Opinion
Docket No. 111522.
1943-08-4
LURA H. MORGAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Elden McFarland, Esq., and Harry B. Hoffman, Esq., for the petitioner. Harold H. Hart, Esq., for the respondent.
1. The income of four trusts that was to be accumulated and paid to the grantor's husband, together with the corpora, at the end of terms exceeding ten years, held, nor taxable to the grantor under section 22(a) or 167 of the Internal Revenue Code.
2. The grantor-trustee held taxable upon income of a trust which was to be accumulated, where she reserved the power to appoint corpus and income at the end of the trust period among her husband, nieces, and nephews. Commissioner v. Buck, 120 Fed.(2d) 775, followed. Elden McFarland, Esq., and Harry B. Hoffman, Esq., for the petitioner. Harold H. Hart, Esq., for the respondent.
Petitioner challenges the Commissioner's determination of income tax deficiencies for the years 1938, 1939, and 1940 in the respective amounts of $5,731.76, $7,447.11, and $9,698.50. Minor adjustments made by the Commissioner are not in issue, the only question being whether he erred in adding to petitioner's income the net income of five trusts created by her.
FINDINGS OF FACT.
Petitioner, at all times material hereto a resident of Peoria, Illinois, filed her returns for the tax years in the eighth district of Illinois. She resided with her husband, Harry T. Morgan, whom she married in 1906. They have no children.
On July 21, 1937, petitioner created four trusts, known as the Lura . Morgan trusts A, B, C, and D. The corpus of trust A was 149 shares of Block & Kuhl Co. common stock, a corporation operating retail department stores in Peoria and elsewhere in Illinois; and the corpus of each of the other three trusts was 150 shares of such common stock. The trust instruments were short and were identical except for the certificate number of the stock comprising the corpus of each trust, the designations A, B, C, or D, and the dates of termination.
Petitioner named herself trustee of each trust. The net income of each trust was to be accumulated and paid to petitioner's husband, together with the corpus of that trust, on the following dates: Trust A, January 2, 1948; trust B, January 2, 1949; trust C, January 2, 1950, and trust D, January 2, 1951. Petitioner's husband was 60 years of age at the time the trusts were created and would be approximately 71 years of age upon the date of termination of trust A, January 2, 1948.
The trustee was granted authority to sell, exchange, or otherwise dispose of the trust estates at public or private sale; to invest and reinvest principal or income, not being limited to investments prescribed by law for trust funds; to borrow money, if necessary, to exercise preemptive rights; to loan any part of the principal and income; and to hold and manage the principal and net income. The purpose of the trusts was stated to be to provide for the welfare and maintenance of petitioner's husband in case he should retire or meet with business reverses or be incapacitated. In any event, however, distribution of the corpora and accumulated income was to be made to him on the dates set forth in the respective instruments. A successor trustee was named in case of petitioner's death. Each instrument provided:
Said Lura H. Morgan further declares that she hereby divests herself permanently and definitely, of every right which might, by any possibility, enable her to have the income at some time, distributed to her, actually or constructively, and that she has retained no right whatsoever in the corpus of this trust and that said trust shall not be administered in the interest of her, Lura H. Morgan, the grantor; * * *
On January 3, 1938, petitioner created another trust, known as the Lura H. Morgan trust E, the corpus of which was 190 shares of Block & Kuhl Co. common stock. This trust was similar to those created on July 21, 1937, in that petitioner was named trustee and reserved broad powers of management over the trust estate. The income was to be accumulated and paid over with the corpus on January 2, 1952, to petitioner's husband ‘or to such other beneficiary or beneficiaries as the Trustor may hereafter designate.‘ The instrument provided:
It is further stated that the purpose of this trust is to provide for the welfare and maintenance of said Harry T. Morgan in case he retires from business or has met with business reverses or has been incapacitated because of illness or from any cause whatsoever; and that in any event, the Trustor declares that the above described estate, together with the net accumulations, as above described, shall be paid to said Harry T. Morgan on said date, January 2, 1952. But if, in the judgment of the Trustor, the said Harry T. Morgan shall not be in need of either the income, or the corpus, of the Trust, the beneficiary may later be changed by the Trustor, and the income and the corpus paid and given on said January 2, 1952, to one or more of the several nephews and nieces of the Trustor and of said Harry T. Morgan.
Petitioner's object in creating the trusts was to provide a retirement fund for her husband. No arrangement was made by the company for which he worked for retirement of its employees, and petitioner and her husband have been in the habit of spending most of their current income. Petitioner, in executing the trusts, was conscious of the income tax feature. The suggestion of creating the trusts was originated by petitioner's husband and was discussed with a neighbor and close friend, who was an accountant and tax consultant, and with the comptroller of Block & Kuhl Co. The instruments were actually drawn by the comptroller, with some changes made by the neighbor accountant.
