McDonald v. Commissioner , 19 T.C. 672 ( 1953 )

Trust Under the Last Will and Testament of D. G. McDonald, Deceased, The Chase National Bank of the City of New York -- Trust Division and Eileen June McDonald, Trustees (Alleged Transferee), et al., Petitioners, ¹ v. Commissioner of Internal Revenue, Respondent

McDonald v. Commissioner

Docket Nos. 22506, 22507, 30556

United States Tax Court

19 T.C. 672; 1953 U.S. Tax Ct. LEXIS 253;

January 22, 1953, Promulgated

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Decisions will be entered under Rule 50.

Decedent created a trust for the purpose of first providing support and maintenance for his children during their minority. They were income beneficiaries thereafter and entitled to the corpus on reaching the age of 35. Decedent reserved the power to alter, amend, and revoke, the power to be exercised in conjunction with his divorced wife. Held, decedent "made a transfer" to the trust within the meaning of section 811 (d) (2), Internal Revenue Code, part of which was for an adequate and full consideration in money's worth, and pursuant to section 811 (i) there should be included in decedent's gross estate only the excess of the fair market value at the time of death of the trust assets over the value ("money's worth") of the children's right to support. Held, further, the income from the trust was taxable to decedent in 1944, 1945, 1946, and that portion of 1947 preceding his death, under sections 166 and 167, I. R. C.

James D. Conway, Esq., and Philip G. Johnson, C. P. A., for the petitioners.

William B. Springer, Esq., for the respondent.

Tietjens, Judge.

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TIETJENS

These consolidated proceedings involve a redetermination of a deficiency of $ 418,277.16 in estate tax in Docket No. 30556, and the following deficiencies in income tax in Docket No. 22507:

Year	Amount
1944	$ 26,681.29
1945	26,973.15
1946	19,076.55
Jan. 1, 1947, to May 16, 1947	44,177.53

There is also the further question in Docket No. 22506 of the liability of the petitioners as transferees, which liability is conceded in the event any deficiencies in income tax are determined.

The questions for decision are: (1) whether all or any part of the value at the date of death of the assets of a trust designated D. G. McDonald Trust No. 924, Bank of America National Trust and Savings Association, Trustee (hereinafter sometimes called Trust 924), are includible in the gross estate of decedent, D. G. McDonald; and (2) whether the income from that trust is taxable to decedent in any of the periods involved. For 1944 the subsidiary question is raised of the applicability of the 5-year limitation contained in section 275 (c) of the Internal Revenue Code.

Agreed adjustments can be reflected in a Rule 50 computation.

FINDINGS OF FACT.

The stipulated facts are so found and incorporated herein by reference.

Eileen June McDonald and Eileen June McDonald Thompson is one and the same person. She is the duly appointed and qualified executrix of the estate of D. G. McDonald who died on May 16, 1947, a resident of Hastings, Nebraska. As executrix she filed the estate tax return for said estate with the collector at Omaha, Nebraska.

D. G. McDonald filed his income tax returns for 1944, 1945, and 1946 with the collector for the district of Nebraska. His executrix filed an income tax return for decedent for the period January 1, 1947, to May 16, 1947, with the collector for said district. The 1944 return was filed on March 15, 1945, and reported gross income of $ 47,416.65. ² The statutory notice of deficiencies for said periods was mailed to the executrix on January 17, 1949.

The petitioners in Docket No. 22506 are the duly appointed, qualified, and acting trustees of the trust created under the last will and testament of D. G. McDonald, deceased.

D. G. McDonald, hereinafter sometimes called the decedent, was born March 18, 1885. On January 29, 1912, he married Lenore E. McDonald in Kansas. A few months later they moved to Spokane, Washington, where they stayed less than a year. From Spokane the couple went to Kellogg, Idaho, where they remained for about 5 years. Neither had any property at the time of marriage.

After coming to Kellogg the decedent engaged in the general merchandising business and acquired an interest in several stores in Idaho with his brothers. On or about July 1, 1913, the store in Kellogg in which he was interested was consolidated into the J. C. Penney Co. chain (hereinafter called Penney) as store No. 42. As a result decedent acquired 20 shares of Penney classified common stock. Decedent managed the store and from time to time Lenore worked in the store until March 1917, when they moved to St. Paul, Minnesota.

In St. Paul decedent had supervision of a newly opened buying office for Penney and Lenore entertained buyers and their wives at various times. In January 1922 decedent was transferred to New York where he continued as an executive and became a director of Penney until he severed all connections with that company in 1929. During the period in New York decedent received a salary of $ 10,000 per year.

