Opinion
Docket No. 106600.
1943-06-29
LAWRENCE MILLER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Franklin P. Hays, Esq., for the petitioner. J. O. Durkan, Esq., for the respondent.
1. In 1935 and 1936 petitioner and his parents gave to petitioner's minor son 12,500 shares of X corporation stock. Certificates representing this stock were issued by X in the name of petitioner's son, but were not delivered because X would deliver the stock only to the minor's legal guardian. In 1938 petitioner was appointed such guardian and stock certificates were issued and delivered to him as guardian. In the same year petitioner and his wife, in anticipation of a divorce, executed an agreement in which petitioner agreed to pay $5,000 a year out of the income from this stock to his wife for the support of his son. Such payments were not made but only a part of the income was expended pursuant to the authority of the guardianship court for insurance for the benefit of the minor. Held, the income from this stock is not taxable to petitioner.
2. Pursuant to a property agreement executed in anticipation of divorce, petitioner gave to his wife certain shares of Y corporation stock having a current annual yield of $2,475, and agreed that if the stock failed to yield this sum in any year, he would pay to her the difference between this sum and the amount of dividends paid. This agreement was approved by the divorce court as a final settlement between the parties. Held, the income from this stock is taxable to the wife and not to petitioner. Franklin P. Hays, Esq., for the petitioner. J. O. Durkan, Esq., for the respondent.
The Commissioner determined deficiencies in petitioner's income taxes for the calendar year 1937 in the amount of $1,599.54, and for the calendar year 1938 in the amount of $1,968.04. Two questions are presented here for decision: (1) Whether the income from 12,500 shares of stock in the Frankfort Distilleries, Inc., registered in the name of petitioner's minor son is taxable to petitioner; and (2) whether the income from certain shares of stock in Standard Oil Co. of Kentucky transferred by petitioner to his wife was taxable to petitioner.
FINDINGS OF FACT.
A stipulation of a part of the facts was filed herein, and the facts therein are found to be as stipulated, and the pertinent parts thereof are set forth here, together with other facts established by the evidence introduced at the hearing.
The petitioner herein filed his income tax returns for the years 1937 and 1938 with the collector of internal revenue at Louisville, Kentucky.
Prior to December 17, 1935, petitioner was the owner of 52,643 shares of the common capital stock of the Frankfort Distilleries, Inc. On that date, he caused the certificate evidencing such ownership to be canceled by the corporation, and two new certificates issued, No. 3, for 47,643 shares in his own name, and No. 4, for 5,000 shares in the name of his minor son, Lawrence Keyes Miller, then approximately five years old.
About four months later, on April 16, 1936, he caused his certificate No 3 to be canceled and two new certificates to be issued one to himself for 42,643 shares, and one to the same minor son for 5,000 shares. On the same day petitioner's father and mother (grandfather and grandmother of the child) each made a similar transfer to the boy of 1,250 shares. The stock so transferred to the child was intended by the several donors to be a gift to him.
Prior to the several transfers the certificates evidencing the ownership of the stock involved were in the possession of the then registered owners. From and after the dates of the transfers, and until about February 25, 1938, the certificates issued to Lawrence Keyes Miller, the child, were kept and retained in the possession of the Frankfort Distilleries, Inc., because of an unwillingness on the part of the corporation to deliver them to anyone other than a legal guardian of the minor.
Petitioner duly filed Federal gift tax returns reporting his gifts totaling 10,000 shares of the stock to his son, and paid the gift taxes thereon.
On February 24, 1938, petitioner was appointed and qualified as statutory guardian of Lawrence Keyes Miller in the Jefferson County Court. After that appointment, the certificates, aggregating a total of 12,500 shares of stock registered in the child's name, were canceled, and a new certificate for 12,500 shares was issued to Lawrence W. Miller, guardian of Lawrence Keyes Miller. This was kept in a safe deposit box in the joint names of petitioner and the corporate surety on his guardian's bond.
From and after the original transfers of the stock to the child, the dividends accruing thereon were credited to the account of Lawrence Keyes Miller, the minor, on the books of the Frankfort Distilleries, Inc., and certain interest on those dividends accrued and was credited to that account. In February of 1938 in a property settlement entered into between petitioner and his wife in anticipation of their divorce, and prepared by the wife's attorney, it was recited that petitioner had transferred to himself as guardian of his minor son 12,500 shares of Frankfort Distilleries stock and from the income therefrom $5,000 would be paid to the wife each year for the support of the son. None of this income was paid to the wife or used for the education, support, or maintenance of the minor, and the only sums expended from this income were for the purchase of insurance contracts, one of which was an annuity policy, the annuitant being the son, and the other of which was a policy insuring the life of petitioner for the benefit of the son. These sums were expended with the approval of the court having jurisdiction of the guardianship, and the remainder of the income was retained in a guardianship account established by direction of the guardianship court. During the time petitioner and his wife were divorced petitioner paid to his wife out of his own funds the approximate amount of $5,000 a year for the support of his minor son.
