Opinion
Docket Nos. 2304 2305.
1945-09-28
MORRIS EISENBERG, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.HERMAN SCHAEFFER, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Robert Ash, Esq., for the petitioners. Myron S. Winer, Esq., for the respondent.
Petitioners in 1937 organized, by oral agreement, a partnership to engage in the business of selling household goods and furniture at retail under the trade name of Bailey's Furniture Co. On December 30, 1939, they reduced their partnership agreement to writing. January 2, 1940, they conveyed in trust to themselves as trustees one-half of their respective interests in the partnership for their minor children. The next day, January 3, 1940, they entered into an agreement with themselves as individuals and as trustees of the several trusts to make the trusts members of the partnership of Bailey's Furniture Co. Held, that each grantor-petitioner retained such dominion and control over the corpus and income of the trusts which they created by the trusts and partnership agreements as to render them respectively taxable on the income thereunder under section 22(a), I.R.C., as construed in Helvering v. Clifford, 309 U.S. 331; held, further, that the trust indentures as written January 2, 1940, which were in force and effect during the two taxable years before us, 1940 and 1941, must control the tax liability of petitioners for those two years and not as the trust indentures were reformed and approved by a decree of a state court dated in May 1943. Robert Ash, Esq., for the petitioners. Myron S. Winer, Esq., for the respondent.
These cases, which have been consolidated, involve deficiencies in income tax for the calendar years 1940 and 1941 as follows:
+-------------------------------------+ ¦Taxpayer ¦1940 ¦1941 ¦ +----------------+---------+----------¦ ¦Morris Eisenberg¦$6,671.58¦$18,891.32¦ +----------------+---------+----------¦ ¦Herman Schaeffer¦6,540.51 ¦18,936.08 ¦ +-------------------------------------+
The deficiencies result principally from the addition to income of each petitioner, by respondent, of certain sums representing income from the partnership of Bailey's Furniture Co. during the respective taxable years.
Other adjustments made by the Commissioner are not contested. The adjustment complained of is explained in each deficiency notice as follows:
(a) Additional taxable income from the partnership of Eisenberg and Schaeffer, t/n Bailey's Furniture Company. It is held that 50 per cent of the net income of the partnership is taxable in your return.
Each petitioner by appropriate assignments of error contests the correctness of the foregoing determination of the Commissioner.
FINDINGS OF FACT.
The petitioners, Morris Eisenberg and Herman Schaeffer, are individuals residing in Philadelphia, Pennsylvania. They filed Federal income tax returns for the calendar years 1940 and 1941 with the collector for the first collection district of Pennsylvania at Philadelphia, Pennsylvania. By an oral agreement made on January 1, 1937, Eisenberg and Schaeffer entered into a partnership for the retail selling of furniture, household goods, and general merchandise under the trade name of Bailey's Furniture Co.
Petitioner Herman Schaeffer sometimes in 1930 opened four separate accounts with the Philadelphia Savings Society for each of his four children, respectively, in his name as trustee. There was no written instrument of trust in connection with the deposits in these accounts. All of the funds in the account in trust for Raymond Schaeffer, amounting to $6,006.78, were withdrawn by petitioner on July 30, 1937. All of the funds in the account in trust for Toby Schaeffer, amounting to $6,055.99, were withdrawn by petitioner on January 12, 1938. Funds in the account in trust for Harold Schaeffer, in the amount of $6,246.15, were withdrawn by petitioner on April 18, 1939. Funds in the account in trust for Alfred D. Schaeffer were withdrawn by petitioner Schaeffer as follows: $1,000 on June 10, 1938, and $2,327.15 on November 10, 1938, together with an additional amount of $57.62. The funds were withdrawn from the above accounts and were used in the business of Bailey's Furniture Co.
Written articles of copartnership agreement were executed between Eisenberg and Schaeffer on December 30, 1939. The pertinent provisions thereof are:
Whereas by oral agreement heretofore made on January 1, 1937, Morris Eisenberg, 1108 Medary Avenue, hereinafter referred to as ‘EISENBERG‘, and Herman Schaeffer, 7047 McCallum Street, hereinafter referred to as ‘SCHAEFFER‘, both of the City of Philadelphia, State of Pennsylvania, entered into a co-partnership for the retail selling of furniture, household goods, and general merchandise under the trade name of Bailey's Furniture Company at 635 Market Street, aforesaid City and State and
Whereas, it is the desire of the aforementioned parties to reduce to writing said co-partnership agreement
NOW THEREFORE THIS AGREEMENT WITNESSETH
1. That the said parties hereto hereby agree to associate themselves under these Articles of Co-Partnership for the conduct and operation of the business of retail selling of furniture, household goods, and general merchandise under the firm name of Bailey's Furniture Company at 635 Market Street, aforesaid City and State, which said co-partnership shall begin on the date hereof and continue during and for the full term of one year next ensuing; it being further agreed that unless either party hereto shall at least ninety days prior to the expiration of said term give to the other written notice of his intention to withdraw from said copartnership said co-partnership shall be renewed and continued in full force and effect for a further period of one year and so on from year to year until terminated by proper notice in writing as aforesaid.
