford Co. was $40 per week. He also shared in the profits of all these other ventures.
Smith took the initiative in organizing all of the foregoing companies and was very active in connection with the management of their affairs, having charge of purchases, sales, and financial matters, while decedent looked after manufacturing operations. Similar functions were performed by them, respectively, in connection with the Hofford Co.
The question of performance of decedent's promise to give Smith an interest in the Hofford Co. stock was raised on several occasions during the period prior to 1930, and Smith was induced to acquiesce in decedent's continued delay in such performance as Smith was then deriving a satisfactory income from the various companies in which he and decedent were interested. In 1930, due to decedent's remarriage, Smith requested immediate performance of decedent's promise to give Smith a one-half interest in the Hofford Co. Decedent again sought to postpone the matter, stating that it made no difference whether Smith got the stock at that time, as it was decedent's intention that the Smith family should get the business anyway. Smith however, insisted upon immediate consummation of the proposed gift. This was refused by decedent and such refusal resulted in a severance of their business relations and a strained relationship between their two families.
In 1930 the only active companies of those mentioned above were the Hofford Co., the Hazleton Silk Co., the Vertex Hosiery Mills, and the Carbon Silk Mill Co. Smith withdrew from any participation in the management of the Hofford Co., all the stock of which was still owned by the decedent. At that time the decedent also owned 60 percent of the stock of the Hazleton Silk Co., but that interest was then acquired by Smith and Abrams, so that Smith owned 60 percent of the stock of that company and Abrams 40 percent. At that same time Smith became the owner of all the stock of Vertex Hosiery Mills. There was no change in the ownership of the stock of the Carbon Silk Mill Co.
In 1935 the decedent had an automobile accident while driving. It resulted from a piece of ice dropping off of an ice truck in front of him. The decedent's car was demolished, but the decedent was not seriously hurt. As a result of the automobile accident Cora L. Hofford had a conversation with her husband with regard to what was to happen to her in case he should be killed suddenly, and in this conversation she asked the decedent to provide for her in such a way that she would have a definite income. At that time the decedent's health was very good.
During May 1936 decedent lost a business associate upon whom he had depended for the performance of the functions previously performed by Smith in connection with the management of the Hofford Co. Decedent was considerably upset by this loss, and during the next year and a half he repeatedly proposed that he and Smith should fix things up between them and that Smith should resume his former business association with decedent. Smith refused to do this unless decedent first gave to decedent's daughter and grandchildren the Hofford Co. stock which had been promised, as Smith no longer wanted any of the stock for himself. Decedent finally indicated his willingness to do this if provision could also be made for his wife and if he himself could be properly protected, and decedent asked Smith how this could be accomplished. Smith suggested that Cora L. Hofford could be provided for by a cash outlay or annuity and that decedent could have a life contract of employment with the Hofford Co. providing for the payment of the same salary which he was then receiving, namely, $15,000 per year.
During November 1937 the decedent purchased two single premium annuity contracts, one for himself and one for his wife, for each of which he paid $25,000. The annuity contract now in controversy was issued by the Connecticut Mutual Life Insurance Co. under date of November 24, 1937. It provides for the payment of a life annuity of $98 monthly to Cora L. Hofford, as annuitant, beginning December 19, 1937, and further provides that after the death of the annuitant, if the total of such annuity payments made shall be less than a single premium received, then like payments shall be made to the beneficiary, W. F. Hofford, if he be living; if not, to Harry Spangler, his nephew, until the total amount of the payments shall equal the said single premium. The contract reserves the right in the annuitant to change the beneficiaries at any time. The right to change the beneficiaries was never exercised by the annuitant, Cora L. Hofford, during the lifetime of the decedent.
Decedent and Smith conferred with petitioner's counsel with respect to the proposed gifts of the Hofford Co. stock and the proposed contract of employment between decedent and the Hofford Co. Counsel prepared the six trust agreements in controversy and also the contract of employment, all of which were executed under date of December 28, 1937.
At about the same time that the trust agreements and the contract of employment were prepared counsel also drafted a will for the consideration of the decedent. Decedent did not execute his will until May 31, 1938.