Penney was incorporated in Utah in 1913 and was changed to a Delaware corporation in 1925. Expansion of the chain during the interim was accomplished through what was called the "Three Generation System." Pursuant to that system each store had its own outstanding classified stock. A store would open with three stockholders, one of whom was the store manager. When the store had enough earnings accumulated it could open a second store, again with three stockholders, the manager of the old store, the manager of the new, and one of the other stockholders of the old store. In turn, store number two could open a third, which would then be owned by the managers of the three stores.

A summary of transactions in Penney classified common stock owned by and held in the name of decedent prepared from the Penney books and records follows:

		Date
Store No.	Location	acquired
42	Kellogg, Idaho	July 1, 1913
84	Wallace, Idaho	Apr. 1, 1915
111	Coeur d' Alene, Idaho	Mar. 9, 1916
127	Sand Point, Idaho	Mar. 9, 1916
141	Hillyard, Wash	Feb. 15, 1917
151	Tekoa, Wash	Feb. 15, 1917
185	Bradford, Pa	Feb. 23, 1918
210	St. Paul, Minn	Mar. 17, 1920
211	Anderson, Ind	Mar. 17, 1920
224	Connersville, Ind	Mar. 17, 1920
		Mar. 17, 1920
238	El Reno, Okla	Mar. 17, 1920
277	Evansville, Ind	Mar. 17, 1920
291	Huntington, Ind	Mar. 17, 1920
323	Chanute, Kans	Mar. 28, 1922
210	St. Paul, Minn	June 13, 1922
211	Anderson, Ind	June 13, 1922
333	Taft, Calif	Aug. 14, 1922
		Dec. 12, 1922
		Mar. 24, 1923
455	Chickasha, Okla	Mar. 26, 1923
477	Peru, Ind	Feb. 18, 1924
500	Hamilton, Mo	Feb. 18, 1924
Assessments:
210	St. Paul, Minn	Mar. 5, 1924
Recd (See dividends statement):		Mar. 20, 1924
549	Columbus, Ind	Mar. 21, 1924
512	Harrisonburg, Va	July 21, 1924
127	Sandpoint, Idaho	Sept. 13, 1924
127	Sandpoint, Idaho	Sept. 13, 1924
Totals

	Shares
Store No.	acquired	Cost
42	20	$ 2,000
84	20	2,000
111	20	2,000
127	12	1,200
141	20	2,000
151	20	2,000
185	40	4,000
210	1 60
211	1 70
224	1 15
	35	3,500
238	25	2,500
277	50	5,000
291	35	3,500
323	60	6,000
210	20	1,500
211	35	3,500
333	30	3,000
	1 108
	1 145
455	25	2,500
477	1 60
500	5	500
Assessments:
210		5,000
Recd (See dividends statement):	1 160
549	5	500
512	10	1,000
127	10	1,000
127	2 20	2,000
Totals	1,135	56,200

At least 185 of the above shares were purchased by decedent from other individuals.

In 1925 when Penney became a Delaware corporation the 1,135 shares of classified common stock were converted into the following:

Classified Common Stock	635 shares
Class A 6% Preferred Stock	1,034 shares
Unclassified Common Stock	411 shares

On March 5, 1928, decedent sold 35 of his 635 shares of classified common stock to R. J. Wilker. Decedent bought 60 shares of classified common stock from O. Andreasen (Frankfort, Indiana, store) on April 12, 1925, and 30 shares from R. T. Williams (Bristol, Virginia, store) on March 21, 1928. Decedent paid assessments with respect to the Bristol, Virginia, store on June 11, 1928, and January 2, 1930, in the respective amounts of $ 11,499.24 and $ 2,926.05.

On July 7, 1925, decedent purchased 150 shares of unclassified common stock (expansion stock) at $ 1 a share and on January 2, 1926, he acquired 69 shares of unclassified common stock on conversion of 130 of his classified common shares. He then owned 630 shares (411 + 150 + 69) of unclassified common stock which on January 2, 1927, was split 10 for 1. Unclassified common stock was changed in name only to common stock as of January 2, 1927. From January 2, 1927, to January 2, 1929, decedent acquired 1,362 shares of common stock on conversion of 600 shares, all but 90 shares (Bristol, Virginia, store) of his remaining classified common shares. From June 30, 1927, to April 19, 1929, decedent purchased 512 shares of common stock (expansion stock). He then owned 8,174 shares of common stock.

