Empire Trust Co. v. Commissioner , 41 B.T.A. 839 ( 1940 )

EMPIRE TRUST COMPANY, MARGARET PRESCOTT TRACY AND WILLIAM WARD TRACY, AS EXECUTORS OF THE LAST WILL AND TESTAMENT OF WILLIAM DWIGHT TRACY, DECEASED, AND MARGARET PRESCOTT TRACY, INDIVIDUALLY, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Empire Trust Co. v. Commissioner

Docket No.90519.

United States Board of Tax Appeals

41 B.T.A. 839; 1940 BTA LEXIS 1132;

April 16, 1940, Promulgated

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The trustee (who was also the trustor) of a trust, acting under a claimed power conferred in the trust instrument, transferred purportedly as a gift to his wife, the trust beneficiary, certain trust securities. Such transfer was pursuant to an agreed plan to sell the securities and to make the resulting loss available as a deduction from gross income in the joint income tax return of the husband and wife. In compliance with the agreement the securities were sold, a capital loss was claimed by the wife, and the amount thereof was deducted in the return. Held, that the transfer in question did not constitute a gift of the securities to the wife and the loss resulting from the sale thereof was not her loss, and consequently is not deductible in the joint income tax return.

Stuart McNamara, Esq., Ulysses S. Grant, Esq., and John F. Porter, Esq., for the petitioners.

C. C. Holmes, Esq., for the respondent.

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HILL

This is a proceeding for the redetermination of a deficiency in income tax in the amount of $2,358.53 determined on the joint return of a husband and wife for the calendar year 1933. The issue is whether respondent erred in rejecting $18,820 of a deduction claimed in the return as part of a capital net loss sustained by the wife from sale of capital assets in 1933.

FINDINGS OF FACT.

The Empire Trust Co., Margaret Prescott Tracy, and William Ward Tracy are executors of the last will and testament of William Dwight Tracy, deceased February 11, 1937. During his lifetime William Dwight Tracy, hereinafter sometimes referred to as Tracy, was the husband of petitioner, Margaret Prescott Tracy, hereinafter sometimes called Mrs. Tracy. During the taxable year the Tracys resided in the Borough of Manhattan, City and State of New York.

On June 26, 1929, Tracy executed a written declaration of trust transferring to himself as trustee certain income-producing securities and assets, principally, in the first instance, for the benefit of Mrs. Tracy. The trust was irrevocable and conditioned to end April 1, 1934, or at the death of Mrs. Tracy, should such event first occur; or, should Tracy die before either event, to continue under terms, conditions, and for purposes not material here. During her lifetime and the life of the trust, Mrs. Tracy was made sole beneficiary of the trust's net income, with reversion of the trust corpus in Tracy in the event he survived the trust. The trust instrument gave Tracy the right to control, sell, invest, and reinvest the trust corpus at his discretion, and in paragraph third thereof it was provided:

Third: The Trustee, so long as the said William Dwight Tracy shall be such trustee, and so long as Margaret Prescott Tracy shall be such beneficiary, may also transfer and deliver to the beneficiary any part or portion of the principal of the trust fund at any time and in such amounts as the said Trustee, in his sole and uncontrolled discretion may deem advisable and upon the transfer or turning over the said part of the principal of the said trust fund, the beneficiary shall hold such part of the principal absolutely and in fee for her exclusive use and benefit.

The schedule of assets transferred to the trust at its creation included, among others, a group of North American Water Works & Electric Co. 6 percent bonds of the par value of $5,000, purchased by Tracy on December 7, 1928, at a cost of $4,925, and Utilities Service Co. 10-year 6 1/2 percent convertible gold debenture bonds of the par value of $5,000, acquired by said trustor April 12, 1929, at a cost of $5,250. Subsequently, on March 29, 1931, pursuant to a plan of reorganization, the trustee exchanged the North American Water Works & Electric Co. bonds for 50 shares of Northeastern Public Service Co. preferred stock, and on July 11, 1929, purchased for the trust 35 shares of Southwest Dairy Products Co. first 7 percent cumulative preferred stock at the price of $3,360. Tracy, as trustee, designated the Empire Trust Co. of New York as custodian for the safekeeping of the trust securities, collection of income, handling of purchases and sales, deliveries and receipts of securities, and other mechanical details in connection therewith. Accordingly, he lodged with the Empire Trust Co. a copy of the original trust indenture and opened a custodian account for the trust with that company. Also during the taxable year the Tracys each had a similar custodian account with the Empire Trust Co. in respect of their individually owned securities.