2. And to that end and purpose the said EISENBERG and SCHAEFFER agree to contribute the entire stock of merchandise, fixtures, leases, insurance policies, good will, bank accounts, notes, bills, accounts receivable, cash on hand and in bank, and all and any other assets presently connected with or related to the business being presently conducted and operated under the trade name of Bailey's Furniture Company as hereinbefore referred to and as appears by reference to the books and records maintained by said co-partnership; their respective capital investments shall be considered the sum of $60,000.00 each, and all of which said assets as aforesaid shall be used, laid out, and employed between them, the parties to this agreement, for and in the management of said joint business to their general and mutual advantage.
4. There shall be kept during the continuance of this co-partnership a correct book of accounts wherein shall be entered all items of receipts and disbursements and each of the parties hereto may at any and all times have uninterrupted access thereto. Once a year or oftener, if the said parties hereto unanimously agree in writing, there may be made an account of all items of receipts and disbursements of assets and liabilities and a share of the profits, if any, may be paid to each of the parties hereto respectively only if and when the said parties hereto determine and order the payment of same in writing.
5. All monies received by any of the parties hereto and in the course of the co-partnership business shall be deposited in a bank account to be maintained in the names of Morris Eisenberg and Herman Schaeffer in a safe and reputable bank to be determined by the parties hereto and all payments shall be made by cash and/or check drawn against the said bank account and all checks so drawn shall be signed by either of the parties hereto.
8. It is hereby agreed by and between the parties hereto that the said Morris Eisenberg and Herman Schaeffer for and in consideration of the services to be rendered by them to the co-partnership herein for the year 1940 shall each receive and be entitled to draw the sum of $7800.00 as wages during the said year and shall be entitled to draw such sum or sums for the succeeding years as the parties hereto may agree upon in writing on or before the first day of January of any succeeding year. It is distinctly understood by and between the parties hereto that such drawings provided herein shall be paid out of gross receipts and shall be considered upon the books of said co-partnership as expense and shall not be chargeable to the capital investment of the said Morris Eisenberg and Herman Schaeffer.
9. At the termination of this co-partnership, the parties hereto shall render a true and final account of all assets and liabilities and after the payment of all debts and the adjustment of the respective capital accounts, the balance remaining shall be paid and divided equally between them, share and share alike. Each of the parties hereto shall be entitled to and shall receive an equal one-half share of the profits and all losses shall be borne in the same proportion.
By written instruments dated January 2, 1940, Morris Eisenberg created three separate irrevocable trusts for the benefit of his three children, Leon, Estelle, and Libby, in which he was named trustee, and to himself as trustee of each of the trusts there was transferred a percentage of his interest in the business of Morris Eisenberg and Herman Schaeffer individually and copartners trading as Bailey's Furniture Co., as follows:
+-------------------------------------------+ ¦ ¦Percentage of Morris ¦ +-----------------+-------------------------¦ ¦ ¦Eisenberg's interest in ¦ +-----------------+-------------------------¦ ¦Trust ¦Bailey's Furniture Co. ¦ +-----------------+-------------------------¦ ¦Leon Eisenberg ¦20% ¦ +-----------------+-------------------------¦ ¦Estelle Eisenberg¦15% ¦ +-----------------+-------------------------¦ ¦Libby Eisenberg ¦15% ¦ +-------------------------------------------+
By written instruments dated January 2, 1940, Herman Schaeffer created four separate irrevocable trusts for the benefit of his four children, Alfred, Harold, Toby, and Raymond, in which he was named trustee, and to himself as trustee of each of the trusts there was transferred a percentage of his interest in the business of Bailey's Furniture Co., as follows:
+---------------------------------+ ¦ ¦Percentage of Herman ¦ +-------+-------------------------¦ ¦ ¦Schaeffer's interest in ¦ +-------+-------------------------¦ ¦Trust ¦Bailey's Furniture Co. ¦ +-------+-------------------------¦ ¦Alfred ¦14% ¦ +-------+-------------------------¦ ¦Harold ¦14% ¦ +-------+-------------------------¦ ¦Toby ¦8% ¦ +-------+-------------------------¦ ¦Raymond¦14% ¦ +---------------------------------+
As of January 2, 1940, the children of Morris Eisenberg and Herman Schaeffer were of the following ages:
+---------------------------+ ¦Leon Eisenberg ¦17 years¦ +------------------+--------¦ ¦Estelle Eisenberg ¦10 years¦ +------------------+--------¦ ¦Libby Eisenberg ¦9 years ¦ +------------------+--------¦ ¦Alfred Schaeffer ¦9 years ¦ +------------------+--------¦ ¦Harold Schaeffer ¦12 years¦ +------------------+--------¦ ¦Toby Schaeffer ¦16 years¦ +------------------+--------¦ ¦Raymond Schaeffer ¦18 years¦ +---------------------------+