The above mentioned contract of employment between the Hofford Co. (referred to therein as Company) and the decedent (referred to therein as Hofford) recited and provided as follows:
WHEREAS, Hofford is the sole stockholder of Company and for many years has exercised sole management of its affairs; and
WHEREAS, it is the desire of the parties hereto that such management be continued upon the terms and conditions hereinafter set forth:
NOW THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:
1. Company hereby employs Hofford as manager and Hofford hereby accepts said employment for the period of ten (10) years from January 1, 1938, and thereafter until this agreement shall be terminated by Hofford giving Company three (3) months' notice in writing of such intended termination.
2. Unless and until incapacitated by illness or otherwise, Hofford shall control the general management of the business of Company and shall have power, inter alia, to appoint and dismiss all employees, to make all contracts and disbursements upon its behalf, and to do all other acts and things which he may consider necessary or conducive to its interests.
3. Company hereby agrees to pay Hofford and Hofford hereby agrees to accept a salary of Fifteen Thousand ($15,000) Dollars per annum, payable in equal monthly installments during the continuance of this agreement, regardless of whether or not he shall at any time or times be incapacitated by illness or otherwise from performing his duties hereunder.
The above contract of employment between the Hofford Co. and the decedent was ratified by the board of directors of the Hofford Co. on December 28, 1937.
Each of the above mentioned trust agreements of December 28, 1937, provided for an irrevocable assignment and transfer by decedent to William F. Hofford, Donald V. Smith, and the Markle Banking & Trust Co., as trustees, of 200 shares of the capital stock of the Hofford Co. and such other assets as might thereafter be added to the trust. The beneficiaries named in the 6 trusts were, respectively, decedent's daughter, his 4 grandchildren, and Cora L. Hofford. All the beneficiaries were life income beneficiaries except decedent's grandson, Samuel E. Smith, who, in addition to the income from the trust, was to receive one-half of the principal of his trust when he reached the age of 30 years and the other half when he reached the age of 35 years. Upon the death of each life beneficiary and upon the death of Samuel E. Smith before reaching the age of 35 years, the principal of the respective trust was to be held or disposed of for the benefit of decedent's daughter or grandchildren or great-grandchildren, if any. Each of the trusts also provided that the corporate trustee might be removed at any time by written notice signed by the remaining trustees then in office. Paragraph 7 of each trust agreement is identical and provides:
7. All actions of the Trustees hereunder may be determined by the vote of a majority of the Trustees then in office; provided, however, that no stock of W. F. Hofford, Inc. shall be sold or otherwise disposed of during the lifetime of Settlor without his written consent; and provided further that subsequent to the death of Settlor and during the lifetime of Donald V. Smith, no stock of said Company shall be sold or otherwise disposed of without the written consent of the said Smith.
The trusts also provided that in the event all of the grandchildren should die without issue during the lifetime of his daughter, Helen H. Smith, their shares should be added to her trust. Paragraph 2(c) of the trust for decedent's daughter provided:
(c) In the event of the death of said Helen Hofford Smith without issue her surviving, to distribute the principal of said trust in such manner as may be directed in and by her last will and testament.
The stock of the Hofford Co. referred to in each of the trusts was transferred to the trustees on December 28, 1937, upon the creation of the trusts, and an additional 133 1/3 shares of the stock of Hofford Co. were transferred by decedent to each of the trusts on January 8, 1938, the certificates representing such stock being held by Markle Banking & Trust Co. These transfers, including the annuity for decedent's wife, were duly reported in Federal gift tax returns.
Under the above mentioned will executed by the decedent on May 31, 1938, certain provisions respecting the use and disposition of his real estate were made and the balance of his estate was to be held in trust to pay the net income therefrom to his wife, Cora L. Hofford, during her lifetime and, upon her death, the principal was to be divided among the trusts created by the decedent on December 28, 1937, for the benefit of his daughter and grandchildren. Cora L. Hofford was not advised as to the creation of the six trusts dated December 28, 1937, until the death of her husband, the decedent herein.
