Weir v. Commissioner , 39 B.T.A. 400 ( 1939 )

E. T. WEIR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Weir v. Commissioner

Docket No. 85324.

United States Board of Tax Appeals

39 B.T.A. 400; 1939 BTA LEXIS 1037;

February 10, 1939, Promulgated

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1. LOSS DEDUCTION - SECTION 23(e), REVENUE ACT OF 1932. - Action of respondent approved in denying deduction of a capital loss sustained by petitioner from the sale in 1932 of certain shares of stock, where the proof fails to bring the claimed loss within the terms of the applicable statute allowing deduction only if the loss was incurred in trade or business, or in a transaction entered into for profit.

2. TRUST INCOME TAXABLE TO GRANTOR. - On May 29, 1924, petitioner executed a trust instrument which provided that a guaranteed amount of net income should be paid to his wife for life, in consideration of the release of her dower interest in his estate or property. Two days later the wife filed a libel for divorce in a Pennsylvania court, and on December 23, 1924, was granted an absolute divorce without any provision for property settlement or alimony. Held, the net income of the trust for the years 1932 and 1933 was paid to petitioner's former wife in discharge of his legal obligation arising under the provisions of the trust agreement, and such income is properly taxable to petitioner. Douglas v. Willcuts,296 U.S. 1">296 U.S. 1.

Earl F. Reed, Esq., for the petitioner.

Arthur W. Carnduff, Esq., and Chester C. Guy, Esq., for the respondent.

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HILL

Respondent determined deficiencies in petitioner's income tax liability for the years 1932 and 1933 in the amounts of $23,075.38 and $11,051.30, respectively. Petitioner in his pleadings assigned 11 errors, all of which were denied by respondent. Assignments 1 and 2 merely alleged generally that respondent erred in determining a deficiency in Federal income taxes against petitioner for each of the taxable years. Issues 3 and 8, 7, and 11, and 5 and 10 were settled by stipulation of the parties filed at the hearing. Such stipulation will be given effect in the settlement under Rule 50.

This leaves for our consideration only issues 4, 6, and 9. Issue 6 involves a deduction from gross income for the year 1932 claimed by petitioner and disallowed by respondent, representing a loss in the amount of $21,296.25 sustained by petitioner in 1932 from the sale of 250 shares of the capital stock of the Bellefield Co. Issues 4 and 9 present the same question, namely, whether respondent erred in including in petitioner's gross income for the taxable years sums representing "profits received and distributed" to petitioner's former wife under a certain trust. The amount of $8,657.57 was so distributed in 1932, and $7,070.35 was distributed in 1933.

FINDINGS OF FACT.

Petitioner has been, since before the 29th day of May 1924, and now is a citizen of the United States and a resident of the city of Pittsburgh, Pennsylvania.

During the taxable years petitioner was chairman of the board of directors of the National Steel Corporation and an active executive of the corporation and of several subsidiaries thereof. During that period the National Steel Corporation and its subsidiaries were engaged in the business of mining and transporting iron ore and coal and of manufacturing and marketing coke, byproducts of coke and iron, steel, and tin products.

On December 16, 1932, petitioner sold 250 shares of the preferred stock of the Bellefield Co., a Pennsylvania corporation, which he had acquired in 1925 and 1926 at a cost of $25,000. The proceeds of the sale amounted to $3,703.75 net, after deducting commissions and taxes from the gross sale price of $3,750.

The shares of stock were sold through petitioner's regular brokerage account with a firm of brokers who were members of the New York Stock Exchange, with a branch office in Pittsburgh. Prior to and after the sale, petitioner bought and sold securities through the same account on several occasions. At times the account showed substantial credit balances on which interest was paid, while on other occasions there were debit balances on which interest was charged.