Each of the irrevocable trusts created by Morris Eisenberg and Herman Schaeffer, as aforesaid, were identical in every respect other than name and percentages of interests in Bailey's Furniture Co. In the deed of trust from Morris Eisenberg to himself as trustee for Leon Eisenberg it was provided, among other things, as follows:
That the said SETTLOR in consideration of his love and affection for his son, Leon Eisenberg, 1108 Medary Avenue, aforesaid City and State, hereinafter referred to as Cestui Que Trust, and in consideration of his desire to provide and secure for him proper maintenance, support and security, and in further consideration of the sum of One ($1.00) Dollar and of other valuable consideration to him in hand paid at the signing hereof, the receipt whereof is hereby acknowledged, does hereby assign, transfer, set over, grant and convey unto the said TRUSTEE twenty (20) per centum of all that certain interest which the said SETTLOR owns and is seized of in the business of Morris Eisenberg and Herman Schaeffer individually and co-partners trading as Bailey's Furniture Company, 635 Market Street, aforesaid City and State.
TO HAVE AND TO HOLD the said interest so granted, transferred and assigned as aforesaid to the TRUSTEE, his successors or successor forever upon the trusts, IN TRUST NEVERTHELESS FOR THE FOLLOWING USES AND PURPOSES:
1. That the said TRUSTEE shall keep, hold and retain the said trust fund, and shall collect and receive the income and profits derived of and accumulated therefrom for the sole use and benefit of the said Leon Eisenberg, the said Cestui Que Trust, until the latter shall attain the age of forty years, upon the happening of which event, the said trust fund as aforesaid, less the Proper charges and expenses, shall be transferred, assigned and paid over to the said Cestui Que Trust absolutely; that simultaneously therewith the said Leon Eisenberg may be admitted if he so expresses his intention in writing to the business of the said Bailey's Furniture Company, to the extent of the interest evidenced by the amount thereof, and which sum is to be considered his capital investment therein.
2. And it is further agreed by and between the SETTLOR and TRUSTEE that the said Cestui Que Trust must within one year prior to reaching the age of thirty or forty years, whichever the case may be, give notice in writing of his intention to either be admitted to the partnership or of his desire to refuse admission to the partnership of Bailey's Furniture Company, in either event the partners or the surviving partner of said Bailey's Furniture Company shall have the exclusive right and option to determine whether or not to admit the said Cestui Que Trust to the partnership. The said partners or surviving partner shall within one year prior to the Cestui Que Trust reaching the age of thirty or forty years, whichever the case may be, give notice in writing of their or his intention to admit or refuse admittance of the said Cestui Que Trust to said co-partnership; if refused admission, then the said Cestui Que Trust shall be paid the trust fund herein created over a period of one year, in four equal installments with six per cent interest on the unpaid balance, same to be calculated as of the date the said Cestui Que Trust arrives at the age of either thirty or forty years as the case may be. If the Cestui Que Trust refuses admission to the partnership when his admission is acceptable to the partners or surviving partner, such Cestui Que Trust shall be paid his interest over a period of five years in equal installments every three months, with six per cent interest on the unpaid balance.
3. In the event the Cestui Que Trust arrives at the age when he is entitled to receive the fund herein created and the said Cestui Que Trust does not wish to become a partner of the said Bailey's Furniture Company but wishes his said interest therein to remain and be inactive, he shall receive the income from the said interest from the earnings in the same proportion as his interest bears to the whole of the partnership fund, said income shall be payable every three months, provided same is agreeable to the partners or surviving partner.
4. The said TRUSTEE is hereby authorized, and may in the exercise of his sole discretion, expend for or pay to the said Cestui Que Trust any part of the trust fund, principal or income prior to the latter's attaining the age of forty years.
5. Upon the death of the said Cestui Que Trust before he attains the age of forty years, the trust fund accumulated as aforesaid, shall be divided into as many parts or shares as there are children of the said Cestui Que Trust living at the time of the latter's death, and said trust fund shall continue to be the subject matter of the trust herein created, and the said TRUSTEE shall keep, hold and retain the said trust fund and shall collect and receive the income and profits derived and accumulated therefrom, for the use and benefit of the said children of deceased Cestui Que Trust until such time as the latter would have attained the age of forty years if alive, and upon the happening of which event, the said trust fund as aforesaid, less the proper charges and expenses, shall be transferred, assigned and paid over to the said children under the same terms and conditions as set forth in Paragraph No. 1 hereof.