No funds were distributed to the beneficiaries of the six trusts dated December 28, 1937, between the date of their creation and the date of decedent's death in 1940, the reason being that there were no dividends declared on the stock of the Hofford Co. During the years 1936 to 1940, inclusive, the Hofford Co. filed with the Federal Government corporation income and excess profits tax returns and reported theron net income or loss for each year, together with its earned surplus and undivided profits account as of December 31 of each year, as follows:
+--------------------------------+ ¦ ¦ ¦Earned surplus ¦ +----+-----------+---------------¦ ¦Year¦Net income ¦and undivided ¦ +----+-----------+---------------¦ ¦ ¦or (loss) ¦profits ¦ +----+-----------+---------------¦ ¦1936¦$3,319.81 ¦$138,726.95 ¦ +----+-----------+---------------¦ ¦1937¦2,528.59 ¦140,736.71 ¦ +----+-----------+---------------¦ ¦1938¦19,847.52 ¦152,937.40 ¦ +----+-----------+---------------¦ ¦1939¦6,179.73 ¦158,984.69 ¦ +----+-----------+---------------¦ ¦1940¦(13,626.13)¦114,735.44 ¦ +--------------------------------+
Decedent's purpose in making the aforesaid transfers of the stock of Hofford Co. for the benefit of his daughter and grandchildren was to induce Smith to associate again with him in the management of the business of Hofford Co. and to remove the cause of the strained relationship between their two families, by satisfying Smith's demands for immediate performance of the promises previously made to him by decedent. Decedent's purpose in creating the aforesaid trust for the benefit of Cora L. Hofford and in purchasing the annuity contract in which she was named as annuitant was to make provision for his wife at that time because of the gifts he was making for the benefit of his daughter and grandchildren. Following the execution of those trusts, Smith was elected vice president and director of the Hofford Co., the remaining directors being decedent and A. E. Moat. Smith was voted a salary of $75 per week and during 1938 he received a total salary of $3,750.
During January 1939 Smith resigned from his position as director and vice president of Hofford Co. at the request of the decedent, who thought it advisable for Smith to terminate his official connection with the company because of the trade situation resulting from the bankruptcy of the Vertex Hosiery Mills in March 1938. No salary was received by Smith subsequent to December 31, 1938. During the summer of 1938 decedent also requested Smith to resign as trustee of all of the trusts created by decedent, stating that it was his intention to remove the Markle Banking & trust Co. as trustee and to terminate the trusts and regain ownership of all of the stock and that he had made a mistake in making the trusts irrevocable. Smith refused to resign.
Subsequent to the transfers in controversy, decedent continued to manage the business of Hofford Co. until his death, at which time Smith assumed and has since remained in active charge of its affairs.
During the years 1938 and 1939 decedent's salary of $15,000 per annum provided for by his agreement with the Hofford Co. dated December 28, 1937, was overdrawn by him in the sums of $7,537.50 and $8,200, respectively. These overdrafts were not known to any other officer or director of the Hofford Co., or to any other trustee or any beneficiary of the trusts in controversy, until after decedent's death, at which time the amount of the overdrafts was offset against a larger amount representing certain unpaid advances made by decedent to the Hofford Co. The offset was made with the knowledge and approval of the executors of decedent's estate.
Cora L. Hofford, after the death of the decedent, refused to take under his will and elected to take against it.
Decedent was a large, husky, very robust man, approximately six feet in height, and weighing about two hundred pounds. He was in very good health when the transfers in controversy were made and, with the exception of typhoid fever contracted many years previously, had had no serious illness prior to November or December 1938.
Decedent's hobby was building, in which he was continually engaged, both before and after the transfers in controversy, until shortly prior to his death. In the spring of 1940 he bought a substantial amount of new spinning machinery for the Hofford Co. and within a year of his death had the company's plant painted and its lighting fixtures replaced with fluorescent lights, both supervising and helping in their installation.
Sometime in 1937 decedent made a visit to the office of Dr. Calvin J. Balliet, who had known and resided next door to decedent for a period of thirty years or more. Two more visits were made in January and February of 1938, but Dr. Balliet could not recall the purpose of any of these three visits. During November or December 1938 decedent complained of feeling tired, but made no complaint about his heart. He again consulted Dr. Balliet, at whose suggestion an electrocardiogram was taken in the early part of December 1938, which revealed an impaired heart condition. Decedent was then advised by Dr. Balliet to limit his activities and to be careful and heart medicine was prescribed, which decedent continued to take up until the time of his death. Decedent, however, continued his previous business and other activities and, notwithstanding this, his heart condition improved during 1939. During July and August 1939 decedent was confined to his home for three weeks as a result of heat prostration, but he fully recovered from this attack and resumed his former activities. During July 1940 decedent did not feel well and complained of being tired. He was persuaded by his wife to consult a surgeon, Dr. Robert L. Schaeffer. Decedent then told Dr. Schaeffer that he feared he had a cancer in his abdomen. His condition however, was diagnosed as an aneurysm (i.e., dilatation of the blood vessel) of the thoracic aorta and of the abdominal aorta. It was Dr. Schaeffer'sopinion that decedent had been suffering from this aneurysm for a year and a half prior to August 13, 1940. Dr. Schaeffer also found a tumor about the size of an orange in Decedent's abdomen, but advised against an operation because of decedent's condition. Dr. Schaeffer also found a weakened heart condition and advised decedent to refrain from all physical activity.