During the taxable years the stock was the property of Lawrence Keyes Miller, son of the petitioner herein, pursuant to valid gifts made by his father and grandparents. No trust with reference to such stock was either intended or effected at any time.
On February 17, 1938, petitioner and his wife entered into a property agreement in anticipation of a divorce granted to petitioner's wife on February 25, 1938, which was incorporated in the decree as a final settlement of property rights and alimony. The portions of that agreement which are pertinent to the question here are as follows:
4. Mr. Miller agrees in the alternative either (1) to pay to Mrs. Miller the sum of Twenty-Four Hundred Dollars ($2,400.00) a year in monthly installments of Two Hundred Dollars ($200.00) each, or (2) to assign, transfer and deliver to Mrs. Miller stock of the Standard Oil Company of Kentucky in such number of shares as will yield at the current dividend rate the sum of Twenty-four Hundred Seventy-five Dollars ($2,475.00) annually. Mr. Miller further agrees that if he elects to assign to Mrs. Miller stock of the Standard Oil Company of Kentucky, he will, in the event said shares of stock fail to yield in dividends the sum of Twenty-four Hundred and Seventy-Five dollars ($2,475.00) in any one year, pay to Mrs. Miller the difference between the dividends paid on said stock in that year and the sum of Twenty-four Hundred Seventy-five Dollars ($2,475.00).
7. Mrs. Miller hereby waives and relinquishes all claims which she now has, or may hereafter have, against Mr. Miller for alimony or for her support and maintenance, or for the support, maintenance and care of their child, or in or to his property, except as may be otherwise provided for in this agreement.
The divorce decree further provided, in part, that:
It is further ordered, considered and adjudged by the Court that the aforesaid contract be, and the same hereby is, adopted and approved by this Court and made a part of this decree as the complete and final settlement between the plaintiff and the defendant as to property rights and alimony: * * *
It is further ordered, considered and adjudged by the Court that jurisdiction of this case be reserved for the purpose of making such other and further orders from time to time as may be necessary or proper (1) in connection with the custody, control, maintenance and education of the said infant child, and (2) to carry out the terms of this Decree.
Pursuant to the second alternative contained in this agreement, petitioner transferred to his wife, without reservation or restriction, the complete ownership of certain stock of the Standard Oil Co. of Kentucky. Dividends, which amounted to $2,475 in 1938 were thereafter paid to the wife as the registered owner of the stock.
Subsequent to the taxable year petitioner and his divorced wife remarried. His wife continues to own and hold the stock in question.
Petitioner transferred this stock with the understanding that it was in complete and final satisfaction of his duty to support his wife subsequent to the divorce unless and until it failed to yield the contemplated amount in dividends.
OPINION.
KERN, Judge:
With respect to the first issue, it is our opinion that the evidence here establishes the existence of every element of a valid, legal gift of the Frankfort Distilleries stock to the minor son of petitioner. With that fact clearly established, it becomes apparent that thereafter the income from the property which was the subject of the gift was the income of the donee, and not that of the petitioner. We find no evidence of any intention on the part of this petitioner to create a trust in 1938, or at any time, involving the stock or the income therefrom. But, in view of our holding that an earlier gift of the stock had been effected, even if an attempt had been made to create a trust at some later date, it would certainly have been unavailing. James T. Pettus, 45 B.T.A. 855. Equally futile was the attempted agreement between petitioner and his wife as to the use of the income from the stock which was the sole property of their minor son. The divorce court had the power to require petitioner or his wife to furnish adequate support for the child, but neither the parties nor that court had any power to direct the expenditure of the child's own funds for that purpose, since the jurisdiction of the guardianship court had already been invoked with respect to that property. The laws of Kentucky require a father to support his infant children, even though they may be possessed of an estate of their own. Hedges v. Hedges, 73 S.W. 1112 (Court of Appeals of Kentucky, Apr. 21, 1903). We may therefore assume, in view of the financial status of the petitioner, that the guardianship court would not have permitted the use of the funds for the child's support. Clearly, therefore, the money was not available to petitioner for the support, maintenance, or education of his child, or for the discharge of petitioner's legal obligations, within the rule of Helvering v. Stuart, 317 U.S. 154, or of Douglas v. Willcutts, 296 U.S. 1.
Respondent suggests that the funds used for the purchase of insurance contracts for the benefit of the child, on petitioner's life, should be taxed to petitioner under section 167(a)(3). That section is manifestly inapplicable. No trust was created for the payment of the premiums, but they were paid by the child, and for his own benefit. All such expenditures which were made from the income here involved for the purchase of insurance were made with the specific approval of the guardianship court, and we can not say, as respondent contends, that they were illegally made, or illegally received as benefits by the petitioner.
