Donnelly v. Commissioner , 38 B.T.A. 1234 ( 1938 )

ESTATE OF PAUL F. DONNELLY, DECEASED, MERCANTILE-COMMERCE BANK & TRUST CO., A CORPORATION, AND VIRGINIA G. DONNELLY, CO-ADMINISTRATOR DE BONIS NON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Donnelly v. Commissioner

Docket No. 87103.

United States Board of Tax Appeals

38 B.T.A. 1234; 1938 BTA LEXIS 767;

November 23, 1938, Promulgated

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The decedent created a trust the income of which was payable to his wife, with the provision that she should use it for their family and joint living expenses and for her own maintenance and support, among other things. Held, that the amount distributable to the wife upon the death of the husband was not properly included in his gross estate under section 302(c) of the Revenue Act of 1926, as amended by section 803(a) of the Revenue Act of 1932.

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MURDOCK

The Commissioner determined a deficiency of $46,104.01 in estate tax. Facts have been stipulated showing that the petitioner is entitled to an additional credit for state inheritance taxes, leaving as the only issue for decision by the Board whether or not the Commissioner erred in including $100,000 in the gross estate. This amount was distributed from the corpus of a trust to the widow of the decedent. The Commissioner included it in the gross estate under the provisions of section 302(c) and (d) of the Revenue Act of 1926, as amended. The respondent does not contend that this transfer in trust was made in contemplation of death, and, consequently, no facts relating to that point will be found.

FINDINGS OF FACT.

Paul F. Donnelly died on September 7, 1934, a citizen and resident of Kansas City, Missouri. He was survived by his widow, Virginia George Donnelly, and by a daughter born posthumously. Although the decedent left a will, it was of no effect under the law of Missouri because of the birth of a posthumous child, and his estate was subject to the laws of intestacy.

The decedent married Virginia George on February 13, 1933. They had entered into a prenuptial agreement at the suggestion of the decedent on February 11, 1933. The agreement provided that the decedent would create a trust shortly after their marriage. The agreement recited that Donnelly was subject to the unfortunate habit of using liquor intemperately and as a result there might be times when he would neglect the comfort and support of his wife. The trust instrument was to provide that $500 a month would be paid directly to his wife whenever he would be incapacitated. The agreement further provided: "When Mr. Donnelly is not in such condition he shall himself receive and be entitled to have such and any other income from the trust fund. He shall also have all income in excess of the $500." The agreement also stated what should be done with the trust property in case of divorce, in case of remarriage, and in case of death of the parties.

The decedent executed the promised declaration of trust on November 20, 1933, and on February 26, 1934, made an absolute and complete transfer to the trust of certain securities having a value in excess of $100,000. The agreement recited:

WHEREAS, the Settlor is desirous of establishing a Trust Estate for the benefit of himself and the beneficiary hereinafter named, which shall be revocable only upon the joint written consent of the beneficiary, Virginia George Donnelly, and Settlor, as hereinafter provided; * * *

The income of the trust was to be paid as follows:

1. At the time of the execution of this trust indenture, the Settlor has a living wife, namely, Virginia George Donnelly, and the said Trustees shall pay to said Virginia George Donnelly, as long as Settlor lives and Virginia George Donnelly remains the wife of Settlor, the sum of Four hundred seventeen and no/100 dollars ($417.00) per month, the liability therefor to date from the first day of January, 1934, and which said monthly payments shall commence as soon as there is sufficient income thereafter available, provided however, and regardless of any term or provision herein contained, if at any time there be not sufficient net income in the hands of the Trustees, after deducting the reasonable and necessary expenses of the Trust, including compensation to the Trustees, to provide said Four hundred seventeen dollars ($417.00) payment each month, then the Trustees shall pay the entire net income of said Trust monthly to the beneficiary and shall thereafter and as soon as sufficient net income is available in the Trust Estate, increase said monthly payments so that the payments to said beneficiary shall average Four hundred seventeen dollars ($417.00) each month, from January 1, 1934, provided the net income is sufficient to provide such average monthly payments, and which monthly payments when received by said Virginia George Donnelly shall be used and applied upon their family and joint living expenses and provide in full for her own bills and expenses and for her own care, maintenance and support, and if at any time the said Virginia George Donnelly shall not use said monthly income of $417.00 to pay her own bills and expenses and to care for her own support, maintenance and care and in and about their joint living expenses, then the Trustees may pay out and apply and use said monthly income of $417.00 to pay and discharge and take care of her maintenance, care and support and apply any excess to their joint living expenses, but there shall be no liability whatsoever upon the Trustees to ascertain whether said Virginia George Donnelly is paying out said monty [sic] for her own maintenance, care and support and in and about their joint family expenses, and the Trustees may continue to make said payments to said beneficiary until such time as the Settlor may deliver to the Trustees affidavit accompanied by statements of unpaid accounts incurred by said beneficiary showing that the beneficiary is not applying said payments as herein provided and the Trustees shall in no event be liable for any payments made to said beneficiary before receiving such affidavit.

