Donahue v. Commissioner , 44 B.T.A. 329 ( 1941 )

JESSIE W. DONAHUE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Donahue v. Commissioner

Docket No. 92980.

United States Board of Tax Appeals

44 B.T.A. 329; 1941 BTA LEXIS 1345;

April 29, 1941, Promulgated

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In 1931 petitioner established trusts for brothers and sisters of petitioner's deceased husband. The beneficiaries had never been members of petitioner's household. The trusts were to terminate and the corpora revert to petitioner on death of the respective beneficiaries. Petitioner agreed in the instrument to make up any deficiency in income. Held, income from the trusts is not taxable to petitioner.

Paul L. Peyton, Esq., for the petitioner.

L. A. Spalding, Jr., Esq., for the respondent.

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VAN FOSSAN

Respondent determined a deficiency in petitioner's income tax for the year 1934 in the sum of $19,470. The sole issue before the Board is whether or not the income of certain trusts created by petitioner which is payable to relatives of her deceased husband during their lives is taxable to petitioner.

FINDINGS OF FACT.

The facts were stipulated substantially as follows:

Petitioner was the wife of James P. Donahue, hereinafter referred to as decedent, who died in April 1931. During his lifetime decedent had from time to time advanced sums of money to assist certain of his brothers and sisters. Petitioner, desiring to continue such assistance, entered into an agreement with the Chase National Bank, as trustee, for the benefit of those brothers and sisters of decedent.

Under the trust agreement, dated May 1, 1931, petitioner transferred to the trustee, "for and in consideration of the sum of one dollar ( $1) and other good and valuable considerations", 15,000 shares of the capital stock of F. W. Woolworth Co. as the corpora of the trusts. The agreement provided that without requiring physical division of the trust property a stated fractional portion thereof should be held for each of the named individuals and that the net income should be paid annually to the beneficiaries during their respective lives as follows:

Mary D. Des Anges	$5,400
Katherine D. Conville	10,800
Agnes I. Donahue	7,200
John V. Donahue	5,400
Stephen J. Donahue	4,200
Total	33,000

None of these brothers and sisters of decedent ever at any time lived in petitioner's household. The trust agreement provided that any surplus income over the stipulated amounts payable to the beneficiaries was to be paid to petitioner or, if she were not living, to her executors or administrators.

Other provisions of the trust agreement here material are as follows:

2. Upon the death of any beneficiary for whom a trust is hereby created, to transfer and pay over the principal of the trust for such beneficiary and any undistributed income thereof to the Grantor if she is then living, or, if she shall have died, to the executors or administrators of her estate, to be received and disposed of by them with the same force and effect as if the principal so paid had constituted part of the Grantor's estate at the time of her death.

3. If in any year during the continuance of this trust the Trust Property shall not have produced for that year sufficient net income to meet in full all payments hereinbefore specified for that year for each and all of the aforesaid trusts, the Grantor hereby agrees for herself and her executors or administrators to pay to the Trustee the whole of such deficiency. In default of such payment the Trustee is hereby authorized and empowered in its discretion to borrow upon the security of the whole or any part of the Trust Property a sum sufficient to make up the deficiency or to sell enough of the Trust property to provide the amount of such deficiency, and in either event the Grantor, for her-self and her executors or administrators, hereby agrees to make good to the principal of the Trust Property the amount essential to enable repayment of any money so borrowed or the amount by which the principal of any of such trusts may have been depleted by such sale, as the case may be, within six months after the making of such loan or such sale; it being the purpose and intent of this instrument that each of the five beneficiaries herein named shall beyond peradventure receive respectively in each year the amount of income hereinbefore provided.

4. During the life of the Grantor, in respect to any of the trust powers hereinafter conferred upon the Trustee, the Trustee shall accept such directions from time to time as to sales, investments, reinvestments or other operations in respect to the various trusts as the Grantor shall give to it in writing, and any directions so given shall remain in full force and effect until revoked or modified by the Grantor in writing. The power of direction thus reserved to the Grantor shall not, however, be exercised by her at any time or in any way so that such exercise shall have the effect of terminating any trust hereby created prior to the time hereinbefore expressly provided for its termination.

The agreement also provided that except as the trustee might be directed otherwise by petitioner under terms of the trust instrument, the trustee was to be given broad powers of management and control of the trust corpus.

The agreement of May 1, 1931, was under seal and was executed in the State of New York.

The 15,000 shares of Woolworth stock transferred by petitioner to the trustee under the agreement of May 1, 1931, have at all times constituted the entire corpora of the trusts created by that agreement with the exception of 1,910 shares of the stock which reverted to petitioner under terms of the agreement by reason of the death of Stephen J. Donahue, one of the beneficiaries of the trust, in August 1939.

Pursuant to the terms of the trust agreement, petitioner by letter dated May 18, 1931, directed the trustee not to sell any part of the Woolworth stock constituting the corpora of the trusts without petitioner's express consent in writing. Petitioner has in no other respect given any instructions to the trustee.