Decedent received rights to subscribe to two shares of common stock at $ 7 for each share of common held and he exercised those rights on July 11, 1929. He then owned 24,522 (8,174 + 16,348) shares of common stock. From January 2, 1926, to January 2, 1929, decedent acquired 441 shares of Class A 6 per cent preferred stock on conversion of 600 shares of his classified common stock.

Exclusive of any common stock attributable to purchases of classified common stock from O. Andreasen and R. T. Williams, respectively, on April 12, 1925, and March 21, 1928, from January 1, 1925, to January 2, 1930, decedent purchased 19,242 shares of J. C. Penney Co. common stock as follows:

		Number
		of shares
	Date acquired	after 10	Cost
		for 1 split
		Jan. 2, 1927
Expansion stock	July 7, 1925	1,500	$ 150.00
Expansion stock	June 30, 1927	188	15,040.00
Expansion stock	May 11, 1928	180	18,000.00
Expansion stock	April 19, 1929	144	17,280.00
Exercise of rights	July 11, 1929	16,348	114,436.00
Conversion of last 90	Assessments June 11,
shares of classified	1928 and January 2,
common stock (Bristol,	1930 converted January
Va.)	2, 1930	882	12,433.28
Totals		19,242	$ 177,339.28

J. C. Penney Co. stock rights issued in 1929 were of record May 10, 1929, and expired July 12, 1929. The price the week ending May 10, 1929, was a high of $ 360 and a low of $ 351. The price the week ending July 12, 1929, was a high of $ 123 and a low of $ 123.

About April 15, 1927, the Chemical National Bank took over the transfer work with respect to the Class A 6 per cent Preferred stock of J. C. Penney Co. From July 6, 1925, down to the time Chemical National Bank took over the transfer work, decedent sold 517 shares of J. C. Penney Company preferred stock.

In July of 1929, after the exercise of stock rights, decedent was the owner of 24,522 shares of common stock of Penney Company and 90 shares of classified common stock which were converted into 882 shares of common stock on January 2, 1930.

In November and December of 1929, decedent sold 3,700 shares of Penney common stock, and sold 500 shares in January and March of 1930, leaving a balance of 21,204 shares of Penney common stock owned by him on November 10, 1930.

After going to New York decedent purchased a home in New Rochelle which was sold for between $ 65,000 and $ 75,000 before a new home was built in Bronxville, New York, in 1926 at a cost of $ 450,000. The new home was paid for out of a joint bank account maintained by decedent and Lenore by checks drawn by Lenore. The money in the account was furnished by decedent. The house contained 22 rooms and was serviced by five servants, including a chauffeur and gardener.

In the fall of 1929 the Bronxville home was sold for $ 180,000, and in the spring of 1930 Lenore and the decedent moved to California. Decedent intended to retire.

The McDonalds had two children, a son, Delos, born December 13, 1914, and a legally adopted daughter, Nedra, born October 2, 1925. The family maintained a high standard of living. Delos attended various schools and traveled extensively with his mother. He had a car. For a period his mother took him to Arizona for his health. Nedra attended private schools, took riding lessons, and also traveled with her mother.

After Lenore and the decedent arrived in California, marital difficulties arose between them which led to their separation in September of 1930 and they never lived together again.

On November 10, 1930, decedent created a trust. An instrument entitled Trust No. 924, Declaration of Trust, Bank of America National Trust and Savings Association to D. G. McDonald was executed on November 10, 1930. The Bank of America National Trust and Savings Association was designated trustee and decedent was designated as trustor and he signed as trustor. In a recital, following decedent's signature, and subscribed to by Lenore as "Wife of Trustor" the following was provided:

I, Lenore E. McDonald, wife of D. G. McDonald, the within named Trustor, hereby join in, ratify and approve the foregoing declaration and agreement and each and every condition thereof and the trust thereunder created and declared and hereby assign to the Trustee and waive, for the purpose of said trust, any community or other interest which I might otherwise assert in or to the property made subject to said trust or which shall at any time in the future be made subject to said trust and to the proceeds thereof.

Decedent transferred 12,000 shares of his Penney common stock to the trust. In the trust instrument the trustee acknowledged receipt from D. G. McDonald of 12,000 shares of common stock of J. C. Penney Co. issued in the name of D. G. McDonald and assigned by him for transfer into the name of the trustee. In Article I the trustee was given the power during continuance of the trust to hold, manage, and control the trust funds and estate and to collect and receive the income therefrom and apply the net income to the uses mentioned in the instrument. The trustee, among other powers, also was given the power to do, in general, any and all things which it should deem for the best interest of the trust and which any individual might or could do if the trust estate were held and managed by him for his own use. Article I further provided:

* * * Notwithstanding any of the provisions in this Article I contained, the Trustee shall not, during the lives of the Trustor and Lenore E. McDonald, wife of the Trustor, sell any of the capital stock of the J. C. Penney Co. deposited in this trust by the Trustor without the joint written direction of the Trustor and Lenore E. McDonald, wife of the Trustor, or if either of them shall be deceased, upon the written direction of the survivor.

