Opinion
Docket No. 12957.
1947-10-6
THE NORBURY SANATORIUM CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Stanley Worth, Esq., for the petitioner. A. H. Moorman, Esq., for the respondent.
Petitioner is an institution specializing in the care of the mentally ill for profit, and keeps its books on an accrual basis. In 1924 it undertook the care of William, the mentally defective son of Victor Gauss. Victor was 69 years old and of limited financial means. For the primary purpose of insuring the care of William during his lifetime and after the death of Victor, Victor entered into an agreement in 1924 with petitioner and with a bank as trustee. Pursuant to this agreement Victor gave bonds of a value of $28,000 to the trustee. After Victor's death the trustee was to pay the trust income to petitioner, or, if petitioner had not given William proper care, then to some other institution in which the trustee had placed William, and at William's death the trustee was to hand over all the bonds to petitioner or to such other institution having the care of William for 6 months prior to his death. Victor died in 1931. William died in 1944, while still in the care of petitioner. In the latter year petitioner was entitled to have delivered to it by the bank the bonds having a value of $28,000. Held, petitioner received income in that amount in 1944. Stanley Worth, Esq., for the petitioner. A. H. Moorman, Esq., for the respondent.
Respondent determined a deficiency in petitioner's income tax for the year 1944 of $12,421.72, and a deficiency in declared value excess profits tax for the same year of $3,167.72. These deficiencies result from respondent's holding that petitioner realized taxable income in 1944 in an amount representing the value of the assets of a trust of which, respondent contends, petitioner became the owner in that year.
FINDINGS OF FACT.
Petitioner is an Illinois corporation which filed its tax returns for the year 1944 with the collector of internal revenue at Springfield, Illinois. During all the years here material it kept its books and filed its returns on the accrual basis. Its business was and is, to a large extent, the treatment and care of nervous and mental cases.
On September 28, 1924, William Gauss was admitted as a patient to petitioner's sanatorium. He was the only surviving child of Victor Gauss, who was 69 years old and had lost his wife and 3 other children from tuberculosis. William was at that time 32 years old, but had the mentality of a 3-year old child. He weighed 89 pounds, had been losing weight, would not eat, and required forced feeding.
In addition to being mentally defective, with the mentality of a three-year old child, William Gauss showed definite organic signs of brain involvement and physical involvement of both the heart and the lungs, his diagnosis at the time of said admission being:
Mental defective; probably suffering from affective oculation at the present time. Physical: Underdeveloped, undernourished. Microcephalic type of head; pupils do not respond to light; pyorrhea; whistling cystolic murmur transmitted to axilla; slight peripheral thickening of vessels; plus 100; blood pressure 120 over 70; dullness of both apices; rare crackles on inspiration; increased fremitus over dull area; simian type of growth of hair over lower back; bilateral Babinski, Gordon and Oppenheim.
Victor Gauss realized that his son would require institutional care throughout his life. Because of his own advanced age he was especially concerned about the care of William in the event William survived him many years, since his financial resources were limited. He was anxious to make some arrangement by which the proper care of William might be assured during William's lifetime, even though he (Victor) should predecease him and leave a negligible estate. William was his only remaining obligation.
After some negotiations with the president of petitioner a contract and and trust agreement was entered into by Victor, petitioner, and the First National Bank of Belleville, Illinois. This reads as follows:
THIS AGREEMENT made and entered into the 30th day of October A.D. 1924, between Victor Guss of the first part, The Norbury Sanitorium Company, an Illinois Corporation of the second part, and the First National Bank of Belleville, Illinois, of the third part;
WITNESSETH: That Whereas, the second party is operating a sanitorium in and near the City of Jacksonville, Illinois, for the treatment of persons afflicted with nervous diseases and other mental troubles; and,
WHEREAS, the second party has been caring for, maintaining and treating William Gauss, son of the first party, for some time past; and,
WHEREAS, it is realized by the parties hereto that in all probability the physical and mental health of said William Gauss will never be fully restored and that he will require hospitalization and treatment for the term of his life; and,
WHEREAS, the first party is unable to personally care for his son, but is willing and anxious that some suitable arrangements be made whereby the son may have as much medical treatment, comfort and happiness as the circumstances will justify; and,
WHEREAS, the services rendered by the second party to the first party for and on behalf of said William Gauss have been satisfactory to said first party, and it is the desire of said first party that the second party shall continue to care for said son so long as he lives, and is desirous of creating a trust fund that the expense for such care and treatment may always be forthcoming irrespective of what may happen to the first party, and is willing to reward the said second party for its faithful services;
NOW THEREFORE: Said first party has this day deposited with the party of the third part, as trustee, bonds of the par value of twenty-eight thousand dollars ($28,000.00) and of the approximate market value of twenty-eight thousand dollars ($28,000.00), which said bonds are to be held in trust on the conditions hereafter mentioned.