In the event the said Cestui Que Trust dies unmarried, or married and without issue, the principal of the trust fund shall then fall into and become a part of the respective trust funds established by the said SETTLOR in an Agreement and/or Deed of Trust bearing even date herewith, with the TRUSTEE herein, in behalf of Estelle Eisenberg and Libby Eisenberg.
6. The TRUSTEE may without liability, invest, reinvest and keep invested the principal of the trust in such investment as said TRUSTEE may deem prudent, without being confined to such as are usually termed ‘legal investments;‘ with full power and authority to purchase investments as aforesaid at a premium and, in his discretion, to deduct all or any part of such premium from income.
7. The TRUSTEE may exercise any right to subscribe for stocks or bonds or other allotments received by reason of investments held in the trust, or may sell such right for such price as to him may seem best.
8. The TRUSTEE is hereby authorized and empowered to join in, or become a party to any agreement, reorganization, merger, readjustment or foreclosure proceeding; likewise to pledge any of the trust funds herein established and accumulated, irrespective of what said funds consist of, as collateral security for a loan or loans, or for the use in the management and operation of said Bailey's Furniture Company.
14. In the event of the death of the TRUSTEE herein named, FANNIE EISENBERG, wife of SETTLOR, and mother of the said Cestui Que Trust, is hereby declared Substituted Trustee under the same terms, conditions and powers as herein created, except that wherever herein the figure and/or word ‘forty‘ relating to the age of the said Cestui Que Trust appears, it should be changed to read ‘thirty‘; it being the express intention of the said SETTLOR that in the event of the death of the original TRUSTEE as aforesaid, that the said trust herein created shall be terminated as herein provided when the said Cestui Que Trust attains the age of thirty years.
15. The SETTLOR hereby expressly waives the right to revoke, cancel and annul this indenture in trust hereby created, and declares this to be a Deed of Trust irrevocable.
Under date of January 3, 1940, Morris Eisenberg, Herman Schaeffer, Morris Eisenberg as trustee for Estelle Eisenberg, Libby Eisenberg, and Leon Eisenberg, and Herman Schaeffer, as trustee for Raymond Schaeffer, Alfred Schaeffer, Toby Schaeffer, and Harold Schaeffer, executed an ‘ADDENDA TO (their) ARTICLES OF COPARTNERSHIP AGREEMENT‘ dated December 30, 1939. After reciting that the various trusts were made by each partner with the knowledge and consent of the other, the ‘addenda‘ provided as follows:
Whereas it is the intention of the said Morris Eisenberg and Herman Schaeffer, both as co-partners and as Settlors and Trustees, that the said co-partnership agreement heretofore executed on the 30th day of December, 1939, be the only agreement relating to the co-partnership of the parties.
NOW THEREFORE it is agreed that the said agreement heretofore executed on the 30th day of December, 1939, and referred to as articles of co-partnership agreement herein, shall be construed in all of the terms to include all of the trust interest as parties to the said agreement. And it is distinctly understood and agreed that all of the terms contained and provided for in the said articles of co-partnership shall be binding upon the Settlors, Trustees, Co-partners and Cestuis Que Trust mentioned herein.
As of January 1, 1940, capital accounts were set up on the books of Bailey's Furniture Co. for each of said trusts in which was reflected the assignment to the trusts of 50 percent of the net worth of Morris Eisenberg and of Herman Schaeffer in Bailey's Furniture Co.
The bank with which the firm did business was furnished a copy of the financial statements showing the trusts' interests in the business. In addition, a fictitious name certificate was filed with the proper state authorities.
No distributions of either income or corpus were made by Herman Schaeffer or Morris Eisenberg as partners or as trustees to the trusts during the taxable years except for the payment of income taxes in behalf of the trusts.
Federal income tax returns for the calendar years 1940 and 1941 were filed by Morris Eisenberg as trustee and Herman Schaeffer as trustee on behalf of the respective trusts created for the benefit of their children as aforesaid, in which was reported the income of Bailey's Furniture Co. which was credited to the respective capital accounts of the trusts on the books of Bailey's Furniture Co. Partnership returns were filed by the Bailey's Furniture Co. for the calendar years 1940 and 1941, in which was reported net income of $84,366.24 and $139,909.44, respectively.
During the years 1940 and 1941 no services were rendered by any of the children of Morris Eisenberg and Herman Schaeffer for Bailey's Furniture Co., except services rendered by Raymond Schaeffer during the period from June 1941 to December 31, 1941, for which services he received a compensation from the business of $40 per week.