The trust was to cease and all property was to be paid to the settlor in case he obtained a divorce from his wife for her fault. The monthly income of $417 was to be paid to the wife until she remarried in case she should obtain a divorce for her husband's fault. Upon her remarriage under such circumstances, she was to receive $25,000 from the trustees and the remainder of the property was to be turned over to the settlor. All income in excess of $417 per month and expenses, including taxes, was to be paid to the settlor. The trust was to remain in full force and effect during the joint lives of the settlor and his wife unless it was sooner terminated by divorce for the fault of the wife or for the fault of the husband followed by remarriage of the wife. One hundred thousand dollars was to be paid over to the wife in case she survived her husband and they were still married at the time of his death, whereas the entire trust property was to be paid over to him after paying her funeral expenses "if he be then living." In case she survived him the $100,000 received by her from the trustees "shall be credited by her upon, and applied against, any portion of the estate of Settlor which she, as his widow, would be entitled to receive." Paragraph IV was as follows:

It is specifically provided herein that the Settlor retains no power of revocation of the trust herein established whatsoever, nor in any way to change, alter or modify the same, except that Settlor reserves the right and this trust indenture is executed by all parties subject to the express agreement, understanding and reservation that the trust may be terminated at any time by mutual agreement in writing signed by the Settlor, Paul F. Donnelly, and by the beneficiary Virginia George Donnelly, and acknowledged as provided for the acknowledgment of conveyances of real estate in Missouri.

Paragraph IX recited that it was the wish and desire of the settlor to create a trust sufficient to pay "a monthly net income to said Virginia George Donnelly of $417.00 each month as long as she is the wife of the Settlor", and as long as she remains unmarried after a divorce for his fault, but in case the income was not sufficient to pay $417 each month, the deficit was to be made up by later payments, if possible.

The decedent and his wife entered into an agreement on November 20, 1933, in which it was stated that the declaration of trust was accepted as substantial and adequate compliance with their prenuptial agreement, in view of changed financial and other conditions. The agreement further provided:

In consideration of the premises and of the provisions made for her under said Trust Agreement, Virginia George Donnelly further agrees that as long as she remains the wife of Paul F. Donnelly, the monthly payments to be made to her under the provisions of said Trust Agreement shall be used, when paid to her, as a common fund, and shall be used and applied upon their family and joint living expenses, and that she will provide and pay in full for her own bills, expenses and her own maintenance, care and support, out of said monthly payments, except that while they are living together, Paul F. Donnelly agrees to provide or pay for their lodging and meals, and that if she is living separate and apart from said Paul F. Donnelly, but not divorced from him, she is to pay for her own lodging and meals, and pay all her expenses and take care of and pay for her own maintenance and support out of said monthly payments and she will at no time cause or permit any bills to be incurred or claims to be made against Paul F. Donnelly in connection with her care, maintenance, support or any other obligations which she may incur.

Virginia George Donnelly also agreed that the provisions of the trust were in full discharge of all claims which she might ever assert against her husband for alimony, maintenance, support, marital rights, interest, estate or claims either vested, contingent, or otherwise, in case of a divorce from him for his fault, and she released all claims for dower and statutory allowances of every kind. The decedent agreed that in case the income from the first was at any time insufficient to pay $417 a month, he would promptly pay to his wife a sum making up the difference.

The decedent was not engaged in any business, but he had a substantial income from annuities which he had purchased and from securities which he owned. He and his wife lived together as man and wife without any divorce or separation from the time of their marriage until the time of his death. The decedent during that period on several occasions drank excessively and had to be placed in hospitals under the care of doctors. He took his own life while in a hospital being treated for alcoholism.