Article III of the trust instrument provided that the trustor, with the written consent of the trustee, might at any time during the life of the trust deposit with and convey to the trustee, additional property.

Article V of the trust instrument provided that the trustee should pay all of the net income to Lenore E. McDonald, wife of the trustor, until Delos, son of the trustor, attained the age of 21 years, until Lenore remarried, or until Lenore died. When Delos attained the age of 21, if Lenore was still living and had not remarried, the trustee was to pay $ 3,600 a year to Delos and the remaining net income to Lenore.

If Lenore remarried, the trustee was to pay one-half of the net income to Lenore as long as she should live and so much of the remaining one-half of the net income as should be required for the care, education, and maintenance of Delos, until he attained the age of 25 years. In ascertaining the amount required for the care, education, and maintenance of Delos, it was provided the trustee should consult the trustor during the life of the trustor; and when Delos attained the age of 25 years, the trustee was to pay the remaining one-half of the net income to Delos during the existence of the trust.

After the death of Lenore the trustee was to pay so much of the net income as should be required for the care, education, and maintenance of Delos until he attained the age of 25 years. In ascertaining the amount required the trustee was to consult the trustor. When Delos attained the age of 25 years the trustee was to pay all of the net income to Delos. When he reached the age of 30 years one-half of the principal was to be distributed to Delos, and when he reached the age of 35 years he was to receive the entire remaining trust estate.

If not sooner terminated, the trust was to terminate upon the death of the survivor of Lenore and Delos and the trustee was to distribute the entire trust estate to the issue of Delos, per stirpes, or, in the event of no surviving issue of Delos, to the trustor if living, and if not living to the executor or administrator of the trustor.

Article V (f) provided that:

After the death of the Trustor, the Trustee shall pay from the corpus of the trust estate all State Inheritance Tax and Federal Estate Tax which may be chargeable against this estate or against the gifts, benefits and interests accrued or to accrue under the terms of the trust, it being the intention of the Trustor that each and every gift, benefit and interest shall be delivered to and taken by every beneficiary hereunder in full and without deduction on account of said taxes.

Article VI of the trust agreement read as follows:

The Trustor reserves the right, while he shall be competent to act, and while Lenore E. McDonald, wife of the Trustor, shall be living and competent to act, to change or amend any of the provisions of this trust or any of the trusts hereby created, and also to revoke the trust in whole or in part and take out of the trust and remove from the operation thereof any part or all of the trust estate, provided, however, that any change or amendment of the trust shall be made only by written declaration or agreement, subscribed by the Trustor, Lenore E. McDonald, wife of the Trustor, and by the Trustee, and revocation, either partial or as to the whole trust, shall be by notice in writing, signed by the Trustor and Lenore E. McDonald, wife of the Trustor, and delivered to the Trustee. This trust shall not be subject to amendment or revocation after the death of either the Trustor or Lenore E. McDonald, wife of the Trustor.

Article VII of the trust provided that, in the event of the resignation of the trustee, the trustee should convey the trust property to such trustee as the trustor should designate.

In addition to four dividends paid in 1930 of 75 cents each, a dividend of $ 2.50 on the Penney common stock was paid January 31, 1930.

On November 10, 1930, the market quotation for Penney common stock was a high of $ 36 and a low of $ 34.50.

On November 10, 1930, when the trust was created, decedent hoped for a reconciliation with Lenore, but about Christmas of that year Lenore advised him that she was going to get a divorce. Both were represented by counsel.

Acrimonious negotiations concerning a property settlement and the divorce extended over a period of several months in 1931 leading up to a written agreement between Lenore and decedent executed on November 30, 1931, and also to amendment, partial revocation, and addition to Trust 924 by instrument dated November 30, 1931. Lenore was present at only two conferences at which decedent was present and that was at the beginning of the negotiations.

On November 28, 1931, Lenore signed a complaint for divorce which was filed on November 30, 1931. The complaint asserted that a property settlement had theretofore been entered into between the parties and prayed that upon the granting of the decree, the property settlement be embodied in and made a part thereof.