(1) The second party hereby agrees to take care of said William Gauss, that is to say, to room and board him, laundry his clothes, give him necessary medical attention and render such other services as might reasonably be expected and be necessary for his comfort and welfare as long as the said William Gauss lives, or so long as this contract remains in full force as hereinafter provided; the said William Gauss to have the very best and highest degree of care and attention.
(2) In consideration of the services rendered by the second party to the said William Gauss, the first party agrees to pay the second party the sum of one hundred dollars ($100.00) on the first day of each and every calendar month from the date of this contract, and shall continue to pay said amount on the first day of each and every month during the lifetime of said William Gauss; said payment to be made from the funds of private resources of said first party, exclusive of the trust funds hereinafter mentioned. And it is further agreed that in case the said William Gauss precedes the first party in death, that bonds in the sum of five thousand dollars ($5,000.00) of the then market value, shall also be paid over to said second party by the party of the third part, which said bonds shall be the absolute property of said second party, and the remainder of said trust fund shall be paid over immediately to the first party, his heirs, executors, administrators or assigns.
(3) In the event that the first party precedes the said William Gauss in death, it is further agreed that the income from the twenty-eight thousand dollars ($28,000.00) in bonds so held by said Trustee, shall, after paying the expenses of said trusteeship, be paid to the second party in annual, semi-annual or quarterly payments as may be designated by said second party, and upon the death of said William Gauss, said trustee shall turn over and transfer to the second party said bonds, or other securities, which might be in said trustee's hands of the approximate market value of twenty-eight thousand dollars ($28,000.00) and said bonds or securities shall be the absolute property of the second party; it being the intention of the first party that said twenty-eight thousand dollars ($28,000.00) shall be a reward and proper compensation to said second party for having rendered care and treatment to the said William Gauss during his lifetime.
(4) So long as the said first party and his son, William Gauss, are living, the income from the bonds of the par value of twenty-eight thousand dollars ($28,000.00) shall be paid to the said first party in annual, semi-annual or quarterly installments as may be designated by said first party, but that in case of the death of William Gauss prior to the death of the first party, then bonds of the market value of five thousand dollars ($5,000.00) shall be transferred to said second party, and the remainder of said trust fund shall be paid to the first party as hereinbefore set forth, and, in the event of the death of William Gauss subsequent to the death of the first party, then the income from said trust fund of twenty-eight thousand dollars ($28,000.00) shall be paid to the second party during the lifetime of said William Gauss, and at his death, the whole of said bond fund shall be paid to said second party as hereinbefore set forth.
(5) It is further understood and agreed between the parties that the first party may, at any time prior to his death, withdraw his son, William Gauss, from said sanitorium upon the payment of a lump sum of money which would produce an equivalent of three hundred dollars ($300.00) per month from the date of this contract to the date of such withdrawal, less, however, the payment of one hundred dollars ($100.00) heretofore paid by the first party under this contract, and this contract shall thereupon become null and void and said trustee shall be allowed to return the bonds held in trust by him whenever said first party exhibits receipts signed by said The Norbury Sanitorium and its duly authorized officers, showing full receipt of payments made to it by said first party as provided herein.
(6) In case, however, the second party should mistreat the said William Gauss, or should wilfully neglect him after the death of said first party, it is further understood that the trustee may, after the Board of Arbitration so awards, remove said William Gauss from the sanitorium of the second party and transfer said William Gauss to another institution or to some person or persons whereby he can properly be cared for, and the income from said twenty-eight thousand dollars ($28,000.00) in bonds shall be paid to such other institution or person or persons who shall have the care of said William Gauss, and, in the event such other institution or person or persons have properly kept said William Gauss for a continuous period of six (6) months prior to his death, then upon the death of said William Gauss, the bonds of the approximate market value of twenty-eight thousand dollars ($28,000.00) shall be transferred by said trustee to such other institutions or person or persons, and such other institution or person or persons shall be the absolute owner thereof.