As of January 1, 1940, there was transferred on the books of Bailey's Furniture Co. to the trusts created by Herman Schaeffer from the capital account of said Herman Schaeffer the amount of $30,000 as follows:
+-------------------------------------------------+ ¦Trust for the benefit of Raymond Schaeffer¦$8,400¦ +------------------------------------------+------¦ ¦Trust for the benefit of Toby Schaeffer ¦4,800 ¦ +------------------------------------------+------¦ ¦Trust for the benefit of Harold Schaeffer ¦8,400 ¦ +------------------------------------------+------¦ ¦Trust for the benefit of Alfred Schaeffer ¦8,400 ¦ +------------------------------------------+------¦ ¦Total ¦30,000¦ +-------------------------------------------------+
As of January 1, 1940, there was transferred from the account of Morris Eisenberg on the books of Bailey's Furniture Co. to capital accounts in the name of the respective trusts for the benefit of his children the amount of $30,000 as follows:
+-------------------------------------------------+ ¦Trust for the benefit of Estelle Eisenberg¦$9,000¦ +------------------------------------------+------¦ ¦Trust for the benefit of Leon Eisenberg ¦12,000¦ +------------------------------------------+------¦ ¦Trust for the benefit of Libby Eisenberg ¦9,000 ¦ +------------------------------------------+------¦ ¦Total ¦30,000¦ +-------------------------------------------------+
Federal gift tax returns were filed by Herman Schaeffer and Morris Eisenberg, in which were reported the gifts in trust for the benefit of the children made as aforesaid.
In August or September 1942 Raymond Schaeffer, then 21, contemplated becoming engaged to be married and, wondering if he was financially able to do so, consulted his father with reference to a statement his father had purportedly made sometime in 1939, that the latter was going to give him an interest in the partnership business. At that time he was ready to go into the Army. The father said that he could not get financial assistance from such gift at that time. Raymond Schaeffer thereupon consulted a lawyer. He was told by the lawyer to bring the trust agreement to him for inspection and also to bring his father and Eisenberg with him. A conference was held in the lawyer's office, with Herman Schaeffer and Morris Eisenberg president, as a result of which the lawyer recommended a suit to reform the original trust agreements.
In the June term of 1942 Raymond Schaeffer filed a bill in equity in the Common Pleas Court of Philadelphia County against his father, Herman Schaeffer, as trustee, seeking a reformation of the declaration of trust which had been executed in his behalf. In the bill he alleged in substance that Herman Schaeffer and Morris Eisenberg, partners, had a one-half interest each in Bailey's Furniture Store; that shortly after January 1, 1940, Herman Schaeffer entered into an oral agreement with him as follows: That defendant agreed to make a gift of 14 percent of his one-half interest in the partnership to plaintiff; that income and profits from this interest would belong to plaintiff and be set aside for his sole benefit and use; that during the life of plaintiff or when he arrived at 40 years of age he, with the consent of defendant's partner, would be entitled to be admitted into the partnership business; and that the agreement would be reduced to writing in the form of a declaration of trust and a trustee appointed who would be authorized to collect and receive the income. He further alleged that the declaration of trust was made on January 2, 1940; that the declaration did not carry out the intent of the settlor nor the agreement between defendant and plaintiff, for the reason as alleged that the written trust agreement conveying 14 percent of the partnership interest to plaintiff failed to provide procedure for the collection of income; that the settlor, as trustee, could not carry out his obligation by reason of conflicting and adverse interests as partner and his duties and obligation to his partner; that the trust agreement subjected the trust property to control of the defendant's partner not intended under the parol agreement; that it subjected the trust income to the hazards of commercial business; that paragraph 6 of the agreement referred to the principal of the trust when in fact it was intended to refer to the income, with the result that the trustee was given the right to take the principal out of the trust estate and invest it in other ventures, and that it failed to give the trustee the right to invest the income, which was the intent of the parties. It was further alleged that the income earned since the creation of the trust had not been set aside and paid to the trustees, notwithstanding that demand had been made on the partners. The prayers asked for reformation of the document, the substitution of other trustees, and such other equitable relief as the court might grant.
The defendant, Herman Schaeffer, admitted paragraphs 1 through 5 set forth above in substance, averred that the construction of the agreement was for the court, denied that he could not properly carry out its terms as trustee, admitted that his partner, Eisenberg, objected to withdrawal or setting aside of income, and submitted himself to any decree of the court. Subsequently the remaining children of Herman Schaeffer and Morris Eisenberg were made parties plaintiff and Morris Eisenberg was made party defendant.
After certain testimony was taken, requests for findings of fact were prepared by plaintiff's counsel, to which there was no objection, and they were approved by the court and a final decree was entered. The court accordingly approved new declarations of trust.