On November 30, 1931, both Lenore and decedent signed the property settlement agreement referred to in the complaint. Lenore was designated party of the first part and decedent party of the second part. They signed separately before different notaries public. Relevant portions of the agreement follow:

Whereas, the parties hereto desire to forever settle and adjust their property rights, both present and future, including division of the community property of the parties, and

Whereas, the parties have agreed upon a full and complete settlement of all property rights including support and maintenance of the party of the first part and their children, and

Whereas, each of the parties, in the negotiations between them resulting in this agreement, has retained his or her own separate, independent legal counsel, and has been fully advised in respect thereto by such counsel,

* * * *

2. The parties hereto agree that Trust No. 924, Bank of America, shall be so revised and amended as to permit the withdrawal therefrom of 5,500 shares of the J. C. Penney Co. stock now subject to said Trust, which said 5,500 shares shall be delivered to first party, free from the provisions of said Trust and shall become and be her sole and separate property. That there shall be added to said Trust by second party hereto an additional 500 shares of said J. C. Penney stock of the same kind, as is now covered by said Trust, making a total number of shares remaining in said Trust of 7,000; that said Trust shall be further revised, changed and modified as set forth in the annexed copy of said Trust No. 924, and the amendment, modification and revision of the same; said original Trust being marked Exhibit "A" and said amendment and revision being marked Exhibit "B", attached to and made a part of this Agreement.

The parties agreed that all the household furniture, furnishings, rugs, carpets, drapes, pictures, and objects of art in the possession of Lenore and the two automobiles and all her jewels in her possession, except three certain rugs and a star sapphire, should be her sole and separate property. The star sapphire without the mounting and the three rugs were to be decedent's.

Paragraph 4 of the agreement provides that it "is expressly understood and agreed that the property transferred and conveyed to first party under this agreement, and under said Amended Trust Agreement," now is and henceforth shall be her sole and separate property, and second party relinquishes any interest which he has or hereafter may acquire in and to said property.

In paragraph 6 of the agreement the parties agree that all property of either party owned or thereafter acquired should be his or her separate and sole property and that each relinquished and released any interest which he or she may have had therein under the law, if the agreement had not been entered into. In paragraph 7 it is provided that each of the parties does relinquish, release, renounce, waive, and give up all interest or claim against the person, property, or estate of the other, "including the right of alimony, support, maintenance, and any and all rights of inheritance which shall be a part of the estate of the other, * * * it being expressly understood that included herein is any community right, right of dower, right of homestead, right of former allowance, or any other right or claim * * *" the parties have or may have.

In paragraph 8 it is provided that the agreement shall not operate as a waiver of the right of either party to maintain an action for divorce; that the agreement is made to adjust the obligations and property rights of the parties; and that "if hereafter in any pending action for divorce between the parties hereto, there shall be made any order or decree of the court, it is agreed between the parties that this contract and agreement may be made a part of such order or decree."

In paragraph 9 it is provided that the care, custody and control of Delos and Nedra shall be given to Lenore, subject to the right of decedent to see and visit with the children at all reasonable times and to have custody during school vacations for at least one-half of the vacation period.

Paragraph 10 reads as follows:

It is also understood and agreed between the parties hereto that the income as received by first party from the Amended Trust created for the benefit of said children shall be the sole and separate property of said first party, said first party being hereby released by the second party of any requirements of accounting therefor; it being, however, understood and agreed between the parties to this agreement that the income payable to the first party under and by virtue of said Amended Trust is paid to said first party for the purpose of supporting, educating and maintaining said children, and in consideration thereof said first party does hereby agree to maintain, educate and support said children and does assume full responsibility for their maintenance, support and education, and said payments of income to said first party shall be in full satisfaction of any and all obligations of said second party for the support, maintenance and education of said children.

Paragraph 12 of the agreement reads as follows:

It is understood and agreed that this settlement is made for the purpose of settling, adjusting and disposing of all rights, duties and obligations of support and maintenance, one to the other, of said parties, and of the aforesaid children, it being understood that Delos McDonald is a natural child of the parties hereto and that Nedra McDonald is an adopted daughter. It is also understood that the divorce and/or remarriage of either of the parties hereto shall not alter, vary, or affect the terms of this settlement in any way or manner except as herein provided.