The Bellefield Co. owned the Schenley Apartments. When petitioner became a tenant in the Schenley Apartments, he expected to live there permanently and purchased the stock so that he would be a stockholder in the company and have some influence in maintaining certain standards. Before petitioner sold the stock in question in 1932, he was seeking a substantial reduction in his rent, and at the same time he was building a home outside of the city, about 40 miles from Pittsburgh. He decided he would not renew his lease, but move out of the apartments. Such being the case, he had no interest in owning any stock in the Bellefield Co., and so sold the stock he then held. Later, his rental was reduced from $18,600 to $10,000 per year, and he renewed his lease on February 28, 1933. Having decided to remain as a tenant, petitioner desired to reacquire stock in the company for the same purpose for which he had originally bought it, and on March 1, 1933, repurchased through the same brokers at the same price the same number of shares of stock previously owned and sold.

At the time of selling the stock petitioner did not know the identity of the purchaser and had no agreement or understanding with him, or with anyone else, that he was to repurchase the stock. Although the stock was sold to and repurchased from one Leon Falk, with whom petitioner was acquainted, petitioner did not know that Falk was either the purchaser or seller until after the transactions had been completed. Petitioner had never had any financial dealings with Falk, and had no agreement or understanding with him with respect to these shares. Petitioner sustained a loss on the sale in the amount of $21,296.25.

On May 31, 1924, the petitioner's then wife, Mary K. Weir, who was then a resident of the city of Pittsburgh, Allegheny County, Pennsylvania, filed a libel for divorce in the Court of Common Pleas of Allegheny County and on December 23, 1924, the court entered a decree granting her a divorcea vinculo matrimonii (or absolute divorce) from petitioner, without any provision for property settlement, support and maintenance, or alimony.

On May 29, 1924, the petitioner, his then wife, Mary K. Weir, and the Fidelity Title & Trust Co., a Pennsylvania corporation, with its principal office in the city of Pittsburgh, executed and delivered a certain trust instrument, pursuant to which petitioner transferred to the Trust Co. as trustee 2,500 shares of the capital stock of the Weirton Steel Co., a Delaware corporation, and certain residential property situated in the city of Pittsburgh.

During the years 1932 and 1933, the Fidelity Trust Co. (successor to the Fidelity Title & Trust Co.) as trustee received and paid over to Mary K. Weir $8,657.57 and $7,070.35, respectively, being all of the income derived in those years by the trustee from the properties held by it under the trust instrument.

The trust instrument recited that the party of the first part (petitioner herein) in consideration of the release thereinafter set forth of the party of the second part (petitioner's then wife, Mary K. Weir) assigned, transferred, and conveyed to the trustee the property hereinabove mentioned. The release of the party of the second part referred to was set forth in the trust instrument as follows:

THIRD. In consideration of the creation of the foregoing trust by the party of the first part, and his covenants hereinafter set forth, and his release hereinafter set forth, the party of the second part hereby releases, quit-claims and relinquishes unto the party of the first part all right of dower and all and every other right, title, interest, claim or demand she has or can or may at any time hereafter have, in the estate or property of the party of the first part, now or hereafter possessed by him, and especially any and every estate, right, title and interest she has or can or may at any time hereafter have, in his estate or property now or at any time hereafter possessed by him, growing out of or in anywise connected with the marriage relation; and the party of the second part does hereby agree that she will, from time to time, execute any and all other instruments, deeds, agreements or assurances necessary or proper to release or convey her dower and all and every other estate, right, title and interest she has or can or may have in any property, real, personal or mixed, now or hereafter owned by the party of the first part.

The fourth paragraph of the trust instrument contained a similar release of the party of the first part of his right of curtesy in the estate or property of the party of the second part.

The trust instrument further provided that all income from the property held in trust should be paid by the trustee to the party of the second part during her lifetime in approximate equal monthly installments, provided that the amount so to be paid should not exceed $18,000 per year, and any excess of income over that amount should be held by the trustee until the sum of $50,000 had been accumulated, which amount should be treated as a reserve fund to be used to make up any deficiency thereafter occurring in the income, and in so far as not used for such purpose, should be invested and become a part of the principal of the trust fund. After accumulation of the reserve fund, any excess of income over and above $18,000 per year should be paid to the three children of the parties of the first and second part.