For a number of years prior to and including the taxable year, the Tracys reported their incomes for Federal income tax purposes in a joint return prepared by a certified public accountant. In connection with his preparation of such returns it was the custom of the accountant, where losses were indicated in investments held by them, to advise his clients to sell or liquidate certain of such investments for the purpose of reducing their income taxes.

In October 1933 Tracy employed Myles F. Connors, an investment counsel, to study and appraise investments owned by himself, the trust, and Mrs. Tracy. In connection with such employment, Tracy caused the Empire Trust Co., trust custodian, to deliver to Connors a complete list of all trust-owned securities, and also a list of all securities in its custody individually owned by himself and Mrs. Tracy. The lists so delivered to Connors included the trust-owned items heretofore mentioned, and also certain Utilities Service 10-year 6 1/2 percent convertible gold debenture bonds belonging to Mrs. Tracy of the par value of $5,000, acquired by her April 12, 1929, at a cost of $5,250. After studying the lists submitted to him, Connors advised the Tracys that in his judgment the 50 shares of Northeastern Public Service Co. preferred stock, the $5,000 par value Utilities Service Co. 10-year 6 1/2 percent convertible gold debenture bonds, series A, 1938, and the 35 shares of Southwest Dairy Products Co. 7 percent cumulative preferred stock, owned by the trust, and also the Utilities Service gold debenture bonds personally owned by Mrs. Tracy, were each and all, of some value and were not worthless, although their value was small. It was thereupon decided that the loss indicated by such appraisals could be made available as a deduction in the taxable year in the joint income tax return of the Tracys. The matter was referred to Tracy's lawyers to direct the legal formalities necessary to transfer the trustowned securities to Mrs. Tracy and their immediate sale together with her personally owned utilities bonds within the taxable year. To accomplish this the attorneys prepared an assignment for execution by Tracy, as trustee, transferring the securities belonging to the trust to Mrs. Tracy. This assignment they sent with a letter of instructions to Tracy on December 29, 1933, the letter, endorsement, etc., being as follows:

December 29, 1933.

Dear Mr. Tracy:

Enclosed is an instrument formally revoking the trust of June 26, 1929 in respect of the certificate of deposit for 50 shares of Northeast Public Service Preferred Stock, 35 shares Southwest Dairy Products Preferred Stock, and certificate of deposit for $5,000 Utilities Service Company 10 Year Convertible Debenture 6 1/2's of 1938.

I have not inserted the names of these securities in the instrument of termination because I do not know what the correct description of them may be.

Mr. Whiting is sending to you the necessary papers to provide for the transfer of these securities by you to Mrs. Tracy. We suggest that you insert in your own handwriting the names of the securities as they are described in the papers which Mr. Whiting will send you. You will sign as Trustee.

Mr. Whiting will send to you also instruments of assignment for execution by Mrs. Tracy covering the foregoing securities and also an additional $5,000 face amount of the Utilities Service Company Debentures which belong to Mrs. Tracy.

When you have executed and acknowledged the instrument terminating the trust as to these securities and all of the instruments are executed, return all of the papers to Mr. Whiting. Mr. Whiting will then deliver them to Greer, Crane & Webb for sale before noon tomorrow.

I have instructed Mr. Whiting to affix the transfer stamps required upon the transfer from you to Mrs. Tracy. Greer, Crane & Webb will affix the transfer stamps necessary upon the transfer from Mrs. Tracy to the purchaser. Empire Trust Company will not be required to collect any part of the purchase price.

I am sending a copy of this letter to Mr. Whiting in order that he may be informed this afternoon as to what we wish to do. I am enclosing a second copy of this letter which you and Mrs. Tracy should sign at the place indicated and forward to Mr. Whiting as evidence of the authority of Empire Trust Company to proceed.

Yours faithfully,

HENRY L. WHEELER, JR.

P.S. After writing the foregoing letter, I arranged to have all of the necessary stamps affixed by Empire Trust Company.

To Empire Trust Company:

Please proceed in accordance with the terms of the foregoing letter.