An interlocutory judgment of divorce was filed on December 7, 1931, which contained the following paragraph:

It is Further Ordered, that the property settlement entered into by and between the parties hereto, as evidenced by Exhibit "1" in this cause, is hereby ratified and approved, and that said property as set forth in said Agreement is and shall belong to the parties as set forth therein, and all of their rights as evidenced thereby, is hereby confirmed and approved; that said Property Settlement, together with the original Trust and the Amended Trust is hereby referred to and made a part of this Decree the same as if set forth in full, and it is ordered by the Court that said Exhibit "1" be annexed to and become a part of this Decree in all of its terms and conditions. That defendant pay to plaintiff as set forth in said Property Settlement, the amount specified therein as attorney's fees or for costs.

On November 30, 1931, an instrument entitled "Amendment To Trust, Partial Revocation Of Trust, And Addition To Trust, Trust No. 924" was executed by decedent, Lenore, and the Bank of America National Trust and Savings Association. The instrument provided that under the exercise of the power of revocation in Article VI of Trust 924 the trustee is directed to withdraw from the trust and deliver to Lenore, wife of the trustor, as her separate property, 5,500 shares of the Penney common stock. The trustee delivered 5,500 shares of the Penney common stock to Lenore. The instrument provided that in the exercise of the right to add additional property, the trustor does hereby transfer and convey to the trustee an additional 500 shares of Penney common stock. There is a notation on page 7 of the instrument reading that the 500 shares "is to be delivered later and when received will be held under the terms hereof." The 500 shares were transferred and conveyed by decedent to the trust on February 6, 1932.

The amended trust agreement added the following to Article I of the original agreement:

So long as any of the capital stock of the said J. C. Penney Company is held in this trust, the Trustee shall vote the said stock or shall execute and deliver proxies therefor in accordance with the written directions executed by the Trustor and the said Lenore E. McDonald during their joint lives, and executed by the survivor of them after the death of either, and delivered to the Trustee.

The amended trust agreement also directed the trustee to hold the trust estate without making any physical segregation except as it deemed necessary or advisable, in the proportions of six-sevenths for the benefit of Delos and one-seventh for the benefit of Nedra. The net income of the share held for the benefit of Delos was distributable to Lenore until Delos attained the age of 21 years; thereafter, and until he attained the age of 25 years, $ 3,600 per year was payable to Delos and the remainder to Lenore. When Delos reached the age of 25 the trustee was to distribute all the net income from his share to Delos and since December 13, 1939, it has been so distributed. The net income of the share held for the benefit of Nedra was distributable to Lenore until Nedra attained the age of 18 years on October 2, 1943, and since then all the income from her share has been distributed to Nedra.

The principal of the share of the trust estate held for the benefit of each child is to be distributed to the child for whom it is so held upon his or her attaining the age of 35 years. Article V (f) of the trust instrument, as amended, provides that in the event of the death of either of said children prior to receipt of their respective shares of the principal, the share held for such deceased child is to be distributed as follows:

1. If such deceased child leaves issue surviving, to the Executor or Administrator of the estate of such deceased child to be held and distributed as a part of the said estate.

2. If such deceased child leaves a surviving spouse but no surviving issue, one-third (1/3rd) thereof to the Executor or Administrator of the estate of such deceased child, to be held and distributed as a part of the said estate, one-third (1/3rd) thereof to D. G. McDonald, Trustor herein, and one-third (1/3rd) thereof to the said Lenore E. McDonald.

3. If such deceased child leaves neither a spouse nor issue surviving, one-half (1/2) thereof to the said D. G. McDonald, and one-half (1/2) thereof to the said Leonore E. McDonald.

4. In the event of the prior death of either the said D. G. McDonald or the said Lenore E. McDonald, the share of the principal which such deceased would have taken under any of the provisions hereof shall be added to the share of this trust held for the benefit of the other of the said children of the Trustor and held and distributed as a part of such child's share.

Article V (g) of the amended instrument provided:

The share of any deceased beneficiary in any accrued or undistributed net income as of the date of the death of such beneficiary shall be distributed to the beneficiary entitled to the next successive interest hereunder.

Article XI of the trust instrument added by the amendment of November 30, 1931, is as follows:

D. G. McDonald the Trustor, and Lenore E. McDonald, his wife, agree that the provisions of the trust as hereby amended are made pursuant to the terms of a property settlement settling the rights of the parties; that the income to be paid to the said Lenore E. McDonald from the trusts created for the benefit of the said Delos McDonald and the said Nedra McDonald, respectively, shall be considered as full satisfaction of any and all legal obligation of the said D. G. McDonald for the support and maintenance of the said children; that the said payments of income to said Lenore E. McDonald are for the purpose of supporting, educating and maintaining the said children, and that the said Lenore E. McDonald assumes full responsibility of educating, maintaining and furnishing a home for the said children.