The trust instrument provided that, as long as the party of the first part should remain an officer of the Weirton Steel Co., all of the stock of that company held by the trustee should be voted under the direction of the party of the first part and by him as proxy for the trustee, and that the stock should not be sold or converted without the consent in writing of the parties of the first and second part. It was also provided that the party of the second part should have the right to use and occupy the residence property conveyed to the trustee during her lifetime without paying any rent therefor, or the property might be rented to others at her request and the income therefrom paid to her in addition to the $18,000 per year otherwise to be paid to her under the trust agreement; or the property might be sold by the trustee upon the written request of the wife and the income from the proceeds paid to her in addition to such sum of $18,000 per year.

Petitioner, as party of the first part, agreed that, in case the income from all the property held in trust, other than the residential property or the proceeds thereof, if sold, should be insufficient to pay to his wife, party of the second part, the sum of $18,000 per year he, party of the first part, would pay to her directly, at the end of each year, the deficiency, that is, an amount necessary, in addition to the sum received by her during each year, to make $18,000. The trust agreement further provided:

(10) It is the intention hereof that the party of the second part shall receive eighteen thousand dollars ($18,000.00) per year each and every year during her natural life in addition to having the use of said real estate, or the income therefrom in case it is rented or sold; and the party of the first part guarantees the payment of said annual sum of eighteen thousand dollars ($18,000.00) to the party of the second part. If the income from the trust propety shall be insufficient at any time, or from time to time, the party of the first part shall make up the deficiency. If he fails to do so, a part of the principal of the trust funds may be used for the purpose and the Trustee is hereby directed and authorized to so use the same; but, if so used, the party of the first part shall, and he hereby agrees to forthwith, replace the same so that the whole of the principal shall be restored and shall be maintained intact and unimpaired.

All charges of the trustee for services and all other costs and expenses of the trust, and all income or other taxes which the trustee or party of the second part might be required to pay upon the $18,000 annually to be paid to the wife, it was provided should be paid by the party of the first part unless there should be an excess of income sufficient to pay such charges, costs, and expenses.

Petitioner, party of the first part, reserved the right at any time to be relieved of his personal obligation to make up any deficiency in the income of $18,000 per year, guaranteed to his wife, party of the second part, by transferring to the trustee in substitution for the securities held, United States bonds producing an income of $18,000 annually, or other property equal as security to such bonds, whereupon it was provided that the securities previously held by the trustee should be transferred to the petitioner.

The trust agreement further provided that upon the death of the party of the second part the trust should cease absolutely and all the securities and property in the possession of the trustee should be paid, transferred, and conveyed to the three children of the parties, or their survivor or survivors, in equal shares; provided that if any child died prior to that time leaving issue surviving, the issue should take the share the parent would have taken if living.

OPINION.

HILL: We are to determine in this case, first, whether petitioner is entitled, under section 23(e), Revenue Act of 1932, ¹ to deduct from his gross income for 1932 the sum of $21,296.25 representing a capital loss sustained by him in that year from the sale of 250 shares of preferred stock of the Bellefield Co. In denying such deduction, respondent stated in the deficiency letter:

7. In your return you claimed a loss of $21,296.25 on a transaction involving the Bellefield Company stock. It is held that the claimed deduction is based on a transaction which the Bureau can not recognize as giving rise to a loss deductible for income tax purposes.

Petitioner purchased the stock in 1925 and 1926 at a cost of $25,000, and sold it in 1932 for the net sum of $3,703.75. Petitioner erroneously assumed that respondent denied the deduction on the ground that the transaction was not bona fide, and offered evidence to establish the circumstances surrounding the sale, which shows that it was made in good faith, and that he had no understanding or agreement with the purchaser, or anyone else, to reacquire the stock. But respondent raises no question concerning the bona fides of the transaction, nor that petitioner in fact sustained a loss in the amount claimed. Respondent contends only that the loss was in the nature of personal or living expense, not allowable as a deduction under the provisions of the statute above quoted. For reasons presently appearing, it is unnecessary to determine the correctness of respondent's contention that the loss was in the nature of personal or living expense.