[Signed]

WILLIAM DWIGHT TRACY

As Trustee under Indenture of June 26, 1929, etc.

MARGARET PRESCOTT TRACY

The assignment referred to as "instrument" in the first paragraph of the above letter, was in words and figures as follows:

On this 29th day of December, 1933, WILLIAM DWIGHT TRACY, as Trustee, under the Indenture made the 26th day of June, 1929, by and between William Dwight Tracy, individually, of the Borough of Manhattan, City and State of New York, as Grantor, and William Dwight Tracy, as Trustee, and pursuant to the provisions thereof, and particularly pursuant to the provisions of the paragraph thereof numbered THIRD, has transferred and turned over to MARGARET PRESCOTT TRACY the following securities, which were, prior to such transfer, a part of the principal of said trust:

Certificate of Deposit covering $5,000 Utilities Service Co. Conv. Debenture Series A 6 1/2 Bonds due Aug. 1st 1938 #826.

50 shares Northeastern Public Service Co. preferred stock Certificate # N.Y.X. 1666.

Certificate of deposit covering 35 shares Southwest Dairy Products Co. preferred stock - Certificate # N.Y.P.W. 5

IN WITNESS WHEREOF, I have hereunto set my hand and seal this 29th day of December, 1933.

[Signed] WILLIAM DWIGHT TRACY (L.S.)

individually and as Trustee.

IN THE PRESENCE OF:

[Signed] E. R. MOORE.

The foregoing letter, with the instructions endorsed thereon by the Tracys, and the accompanying document therein referred to were delivered to the Empire Trust Co., which thereupon made entries on its books showing a transfer of the trust securities in question from the trust account to the account of Mrs. Tracy. Transfer stamps were affixed thereto and the securities were transferred in the files of the Empire Trust Co. from the container of the trust securities to the container of Mrs. Tracy's securities. The Empire Trust Co. then delivered the securities, together with $5,000 additional utilities bonds owned by Mrs. Tracy, to Greer, Crane & Webb, brokers, with instructions to sell before the end of the year in order that Mrs. Tracy might claim a loss deductible from income for the taxable year. The brokers were unable to sell the securities or find any market for them. Having in mind the time limit put upon the sale and knowledge that Connors was advising the Tracys in their tax matters, the brokers approached that attorney and proposed, in order to accomplish the sale within the time limit, that he buy the securities. Connors had no desire to buy the securities as an investment, but was anxious to serve his clients in the situation. Being influenced by such desire and believing that the securities, although not to be recommended for investments, had some value though small, Connors finally consented and agreed to purchase the entire lot for the cash price of $5, plus a commission of $5, a total of $10, which was paid by check dated December 30, 1933. Mrs. Tracy claimed a capital net loss of $18,820 on the sale. The income of the trust for the taxable year was $1,600.

On March 15, 1934, the Tracys filed a joint income tax return for 1933 and paid taxes thereon in amount of $395.11. In the return a deduction in amount of $24,446.20 was claimed as capital net losses sustained in that calendar year, which deduction included the item of $18,820, claimed as losses sustained by Mrs. Tracy in the sale of securities to Connors in the circumstances shown. In computing such losses Mrs. Tracy used as cost basis of the securities sold actual cost to her of the bonds which she acquired by purchase plus "bondholder's protection fee" of $20, and as a cost basis of the securities received from the trust she used their cost to Tracy and/or the trust, plus a "bondholder's protection fee" of $20. The cost bases used by her are the costs to her and the trust, respectively, in respect of the securities described. If in contemplation of the taxing statutes there was a gift of the described trust securities to Mrs. Tracy, the cost basis thereof of the trust is also the cost basis thereof to Mrs. Tracy.

In auditing the joint return the respondent disallowed $18,820 of the capital net loss deduction claimed by petitioners and determined a deficiency based on such disallowance. In a statement accompanying his deficiency notice, respondent stated that "It is held that the transfer of the securities in question by your wife to your investment counsel for $5.00 did not constitute a sale from which a loss may be allowed for income tax purposes." In his brief respondent concedes, without prejudice to principles contended for, that a deductible loss "was sustained by Mrs. Tracy on the sale of the $5,000 par value of Utilities Service Company bonds which had been owned by her personally and had never constituted part of the trust property."

OPINION.