The trust had no income with which to pay Virginia George Donnelly the first payment due under the trust and the decedent paid her $417 for January 1934 from his own separate funds in lieu of that payment. Thereafter, the wife received regular payments under the trust.

When the final draft of the trust instrument was presented to the decedent for execution, his wife stated that the provision requiring her to use trust income for joint household expenses was not in accordance with the wishes of herself or her husband, but the money was to be her own in lieu of the monthly allowance which her husband had been giving her up to that time. The attorney suggested that the provision be left unchanged and the decedent said that as far as he was concerned she could always have the money for her own benefit. The wife always used the income which she received from the trust for her own benefit. She deposited the checks in her own separate bank account. She used the money to buy her own clothes, for spending money, and, with the knowledge of her husband, she used a part of the amount received each month for the support of her brother, who was in a sanitorium. The decedent paid all of their household and family expenses at all times during their marriage.

The trustees paid to Virginia George Donnelly, after the decedent's death, $100,000 in cash and securities at their fair market value, and paid over the remainder of the trust funds to the administrators of the decedent's estate. The Commissioner included the entire amount of the trust property in the gross estate.

Any additional facts contained in the stipulation and the exhibits attached thereto not heretofore found as facts are hereby incorporated in these findings by this reference.

OPINION.

MURDOCK: This trust was not a revocable trust within the meaning of section 302(d) of the Revenue Act of 1926, as amended by section 401 of the Revenue Act of 1934. That section, as amended, provides for the inclusion in the gross estate of property transferred in trust by the decedent, "where the enjoyment thereof is subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke." The decedent reserved no power to alter or amend. He purported to reserve the power to revoke the trust with the consent of his wife. Those two, being the only interested parties, could have revoked the trust at any time in the absence of that reservation. ; . It has been held that a reservation of that kind is not a power to revoke within the meaning of the words above quoted. ; ; affd., .

Section 803 of the Revenue Act of 1932, entitled "Future Interests," provides in part as follows:

(a) Section 302(c) of the Revenue Act of 1926, as amended by the Joint Resolution of March 3, 1931, is amended to read as follows:

"(c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise * * * intended to take effect in possession or enjoyment at or after his death, or of which he has at any time made a transfer, by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death (1) the possession or enjoyment of, or the right to the income from, the property * * *."

The property in question is the $100,000 which the wife was to receive and did receive under the trust instrument upon the death of her husband. Possession of that property from the time of the creation of the trust until the death of the decedent was in the trustees. The enjoyment of the property likewise took effect immediately when the trust was created. Thus, the transfer which the decedent made took effect in possession or enjoyment immediately, rather than at or after his death, and the decedent did not retain the possession of the property for himself during any period. ; ; ; ; ; ; . , is not in point because here the decedent divested himself of the entire estate and the remainder could vest in him only upon the happening of a condition precedent.

The remaining question is, Did the decedent retain for his life or for a period which in fact did not end before his death, the enjoyment of the property or the right to the income from the property, within the meaning of section 302(c), as amended? The respondent argues that the rights which the decedent retained in regard to the use of the income, that is, the right to have it used for their family and joint living expenses and for the support and maintenance of the wife, were such that the income of the trust would be taxable to the grantor under a line of cases beginning with . See also ; ; ; . Cf. . The courts in those cases held that income from trusts set up by a husband and father for the support and maintenance of his wife, or for the payment of family living expenses, is income to him under the general definition of income, since it is used to discharge his obligations, and in that way he has the enjoyment and benefit of it. This is an estate tax case, not an income tax case, and it must be decided under the specific provisions of section 302(c), as amended, rather than upon any analogy from income tax cases. The language of the statute does not clearly indicate that it was intended to apply to a situation like this. This decedent did not retain the enjoyment of the property nor the right to the income from the property, as those phrases are ordinarily understood. He retained no right to receive the income, and any enjoyment of the property or right to the income from the property came to him in a very indirect manner, if at all. The use of the income was not limited to the discharge of his legal obligations. The legislative history of the amendments to section 302(c) of the Revenue Act of 1926 indicates that Congress was trying to prevent the evasion of estate tax in cases where the decedent retained a life interest in trust property for himself and conveyed the remainder to others.