The allowance of deductions from gross income for tax purposes is a matter within the sound discretion of Congress, and a taxpayer claiming a deduction must be able to point to an applicable statute and show that he comes clearly within its terms. ; ; .

The statute applicable in the instant proceeding is quoted in footnote 1, supra, and in order to show that he comes within its terms, petitioner plainly has the burden of proving not only that the deduction represents a real loss resulting from a bona fide transaction, as he has done, but also that the loss was incurred either (1) in trade or business, or (2) in a transaction entered into for profit, though not connected with the trade or business. There is no contention that the loss in controversy was incurred in petitioner's trade or business, and there is nothing in the record to suggest that such was the case.

In his brief petitioner argues that it is a legitimate inference from the facts in the record, although admitting there is no specific proof, that the Schenley Apartments were operated for the profit of the Bellefield Co., and that the stock which petitioner purchased was an ordinary investment which was expected to result in dividends to the owner, whether he was a tenant or not. We do not think petitioner's burden of proof may be viewed so lightly. We may not indulge the assumption, predicated upon mere inference or conjecture, that the transaction giving rise to the claimed loss deduction was entered into for profit. Petitioner's own testimony does not tend to support such a conclusion. He testified as follows:

Q. Why did you sell it (the Bellefield stock)?

A. To go back to the earlier years, when we moved into the Schenley Apartments, I wanted to have some ownership, so that I could have some influence in helping maintain certain standards - * * * The Bellefield Company owned the apartments, yes sir. We expected to live there permanently, and I bought 250 shares of stock, so that I would be a stockholder in the apartment, and I held the stock until 1932.

Petitioner stated that prior to the expiration of his lease he entered into negotiations for a substantial reduction of the rental, but at that time was unable to secure a satisfactory adjustment. He then testified:

* * * at the same time I was building a home outside of the city, about 40 miles, so we decided we would not renew the lease, and would move out of the apartment. That being the case, I had no interest in owning any stock in the apartment, so I told Mr. Hesse to sell the stock.

Subsequently, the rental having been reduced, petitioner decided to renew his lease and remain as a tenant. Accordingly, he repurchased the same stock which he had previously sold. He testified in that connection:

* * * we decided to make a lease with them on the basis of $10,000 a year; and I told Mr. Hesse that, if we were to stay there as tenants, I would want to own the stock for the same purpose for which I bought it, and I told Mr. Hesse to buy the stock back.

Petitioner was a man of substantial means; his net income as determined by respondent for the taxable year 1932 was $292,154.68. Obviously, he could well afford to gratify his desire to exercise some control over the management of the company which owned the apartments in which he resided, through ownership of its stock, without regard to whether or not such stock constituted a profitable investment. In our opinion petitioner's testimony does not establish that his purchase of the stock in the Bellefield Co. was a transaction entered into for profit. He has wholly failed to establish that the deduction claimed comes within the purview of the applicable statute.

Respondent's determination of the first issue is approved.

The second issue is whether or not respondent erred in including in petitioner's gross income the amounts paid during the taxable years to petitioner's former wife by the trustee pursuant to the provisions of the trust instrument referred to in our findings of fact above. On May 29, 1924, petitioner executed the trust agreement, which was also signed by the trustee and petitioner's then wife, Mary K. Weir. Two days later, on May 31, the wife filed a libel for divorce and on December 23 of the same year the court granted her an absolute divorce without any provision for property settlement or alimony. The parties resided in Pennsylvania.

