Wolcott v. Commissioner , 42 B.T.A. 1151 ( 1940 )

FRANK E. WOLCOTT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Wolcott v. Commissioner

Docket No. 100008.

United States Board of Tax Appeals

42 B.T.A. 1151; 1940 BTA LEXIS 894;

November 5, 1940, Promulgated

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1. Petitioner is not taxable under section 166 of the Revenue Act of 1936 on the incomes of four trusts created for the benefit of his children, where he reserved no power of revocation and it is shown that the contingency upon which corpus might be invaded in order to discharge his legal obligations did not occur during the taxable year. Helvering v. Wood,309 U.S. 344">309 U.S. 344, and Lewis Hunt Mills, Administrator,39 B.T.A. 798">39 B.T.A. 798, followed.

2. Where petitioner created four trusts for his children, two of whom were minors and two of whom were adults in the taxable year, provided in the indentures that the trust income be applied by the trustee for the "suitable support, maintenance and education" of each beneficiary, and directed that the corpus be returned to him on the termination of each trust, it is held:

(a) Petitioner is taxable on the income of the trusts for the minor children only to the extent such income was actually paid over for their maintenance, support, and education; and

(b) Petitioner is not taxable on the income of any of the trusts under section 167 of the Revenue Act of 1936.

3. Assuming but not deciding that the applicability of section 22(a) is in issue, petitioner is not taxable thereunder since the rights retained by petitioner in the creation of such trusts fell short of the measure of control required. Helvering v. Clifford,309 U.S. 331">309 U.S. 331; Frank G. Hoover,42 B.T.A. 786">42 B.T.A. 786, distinguished.

Thomas Hewes, Esq., E. Barrett Prettyman, Esq., F. Gloyd Awalt, Esq., and Charles L. Smiddy, Esq., for the petitioner.

Davis Haskin, Esq., for the respondent.

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LEECH

This is a proceeding to redetermine a deficiency in income tax of $1,418.63 for the calendar year 1936. Petitioner also requests a finding that he has overpaid his tax in the amount of $4,234.64. The issues submitted are (1) whether respondent can raise the question of the applicability to petitioner of section 22(a) of the Revenue Act of 1936 in his opening statement at the hearing without having invoked it in either his deficiency letter or original or amended answer; (2) whether the income of two trusts created by petitioner for the benefit of two children who were minors during 1936 is taxable to the petitioner to the extent such income exceeded the amounts paid over to the children for their "suitable support, maintenance, and education"; and (3) whether the income of two trusts created by petitioner for the benefit of two children who were adults during 1936 is taxable to petitioner to any extent.

FINDINGS OF FACT.

Petitioner is an individual, residing in the State of Connecticut. In 1928 he was president, treasurer, and owner of more than 90 percent of the 8,000 shares of outstanding stock of the Frank E. Wolcott Manufacturing Co., hereinafter referred to as the Wolcott Co. This common stock was than worth between $35 and $40 a share.

On March 30, 1928, petitioner created four identical and irrevocable trusts for the benefit of each of his four below named children, all of whom were then minors. In the taxable year, 1936, however, only Janet M. Wolcott and Richard S. Wolcott continued to be minors. Frank E. Wolcott, Jr., and William G. Wolcott were adults.

To each trust petitioner transferred 800 shares of his stock in the Wolcott Co. The trustee was the Riverside Trust Co. of West Hartford, Connecticut, a corporation organized under the laws of that state and authorized by its charter to accept and execute trusts of real and personal property.

Each trust authorized the trustee to manage, invest, and reinvest the principal and to apply the net income thereof for "the suitable support, maintenance and education of [the particular child] and if the income thereof is not sufficient for such purposes the TRUSTEE is authorized and directed to expend such part of the principal sum as may be necessary to do so." Each trust was to terminate and the corpus to be paid over to petitioner, if then living, when the beneficiary should reach the age of 25; or, if the beneficiary died before becoming 25, the trust was to terminate and the corpus and any unexpended income was to be divided among the three other trusts on terms and conditions not presently material. If petitioner died before the particular beneficiary reached 25, then the trust for such beneficiary would continue during his or her lifetime and upon his or her death would be divided both as to principal and unexpended income among either his or her issue, the other three trusts, or the lawful heirs of the particular beneficiary.

In 1936, the ages of the respective beneficiaries were as follows: Janet, 15; Richard, 11; Frank, 24; and William, 22.