The following language appears in the report of the Ways and Means Committee of the 72d Congress, Report No. 708, p. 46:

The purpose of this amendment to section 302(c) of the revenue act of 1926 is to clarify in certain respects the amendments made to that section by the joint resolution of March 3, 1931, which were adopted to render taxable a transfer under which the decedent reserved the income for his life. The joint resolution was designed to avoid the effect of decisions of the Supreme Court holding such a transfer not taxable if irrevocable and not made in contemplation of death. * * *

(2) The insertion of the words "or for any period which does not in fact end before his death," which is to reach, for example, a transfer where decedent, 70 years old, reserves the income for an extended term of years and dies during the term, or where he is to have the income from and after the death of another person until his own death, and such other person predeceases him. This is a clarifying change and does not represent new matter.

(3) The insertion of the words, "the right to the income" in place of the words "the income" is designed to reach a case where decedent had the right to the income, though he did not actually receive it. This is also a clarifying change.

Similar statements are contained in the Finance Committee Report, Report 665, p. 49. The discussion of the Joint Resolution of March 3, 1931, contained in the Congressional Record of that date, volume 74, pp. 7078, 7079, indicates that the purpose of the Joint Resolution was to preclude the possibility of estate tax avoidance through trusts where the grantor reserved the income to himself for life, or the right to the disposition of the income, with remainder to others, which, under decisions of the Supreme Court handed down on the previous day in the cases of ; ; , following , were held not a part of the decedent's gross estate under section 302(c) of the Revenue Act of 1926.

This was not the kind of a trust that the amendments to section 302(c) were intended to catch. It is obvious that the present trust was designed neither to evade estate tax nor as a substitute for a testamentary disposition of the decedent's property. The decedent did not reserve the income to himself for life and convey the remainder to others. He knew that he was given to the intemperate use of alcohol and that there would probably be times when he would not have sense enough to take care of his wife or himself. He wanted his wife to have income with which to take care of herself and also himself at such times, and he wanted her at other times to have a small independent income. The fact that the decedent retained the right to receive all income in excess of $417 a month seems unimportant. The property in question is not the entire corpus of the trust which was placed there to produce income of $417, but is only $100,000 thereof. It is unlikely that a fund of $100,000 would produce more than $417 a month and expenses, and, furthermore, the evidence does not indicate that there ever was any excess from the entire trust fund. The application of section 302(c), as amended, to this trust is doubtful, to say the least, and doubts under such circumstances must be resolved in favor of the taxpayer. The $100,000 was not properly included in the decedent's estate under section 302(c), as amended.

Reviewed by the Board.

Decision will be entered under Rule 50.

OPPER

OPPER, dissenting: In the majority opinion the underlying questions of fact are treated as though found in favor of respondent. The opinion assumes that the trust instrument carried out the grantor's desire for "his wife to have income with which to take care of herself and also himself at such times [as he was unable to care for himself] and he wanted her at other times to have a small independent income." Although the wife did not in fact use the income for the family living expenses, she did use it "to buy her own cloths" and "for spending money." Whether or not the terms of the trust instrument itself and their requirement that the income be "used and applied upon their family and joint living expenses, and provide in full for her [the wife's] own bills and expenses and for her own care, maintenance and support" would be reformed in an action brought by the wife is at least doubtful. Robinson v. Korns,250 Mo. 663">250 Mo. 663; 157 S.W. 790">157 S.W. 790; Parker v. Vanhoozer,142 Mo. 621">142 Mo. 621; 44 S.W. 728">44 S.W. 728; Southern Surety Co. v. United States Cast Iron Pipe & Foundry Co., 13 Fed.(2d) 833. In any event payment for the wife's necessary personal expenses and for her clothes were obligations of the husband and when incurred were debts of his which he could be required to pay. See Johnson v. Briscoe,104 Mo.App. 493; 79 S.W. 498">79 S.W. 498. The use of the proceeds of a fund of this size by the wife, under her admitted obligation, for the discharge of her personal expenses and for the purchase of her clothing in a case like this where the income of the husband was approximately $25,000 a year can not, it seems to me, be said to be unreasonable as a matter of law. At least the burden must have been upon the petitioner to show that the decedent's obligation to provide funds for his wife's use in those respects was less than the income provided by the trust. See Commissioner v. Grosvenor, 85 Fed.(2d) 2. No such burden has been sustained. For all the foregoing reasons and because the majority opinion proceeds upon that assumption, it seems to me this case must be regarded as presenting the same question as to estate tax that was passed upon under the income tax provisions in Douglas v. Willcuts,296 U.S. 1">296 U.S. 1, and similar cases.