But, in case such other institution or person or persons has not kept said William Gauss for a continuous period of six (6) months prior to his death, then said entire bond fund shall revert to the estate of the party of the first part and shall be distributed according to the terms of the will of said first party, or descend according to the laws of descent as provided by statutes of the State of Illinois for persons dying intestate. It is further agreed that said trustee shall not be the judge as to the degree of care and treatment which shall be rendered by said second party to said William Gauss, and, in the event of a dispute between the second party and the said trustees as to the kind of care and treatment that is given to said William Gauss after the death of the first party, and such difference cannot be amicably adjusted, that said controversy shall be referred to the arbitration of three disinterested persons who shall be selected by the President of the Illinois State Medical Society, and, in case there is no such President or any such organization, or such President refuses to appoint such Board of Arbitration, then three persons composed of persons selected by the then President of the American Medical Association shall form such Board of Arbitration. Said arbiters shall not be related nor connected directly or indirectly with any of the parties who might be directly or indirectly interested in said trust fund, nor shall the members of said Board of Arbitration be residents of Morgan County, Illinois, or St. Clair County, Illinois, nor any other county which lies contiguous to either of said counties. Said Board shall have the right to meet and hear such evidence as they may consider proper and appropriate and make any other investigation as they see fit, and the written award or determination of such Board of arbitration, or a majority of the membership thereof, as to whether or not said William Gauss has received proper care and treatment, shall be final and binding upon the parties hereto respectively and their respective heirs, executors, administrators, successors or assigns; that the expense of said Board of Arbitration shall be paid by said trustee from funds in his hands.
(7) It is further agreed that the bonds or securities placed in the hands of the trustee by said first party may be withdrawn from time to time by said first party and other bonds or securities substituted therefor, provided such withdrawal or substitution is consented to in writing by said second party. After the death of Victor Gauss and prior to the death of William Gauss, the bonds or securities in the hands of said trustee may be withdrawn from time to time by said trustee and other bonds or securities substituted therefor, provided such withdrawal or substitution is consented in writing by said second party.
(8) It is further agreed that upon the death of William Gauss, the second party will ship his remains to the party of the first part at Belleville, Illinois, or in case said first party is not living, then to the nearest next relative of the first party as may be living.
(9) It is further agreed that the trustee shall be paid the sum of $50.00 per year for services rendered as such trustee and said third party represents that it is authorized to act as trustee and will accept the responsibilities therefor.
IN WITNESS WHEREOF said first party has hereunto set his hand and seal the day and year first above written, and the second and third parties have, in pursuance of a resolution of the Board of Directors, caused this contract to be signed by its President and the seal of the corporation has been placed thereon the day and year first above written.
Victor Gauss lived until October 24, 1931, and William lived and remained a patient of petitioner until December 5, 1944.
At the date of this agreement, the petitioner had two general classes of patients, namely, custodial and noncustodial. The former required less intensive care than did the latter, which were the acute cases. The customary rates charged by petitioner at that time were $40 per week for custodial patients and $50 per week for noncustodial patients. Later, the rates were increased and the same rate is now charged for all patients, namely $75 per week for the first four weeks and $65 per week thereafter. These rates included medical care, i.e., services of a staff physician, general nursing, room and board, but did not include laundry or barber services or other incidentals, which were billed to the patient.
During the period 1924 to 1944, inclusive, petitioner accepted patients other than William Gauss at rates less than petitioner's customary charges for similar patients. The number of patients receiving the benefit of a special rate was not large and would average 3 or 4 per cent of petitioner's total number of cases. The account of William Gauss and the accounts of other special rate patients were kept in the same manner on the books of petitioner.
Petitioner operated its sanatorium for profit and received no financial assistance of a state or public character. The sanatorium's profitable operation depends entirely on revenue from services rendered. The stock of petitioner is closely held, and Dr. Dollear, its president, has been the majority stockholder for many years. For the period 1932 to 1937 petitioner operated at a loss.
