Opinion
No. 206.
June 30, 1943.
Petition to Review a Decision of the Tax Court of the United States.
Petition by Howard Phipps to review a decision of the Tax Court of the United States, 47 B.T.A. 357, redetermining the income tax of petitioner for 1935 imposed by the Commissioner of Internal Revenue.
Reversed.
Petitioner, a wealthy man and a resident of New York, in 1931 married, his wife's name being Harriet Phipps. Their only child, Anne Phipps, was born September 12, 1932. At the time of his marriage, petitioner considered making a settlement upon his wife; his two sisters-in-law were well off, and he did not want his wife to feel financially dependent upon them. On his return from his honeymoon, he consulted his lawyers concerning his desire to give his wife an independent income, and they advised the creation of a trust. A trust agreement was executed by the petitioner as grantor on June 3, 1932, naming his wife and child, then unborn, as beneficiaries. It recited that the wife was with child and that petitioner desired to transfer securities to trustees therein named "in order to make provisions of settlement for the benefit of his said wife * * * and of said child." The corpus of the trust was composed of first mortgage bonds and notes aggregating the face amount of $1,276,000 and sundry preferred and common stocks. The trustees named in the instrument were petitioner, his wife and the Bessemer Trust Company. On December 6, 1934, petitioner, who had not theretofore exercised any rights as trustee, resigned, and throughout the calendar year 1935 the wife and the corporate trustee were the only trustees.
The trust contained the following provisions:
"Until such child of the said Harriet Phipps, now en ventre sa mere, shall attain the age of twenty-one (21) years, the Trustees shall pay to the said Harriet Phipps such part of the net income of the trust estate as they, in their uncontrolled discretion, may decide upon and shall pay over such part of the balance of said net income as they shall, in their absolute uncontrolled discretion, consider necessary and advisable to the said Harriet Phipps as custodian for the maintenance, support and education of such child. The expenditure of said income paid to the said Harriet Phipps, as custodian for such child, shall be in her sole and absolute discretion and she shall not be required to give any bonds or other security covering her expenditure of said income. The receipt of the said Harriet Phipps for the payment to her of said income shall effectually discharge and release the Trustees for all payments made to her hereunder. The balance of said net income remaining in the hands of the Trustees shall be accumulated by them during the minority of such child and shall be paid over to such child upon his or her attaining the age of twenty-one (21) years.
"From and after the time when such child shall attain the age of twenty-one (21) years, the Trustees shall pay out the net income of the trust estate to the said Harriet Phipps and to such child in such proportions as they shall, in their sole discretion, fix and determine, even to the extent of paying all of said income to one of said beneficiaries.
"From and after the death of the said Harriet Phipps, should she predecease such child, the Trustees shall pay out the entire net income of the trust estate to such child; provided, however, should the said Harriet Phipps die during the minority of such child, the Trustees, if they so elect, may accumulate any and all of the income to which such child may be entitled until such child shall attain the age of twenty-one (21) years and may apply as much of such income as they may, in their sole and absolute discretion, decide upon towards the education, comfort, maintenance and support of such minor child.
"From and after the death of such child, should he or she predecease the said Harriet Phipps, the Trustees shall pay out the entire net income of the trust estate, including any accumulations for the benefit of such child, should such child not live to be twenty-one (21) years of age, to the said Harriet Phipps.
"Upon the death of the last survivor of the said Harriet Phipps and such child, the Trustees shall pay out the entire trust estate, including principal and income, to such of the descendants of the said Howard Phipps, in such proportions and in such manner, as the said Harriet Phipps in and by her last will and testament shall direct and appoint and in default of such testamentary appointment, then to the descendants of the said Howard Phipps in equal shares, per stirpes and not per capita, and in default of any such descendants, then to the said Howard Phipps, if he be then living, otherwise to the descendants of the brothers and sisters of the said Howard Phipps, in such proportions as the Corporate Trustee may direct, per stirpes and not per capita.
"At any time within the duration of this trust and during the life of the said Howard Phipps, upon the written direction of the said Harriet Phipps, acting in her sole and absolute discretion, the Trustees shall pay over and transfer all of the trust estate, including principal and income, which may at such time be in their hands to the said Howard Phipps, and thereupon the trust estate hereby created shall cease and determine and the said Trustees shall thereupon be discharged from all further responsibility therefor."
The trust instrument gave the trustees broad powers of management, including the power to sell the trust assets and to reinvest the proceeds.