The new declarations of trust made the following material changes from the original trusts. The wife of Morris Eisenberg and another person were substituted as trustees in the Eisenberg trusts. The wife of Herman Schaeffer and another person were substituted for Herman Schaeffer in the Schaeffer trusts. The trust property conveyed was more particularly described by reference to a balance sheet attached showing the net worth of the partnership as of January 2, 1940. In lieu of paragraph 4 of the original trust, where the trustee could exercise his sole discretion in the distribution of principal or income prior to the beneficiaries attaining the age of 40 years, the reformed trust provided:
7(a). Settlor intends that until the trust shall be terminated, none of the trust principal shall be paid out, distributed, awarded, or otherwise diminished, except for the payment of proper trust administration fees, charges and costs; provided, however, that Settlor does not intend thereby to limit the administrative, investment and reinvestment rights and powers with respect to the trust principal granted to Trustees herein.
Settlor further intends, during Beneficiary's minority, personally, out of Settlor's own assets and earnings, and without recourse to the principal or income of this trust, to support, educate and maintain Beneficiary and otherwise discharge his legal obligations to him.
(b) Upon termination of this trust, Trustees shall distribute, award and pay over the trust principal and accumulated income, if any, to Beneficiary. Prior to the termination of the trust, Trustees may exercise, with respect to the trust principal, such administrative investment and reinvestment rights and powers as are granted herein, but shall not pay out or distribute such trust principal, or any part thereof, except for proper trust administration fees, charges and costs.
(c) During Beneficiary's minority, Trustees shall collect, receive, accumulate, invest and reinvest the trust income under and subject to the powers and rights hereinafter granted Trustees with respect to income, but shall not pay out, distribute or award said income or any part thereof, except for proper trust administration fees, charges and costs.
(d) After Beneficiary shall attain his majority, and thereafter until the termination of the trust, Trustees shall pay over to, or for and on behalf of, Beneficiary, such sum or sums from income as Trustees may deem advisable or necessary for Beneficiary's support, education, maintenance, welfare and happiness. Such payment shall be made in such amounts, at such times, and on such terms and conditions as shall be determined by Trustees in their sole and exclusive discretion and the decision of Trustees with respect to such payments shall be final and binding and there shall be no appeal therefrom.
(e) Any other provision of this agreement to the contrary notwithstanding, Trustees shall not pay, or use any part of, the principal or income to, for or on behalf of, Settlor, or in payment, release, satisfaction, or discharge of, Settlor's legal obligations.
The trustees were entitled to inspect the partnership books to determine income and profits earned from net worth and it was provided:
11. Settlor and Settlor's partner or partners, shall, on demand, pay over to Trustees from time to time said profits and income earned by Trustees' net worth in the business.
On May 19, 1943, the judge of the Common Pleas Court approved reformed declarations of trust of which the foregoing is a sample, executed March 15, 1943, ‘but as of January 2, 1940.‘ Other provisions of the trusts, so far as material, are substantially the same as the original trust declarations.
OPINION.
BLACK, Judge:
The Commissioner in his determination of the deficiencies involved in these proceedings has taxed petitioners with all the net income of the partnership of Bailey's Furniture Co. for the calendar years 1940 and 1941. In the statement which accompanied the deficiency notices the Commissioner did not explain in detail his reasons for doing this. He simply stated that he was doing it.
In his brief the several grounds which the Commissioner urges in behalf of the sustaining of his determination may be condensed, we think, into two, namely: (1) Petitioners, who were grantors of the trusts, made themselves trustees and conferred upon themselves such extensive powers of administrative authority and control over the corpus and income of the trusts as to leave them still the owners of the interests conveyed in trust for their minor children. Therefore, whatever income there may have been to the trusts from the partnership was taxable to petitioners under the doctrine of Helvering v. Clifford, 309 U.S. 331. (2) That even though we should hold that the trusts created by petitioners do not fall within the ambit of the Clifford case, nevertheless no actual partnership was created between petitioners and the several trusts and whatever income the trusts might be entitled to receive from the partnership by reason of the transfers in trust would be from a mere assignment of income and the entire income of the partnership would first be taxable to petitioners under the doctrine of Rossmore v. Commissioner, 76 Fed.(2d) 520; and Burnet v. Leininger, 285 U.S. 136.
The petitioners on their part deny that they retained any such bundle of rights in the trust corpus and income as to leave them the owners of the property transferred and, therefore, make applicable the doctrine of the Clifford case. They also contend that the trusts were made actual partners in Bailey's Furniture Co. by the trust indentures which were executed January 2, 1940, and the ‘Addenda To Articles of Co-Partnership Agreement‘ dated January 3, 1940. Petitioners contend that, since the trusts were legally made partners, their share of the net income of the partnership is taxable to the respective trusts and not to petitioners. Petitioners contend that the case of Robert P. Scherer, 3 T.C. 776, is almost on all fours with the instant case, both as to whether the trusts were made partners in Bailey's Furniture Co. and whether their share of the income is taxable to the trusts as such, and not to the settlors of the trusts.