The first paragraph of the trust instrument recited that petitioner (grantor) transferred to the trustee the property therein described, in consideration of the release by his wife (the beneficiary) of all right of dower and any other interest which she had in his estate or property growing out of or in anywise connected with the marriage relation, as set out in the third paragraph of the instrument. In the fourth paragraph, petitioner released his right of curtesy in the estate or property of his wife. Thus, the trust instrument clearly constituted a settlement of the property rights of petitioner and his wife, and obviously was executed in contemplation of the divorce action which was instituted by the wife two days thereafter. The income of the trust property was payable to petitioner's wife during her lifetime, and petitioner guaranteed that the amount of such income, in addition to the use of the residential property or the income therefrom if rented or sold, would not be less than $18,000 per annum. If the income in any year should be insufficient to pay to his wife such sum, petitioner agreed to make up the deficiency. All trust expenses, including income and other taxes levied on the $18,000, were to be paid by petitioner. Upon the death of the wife, the trust was to be terminated and the property distributed among the three children of herself and petitioner.

Respondent contends that the income of the trust which was paid to petitioner's former wife during the years 1932 and 1933 is properly taxable to him under the doctrine of , wherein it was held that the income of a trust used to discharge a legal obligation of the grantor is taxable to the grantor. Numerous subsequent decisions both of the Board and the courts have followed the cited case, and other cases, distinguishable on the facts, have been held not to come within the stated rule. Application of the rule clearly depends upon whether the trust income was used to discharge a legal obligation of the grantor, whatever may be the precise nature of such obligation. In the Douglas case, supra, the trust income was held taxable to the grantor, because under the trust agreement, made pending divorce, such income was payable to the wife in lieu of alimony and property rights, and discharged the grantor's general legal obligations to support, made specific by decree. Some of the subsequent decisions, in so far as pertinent, will be discussed below.

While petitioner concedes that the doctrine of , and similar decisions, is that the grantor of the trust is taxable upon the trust income where it is currently applied to the satisfaction of a continuing obligation on the part of the grantor, he contends that in the instant case there was no continuing obligation on the part of the grantor. He argues that the trust agreement embraced a fully excuted transaction in that each party made an immediate release of a contingent dower or curtesy interest in the other's property, and petitioner made an irrevocable and immediate grant of the trust estate to Mrs. Weir and their three children. Petitioner further points out that when the wife was granted an absolute divorce in 1924, under Pennsylvania law petitioner was relieved of his obligation to provide support and maintenance, and thereafter he was under no legal duties whatsoever to his former wife.

We can not agree with petitioner's argument. Under the facts presented, his position, we think, is untenable. There was a continuing legal obligation on the part of the petitioner, created by the trust instrument, which was discharged pro tanto by payments in the taxable year of the trust income to his former wife. Petitioner in effect acquired the interest of his wife in his estate or property in consideration of his agreement to pay her $18,000 per year during her lifetime, in addition to the use of or income from the residential property. The trust was in the nature of collateral security to insure payment of the agreed compensation. Whether or not the income of the trust was sufficient, petitioner was obligated to pay to his wife the stipulated amount.

If the trust had not been created and petitioner had used the income from the property to pay to his former wife the annual amount agreed upon as consideration for the release of her dower interest in his estate, there can be no doubt that such income would be taxable to him. The creation of the trust as a means of securing payment does not render the income any the less attributable to petitioner. Under the trust agreement the income was to be used to satisfy his legal obligation arising from the contract. Also, the fact that the agreement was irrevocable and upon the death of petitioner's former wife the trust property is to be distributed to their three children, is immaterial. He retained the beneficial interest in the property during her lifetime by requiring the income to be used to discharge his contractual obligation.

It is unimportant whether or not petitioner made a profitable bargain with his wife. It is true that he released his right of curtesy in her estate and she released her dower interest in his property, but such release on the part of the one was not necessarily the moving consideration for the release on the part of the other. The wife may have owned but little if any property, and petitioner may and apparently did possess an estate of very large value. In any event, petitioner agreed to pay his wife, in consideration of her release, the sum stipulated in the trust instrument, and obviously the parties did not contemplate that petitioner should be relieved of his obligation in the event the wife obtained a divorce.