The Bessemer Trust Company was organized under the laws of the State of New Jersey in 1907. The shares of its stock were owned by petitioner, his two brothers and his two sisters in equal shares. Petitioner has served as director of the Trust Company ever since the date of its inception and as vice-president since January 1910. His brother is president. The Trust Company handles the financial matters for members of the Phipps family and acts as trustee solely for trusts created by them. It provides investment services with respect to investment funds of members of that family as it does for the investment of the funds of trusts created by them. During each of the calendar years 1934 to 1940 inclusive, payments out of the income of the trust, aggregating $249,829 were made to the wife as follows:
1934 ......................... $36,000.00 1935 ......................... 40,000.00 1936 ......................... 40,000.00 1937 ......................... 22,459.00 1938 ......................... 26,879.47 1939 ......................... 44,539.51 1940 ......................... 40,000.00
No payments were ever made by the trustees to the wife as custodian for the support and education of the daughter. All the payments from the trust to the wife were used by her for personal ends other than maintenance and support; none of such payments was used by her to defray household expenses or for the support of herself or daughter; household expenses of the petitioner were paid by the wife out of funds furnished directly by him for that purpose; the income received by her from the trust was used by her principally for paying her income taxes, for making personal investments and for gifts to charities and to her relatives and friends; petitioner never advised his wife with respect to the disposition to be made by her of any of such income. The Board of Directors of the Trust Company never took up for consideration the question of the amount of the income from the trust which should be distributed to the wife. The Trust Company each year has distributed to her the amounts which she requested of it, but these amounts were determined by her lawyer and a tax expert, their advice being predicated upon the amounts which, if distributed, would result in the minimum income tax liabilities for the wife and for the trust. Petitioner never participated in discussions at conferences held by officials of the Trust Company with respect to the investment or reinvestment by the trustees; he never bought any securities from, or sold any securities to, the Trustees nor did he ever borrow any money from or enter into any transaction with them.
Petitioner's wife reported the amount distributed to her from the trust in 1935 (except such as was tax-exempt) in her federal income tax returns for that year. The Commissioner determined that the income paid to the wife from the trust during that year was the taxable income of petitioner, and determined a deficiency in his income taxes for the year 1935 accordingly. The Tax Court, relying on § 22(a) of the Revenue Act of 1934, 26 U.S.C.A. Int.Rev.Acts, page 669, affirmed this determination.
In its opinion, the Tax Court [47 B.T.A. 357, 365] said: "Income was payable for the wife's use or for the support of the child, or was to be accumulated, depending exclusively on the discretion of the trustees. In New York, decisions of that nature must be unanimous in the case of multiple trustees, and that, of course, is even more true where there are but two. `It seems to be well established that where the acts of trustees call for exercise of discretion and judgment, the concurrence of all is necessary.' * * * The wife, therefore, could lay no positive claim to a single penny of the trust income. See Fulham v. Commissioner, 1 Cir., 110 F.2d 916. If the corporate trustee of which petitioner had practical control refused to sanction the enjoyment of these benefits by the wife, her capacity to share in the prospective gifts could be limited, reduced, or destroyed. The money could then be spent for the support of petitioner's child, or it could be withheld from both wife and child. * * * Thus, so long as the anticipated relationship between petitioner and his wife might prevail we have the very essence of the family's solidarity upon which the principle of the Clifford case [Helvering v. Clifford, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788] fundamentally rests. And if the time arrives when this no longer obtains, the structure and arrangement of the trust is such that petitioner's intervention can be made effective. * * * He can then control, by indirection, the distribution of the trust income. Commissioner v. Buck [2 Cir., 120 F.2d 775]."
The case is here on petitioner's petition to review the Tax Court's decision.
Joseph M. Proskauer and B.H. Bartholow, both of New York City (Irving H. Bull and W.G. Dunnington, both of New York City, of counsel), for petitioner.
Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, Helen R. Carloss, and Joseph M. Jones, Sp. Assts. to the Atty. Gen., for respondent.
Before L. HAND, AUGUSTUS N. HAND and FRANK, Circuit Judges.
1. There can be little doubt that, within the doctrine of Helvering v. Clifford, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788, the corporate trustee is not to be regarded as independent and that the situation must be considered as if, in effect, the taxpayer and the wife were the two trustees named in, and acting under, the trust instrument. See Commissioner v. Barbour, 2 Cir., 122 F.2d 165, 167 where a trustee who was the taxpayer's lawyer was considered as not independent; Commissioner v. Lamont, 2 Cir., 127 F.2d 875 holding similarly where the trustee was the taxpayer's attorney and financial adviser; Bush v. Commissioner, 2 Cir., March 4, 1943, 133 F.2d 1005 where we reached a similar conclusion as to a trustee who was the taxpayer's close friend and business associate.