The problem under the language of section 803(a) of the Revenue Act of 1932 ¹ is therefore to determine whose income it was that the trust fund provided. This is the same question as was before the Supreme Court in The Court said there (pp. 9, 10):

* * * We have held that income was received by a taxpayer, when, pursuant to a contract, a debt or other obligation was discharged by another for his benefit. The transaction was regarded as being the same in substance as if the money had been paid to the taxpayer and he had transmitted it to his creditor. * * * The creation of a trust by the taxpayer as the channel for the application of the income to the discharge of his obligation leaves the nature of the transaction unaltered. * * * In the present case, the net income of the trust fund, which was paid to the wife under the decree [providing for the wife's maintenance], stands substantially on the same footing as though he had received the income personally and had been required by the decree to make the payment directly.

* * * we find no warrant for a construction which would preclude the laying of the tax against the one who through the discharge of his obligation enjoys the benefit of the income as though he had personally received it.

* * * in contemplation of law the income remains in substance that of the grantor. * * * [Emphasis added.]

It can not, I think, be doubted that if the settlor of a trust were to provide that his trustees should use the income to pay his bills instead of distributing the cash to him he would be held to have "retained * * * the * * * enjoyment of or the right to the income from, the property", within the meaning of section 302. Here the only difference is that the wife was constituted an intervening agency for attaining the same result. This does not require a different conclusion. See In fact upon her omission, the trust instrument provided for the direct payment by the trustees of those obligations of the settlor which it was contemplated it would in the first instance be the duty of the wife to discharge. The precise language is:

If at any time the said Virginia George Donnelly shall not use said monthly income of $417.00 to pay her own bills and expenses and to care for her own support, maintenance and care and in and about their joint living expenses, then the trustees may pay out and apply and use said monthly income of $417.00 to pay and discharge and take care of her maintenance, care and support and apply any excess to their joint living expenses * * *.

To hold in the face of that language that the settlor did not retain the enjoyment of and the right to the income from the property seems to me to deprive the provisions of the statute of all meaning and practical effect.

It is said in the majority opinion that the legislative history of the section shows that it was designed "to preclude the possibility of estate tax avoidance through trusts where the grantor reserved the income to himself for life" and that "the instant proceeding does not present the kind of a trust that the amendments to section 302(c) were intended to catch." But the very situation thus described appears to be present here. True, there is no evidence of any intention on the part of the decedent to avoid estate taxes. But it has been repeatedly stated that the mere desire to escape taxation is not material in determining whether or not a particular transaction is subject to tax. See , and cases there cited. And certainly the effect, if not the intent, will have been accomplished. The $100,000 which the wife received from the trust fund at decedent's death would have been a part of decedent's estate and taxable as such had it not been for the creation of the trust. It seems clear that the kind of trust now before us could be used as a vehicle of avoiding estate taxes. Prevention of this is the very motivation recognized in the majority opinion, for the passage of the amendments to section 302.

The language quoted in the majority opinion from the report of the Ways and Means Committee seems to me to indicate that the provisions of section 302 should apply to such a situation as this, rather than otherwise. For the purpose is said to be "to render taxable a transfer under which the decedent reserved the income for his life." What the decedent did here was tantamount to such a reservation. The income was reserved to him as much as though he himself had received it. The report says further: "the insertion of the words 'the right to the income' in place of the words 'the income' is designed to reach a case where decedent had the right to the income though he did not actually receive it." This language is peculiarly apt to describe the provisions of the present instrument under which, even though decedent may have failed to insist upon it, he could have compelled the trustees to use the income for his own living expenses and to discharge the obligations placed upon him by law to pay those of his wife. I think the principle of , is applicable to this proceeding and an obliged to note my dissent from the conclusion reached by the majority.

TYSON and DISNEY agree with this dissent.

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Footnotes

• 1. SEC. 803. FUTURE INTERESTS.

  (a) Section 302(c) of the Revenue Act of 1926, as amended by the Joint Resolution of March 3, 1931, is amended to read as follows:

  "(c) To the extent of any interest therein of which the decedent * * * has at any time made a transfer, by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom; except in case of a bona fide sale for an adequate and full consideration in money or money's worth. * * *" ↩