The fact that the wife was subsequently granted an absolute divorce, without any provision for property settlement or alimony, and thereafter petitioner was under no legal duty to her growing out of the marital relation, does not in anywise vitiate the obligation assumed by petitioner pursuant to the terms of the trust agreement. In ; affd., , we held that a legal obligation arose from the trust agreement itself, and the income was, therefore, taxable to the husband, the grantor of the trust, notwithstanding that in the absence of such agreement his obligation to support and maintain his wife would have been terminated under the law of Pennsylvania by her divorce and remarriage.

In , reversing , the essential facts were similar to those of the instant proceeding. There the husband created an irrevocable trust which provided for the payment of $12,000 per year to the wife out of the trust income, as a settlement of their property rights arising from the relationship of the marriage. The wife was then suing her husband for divorce, and the decree subsequently entered contained no provision as to alimony or property rights of the wife. The court held that the income was taxable to the husband, saying:

The taxpayer argues that there is a distinction between an agreement to pay alimony and an agreement for the settlement of property rights between husband and wife. The asserted distinction is without substance on the present issue. Whether the trust income is used to discharge the husband's duty, made specific by agreement, to support the wife, or to discharge anobligation to pay her agreed sums for a release of rights in his property, can not be material in determining the taxability of the husband. The creation of a trust the income of which is to be used to discharge any legal obligation of the settlor enables him to enjoy the benefit of the income; hence the income is properly taxable to him (citing authorities which include among others ). Indeed, in the Douglas case itself the trust provisions for the wife were in settlement not only of alimony but also "of any and all dower rights or statutory interests in the estate" of the husband, and the court pointed out * * * that this did not affect the essential quality of the payments. [Italics supplied.]

Cf. , reversing ; ; and .

Petitioner cites , as controlling under the facts of the present case. Such contention overlooks an important difference in the facts. In that proceeding we held that the trust income, which was payable to the wife during her lifetime and after her death to the two children, with contingent remainder over to the grantor, constituted a mere gift to the wife. The transfer was wholly without consideration, and the payment of the income to the wife did not discharge any legal obligation of the grantor. This is plainly indicated by the following quotation from our opinion at page 1134:

The trust agreement does not show on its face that it was created to provice income for the support of the wife or in lieu of alimony, or that it constituted a settlement of the rights of the parties growing out of the marital relationship existing between them. It does not refer to a contemplated separation of the parties and contains no waiver or relinquishment by the wife of support or of her interest in petitioner's estate. * * * The instant proceeding is distinguishable from the above cases [including ] involving income from trusts created by the husband for the wife in that therein either the separation agreement, decree of the court, or stipulation of the taxpayer and the Commissioner disclosed that the income involved was provided for and paid in lieu of alimony or the wife's interests in the husband's property. Furthermore, in all of the above cases there was an existing legal obligation on the part of the taxpayer, which obligation was discharged with the income derived from the trust created by the taxpayer.

Cf. .

Petitioner also cites , affirming , as controlling in the present proceeding. However, the opinion of the court clearly distinguishes that decision on two material points from the case at bar. It was there held that the income from a trust created for the benefit of the taxpayer's wife was not taxable to him for the reason, first, that under Michigan law the settlement was not alimony but analogous to a lump-sum property settlement. The second point stressed by the court was that the transfer was absolute, and there remained no continuing obligation on the part of the taxpayer for support or maintenance, and no debt to be paid out of his income, either actually or constructively. Upon the creation of the trust the grantor's obligations to his wife under both the contract and the decree were fully and finally liquidated.

On the second issue respondent's determination is approved.

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.

  In computing net income there shall be allowed as deductions:

  * * *

  (e) LOSSES BY INDIVIDUALS. - * * * in the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise -

  (1) if incurred in trade or business; or

  (2) if incurred in any transaction entered into for profit, though not connected with the trade or business; * * * ↩