Prior to his illness in the summer of 1940 decedent never talked about dying or intimated either by word or action that he contemplated his early death, and in the opinion of his physician, Dr. Balliet, there was no reason to believe that decedent would not live to a ripe old age if he took reasonable care of himself. The transfers by the decedent of the capital stock of the Hofford Co. and the purchase of the annuity contract for the benefit of his wife, Cora L. Hofford, as annuitant, were not transfers made in contemplation of death within the meaning of section 811(c) of the Internal Revenue Code.
At the time of his death decedent was liable as endorser on a demand note of the Lehighton Legion Home Association dated December 18, 1939, in the amount of $571.50, which was held by the First National Bank of Lehighton, Pennsylvania. The money so obtained was used by the association for the purchase of uniforms for its members. It paid some interest on the note, but never paid anything on the principal. On or about September 22, 1941, the bank demanded and received payment of this amount from the decedent's estate. The note was presented to the representatives of the association by counsel for petitioners and payment demanded, but the association had no money and the note was uncollectible. On the Federal estate tax return filed by the executors of the estate of decedent the above mentioned amount of $571.50 was claimed as a debt of decedent on schedule K of the return, and it was disallowed by the respondent in the determination of the deficiency on the ground that there was an absence of proof that the debt was contracted for adequate and full consideration in money or money's worth. This note in the amount of $571.50 was contracted for an adequate and full consideration in money or money's worth and is deductible from the decedent's gross estate under the provisions of section 812(b)(3) of the Internal Revenue Code.
OPINION.
BLACK, Judge:
As set out in our opening statement, the principal issue left for our consideration is whether the transfers by the decedent of the capital stock of Hofford Co. and the purchase of the annuity contract for the benefit of his wife were transfers includible in the decedent's gross estate under section 811(c) of the Internal Revenue Code. The material provisions of this section are set forth in the margin.
Under these provisions any transfer made by a decedent during his lifetime is includible in his gross estate if it falls within any one of the three classifications specified, namely, (1) transfers made in contemplation of death; (2) transfers made with the intention of taking effect in possession or enjoyment at or after the death of the decedent; or (3) transfers made where the decedent retained for his life or other designated period the possession or enjoyment of, or the right to the income from, the property transferred. Do the transfers in question fall within any one of these three classifications?
SEC. 811. GROSS ESTATE.The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated, except real property situated outside of the United States—(c) TRANSFERS IN CONTEMPLATION OF, OR TAKING EFFECT AT DEATH.— To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, or of which he has at any time made a transfer, by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact and before his death (1) the possession or enjoyment of, or the right to the income from, the property, or * * * except in a case of bona fide sale for an adequate and full consideration in money or money's worth.