After the death of Victor Gauss, a representative of the bank would visit the sanatorium at least once, and sometimes twice, a year. The bank representative would observe the patient, William Gauss, look about the sanatorium, and confer with some member of the staff. The distance between Belleville, Illinois, where the First National Bank is located, and petitioner's sanatorium is about 125 miles. The visits were usually unannounced, surprise visits made for the purpose of ascertaining William Gauss' condition and the care he was receiving. The bank felt that its duties and responsibilities as trustee required it to make such visits. On one occasion when the bank received a letter stating that the writer had information regarding William Gauss, the bank requested and obtained a conference with Dr. Dollear, president of petitioner. The conference related to the question whether petitioner was providing proper care to William Gauss. Petitioner regularly submitted written reports to the trustee relating to the physical condition and welfare of William Gauss. Such reports were submitted to the trustee on the average of twice a month.
Between the date of the agreement in 1924 and the date of his death in 1931, Victor paid the petitioner the sum of $100 per month for the care of William, and also paid for incidental charges, other than for laundry, as provided in the agreement. Following the death of Victor, the trustee under the agreement reimbursed petitioner for incidental charges for William (not including laundry and barber service) and paid currently to the petitioner the balance of the income from the bonds which it held, after deducting its annual fee of $50.
After the death of Victor in 1931, the petitioner continued to accrue income for the care of William at the rate of $100 per month just as it had during the lifetime of Victor. Periodically, when a debit balance in the account had accumulated by reason of the fact that such accruals exceeded the income from the bonds which was remitted to petitioner by the trustee, certain credits were made to the account, the credits being designated ‘Rebates to adjust rate to conform to revenue from interest on bonds held in Trust Fund.‘ These credits were made for the purpose of adjusting the charges made to the account to correspond with the amounts actually received.
Petitioner reported as income for each year with respect to the account of William the amount actually received by it in such year.
It is admitted by the pleadings that when William died on December 5, 1944, the petitioner was entitled to have delivered to it by the trustee bonds having a fair market value of $28,162.20.
OPINION.
KERN, Judge:
The decision of this case upon the construction to be given to the contract of October 30, 1924, which is set out in its entirety in our findings.
It is petitioner's contention that it became the equitable owner of the bonds held in trust pursuant to that contract in 1931, and therefore, the market value of those bonds was taxable income to it in that year rather than in 1944, when William Gauss died. In the alternative, petitioner contends that it should have accrued its regular charges for the care of William commencing with the date of his admission to petitioner's institution and should have charged the excess of such accruals over the income from the bonds actually received, to the corpus of the bonds held by the trustee.
Respondent contends that, since petitioner was not entitled to receive the bonds from the trustee until William's death in 1944, the fair market value of the bonds on that date was taxable income to petitioner in 1944 and in no other year.
The unusual arrangement made by petitioner Victor Gauss and the bank, as trustee, must be construed as a whole and in the light of all the facts disclosed by the record.
In 1924 Victor Gauss was approaching the age of three score years and ten. He was a man of limited financial means. His wife and three of his children had died from tuberculosis. His one surviving child was a son, who was so completely defective mentally and physically that he would need specialized care throughout his life. Victor Gauss felt that petitioner could give to his son such care. His great concern was to arrange for the care of his son after his own death and to arrange for the payment of this care with the limited funds which he had for this purpose.
Petitioner was willing to furnish the care for William, but, of course, desired to be adequately compensated for its services.
The contract in question covered all possible eventualities. During Victor's life he agreed to pay to petitioner $100 per month (an amount somewhat below the usual charge made by petitioner in 1924 for the care of patients). If, during Victor's lifetime William was withdrawn from petitioner, then Victor agreed to make additional payments to petitioner so that the total amount paid would be equivalent to $300 per month for the time William was in petitioner's care. At the time the contract was executed Victor gave to a bank, as trustee, bonds having a fair market value of $28,000. If William died during Victor's life, then petitioner was to receive from the trustee, in addition to the $100 per month paid by Victor, bonds of the market value of $5,000. If Victor should predecease William, then petitioner was to receive, in lieu of the $100 per month paid by Victor, the income from the bonds held in trust, and upon the death of William (after the death of Victor) was to receive these bonds from the trustee as ‘a reward and proper compensation * * * for having rendered care and treatment to the said William during his lifetime.‘ If, after Victor's death, it should be determined that petitioner mistreated William or willfully neglected him, then William was to be transferred to another institution, which, if it cared for William for six months before his death, would be entitled to receive the bonds.