Decedent was the grantor, creator and settlor of Trust 924 and it was his property that was transferred to the trust. Lenore, during the taxable years, had no substantial adverse interest in the corpus or income of the trust or in its disposition.

The 7,000 shares of Penney common stock, which comprised the corpus of Trust 924 from February 6, 1932, until the end of 1945, became 21,000 shares as of December 26, 1945, by virtue of a three for one split effective on that date. Dividends paid on the Penney common stock during 1931 were $ 2.40 per share or 60 cents per quarter.

On November 30, 1931, the market quotation of Penney common stock was a high of $ 36 and a low of $ 34 1/2. During 1931 dividends totaling $ 2.40 per share were paid.

The net income of the trust ranged from $ 28,084.26 in 1931 to a high of $ 60,500 in 1936. Its lowest point was $ 8,578 in 1933.

On November 30, 1931, the reasonable prospective value of the support and maintenance of Delos and Nedra was $ 30,000.

During the calendar years 1944, 1945, and 1946, and for the period January 1, 1947, to May 16, 1947, all the net income of Trust No. 924 Bank of America National Trust and Savings Association was paid to Delos or Nedra.

For the years 1944, 1945, 1946, and 1947 the Bank of America National Trust and Savings Association filed fiduciary income tax returns for D. G. McDonald Trust 924 indicating thereon the beneficiaries as Delos and Nedra and that the net income was distributable to the beneficiaries.

For 1944, 1945, 1946, and 1947 Delos reported on his individual income tax returns the amounts distributed during those years to him from Trust 924. For 1944, 1945, and 1946 Nedra reported on her individual income tax returns the amounts distributed during those years to her from Trust 924.

Delos was married on July 15, 1936. He attained the age of 21 years on December 13, 1935, and the age of 25 on December 13, 1939. Nedra was married in February of 1944. She attained the age of 18 years on October 2, 1943.

On the day of D. G. McDonald's death, Delos had one child born April 24, 1941, and Nedra had one child born in March of 1945.

The Federal estate tax return for decedent was duly filed, and the notice of deficiency in Docket No. 30556 was mailed to the petitioner on June 28, 1950.

Decedent in his last will and testament executed February 15, 1947, provided, in part, as follows:

SECOND:

I give, devise and bequeath unto my son Delos Gillis McDonald, the sum of $ 5.00, reciting herein that my reason for such bequest is that I have previously made a settlement upon him from my estate.

THIRD:

I give, devise and bequeath unto my adopted daughter, Nedra Eileen McDonald, the sum of $ 5.00, reciting herein that my reason for such bequest is that I have previously made a settlement upon her from my estate.

In Schedule G of the Federal Estate Tax Return filed for decedent's estate, question (5) reading, "Were there in existence at the time of the decedent's death any trusts created by him during his lifetime?" was answered "Yes" and explained as follows: "Trust established with Bank of America, November 10, 1930, to provide support for Delos Gillis McDonald and Nedra McDonald."

On the fiduciary income tax returns filed by the Bank of America National Trust and Savings Association for Trust 924 for the years 1944, 1945, and 1946, on page 4 of each return under question (6) the name of the "grantor" is given as D. G. McDonald.

On page 2 of the statement attached to the deficiency notice in Docket No. 30556, the following explanation was given with respect to the inclusion in the gross estate of the assets of Trust 924:

It is held that the assets of a trust created November 10, 1930, Bank of America National Trust and Savings Association, Trustee, designated Trust No. 924, transferred by decedent during his life time, are includible in the gross estate. It is further held that the fair market value of said assets was $ 841,260.00 on the applicable valuation date.

On March 15, 1948, Delos filed a claim for refund of 1944 income tax with the collector of internal revenue for the district of Nebraska with respect to Trust 924 income, stating thereon:

The taxpayer filed a federal income tax return covering the income of a trust and paid the federal income tax on the income for the calendar year 1944. The trust is revocable and the income should be taxable to the grantor rather than the beneficiary. Grantor -- D. G. McDonald, Hastings, Nebraska. Trust -- D. G. McDonald, Trust #934, Bank of America, Trustee, 650 S. Spring St., Los Angeles, California.

He also filed claims for refund of his 1945 and 1946 income tax with respect to Trust 924 income.

The income of Trust 924 for the years 1944, 1945, 1946, and 1947 was $ 35,000, $ 35,000, $ 25,200, and $ 63,000, respectively, and the net income for the same years before distributions was $ 34,240, $ 34,250, $ 24,450, and $ 62,935, respectively. For the period January 1, 1947, to May 16, 1947, the date of decedent's death, the net income of the trust was $ 42,000.