We shall first consider whether the transfers in question, including the annuity contract payable to decedent's wife, were made in contemplation of death. The leading case on the meaning of the words ‘in contemplation of death‘ is United States v. Wells, 283 U.S. 102. Under this decision it is the ‘dominant motive of the donor in the light of his bodily and mental condition‘ that controls. The question is one of ultimate fact, arrived at after carefully scrutinizing all the circumstances. These circumstances or evidentiary facts are set out in our findings. We think they show that the decedent's dominant motive in making the transfers in trust for the benefit of his daughter and grandchildren was to induce Smith to associate again with him in the management of the business of Hofford Co. and to remove the cause of the strained relationship between the two families by satisfying Smith's demands for immediate performance of the promises previously made to him by the decedent; and that the decedent's dominant motive in making the transfer in trust for the benefit of his wife and in purchasing the annuity contract for her was to make some provision for his wife at that time because of the gifts he was then making for the benefit of his daughter and grandchildren. At the time this annuity was purchased and the transfers were made the decedent's health was very good. He had always enjoyed good health until about a year and a half before his death. At the time of the gifts in question he was actually engaged in managing the Hofford Co. Due to the resignation of a valuable employee, the decedent was very anxious to secure again the services of Smith. He saw he could not do this unless he made the transfers in question, so he made them. These were matters associated with life rather than with death. Under such circumstances it can not truthfully be said that the gifts in question were testamentary in character. The respondent places considerable emphasis on the circumstance that the lawyer who drew up the trust instruments also at the same time drafted a will for the decedent's consideration. In a different setting such a circumstance might weigh heavily on the side of showing a testamentary frame of mind on the part of the donor. Cf. Igleheart v. Commissioner, 77 Fed.(2d) 704; Purvin v. Commissioner, 96 Fed.(2d) 929; certiorari denied, 305 U.S. 626. In the instant proceeding we do not think the drafting of the proposed will for consideration at the time the other instruments were executed carries the weight contended for by the respondent. The decedent did not execute his will until May 31, 1938, which was more than five months after the trust agreements were executed. We think the desire of the decedent to secure the services of Smith and to bring the two families closer together, coupled wit the decedent's good health, are circumstances which outweigh the mere drafting of the will for decedent's consideration. Cf. Colorado National Bank of Denver v. Commissioner, 305 U.S. 23; Real Estate Land Title & Trust Co. v. McCaughn, 79 Fed.(2d) 602.
The respondent has requested us to find as a fact that the transfers of the stock of the Hofford Co. to the trusts were to prevent decedent's second wife from obtaining control of the Hofford Co. should she survive er husband and take against his will. We have not made this requested finding for the reason that we do not think the evidence shows such to be a fact.
For the reasons above given, we hold that the transfers in question were not made in contemplation of death.
We shall next consider whether the transfers in question, including the annuity contract payable to decedent's wife, fall within either of the above mentioned classifications (2) or (3), or both. The respondent contends that the circumstances in Estate of Pamelia D. Holland, 47 B.T.A. 807, and 1 T.C. 564, are ‘quite similar to those involved in the instant case‘ and that in any event the transfers, including the annuity, are includible in the decedent's gross estate within the doctrine of Helvering v. Hallock, 309 U.S. 106, on the ground that the decedent had some kind of a remainder interest in the annuity contract and a possibility or reverter in the trusts. It is our opinion that the stock transfers are not includible in the decedent's gross estate within the doctrine of the Hallock case. The possibility that any of those transfers in trust would ever revert to the decedent or to his estate, assuming that they were complete when made, is so remote as to make that doctrine inapplicable. See Commissioner v. Kellogg, 119 Fed.(2d) 54; Lloyd v. Commissioner, 141 Fed.(2d) 758.
We do not mean to say, however, that the stock transfers may not be includible in the decedent's gross estate under some other doctrine. In Estate of Pamelia D. Holland, supra, the decedent and her husband on June 24, 1920, entered into a contract with their five children wherein the parents ‘sold‘ to the children for a nominal consideration of one dollar all the stock of a corporation. The contract further provided that the father was to be paid a salary of $25,000 per year for as long as he should live and, should he predecease his wife, then she was to be paid a similar salary for as long as she lived. The father did predecease the mother and, in holding that the stock so ‘sold‘ was includible in the mother's gross estate when she died to the extent of her interest therein, we said in part:
True, this payment was denominated ‘salary‘ and was not specified as company profits or dividends on the shares. But no services were or could be required in exchange. And at petitioner's request, we have found the value of the company's capital and surplus at that time to have been $125,000. The annual payment would thus approximate a return of 20 percent on the investment. In the absence of evidence of prior earnings in excess of that figure, and there is none, we can not regard it as reasonable that the parties would expect the property to produce a higher average return. * * * Hence, without yielding completely to terminology, and viewing the transaction in its essential reality, the income to be expected from the stock was in effect retained by decedent during her life. * * *
Although our ultimate decision in the Holland case was grounded upon the doctrine of the Hallock case rather than the retention of income theory, this was so, in part at least, because of the fact that the transfers in the Holland case occurred in 1920, which was prior to the adoption of the Joint Resolution of Congress on March 3, 1931, and so the retention of income theory could not prevail in the fact of May v. Heiner, 281 U.S. 238; Hassett v. Welch, 303 U.S. 303; and Estate of Edward E. Bradley, 1 T.C. 518; affirmed by the United States Circuit Court of Appeals for the Second Circuit under mandate dated January 31, 1944. The stock transfers in the instant proceeding occurred after March 3, 1931, and are therefore not controlled by the last cited cases.