In investing and reinvesting the trust funds, the trustee was to be limited to securities or other investments approved by petitioner. The trust instruments expressly provided that the trustee should have:

* * * the following powers in addition to those ordinarily possessed by Trustees:

(a) The power to grant, bargain, sell, mortgage, exchange and otherwise deal in any real estate which may be the subject matter of this trust at public or private sale, and to execute good and sufficient conveyances thereof without any liability on the part of the purchaser to see to the application of the purchase money.

(b) The power to purchase securities at a premium and to charge the premium against principal or against income, or partly against principal and partly against income, as in the opinion of the TRUSTEE may be suitable and appropriate.

(c) The power to join in any plan or reorganization, merger, consolidation, lease, or other reshaping of the financial structure of any corporation of which the trust estate may hold bonds, stocks or other securities.

(d) The TRUSTEE, in its discretion, is especially empowered and authorized to expend any part of the principal of this trust estate, to pay the expense of any protracted illness or surgical operations. The expenditure of the principal is to rest solely within the discretion of the TRUSTEE, and is not a right subject to exercise by any beneficiary.

(e) If any securities or property which is a part of the corpus of this trust shall be sold or otherwise disposed of by the TRUSTEE at a profit, such profit shall be added to and become a part of the corpus of this trust.

(f) To make advances or borrow money upon such terms and conditions, at any time or times, for such purpose as it may deem desirable or proper for the improvement, protection or preservation of the trust estate. For the repayment of such advances, with interest, the TRUSTEE shall have a lien upon the trust estate, and for sums so borrowed may issue its promissory notes as TRUSTEE, and secure the repayment thereof by mortgaging or pledging any part or all of the trust estate.

(g) To compromise, compound and adjust claims in favor of or against the trust estate, upon such terms and conditions, as it may deem best; and the doing of all such things for the preservation in and about the management of said property as it may consider necessary or proper and for the best interest of said estate.

In March or April 1928, the original corpus of each trust, namely, 800 shares of stock in the Wolcott Co., was sold for cash to the Beardsley Manufacturing Co. as an incident of a transaction in which the latter company acquired the business of the Wolcott Co. for $475,000. The trustee reinvested the proceeds in other securities. Both the sale and the reinvestment were approved by petitioner.

In 1930, after a discussion with an official of the Riverside Trust Co., petitioner gave to each trust his personal, unsecured note for approximately $15,000, and the trustee, upon receipt and in consideration of petitioner's obligations, delivered from the trusts to petitioner, as the purchaser of the assets, an equivalent in market value of securities. Some of the latter were listed securities, others were not. The above described transaction was carried out upon the joint approval of petitioner and the official with whom he had the discussion.

The notes given by petitioner to the trusts bore interest at 5 percent. Petitioner paid this interest. At the time he gave the notes he was worth enough to make good on them in full and the notes were, at least, as sound an investment for the trust as the stocks for which they were exchanged. On September 18, 1936, petitioner collateralized each note with 55 shares of stock of the Silex Co., except that, in the case of the note to the trust for William, the security consisted of 60 shares of stock of the Silex Co. The Silex stock was in petitioner's name. Petitioner had paid off the notes in full before 1938.

Petitioner also approved the acquisition by the trusts of notes of Wolcott, Inc., a corporation of which he was the principal stockholder. Each trust purchased about $5,000 worth of these notes, which were secured by stock of Wolcott, Inc., belonging to petitioner. The notes were subsequently paid.

In 1931 or 1932 petitioner approved the acquisition by the trust for Janet of stock in the Silex Co., of whose outstanding stock petitioner owned about 60 percent and of which he was a director. The Silex Co. was the successor to Wolcott, Inc. The trust for Janet, at the date of the commencement of this proceeding, held 27,000 out of the 215,000 outstanding shares of stock of the Silex Co. In 1936 this trust received dividends of $10,000 from its Silex stock.

The trustee made no investments of the trust funds without obtaining petitioner's approval. The incomes of the four trusts for the taxable year were derived wholly from interest on notes held by the trustee and from a dividend on stock held by the trustee.

In the case of the trusts for petitioner's minor children, Janet and Richard, the trustee habitually paid over trust income to petitioner upon the latter's furnishing the trustee with evidence of actual expenditures made by petitioner for the support, maintenance, and education of the minors. Janet and Richard attended private schools in 1936, their respective tuitions being $900. Total payments for Janet's support, maintenance, and education in that year were $1,055.16; the corresponding sum for Richard was $1,057.75. The remainder of the net trust incomes, $9,508.10 in the case of the trust for Janet and $8.09 in the trust for Richard, was retained by the trustee. The total income of Richard's trust was $1,103.52. Expenses chargeable against it were $140.53. Petitioner made up the resulting insufficiency of 1936 income by depositing $85.36 to the trust's account. At the date of the commencement of this proceeding these trusts were still in existence.