We therefore conclude that none of the income, either dividends or interest, arising from the stock which was given to petitioner's son in 1935 and 1936 is taxable to petitioner.
In the property settlement which petitioner and his wife made in anticipation of their divorce, the petitioner agreed either (1) to pay his wife $2,400 per year, or (2) to transfer to her sufficient stock to provide a yearly income of $2,475. In the event he chose the second alternative, he agreed that if, during any year, the stock failed to yield the stipulated amount of $2,475, petitioner would then pay to his wife the difference between the actual yield and $2,475. It is this provision which gives rise to the chief difficulty encountered here.
Petitioner chose to and did make an outright transfer of the stock of the Standard Oil Co. of Kentucky to his wife. The respondent contends that, in spite of the completed and unrestricted transfer of the block of stock to his wife, petitioner, by his agreement to make up any deficiency in dividends, has undertaken a continuing obligation to provide his wife with $2,400 per year. In view of the fact that petitioner's contingent obligation was in the amount of $2,475, and the income from the stock was in this amount, it would seem that respondent is inconsistent in his contention that only $2,400 should be included in petitioner's taxable income.4 The respondent's view is undoubtedly nurtured by the line of cases in which it has been held that, where trusts are regarded merely as security devices for the discharge of a continuing obligation of the donor, the entire income thereof is taxable to the donor of the trust. See Helvering v. Leonard, 310 U.S. 80.
However, in those cases, the taxpayer-husband made use of the trust device for the purpose of allocating the future income from property owned by him to the payment of an obligation, presently existing and continuing, without transferring the property itself to the obligee.
If X has an obligation for the support of his estranged wife in the sum of $10,000, and has property producing an income to him of $10,000, he is not relieved from the payment of income tax upon this item of income because of his agreement to pay or his payment of this amount in satisfaction of this obligation. If he places this same property in the hands of trustees for the purpose of applying the income to the payment of the continuing obligation to support (the obligation not being finally satisfied by the creation of the trust), it is apparent that the situation is similar, for all practical purposes, to the first hypothetical case in which no trust device was used.
But, where the income-producing property is not held by the taxpayer-husbanddddd d or by a trust created by him for the purpose of holding the property and paying over the income to the wife, as in this case where the income-producing property is itself given by absolute gift to the wife in pro tanto satisfaction of the obligation, we are unable to spell out any justification for taxing the income from the property to the husband, rather than to the wife who has received the income by virtue of her ownership of the property, even if the property itself was received by her in satisfaction of her husband's obligation to support her.
This conclusion would seem to be in accord with the latest opinion of the Supreme Court on this subject in the case of Pearce v. Commissioner, 315 U.S. 543, in which the Court carefully pointed out that in the Leonard case and the cases of Helvering v. Fitch, 309 U.S. 149, and Helvering v. Fuller, 310 U.S. 69, there were involved so-called alimony trusts, and then said:
But where, as here, the settlement appears to be absolute and outright and on its face vests in the wife the indicia of complete ownership, it will be treated as that which it purports to be, in absence of evidence that it was only a security device for the husband's continuing obligation to support. * * *
In the instant case there is no reason apparent on the record to question the validity of the transfer of absolute ownership of the stock in question to the wife or to suppose that she held title to it only as security or pledge for the fulfillment of petitioner's obligation. On the contrary, it would seem that this obligation was discharged pro tanto by the transfer to her of the stock. It is significant that even after the remarriage of petitioner and his divorced wife the latter continued to be absolute owner of the stock, thus indicating that she did not hold the stock merely as security.
Respondent contends that petitioner is taxable on this ‘amount of $2,400 (sic) by virtue of section 22(a) of the Revenue Act of 1938.‘ We are not aware of any cases construing this section which hold that individual A is taxable on income received by individual B which is derived from property of which B is the absolute owner, though the property is obtained from A by gift or in satisfaction of some obligation; and we are not disposed to extend the application of this section to such a result. If the transfer of absolute ownership of the property is valid, the income thereafter derived from the property is taxable to the transferee, who is then the owner of both the property and the income; and the motive or purpose of the transfer is immaterial.
In the comprehensive article ‘Five Years with Douglas v. Willcutts,‘ 53 Harvard Law Review 1, Randolph Paul observes:
It is unlikely that income from funds given outright to a wife in settlement of her marital rights could be taxed to the husband. * * * The correct ground for refusing to tax such income to the husband is merely that it is the lump sum which discharges him, and not the future income received by the wife. Even if a misguided husband guarantees that the fund will yield a stipulated amount per year, it is unlikely that even the broadest interpretation of Section 22(a) would warrant an imposition of the tax upon him without a specific statutory mention of such a situation, and even such a specific provision would encounter constitutional difficulties. (Italics supplied.)
We agree with the sentence in italics in the quotation set out above.
Reviewed by the Court.
Decision will be entered for petitioner.