The trust had a net income of $35,297.78 for the calendar year 1934. The sum of $33,000 of that amount was credited and paid in 1934 to beneficiaries of the trust other than petitioner, in the respective amounts provided in the trust agreement of May 1, 1931. Those beneficiaries reported the amounts received in their respective income tax returns for the year 1934. The excess of $2,297.78 was credited and paid to petitioner in 1934 and was reported by petitioner in her 1934 income tax return.

Respondent added to petitioner's taxable net income for the year 1934 the sum of $33,000 which had been paid to beneficiaries of the trust agreement other than petitioner.

OPINION.

VAN FOSSAN: The single issue for our determination is whether or not the income of certain trusts created by petitioner is taxable to her.

Petitioner contends that section 166 of the Revenue Act of 1934 is not applicable since she possessed no power to revest the corpora of the trusts. She maintains that the trusts and substance and that their income can not be taxed to her under the doctrine of Helvering v. Clifford,309 U.S. 331">309 U.S. 331. Petitioner further contends that the income of the trusts did not discharge a legal obligation of petitioner, so that the income is not taxable to her under Douglas v. Willcuts,296 U.S. 1">296 U.S. 1, and Helvering v. Leonard,310 U.S. 80">310 U.S. 80. Finally, petitioner urges that the rule of Lucas v. Earl,281 U.S. 111">281 U.S. 111, as delineated in Helvering v. Horst,311 U.S. 112">311 U.S. 112, does not apply.

Respondent makes no contention that the trusts are revocable or that section 166 applies. He argues that, since the trust instrument was under seal, the seal is to be given presumptive effect, binding petitioner to her promise to make up deficiencies in the trust income payable to the named beneficiaries. He asserts that this promise brings petitioner within the scope of Helvering v. Leonard, supra, and Weir v. Commissioner, 109 Fed.(2d) 996. He also contends that the trusts lack substance and that their income is taxable to petitioner under section 22(a) of the Revenue Act of 1934. Finally, respondent relies on Helvering v. Horst, supra, and Huber v. Helvering, 117 Fed.(2d) 782, arguing that the trust agreement effected a mere assignment of income.

The effect of the last sentence in the quoted paragraph numbered 4 in our findings was to make the trusts irrevocable for the lives of the beneficiaries. Section 166, therefore, is not applicable. Helvering v. Wood,309 U.S. 344">309 U.S. 344. Consequently, we must consider respondent's contentions concerning the applicability of section 22(a) of the Revenue Act of 1934.

We are of the opinion that the instant case differs substantially from Helvering v. Clifford, supra. There the trust was for a five-year period, the beneficiary was a member of the grantor's immediate family group, and the grantor was also the trustee. Here, the trusts were to endure for the lives of their respective beneficiaries, the beneficiaries were relatives of petitioner's deceased husband and had never been members of petitioner's household, and petitioner was not the trustee. The fact that petitioner retained the right to direct investments is not enough, by itself, to cause the application of the Clifford doctrine. Commissioner v. Branch, 114 Fed.(2d) 985. The trusts created by the agreement of May 1, 1931, were real trusts and their income may not be treated as that of petitioner on the ground that she retained the major incidence of ownership and control of the corpora.

Respondent's next contention is that the income of the trusts discharged a legal obligation of petitioner and was taxable to her under Douglas v. Willcuts, supra.The evidence presented clearly shows that these trusts differ from those considered in the "legal obligation" cases of Douglas v. Willcuts, supra;Helvering v. Coxey,297 U.S. 694">297 U.S. 694; and Helvering v. Stokes,296 U.S. 551">296 U.S. 551, in that here the income can not be said to be in discharge of any legal enforceable obligation existing prior to the time of the creation of the trusts. Petitioner had no obligation to support the beneficiaries of the trusts. See New York Code of Criminal Procedure, sec. 914; New York Public Welfare Law, sec. 125; Dunlevy Milbank,41 B.T.A. 1014">41 B.T.A. 1014. The record indicates that she created the trusts out of pure benevolence and humane feeling for decedent's relatives.

Respondent asserts further, however, that the provision in the trust agreement by which petitioner agreed to make up deficiencies in trust income payable to the beneficiaries was a legally enforceable obligation and consequently the income of the trusts must be taxed to petitioner, citing Helvering v. Leonard, supra; Weir v. Commissioner, supra. Respondent also asserts that at the time the trust agreement was executed the law of New York provided that a seal was presumptive evidence of sufficient consideration.

The Weir case was preceded by Dixon v. Commissioner, 109 Fed.(2d) 984, decided a few days prior, in which case the same court discussed the instant question at length. Addressing itself to the law as laid down in Douglas v. Willcuts, supra;Helvering v. Fitch, 103 Fed.(2d) 702; and Helvering v. Leonard, 105 Fed.(2d) 900, the court observed:

* * * However, we think an accurate demarcation in the instant cause may be accomplished by testing our peculiar circumstance against the two main factors which pervade the controlling decisions.