The decedent in the instant case was to be paid a salary by the Hofford Co. of $15,000 per year, ‘regardless of whether or not he shall at any time or times be incapacitated by illness or otherwise from performing his duties ‘ under the agreement of December 28, 1937. This salary was to continue as long as the decedent lived, unless he himself terminated the agreement which he did not do. As we understand this agreement, if in the next year after its execution decedent had become incapacitated by illness and had remained an invalid for several years, he would have continued to draw his salary of $15,000 per annum. The parties have stipulated that the 2,000 shares of stock in question had a value of $75 per share on the date of decedent's death. The salary represented a 10 percent return on such a valuation. Although Hofford Co. earned a net income after deducting the salary paid the decedent in the years 1938 and 1939, it sustained a loss of over $13,000 in 1940. It paid no dividends between the date of the transfers and the date of the decedent's death. The decedent under the contract of employment was to exercise the sole management of the corporation's affairs. The trust agreements all provided ‘that no stock of W. F. Hofford, Inc., shall be sold or otherwise disposed of during the lifetime of Settlor without his written consent.‘ We think all of these circumstances when taken together fall within the ambit of Estate of Pamelia D. Holland, supra, and require us to hold that the stock transfers fall within the meaning of the above mentioned classifications (2) and (3), and the stock is includible in the decedent's gross estate. The value at which the stock is to be so included is $150,000.
Regarding the annuity, the insurance company, for a cash premium of $25,000 paid by the decedent, agreed to pay a life annuity of $98 monthly to Cora L. Hofford, the annuitant, beginning on December 19, 1937. The payment of this annuity to Cora L. Hofford is unconditional so long as she may live. The annuity agreement also provides:
The Company also agrees that if the total of such annuity payments shall be less than the single premium received, then, after the death of the Annuitant, like payments shall be made until the total amount of all payments shall equal the said single premium (the final payment not to exceed the then unpaid remainder of said single premium), such remaining payments to be made to the beneficiary, William F. Hofford, husband of the Annuitant, if he be living, if not, to Harry Spangler, nephew of said William F. Hofford, if he be living (subject to the rights of the Annuitant as hereinafter reserved to change any beneficiary.)
Change of Beneficiary. Subject to the rights of his assignee, if any, the Annuitant may at any time change any beneficiary by filing written notice thereof at the Home Office of the Company on its form therefor, accompanied by the contract for suitable endorsement by the Company, such change, when so endorsed, to the effective as of the date of execution of such notice by the Annuitant.
The respondent determined and contends that the entire cost of the annuity in the amount of $25,000 is includible in the decedent's gross estate within the purview of section 811(c), supra. We have already held that the purchase of this annuity by the decedent was not made in contemplation of death. The annuity took full effect at once and was not conditioned in any way upon the decedent's death. The only possible interest in this annuity retained by the decedent was that if the annuitant should die before decedent, without having received a total amount equal to $25,000 and without having changed the beneficiary, then the decedent would receive $98 monthly until the total amounts paid the annuitant and the decedent equaled $25,000.
As we have already stated, respondent contends in the first place that this $25,000 which decedent expended in the purchase of an annuity for his wife was a gift made in contemplation of death, was testamentary in character, and, therefore, should be included in decedent's estate. Of course, if we had sustained respondent's contention in this respect the $25,000 would be included as part of decedent's estate. But, for reasons already stated, we have rejected that contention. Respondent submits in the next place, if we reject his contention that the transfers, including the purchase of the annuity, were made in contemplation of death, that the $25,000 expended in the purchase of the annuity by decedent should nevertheless be included in his estate because it was intended ‘to take effect in possession or enjoyment at or after death within the doctrine of Helvering v. Hallock, 309 U.S. 106.‘ We do not think this contention can be sustained. In the group of cases decided on the same day by the Supreme Court of which the Hallock case was one, the Court pointed out that ‘All involve dispositions of property by way of trust in which the settlement provides for return or reversion of the corpus to the donor upon a contingency terminable at his death.