In Robert P. Scherer, supra, we held that the Commissioner had, in effect, conceded that completed gifts had been made to the trusts for the minors of interests in the business of Gelatin Products Co. and that the trusts were partners in the business. In Rose Mary Hash, 4 T.C. 878 (now on review, C.C.A., 4th Cir.), this was not true and we so found. The primary issue in the instant case, we think, is similar to the issue in the Hash case, i.e., whether by the arrangements petitioners made they respectively retained such a ‘bundle of rights‘ in the property transferred to the trusts and made subject to the partnership agreement as to render them respectively taxable on the income therefrom under section 22(a) of the Internal Revenue Code, as construed by Helvering v. Clifford, supra. In passing on this question, the circumstances seem to us to warrant the consideration of the trusts and the partnership agreements to which they were respectively made parties, together. Losh v. Commissioner, 145 Fed.(2d) 456, affirming 1 T.C. 1019; Rose Mary Hash, supra.
In resolving the issue we should not consider isolated provisions of the respective trusts and partnership agreement. Rather the question must be answered after consideration of all the terms of both the trusts and the partnership agreement to which they became parties, as well as the circumstances surrounding the execution of both. Losh v. Commissioner, supra; Rose Mary Hash, supra.
The furniture business in which the two petitioners were already engaged as partners under the name of Bailey's Furniture Co. was a prosperous one. All of the children, alleged beneficiaries of the trusts, were minors. Both petitioners had, in 1930 and 1932 ostensibly created trusts for their children in the form of savings bank accounts and had later withdrawn the funds to use in the partnership business, apparently as their own capital investments and without any trust accounting. Under the partnership agreement in effect during the taxable years no distribution of profits could be made except by the unanimous consent of all the partners. See paragraph 4 of the partnership agreement. Thus neither trust nor the children, alleged beneficiaries, had a right to any of the income of the partnership unless the settlor, in his individual capacity as a partner, and the other settlor, both as an individual partner and as trustee, agreed in writing thereto. It is worth noting that ‘No distributions of either income or corpus were made by Herman Schaeffer or Morris Eisenberg as partners or as trustees to the trusts during the taxable years except for the payment of income taxes in behalf of said irrevocable trusts.‘ Each petitioner, as an individual partner and as trustee, could prevent the distribution of any partnership income and compel the trust to leave the income in and subject to the commercial hazards of the business until the termination of the trust, which was to be when the beneficiary arrived at the age of 40 years, or when he arrived at the age of 30 years if the settlor had previously died. As has already been pointed out, petitioners, the settlors of the trusts, made themselves trustees of the trusts.
Taking the trust indentures and partnership agreement all together and having in mind their several provisions, we think the instant case falls within the ambit of Losh v. Commissioner, supra, and Rose Mary Hash, supra, rather than Robert P. Scherer, supra, and we so hold. In considering whether the trusts and partnership agreement in the instant case are so similar in character to those present in the Losh and Hash cases as to be ruled by the decisions of those cases, we have considered the trusts as they were written January 2, 1940, and not as reformed in certain respects and approved by the court's decree of May 19, 1943.
Petitioners direct our attention to the fact that the judge of the Common Pleas Court approved reformed declarations of trust executed March 15, 1943, ‘but as of January 2, 1940,‘ and they argue that under the doctrine of the Board's decision in George N. Spiva, 43 B.T.A. 1174, and the Supreme Court's decision in Blair v. Commissioner, 300 U.S. 5, we should be governed by the terms of the reformed trusts as approved by the decree of the Pennsylvania Common Pleas Court. We think the instant case is distinguishable from the cases upon which petitioners rely. They were cases where state courts of proper jurisdiction had interpreted the provisions of certain trust indentures and it was held that the interpretations given by the state courts were binding upon the Federal Government.
The question we have here to decide is whether, under the language of the trust indentures and the partnership agreement, when considered together, the petitioners are taxable on all the income of the partnership of Bailey's Furniture Co. for the taxable years under the broad language of section 22(a) as it has been interpreted by the Supreme Court in Helvering v. Clifford, supra. That is a Federal question and is not to be controlled by any decree of a state court. See Doll v. Commissioner, 149 Fed.(2d) 239, affirming 2 T.C. 276. For example, under the trust indentures of January 2, 1940, the settlors made themselves trustees. Under the reformed trust indentures as approved by the Common Pleas Court, the wife of each settlor and another person were made trustees, supplanting the settlors in that respect. Whatever effect this substitution of trustees and other changes made by the court's decree may have had as between the parties, it seems clear to us it can not affect the question of taxation of the income in question for the taxable years which we have before us.