Thus, after Victor's death petitioner was obligated by this contract to furnish care and attention to William during his life and was entitled to receive as compensation the current income from the bonds put in trust by Victor to accomplish the purposes of the contract and to receive the bonds themselves (the corpus of the trust) at the end of William's lifetime if William was being cared for by petitioner at that time.
While petitioner had certain rights under the contract of 1924 contingent upon its furnishing proper care to William, it is apparent that the real beneficiary of the trust referred to in the contract and created contemporaneously with its execution was Victor's defective son William. It was primarily for his benefit that the trust was created. The purpose of the trust was to provide and insure proper care for William during his lifetime. It was contemplated that petitioner would furnish this care, but the possibility was also contemplated that petitioner could not, or would not, furnish the proper care for William. The income of the trust during William's life was to be expended for William's benefit. It was to be paid to petitioner or any other institution caring for William. Since this income would not, in all probability, be sufficient to pay charges usually made for institutional care, it was provided, for the purpose of inducing petitioner or another similar institution to furnish proper care to William at a rate of compensation below the customary charges, that upon William's death the corpus of the trust was to be distributed either to petitioner or to such other institution which had cared for William for six months prior to his death.
Petitioner's principal contention is that its rights after the death of Victor in 1931 were analogous to those of a vendee in situations where the possession of or the legal title to property is placed in escrow for the purpose of securing the payment of the purchase price, and it points out authorities holding, for tax purposes, that the vendee obtains equitable and beneficial ownership of the property when it is placed in escrow, subject only to the possibility of losing that ownership upon failure to pay the purchase price agreed upon. Long v. United States, 66 Ct.Cls. 475; Moore v. Commissioner, 124 Fed.(2d) 991; De Guire v. Higgins, 159 Fed.(2d) 921; Bonham v. Commissioner, 89 Fed.(2d) 725; Philip W. McAbee, 5 T.C. 1130. Petitioner argues that upon Victor's death it became the beneficial and equitable owner of the bonds forming the corpus of the trust, legal title to which was held by the trustee to secure the performance of petitioner's obligation to care for William, and that it was only subject to be divested of this ownership upon the occurrence of a condition subsequent, viz., its failure to furnish proper care to William. Therefore, petitioner concludes, it was taxable upon the fair market value of the bonds held by the trustee as income received by it in 1931, and not in 1944, the year of William's death.
We do not agree with petitioner's argument. In our opinion, Victor did not intend by the arrangement entered into in 1924 to transfer to petitioner upon his death the beneficial ownership of the bonds forming the corpus of the trust, subject to being divested of this beneficial ownership upon the occurence of a condition subsequent, viz., petitioner's failure to furnish proper care to William during William's lifetime. William was the real beneficiary of the trust; it was for the purpose of obtaining proper care for him during his lifetime and after the death of his father, that the trust was created. As compensation for its services rendered to the trust in caring for William, petitioner was to receive the current trust income; and as additional compensation and an inducement to petitioner to comply faithfully with its undertaking to care for William, even though the currently distributable compensation was less than the charges customarily made for similar services, it was provided that upon William's death while still in petitioner's institution, and upon the consequent termination of the trust, petitioner was to receive the trust corpus.
We conclude, after an examination of the 1924 contract as a whole and in the light of all the surrounding facts, that petitioner became the beneficial owner of the bonds held by the trust only at the end of William's life, when the trust terminated and when petitioner completed its undertaking to properly care for William during his lifetime.
We are also unable to agree with petitioner's alternative contention that the bonds constituted accrued income in years prior to 1944. In connection with this contention, petitioner suggest that it should have accrued its regular charges for the care of patients as charges for William's care and, in so far as they would have been in excess of the trust income, this excess should have been charged to the corpus of the bonds held by the trustee. In our opinion such an accrual method was not justified under the terms of the contract.
Decision will be entered for respondent.