2. Nevertheless, we cannot agree with the Tax Court that this case is like Commissioner v. Buck, 2 Cir., 120 F.2d 775 or otherwise within the Clifford doctrine. The trust here is a long-term trust, and, as we said in the Buck case, the control over the income exercised by the grantor must be "very substantial" in such circumstances if the income is to be considered his. It may be argued that during the minority of the child, the taxpayer (operating through the trust company) could refuse to agree to the payment of any income to the wife, and that, if she, in turn, thereupon refused to agree to the payment of any income for the support and maintenance of the child, the income would accumulate and be paid to the child at the age of 21, with only a contingent possibility of the wife's receiving these accumulations (i.e., in the event that the child predeceased the wife before the child reached the age of 21.) But, as the obvious purpose of the trust was that the wife was to receive a considerable part of the income, an arbitrary refusal on the part of her co-trustee to pay her any of the income so that it would accumulate, would, we think, induce the New York courts to interfere and compel the co-trustee to exercise a genuine discretion in the light of the purpose of the trust. Collister v. Fassitt, 163 N.Y. 281, 57 N.E. 490, 79 Am.St.Rep. 586; Matter of Van Zandt's Will, 231 App. Div. 381, 247 N.Y.S. 441; Colton v. Colton, 127 U.S. 300, 8 S.Ct. 1164, 32 L.Ed. 138.
Fulham v. Com'r, 1 Cir., 110 F.2d 916, 918, related to § 166, 26 U.S.C.A. Int.Rev.Code, § 166 and is distinguishable on its facts which we discuss below.
It is true that the trust agreement also provides that, after the child reaches the age of 21, the income is to be allocated by the trustees in their discretion to the wife and the child. But again we think the wife's co-trustee would be obliged to exercise a genuine discretion; a refusal on the part of the co-trustee to distribute anything to the wife, followed by her refusal to allocate anything to the child, would bring about the intervention of a court of equity to compel distribution and to avoid an unintended accumulation of income, one indeed which would be unlawful under New York law. Real Property Law, § 61, Consol.Laws N.Y. c. 50; Personal Property Law § 16, Consol. Laws N Y c. 41.
In a case like this, where, only through a disregard of the purposes of the trust — a disregard which would result in judicial intervention — could the husband control the allocation of the income among members of his family, is not sufficiently like the Clifford or Buck cases to make the doctrine of those cases applicable. Nothing in those cases suggests that a wife, who has an obviously selfish adverse interest in receiving income for herself, is so lacking in independence that it is to be conclusively presumed that she will exercise her powers as a trustee in accordance with the wishes of her husband.
Helvering v. Stuart, 63 S.Ct. 140, 87 L.Ed. ___, November 16, 1943, indicates, as we held in Bush v. Commissioner, 2 Cir., March 4, 1943, 133 F.2d 1005, that, in such a case as this, the views of the Tax Court are to be given considerable weight even as to "questions of law"; but here we think the conclusion of the Tax Court is so erroneous that we are not obliged to adopt it.
Cf. Gray v. Powell, 314 U.S. 402, 411-413, 62 S.Ct. 326, 86 L.Ed. 301.
Cf. Estate of Sanford v. Com'r, 308 U.S. 39, 52, 60 S.Ct. 51, 84 L.Ed. 20; United States v. San Francisco, 310 U.S. 16, 31-32, 60 S.Ct. 749, 84 L.Ed. 1050; Associated Industries v. Ickes, 2 Cir., February 8, 1943, 134 F.2d 694.
3. The Tax Court, having reached its decision under § 22(a), did not consider § 166, 26 U.S.C.A. Int.Rev.Code § 166. The Commissioner argues that the income is taxable under § 166 because the wife has no adverse interest in the corpus since she can never receive any of it, having merely a power of appointment restricted to descendants of the taxpayer. But the controlling words of § 166 are those relating to "any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom." Here the wife had a substantial adverse interest in the income. Graff v. Commissioner, 7 Cir., 117 F.2d 247, is not, we think, contra; but if it is, we disagree with it. Fulham v. Com'r, 1 Cir., 110 F.2d 916, 918, is distinguishable since there the court pointed out that on the "face of the trust instrument, the main objective seems to be to accumulate the income during the life of Mrs. Fulham * * *" the wife of the grantor; the court also stated, "It does not appear in the record that Mrs. Fulham has in fact been receiving any payments * * *." Moreover, the instrument there set up a committee of three persons, not including the wife, with power to amend the trust so as to deprive the trustees of the power to make any payments of income to the wife.
Italics added.
Reversed.