In the case of the trusts for petitioner's children who were of age during the taxable year, namely, Frank and William, the trustee paid over certain sums directly to the beneficiaries. Frank, who was in business, received an allowance from the trustee of $940. William, who attended Princeton University, also received an allowance of $940. The remainder of the net trust incomes, $186.72 in the case of the trust for Frank and $341.79 in the case of trust for William, was retained by the trustee. At the date of the commencement of this proceeding, these trusts had terminated, but they were in existence throughout the taxable year. At the termination of the trust for Frank, the corpus was returned to petitioner and all accumulated income was paid over to the beneficiary. At the termination of the trust for William, the corpus was returned to petitioner and the accumulated income was paid to petitioner in reimbursement of an advance made by petitioner to William in anticipation of such termination.

During the existence of all four trusts, the amounts of the distributions to beneficiaries were determined by petitioner's suggestions to the trustee. The beneficiaries never asked petitioner for distributions. He frequently took his family on trips and vacations. In the taxable year the incomes of the four trusts were sufficient to provide for the support, maintenance, and education of the beneficiaries.

In his 1936 return, filed on March 15, 1937, petitioner included all of the income of the trusts for Janet and Richard, but none of the income of the trusts for Frank and William. On October 11, 1938, petitioner filed a claim for a refund of 1936 income taxes in the amount of $4,234.64.

Respondent imposed a deficiency against petitioner by a notice dated June 20, 1939. The notice contained the following statement:

The net income of the Frank E. Wolcott, Jr., William G. Wolcott, Janet Wolcott and Richard S. Wolcott trusts, Riverside Trust Company, Hartford, Connecticut, trustee, is held to be taxable to you under Sections 166 and 167 of the Revenue Act of 1936. Accordingly, your reported net income has been increased by that portion of the net income of the trusts which was not included in your net income for the year 1936.

In his petition, which was filed September 13, 1939, petitioner pleaded that respondent had erred in applying sections 166 and 197 to the trusts, except to the extent that the incomes of the trusts for Janet and Richard were paid over for their maintenance, support, and education. Respondent's answer, which was filed November 2, 1939, was a general denial. At the hearing, which was held April 5, 1940, counsel for respondent announced in his opening statement that respondent now contended petitioner was also taxable on the income from the four trusts under section 22(a) of the Revenue Act of 1936, and that no amended answer, setting up that contention, would or need be filed on behalf of respondent. Neither party pleaded further by amended answer or otherwise. Petitioner presented his proof under section 22(a) after a duly noted objection upon which a ruling was reserved.

OPINION.

LEECH: Respondent's specifically pleaded theory is that petitioner is taxable on the income of the four trusts under sections 166 and 167 of the Revenue Act of 1936. The issues, admittedly, for decision are whether, under sections 166 and 167, (1) petitioner is taxable on the income of the two trusts created for the children who were minors during the taxable year to the extent such income exceeded the amounts paid over for their suitable support, maintenance, and education, and (2) petitioner is taxable to any extent on the income of the two trusts created for the children who were adults during the taxable year.

All of the trusts were irrevocable. At the time of their creation, the trust of shortest duration, i.e., the one for Frank, had nine years to run. In the taxable year, that particular trust had only one more year to run. Nevertheless, there is no legal basis for taxing petitioner on any of the trusts under section 166, since no power of revocation was retained, and since the trusts were to end automatically and their corpora to revert by their terms upon contingencies beyond the grantor's control, namely, the lapse of time and the survival of the grantor. .

Respondent builds a labored argument to the effect that because the trustee, a nonadverse interest, was given the power to invade corpus for the purpose of fulfilling the obligations of the grantor, petitioner was in legal effect vested with a power to revest the entire corpus in himself within the meaning of section 166(2). He is concluded in this position by the case of . In that case the Board held that the power to revest the corpus in the settlor could not vest until the contingency upon which it was exercisable occurred. Decision went against the taxpayer only because he had failed to disprove the occurrence of the contingency. Here, it has been shown that the trust income was ample to support, maintain, and educate suitably the two minor children in the taxable year, and that no invasion of corpus took place. As to the two adult children, petitioner was under no obligation, and no invasion of corpus took place. The nonoccurrence of the contingency vesting the power having been proved, petitioner must be sustained so far as his liability under section 166 is concerned. ;; ; .