Petitioner's husband has been associated with Block & Kuhl Co. for more than 40 years, working his way up from an employee at a salary of $70 per month until he became president in 1934, the position he now holds. His principal source of income during the tax years was his salary, which amount to $28,159.26 in 1938, $41,125.11 in 1939, and $62,255.04 in 1940.
Block & Kuhl Co. had approximately 2,260 shares of preferred stock outstanding in the tax years, none of which was owned by petitioner or her husband. Its outstanding common stock consisted of 11,789 shares in 1937; 12,289 shares on February 1, 1938; 12,436 shares on February 1, 1939; 12,511 shares on August 1, 1939; 12,567 shares on February 1, 1940; and 12,625 shares on August 1, 1940. Of these shares petitioner, individually and as trustee, and her husband owned the following:
+-----------------------------------------------------------------------------+ ¦Date ¦Petitioner ¦Petitioner as ¦Petitioner's ¦Total¦ ¦ ¦individually ¦trustee ¦husband ¦ ¦ +------------------+------------------+----------------+----------------+-----¦ ¦Jan. 1, 1937 ¦1,492 ¦None ¦1 ¦1,493¦ +------------------+------------------+----------------+----------------+-----¦ ¦July 21, 1937 ¦893 ¦599 ¦1 ¦1,493¦ +------------------+------------------+----------------+----------------+-----¦ ¦Jan. 3, 1938 ¦703 ¦789 ¦1 ¦1,493¦ +------------------+------------------+----------------+----------------+-----¦ ¦Jan. 25, 1938 ¦903 ¦789 ¦1 ¦1,693¦ +------------------+------------------+----------------+----------------+-----¦ ¦Nov. 1, 1939, thru¦903 ¦839 ¦1 ¦1,743¦ ¦1940 ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
On November 1, 1939, petitioner, as trustee of trusts A and B and from the accumulated income of such trusts, purchased 50 shares of the common stock from the company for $9,419.
The company has always operated upon a small amount of capital and for more than 50 years it has been the custom of the officers and their families to leave as much of their salaries on deposit with the company as possible, for use as working capital. This was done by all the officers and as much as $900,000 was on deposit at one time under this arrangement. During the tax years petitioner received a salary of approximately $3,000 per annum from the company, and an account was maintained in her name on its books. The company maintained separate accounts for each individual to whom it was indebted and paid interest on the loans. Separate accounts were set up on the books of the company for each of the trusts created by petitioner.
Coincident with the execution of the five trust instruments petitioner caused Block & Kuhl Co. to transfer and issue 789 shares of common stock then standing in her name to the name of ‘Lura M. Morgan, Trustee.‘ On the shares so transferred 519 had been acquired by petitioner as gifts from her husband. He had given her 300 shares in 1931, 50 shares in 1932, 20 shares in 1935, and 149 shares on July 30, 1936. The remaining 270 shares transferred in trust by petitioner had been purchased by her from her husband in 1935.
Petitioner's husband was investing money in land during 1938, and for this purpose he borrowed $18,060 from petitioner individually upon his note. This amount was repaid to her shortly thereafter. For the same purpose he borrowed $16,000 on August 15, 1938, from the trust funds. He gave five demand notes carrying 5 percent interest for this loan, payable to petitioner as trustee of the respective trusts, $3,000 of the loan having been made from each of the trusts A, B, C, and D, and $4,000 from trust E. He has regularly paid interest on such notes. The notes remained unpaid on August 31, 1942. Interest has also been received by the trusts from Block & Kuhl Co. upon the trust funds left on deposit. No other disbursements have ever been made of the trust funds except income taxes upon the net income of the respective trusts.
The net income of each of the trusts A, B, C, and D was between $4,000 and $5,000 in each of the tax years, and the net income of trust E was between $5,000 and $6,000. The bulk of the income in each case was dividends the balance being a relatively small amount of interest. Total net income for the five trusts for the years 1938, 1939, and 1940 was $22,133.61, $25,252.28, and $22,654.70, respectively.
Petitioner reported on her individual income tax returns for the years 1935 through 1939 gross income in the respective amounts of $15,356.03, $19,646.93, $36,202.26, $26,641.06, and $30,295.75, which did not reflect any income from dividends on stock standing in her name as trustee.
OPINION.