We make our decision in the instant case upon the trust indentures as written January 2, 1940, the partnership agreement of about the same date, and the action of the parties thereunder during the two taxable years which we have before us. As to what effect the reformation of the trust indentures by the court decree of May 19, 1943, has on petitioners' tax liability for taxable years thereafter, we express no opinion. We have none of those years before us.
Reviewed by the Court.
Decisions will be entered for the respondent.
SMITH and MELLOTT, JJ., concur only in the result.
LEECH, J., concurring: The conclusion of the majority and the reasoning generally upon which it is based seem to me to be sound. I think, however, there is another and compelling ground supporting that conclusion. The several trusts with which we are here concerned as members of the alleged partnership are controlled by the law of Pennsylvania. The law of that state recognizes the rule against perpetuities. This rule applies, of course, only to contingent estates and not to vested estates. In re Lilley's Estate, 272 Pa. 150; 116 Atl. 392. But there would seem to be no reason to doubt that the interests of the children here were future contingent interests. No division of corpus and accumulated income was to be made until the termination of the trusts. The remainders were therefore not to vest until that time. See In re Lilley's Estate, supra.
The rule against perpetuities was restated by the Supreme Court of Pennsylvania (the highest appellate court of that state) in the case of In re Friday's Estate, 313 Pa. 328; 170 Atl. 123, at page 125, as follows:
A clear statement of the rule against perpetuities is made by Gray in his authoritative discussion of Perpetuities (3d Ed.) sec. 201: ‘No interest is good unless it must vest, if at all, not later than twenty-one years after some life in being at the creation of the interest.‘ The rule was stated by this court in Re Johnston's Estate, 185 Pa. 179, 183, 39 A. 879, 880, 64 Am.St.Rep. 621, as follows: ‘The law allows the vesting of an estate or interest, or the power of alienation, to be postponed for the period of lives in being and twenty-one years and nine months thereafter; and all restraints upon the vesting that may suspend it beyond that period are treated as perpetual restraints, and therefore as void, and consequently the estate or interests dependent upon them are void; and nothing is denounced by the law as a perpetuity that does not transgress this rule.‘ Lockhart's Estate, supra; City of Philadelphia v. Girard's Heirs, 45 Pa. 26, 84 Am.Dec. 470. While we have stated that the rule is grounded on freedom of alienability of property (Lilley's Estate, supra; Feeney's Estate, 293 Pa. 273, 142 A. 284), the rule in fact deals with the remoteness of the vesting of the title. See Perry on Trusts and Trustees (7th Ed.) volume 1, sec. 381, page 636; Yard's Appeal, 64 Pa. 95. * * * The rule prohibits the creation of future interests, legal or equitable, which by any possibility (not probability) may not vest within the lawful period. Feency's Estate, supra; Lilley's Estate, supra, 272 Pa. at page 150, 116 A. 293, 28 A.L.R. 366. Probability that the future interest will vest within the period is not enough; if, at the creation of the interest, by any circumstance or happening, it is a possibility that it may not vest within the lawful period, the rule is operative and the interest destroyed.
It is obvious that the rule applies with equal rigidity to both inter vivos and testamentary transfers. Barton v. Thaw, 246 Pa. 348; 92 Atl. 312; Bogert, vol. I, Sec. 214, p. 634.
Under the trusts here, the prior estates were limited merely upon a term of years and not a life in being. The rule applying in such cases in Pennsylvania has been stated in the Lilley case as follows: ‘If an absolute term is taken, and no anterior term of a life in being is referred to, such absolute term cannot be longer than twenty-one years.‘
Under the terms of each of the respective trusts, unless the trustee died and the period was thereby shortened, the trust was not to terminate and its corpus, the interest in the business, was not to vest until the beneficiary became 40 years of age. The age of the eldest child of either of petitioners, at the time the trusts were created, was 18 years. Thus, except upon the death of the trustee, which obviously was not a certainty, the possible term of the shortest trust was 40 minus 18, or 22 years. Therefore, I think that all transfers of ‘interests in the business‘ by the petitioners to the several trusts were void because violative of the rule against perpetuities and the title thereto remained in the respective grantors by virtue of the resulting trust. In re Lilley's Estate, supra. It may be that, despite this fact, the right to the income passed. But that was all.
Such a situation, I think, brings the case squarely within the scope of Losh v. Commissioner, 145 Fed.(2d) 456, affirming 1 T.C. 1019, and Rose Mary Hash, 4 T.C. 878, and emphasizes the distinction between it and Robert P. Scherer, 3 T.C. 776.