Petitioner admits that he is taxable on the income of the trusts to the extent in was actually paid over in discharge of his duties to support, educate, and maintain those of his children who were minors in the taxable year, i.e., Janet and Richard. The 1936 net income of the trust for Richard was less than the amounts paid over during 1936 for his support, maintenance, and education; so the real question arises only as to the trust for Janet. Respondent contends that petitioner is taxable on the entire 1936 income of the trust for Janet, under both , and section 167 of the Revenue Act of 1936.

Respondent's invocation of Douglas v. Willcuts rests upon the premise that the trust instrument provided for mandatory distributions of all the trust income to the beneficiary, and that whether the trustee distributed all, none, or only part of the income to Janet does not affect petitioner's liability. See .

We do not so read the indenture. It authorizes the trustee to apply the net income of the corpus for "the suitable support, maintenance and education of Janet M. Wolcott." Webster's New International Dictionary defines "suitable" as "fitting, proper, becoming." It lists as synonyms "proper, fitting, becoming, accordant, agreeable, competent, correspondent, compatible, consonant, congruous, consistent." In law, the word "suitable" has been held to involve an element of discretion. ; . Our construction of this indenture is that it authorizes the trustee in the exercise of its discretion to pay over such amounts of income as are necessary, in the judgment and discretion of the trustee, for the support, maintenance, and education of Janet and directs the trustee to accumulate the superfluous balance. Since here the trustee was a bank and not the grantor, the Douglas case thus may be applied only to the extent of taxing to petitioner the amounts actually paid over for Janet's support, maintenance, and education. ;; ; dismissed, C.C.A., 3d Cir., June 29, 1940; ; ; ; ; ;.

Respondent's next contention is that petitioner must be taxed on all the income of all four trusts because the trustee was directed to accumulate such income for petitioner's future benefit within the meaning of section 167 of the Revenue Act of 1936.

Considering these four identical trust instruments, as entireties, each in itself, as is proper (; on appeal, C.C.A., 2d Cir.), we note that a careful distinction has been drawn throughout between principal and income. For instance, if the income is not sufficient for the purposes of the trust, the principal is to be invaded. If a beneficiary should die before reaching 25, the principal and any unexpended income was to be divided among the other three trusts. The trustee is given the power, if it buys securities at a premium, to charge the premium against principal or against income, or partly against one and partly against the other. If securities are sold at a profit, the proceeds are to be added "to the corpus of this trust."

The deeds in their first alternative limitation provide that the particular trust is to terminate when the beneficiary reaches 25, and the trust corpus is then to be paid over to petitioner, if living. That is the only contingency upon which petitioner can receive the corpus. There is nothing said as to the disposition of accumulated income. Nevertheless, we think that the language, both in this instance and throughout the trust indenture, is so carefully chosen as to indicate an intent in petitioner that the unexpended income should be paid over to the beneficiary on termination. This is borne out by the acts of the parties, to which we may resort for evidence of intention. Gibbs-Preyer Trust #1,; on appeal, C.C.A., 6th Cir. When the trusts for Frank and William subsequently terminated (after the taxable year), the corpus was returned to petitioner, but all of the unexpended income was paid over to them. In the circumstances, such a disposition of principal and income was wholly proper for the trustee to make. ; ; ; ; 4 Bogert on Trusts, sec. 811. The trust incomes in the taxable year were derived wholly from note interest and dividends; and there were no sales of corpus, the profits from which would have to be added to corpus. See . It follows, in our opinion, that the incomes of the trusts were not held for future distribution to the grantor, and that he can not be taxed thereon under section 167. ; ; certiorari denied, .

Upon the question of the taxability of petitioner upon the income of the four trusts under section 22(a) of the Revenue Act of 1936, assuming but not deciding that this issue is before us and the burden of proof in respect thereto upon petitioner, we think that the evidence presented, under protest, establishes affirmatively that the rights retained by petitioner in the creation of the trusts fall far short of control or beneficial ownership of the trust properties. The situation as disclosed in no wise resembles that present in . Here the trusts are for long terms. They are all irrevocable and no power was reserved to amend or to remove the corporate trustee. Petitioner here reserved no right to vote the stocks transferred in trust, as in , nor did he, as in that case, reserve the right to direct investments by the corporate trustee. He did reserve the right to disapprove suggested investments, a very reasonable reservation in view of the wide latitude given the trustee in their selection.

The request for a finding of overpayment is granted. The amount of the overpayment will be computed under Rule 50.

Decision will be entered under Rule 50.