In the instant case there was no transfer in trust by decedent of the $25,000 which he used to purchase an annuity for his wife. He purchased the annuity and gave it to her outright and returned the full $25,000 for gift tax purposes on his gift tax return for 1937. At her attained age when the annuity was purchased, she had a life expectancy of 23.81 years. If she lives out this life expectancy, the annuity will not only exhaust the interest, but the principal of the fund. Decedent had no interest in the annuity contract unless Cora L. Hofford should die before the total aggregate payments to her amounted to $25,000, which was the amount of the single premium which had been paid for the policy. At decedent's death Cora was still living and drawing the annuity provided by the contract and there is no reason to expect that she will not live out the full measure of her expectancy based upon the American Annuitants Mortality Table, which was used in the writing of the contract. Her interest in the annuity was not enlarged in any manner whatsoever by reason of decedent's death.
The situation in the instant case is entirely unlike that which was present in Estate of William Walker, 4 T.C. 390. In the latter case the income beneficiaries for life of an inter vivos trust which decedent had in a prior year executed were his two grandsons. Upon the death of both of them without issue or the execution of a limited power of appointment, the corpus of the trust was to revert to the settlor, William Walker, or was to go to whomever he might designate by will. In his determination of a deficiency in estate tax in that case the Commissioner recognized that the gift of the life estates to the settlor's two grandsons was irrevocable and complete, and he computed the value of the two life estates and subtracted that value from the total value of the corpus and included in decedent's gross estate only the remainder, which was $30,624.95. We sustained the Commissioner in including this remainder interest in decedent's gross estate under the principle of Helvering v. Hallock, supra.
Manifestly applying the same rationale, nothing is to be included in the instant case in decedent's gross estate on account of any remainder interest which decedent possessed in the annuity policy which he gave his wife. Cora L. Hofford was not only the income recipient of the annuity policy, but also the recipient from year to year of part of the principal, and at the end of her life expectancy nothing will be left for anyone, either principal or interest. Therefore, when the value of the life estate of Cora L. Hofford in the annuity policy is deducted, there is no remainder to be included in decedent's estate. Thus in this very important respect the instant case is entirely different from Estate of William Walker, supra. It should also be remembered, in considering whether anything should be included in decedent's estate on account of this purchase of annuity for his wife at a cost of $25,000, that decedent had no power whatever to impair or diminish Cora L. Hofford's interest in the annuity. Under the terms of the annuity policy she had the power at any time she chose to remove decedent as the beneficiary of the remainder interest should she die before the collection of the full $25,000 and to substitute another beneficiary, but he had no power to alter or change her interest. That was irrevocably fixed when the annuity policy was written. Therefore, because of the foregoing reasons, we reject the respondent's contention that the $25,000 expended in 1937 by decedent in the purchase of his wife's annuity should be included in his gross estate under section 811(c) because of Helvering v. Hallock, supra.
Did the respondent err in disallowing $571.50 claimed as one of the ‘Debts of Decedent‘ in schedule K of the estate tax return? The applicable statute is section 812(b)(3) of the Internal Revenue Code.
In his deficiency notice the respondent disallowed the item, ‘in the absence of proof that it was contracted for adequate and full consideration in money or money's worth.‘ It is not necessary that the consideration referred to in the statute be received by the decedent. Porter v. Commissioner, 60 Fed.(2d) 673; Dodge v. Gagne, 23 Fed.Supp. 729; Old Colony Trust Co., Executor, 39 B.T.A. 871, 879. In the instant proceeding the decedent endorsed a note for the Lehighton Legion Home Association. The money received by the latter was used to buy uniforms for its members. The association was clearly debtor for borrowed money on the note which it executed. The testimony is that the association paid some interest on the note to the bank, but never paid anything on the principal. There is no evidence that the decedent intended any gift to the association by his accomodation endorsement and there is no reason to suppose that he intended any gift. After the decedent's executors paid the note, they made a demand on the association for repayment, but it was without funds and the note was then uncollectible. We hold that the respondent erred in disallowing the item as a deduction from the gross estate under section 812(b)(3), supra. Old Colony Trust Co., Executor, supra.
SEC. 812. NET ESTATE.For the purpose of the tax the value of the net estate shall be determined, in the case of a citizen or resident of the United States by deducting from the value of the gross estate—(b) EXPENSES, LOSSES, INDEBTEDNESS AND TAXES.— Such amounts—(3) for claims against the estate,* * * The deduction herein allowed in the case of claims against the estate, unpaid mortgages, or any indebtedness shall, when founded upon a promise or agreement, be limited to the extent that they were contracted bona fide and for an adequate and full consideration in money or money's worth.
Decision will be entered under Rule 50.