The first is the nature of the "obligation" ruled upon. In all cases it has been "pre-existing", i.e., alimony decreeable by court, Douglas v. Willcuts, above cited, the support of minor children, Helvering v. Schweitzer,296 U.S. 550">296 U.S. 550, a pre-existing debt, Helvering v. Blumenthal,296 U.S. 552">296 U.S. 552. The second, cognate to the first, is the element of tax avoidance.

As Professor Magill puts it:

"* * * the debtor has created a trust, the income of which is to be used to pay off the principal and interest of his obligations, remainder to himself or persons of his choice. If he paid off the debts directly out of his own income, he would have no deduction for the sums paid in discharge of principal. By use of the trust device he seeks to reduce his own taxable income by the amount of the income from the corpus of the trust; and thus in effect to obtain a partial deduction from his income for the amounts used to discharge his debts.

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Had the husband been required to pay the same amount of alimony directly, he would have been taxable upon the total amount of his net income with no deduction therefor. His income tax liability should not be changed by his creation of a trust to take care of his obligation for him." Magill, above cited, pp. 213, 243.

A like possibility of sidestepping the nondeductibility of a capital outlay inheres, of course, in the application of trust income to the support of wives and minor children. What, therefore, is the "obligation," if any, and the avoidance, if any, implicit in the case at bar?

Relating the case under consideration to the above stated concepts, the court found no obligation.

In the Dixon case, the trust contained a contingent obligation to make good income deficiencies by adding securities to the corpus. In considering this phase of the case the court states:

* * * Where the trust is set up to meet the debt, he must be taxed to prevent him, as we have seen, from circumventing the non-deductibility of debt payments. Where, on the other hand, the trust antedates a true guaranty, there is no circumvention of non-deductibility, even if the guaranty ripens into a debt. However, if trust and guaranty are roughly contemporaneous in origin, it does not seem unduly cynical to unravel the whole transaction into a continuing obligation to pay a stated amount at future intervals to which payment trust income is applied. So the circumstance is brought within the preexisting debt criterion, and the settlor is taxed.

The court absolved the grantor from tax on the trust income involved in the Dixon case.

In the Weir case, the court, after referring to the principles discussed in the Dixon case, held the grantor taxable on the trust income, stating that the presence of a promise to pay by way of guaranty "affords the sole, yet a valid, ground for taxing the income of the instant trust to the petitioner."

The case at bar presents certain aspects of both the Dixon case and the Weir case and certain other aspects not found in either. In both of the cited cases there was a preexisting marital community, with such rights and obligations as adhered thereto under local law. In the case before us there is no such situation. The trust now before us had no background of unhappy marital relations. Grantor was under no legal obligation to support the beneficiaries of the trust. In the Dixon case the trust and settlement agreement recited that the husband "in recognition of his legal liability to support his wife, and pursuant to her demands, has agreed to make provision for her support." By its terms the wife released grantor from all right of dower or any right under intestate laws or any right to take against the will of grantor. The grantor released his right of curtesy. The agreement was executed three weeks before filing of a divorce action by the wife. In the Weir case the trust was likewise in consideration of the release of the right of dower and other marital rights and was executed two days prior to the filing of a divorce action by the wife. In both cases there was real consideration on either side and the discharge of a preexisting legal obligation. In the case presently before us, there was no release of any rights or any recited consideration other than the nominal one of "one dollar and other good and valuable considerations." There was no preexisting obligation of any kind.

In the Dixon case the grantor undertook to supplement the trust corpus so that it would yield the income requisite to make the stipulated payments. In the Weir case there was an unconditional guaranty of the payment of the stipulated payments. In the instant case there was a substantially similar guaranty.

When all the facts are marshaled and compared with those in the various cited cases, we are of the opinion that the present case falls outside the category of those where the income should be held taxable to the grantor. There was no marital background. There was no preexisting obligation. There is no evidence that tax avoidance was in the grantor's mind. Nothing in the nature of consideration was parted with by the beneficiaries. The undertaking to make good the deficiencies in income existed only by virtue of the terms of the trust instrument. It was in the nature of a unilateral commitment by the donor of the gifts. The fact that the agreement was under seal is only presumptive evidence of consideration. New York Civil Practice Act, § 342. It does not follow that the undertaking constitutes an obligation enforceable by the beneficiaries. Farmers Loan & Trust Co. v. Winthrop,207 App. Div. 356, 363; Alexander v. Equitable Life Assurance Society,233 N.Y. 300">233 N.Y. 300, 307. In our opinion the payment of the trust income discharged no enforceable legal obligation of the grantor.

Finally, we are not impressed by respondent's argument that this case comes within the doctrine of Helvering v. Horst, supra. We do not believe that the Supreme Court intended, by the cited decision, to sweep aside as futile gestures all trusts and gifts. Petitioner did not merely assign income. She placed the legal title to the trust corpus in the trustee beyond recall for the lives of the several beneficiaries.

Under the facts here present, we are impelled to the conclusion that the trust income is not taxable to petitioner.

Decision will be entered under Rule 50.