HILL: The principal facts are not in dispute. The parties differ only as to the legal implications and conclusions to be drawn from them. The petitioners concede that the transfer of the securities from the trust to Mrs. Tracy and their sale to Connors were prompted by the sole desire to create and make available a deductible loss to reduce income tax liability on their joint income tax return for the taxable year. They insist, however, that all steps necessary to a bona fide absolute gift of the trust securities to Mrs. Tracy were legally taken and completed, and therefore the motive and purpose are not material here. On the question of "motive", as affecting this issue, petitioners cite , and , as authorities for the doctrine that "a taxpayer may resort to any legal method available to him to diminish the amount of his tax liability." The respondent does not dispute petitioners' construction of the law, but argues that it has no application here, because these transactions were mere shams, in that they "served no other purpose than to reduce income taxes." Respondent cites ; ; ; ; ; , as supporting this objection. These decisions deal with statutory reorganizations which, for recognition, depend upon technical requirements not present here. Respondent's objection may not be sustained merely on the ground that the sole purpose of the transactions was to reduce tax liability. . We are also of the opinion that there was a sale of the securities to Connors. The evidence convinces us that all elements necessary to pass title to him were present. This evidence is not disputed and must be accorded full credit. Under the showing the respondent's objection that the consideration was nominal only is without point, and the sale must be recognized. . The respondent, however, urges another objection which we think is well taken and fatal to petitioner's claim. Independent of the question of whether there was a sale of the trust securities, respondent contends that there was no gift thereof to Mrs. Tracy for the reason that there was no intent on the part of either the trustee or Mrs. Tracy that she should take and hold the securities as her property, but that the sole intent of both was merely that title thereto should pass through her to a vendee pursuant to an agreement for such transfer and sale as constituent steps of one integral plan. Respondent further contends that if there was a gift at all to Mrs. Tracy it was a gift of the proceeds of the sale and not of the securities. The evidence sustains the facts upon which such contentions are based and we think the contentions sound. In support of his contention respondent cites . In that case Weil, on October 1, 1930, claimed he made a gift of corporation stock to his four minor children. He did not cause the stock to be transferred on the corporation's books and executed no writing purporting to convey the securities. He took them from among his certificates of stock which he held in a safety deposit box and placed two certificates of 100 shares each in each of four envelopes bearing severally the names of his minor children in which he kept other securities belonging to them and put the envelopes back into the box. He preserved a memorandum of the certificate numbers and made entries of them on a loose-leaf memorandum book which showed the various securities owned by his children. According to a preconceived plan Weil, on October 9, 1930, caused the stock in question to be sold through a broker in the name of his children and an aliquot share of the proceeds to be credited to each of them. The court held that there was a gift of the proceeds of sale but not of the stock sold. In the Weil case, as in the instant case, the taxpayer admitted that his decision to sell the shares was arrived at before he decided to make the gifts, and that his decision to make the latter before selling was motivated by his desire to "divide the income tax" which he thought permissible. The court said in part:

We think the controlling fact is that Weil proposed at all times to sell the stock and kept control of it to do so. * * * This retention of control for the purpose of exercising dominion over them by sale is inconsistent with a present absolute gift, the legal result of which would have been to prevent a sale.

In the instant case the trustee did not relinquish control of the securities until they were sold and Mrs. Tracy did not gain control of them at any time.

In point on the same issue is the Board's decision in ; affirmed in . The question in that case related to the legal effect of a gift of a $400,000 bank check made by a taxpayer to his wife pursuant to a plan whereby and through which the funds represented were made the corpus of a trust and immediately loaned to the husband upon his unsecured interest-bearing note. Like the plan at bar, the scheme was carefully worked out in advance by lawyers, and intended, among other purposes, to reduce the taxpayer's income tax burdens by creating an interest-bearing debt. That taxpayer paid interest to the trust on his said note and claimed a deduction from income for the same as "interest paid upon an indebtedness." This Board sustained the respondent's disallowance of the taxpayer's claim upon the ground that there was no bona fide gift made, in first instance, from the latter to his wife of the trust corpus, and therefore, no debt created by the pretended loan. The Circuit Court of Appeals, in sustaining our decision, among other things, said:

Counsel for the petitioner asserts that the transactions above described resulted in the following legal relations: Mr. Johnson made an absolute and unconditional gift of $400,000 to his wife; with her own property she set up a trust having a capital of $400,000; the trustee loaned this sum to Mr. Johnson upon his demand note bearing interest, and he paid such interest to the trustee in 1931. If such were indeed the legal relations of the parties, it would follow as of course that the taxpayer should be allowed the claimed deduction, for it is too well settled to require discussion that legal transactions cannot be upset merely because the parties have entered into them for the purpose of minimizing or avoiding taxes which might otherwise accrue. * * * Despite such purpose, the question is always whether the transaction under scrutiny is in reality what it appears to be in form. * * *

But there is a fallacy in the petitioner's contention, and it lies in the premise that he made an absolute and unconditional gift of $400,000 to his wife, and that her money set up the funded trust. There was an agreement between them that the money he made available to her was to be used in only one way; she was to pass it to the trustee upon terms which bound the trustee to return it to him upon request. Everything was done at the same time and as part of one transaction. action. Not for an instant did Mr. Johnson lose control of his "gift", nor did Mrs. Johnson or the trustee have possession of it free from a duty to return it to him. * * *

We think the principle underlying that decision is applicable to the situation here. In this case the trust securities were purportedly transferred to Mrs. Tracy but such transfer was in compliance with, and in pursuance of, an agreement between her and her husband as trustee that such securities be immediately sold to establish a deductible loss on the joint income tax return of the Tracys. It is obvious that the transfer of the securities to Mrs. Tracy was more symbolical than actual and that there was no purpose to transfer them to her apart from the agreed plan to sell them. On this phase of the transactions, the record shows that all steps, including (a) assignment of the securities to Mrs. Tracy by the trustee; (b) the trustee's instructions to the bank to transfer the securities to her account; (c) the direction to the bank to deliver them to the brokers for sale; and (d) the orders to the brokers to sell, were incorporated in a single set of papers, all of which were simultaneously transmitted to the bank over the joint signatures of the Tracys. These several steps, all being part of the single plan worked out by the lawyers and carried out pursuant to instructions, constitute the transfer and sale each a part of a single transaction the purpose of which was not to vest property rights in, and dominion over, the securities in Mrs. Tracy, but to sell the securities to create a loss available as a deduction for tax purposes for the joint benefit of the Tracys. The petitioners argue that after the supposed gift Mrs. Tracy had complete control over the securities and could, at her election, have revoked the order of sale and retained or otherwise disposed of them for her sole use; and that, therefore, a completed gift inter vivos must be recognized. The answer to that argument is that, under the agreed plan adopted and consummated for the sole purpose of effecting a sale of the securities to create a deductible tax loss as above indicated, none of the rights or powers so claimed for Mrs. Tracy were vested, or were intended to be vested, in her by the transfer in question.

On the basis of the facts of the transaction between the trustee and Mrs. Tracy, we hold that there was no gift to Mrs. Tracy of the trust securities in question. We arrive at this conclusion independent of the consideration of the power of the trustee to make a gift of trust securities to Mrs. Tracy for the conceded purpose. We are of the opinion, however, that the trustee did not have the power to make a gift of trust securities to Mrs. Tracy other than for her exclusive use and benefit. The trust instrument gave the trustee power to transfer to Mrs. Tracy a part of the trust principal "absolutely and in fee for her exclusive use and benefit." The alleged gift of trust securities herein attempted to be made was not for the exclusive use and benefit of Mrs. Tracy but was for the joint benefit of herself and the petitioner, who was both her husband and the trustee of the trust. In our opinion, the transfer here in question, for the purpose for which the record shows it was made, was not authorized by the trust instrument and was therefore ineffective to pass title. For this additional reason we hold there was no gift of the trust securities in question to Mrs. Tracy.

The respondent concedes that Mrs. Tracy sustained a deductible loss on the sale of Utilities Service Co. bonds which she purchased at the price of $5,250, April 12, 1929, and upon which she subsequently paid $20 as expenses of a bondholders' committee. Upon the record, we find the sum of $5,270 to be the measure of Mrs. Tracy's loss in the transaction, and hold said amount to be deductible on the joint return as a capital loss.

Reviewed by the Board.

Decision will be entered under Rule 50.

ARUNDELL, MURDOCK, BLACK, AND DISNEY dissent.