ARUNDELL, Judge:
In attempting to apply the Clifford doctrine
to trusts A, B, C, and D, we think the Commissioner has misconceived its foundation and scope. It is true that here, as in the Clifford case, we have a grantor-trustee, spouse-beneficiary, reservation of administrative control, and a relatively short term. But no one of these things, nor all of them together, furnishes the answers to the question of when a person is to be taxed under section 22(a). To state these four factors and cite the Clifford case no more gets to the root of the problem than the opposite approach of dwelling upon the highly technical distinction between legal title in the grantor individually and legal title in the same individual as trustee. The fundamental problem is, Who is the real owner of the property?
Helvering v. Clifford, 309 U.S. 331.
The shortness of the term in the Clifford case was important because at the end of it Clifford reacquired full and unfettered control, dominion, title, and interest in and to the trust property. Meanwhile he had given away nothing other than the income as it periodically accrued. The recognized and accepted rule that the owner of property should be taxed upon its income, though he has temporarily and in advance procured its payment to another, fully supported the imposition of the tax in that instance. To escape its application the taxpayer could but take refuge in the artificial concept that he was no longer owner since the legal title was in Clifford— trustee. It was only necessary to brush that technicality aside, inasmuch as the refinements of title are not controlling in any event. Corliss v. Bowers, 281 U.S. 376. Of course, the added features that Clifford still had possession and administrative powers and that the income remained in the family made crystal clear that the technicality he relied upon had no practical effect and in truth all he had done was to assign irrevocably income from certain property for a term.
That is a far cry from the present facts. Here the relative shortness of the term is significant only in that it marks the time when such sterile powers and interests petitioner still had in the trust property would come to an end. Clifford never gave away the ownership of his property in a real sense, but only a limited, beneficial use of it for a while. Petitioner has given hers away, definitely and irrevocably, and never again may use either the income or the corpus for her own benefit. She retained administrative powers over investments and reinvestments— which in view of the character of the trust property she was not likely to exercise. We can not find as a fact that such was the fair equivalent of full ownership. There is no merit in the Commissioner's suggestion that petitioner would reacquire the property if her husband died before the end of the trust terms. It being a matter of intention, and not of technical words of inheritance, whether the instruments passed a vested interest in the entire estates, Scott on Trusts, vol. 1, p. 665, we think the language used by petitioner clearly shows she did not intend a resulting trust upon the death of her husband.
Underlying respondent's determination, we think, is a sort of skepticism with respect to gifts between husband and wife. Though such transactions are rightfully subject to close scrutiny to determine if they are real and bona fide, so far as we know Congress has not legislated nor has the Supreme Court decided that such gifts are governed by a set of rules different from those governing other gifts; or that thereafter the donor is invariably the party taxable upon the income. Under the law as it stands today we have not doubt that a husband or wife may make a gift, absolute or in trust, to his or her spouse. The Supreme Court said in the Stuart case,
‘So broad a basis (as contended for by the Commissioner) would tax to a father the income of a simple trust with a disinterested trustee for the benefit of his adult child. No act of Congress manifests such an intention.‘ Similarly, no act of Congress manifests an intent to tax a wife upon the income of a trust created by her with no strings attached for the sole benefit of her husband. The fact that in the present case there was not a disinterested trustee has been considered; but, as we have said, the rights flowing to petitioner by reason of her trusteeship, with nothing more, do not even closely approach the equivalence of full ownership required for application of the Clifford rule.
Helvering v. Stuart, 317 U.S. 154.
The Commissioner likewise stresses the fact that petitioner was not unconscious of the tax consequences of her action, but we do not know what can be made of this. So long as the gift is valid and real a motive to reduce taxes becomes immaterial.
We conclude that the Commissioner erred in taxing the income of trusts A, B, C, and D to petitioner under section 22(a). His alternative attempt to invoke the Stuart case and section 167 requires no extended discussion. The principal and income are payable to the husband as his own, regardless of whether he has retired or not or is in need of the funds. Whether he will see fit to use them to pay family expenses, assuming, arguendo, that the wife is liable for them in Illinois, is therefore immaterial, for, even as respondent concedes, section 167 is dependent upon some provision in the trust instrument making possible the application of the income to the settlor's obligations. That section does not reach income that is payable absolutely to a beneficiary without restriction as to use, Lillian M. Newman, 1 T.C. 921, 926, although the beneficiary may thereafter apply it voluntarily to the benefit of the grantor. Stephen Hexter, 47 B.T.A. 483, 492. Respondent's determination with respect to the income of these four trusts is reversed.
Trust E is different. To a person of ample means the right to say who shall receive property and income may be a more important attribute of ownership than the right to use them for his own well- being. While petitioner had somewhat limited her power of disposition, she could appoint the income and corpus among her husband and nieces and nephews. In our view, the case with respect to trust E is sufficiently like Commissioner v. Buck, 120 Fed.(2d) 775, as to call for the same conclusion. Respondent is accordingly affirmed as to this trust.
Decision will be entered under Rule 50.