In his deficiency notice mailed to the Estate of D. G. McDonald, Deceased, Eileen June McDonald, Executrix, in Docket No. 22507, respondent added to the income reported on decedent's income tax returns for the years 1944, 1945, and 1946, and for the period January 1 to May 16, 1947, the net income for Trust 924 for the years 1944, 1945, 1946, and 1947, respectively, with the following explanatory paragraph:

It is held that the income of the trust known as D. G. McDonald Tr 924 Bank of America NT & SA, Trustee, Los Angeles, California is taxable to you under the provisions of the Internal Revenue Code. * * *

OPINION.

We turn first to that aspect of the cases which cuts across both the estate tax controversy and the income tax problem, i. e., the question of whether the decedent "made a transfer" to Trust 924 within the meaning of section 811 (d) (2)¹ or was the "grantor" of the trust within sections 166² and 167, ³ Internal Revenue Code, the pertinent portions of which appear in the footnotes.

In epitome, the petitioners' position on this aspect is that the basis of the decedent's fortune was acquired while the McDonalds were residents of Idaho, a community property state; that all of the property held by Lenore and decedent at the time of their subsequent separation consisted of increments to property originally held as community property or was purchased with the proceeds of such property and that the 12,000 shares of Penney stock placed in trust originally and the 500 shares afterwards added were less than Lenore's interest in the community and were actually her property; and, therefore, that the decedent could not have made the transfer to the trust and could not have been the grantor thereof.

A careful study of the whole record convinces us that it does not contain evidence which would sustain this contention. To the contrary, we think the record as a whole demonstrates that decedent transferred stock of which he was the owner to Trust 924 and that he was the grantor thereof, and we have so found.

Decedent and Lenore lived in Idaho about four years, from 1913 to 1917. While there, approximately 102 shares of Penney stock were acquired, and, Idaho being a community property state, it appears that this stock could properly be treated as community property. Nevertheless, we cannot on the evidence trace these shares or the proceeds of them into the 12,000 shares which originally formed the corpus of Trust 924 and we are less able to find -- after the property settlement of November 30, 1931, the transfer of 5,500 shares from the trust to Lenore pursuant to the settlement as her separate property and the addition of 500 shares to the trust by the second party (the decedent) -- that the shares remaining in the trust had ever been the property of anyone other than decedent, the trustor of the trust.

As is evident from the findings of fact, the great bulk of the transactions in Penney stock took place after the McDonalds had left Idaho in 1917 to take up their residence in the noncommunity property states of Minnesota and New York. There is nothing to show that any of the stock ever was registered in any name other than that of decedent or that any other person ever sold, bought, or managed the shares. The source of the funds used to purchase shares after the 1913-1917 period is not disclosed. The only testimony, aside from the Penney Company books (which show ownership in the decedent) in regard to the stock transactions was given by an assistant secretary of the Penney Company who was first employed by the company in 1917 and was not familiar with the specific way in which decedent acquired his shares. None of the shares were acquired after the couple took up residence in California in 1930. The shares placed in trust in 1930 represented something less than a third of the stock standing in decedent's name at the time. Despite Lenore's very general testimony to the contrary we think it very unlikely that decedent placed in the trust any shares of which he was not the owner.

Though petitioners' counsel have made an earnest attempt to lead us through the maze of complicated stock transactions extending over many years, set out in our findings, to the ultimate conclusion that Lenore rather than decedent was, in fact, the transferor or grantor of the stock placed in Trust 924, we are unable to follow. On the question of ownership of the stock as between husband and wife we attach no significance to the fact that Lenore in a recital following decedent's signature to the trust agreement joined in and ratified the agreement and waived any community or other interest which she "might otherwise assert" to the property made subject to the trust. We think this was simply one of the usual cautionary formalities attendant upon conveyances by either a husband or wife.

After a careful study of the record of stock transactions, the pleadings, the language employed in the trust agreement, the property settlement, and the testimony of Lenore, we conclude that the 7,000 shares of stock which were later split into the 21,000 shares remaining in the amended trust were, at the time placed there, the property of decedent and that he was the transferor and grantor thereof.

This conclusion does not mean, however, that the respondent's action in including the entire value of the assets of Trust 924 in the gross estate of decedent was proper. Section 811 (i) provided that if the transfer of the stock to the trust was made

* * * for a consideration in money or money's worth, but is not a bona fide sale for an adequate and full consideration in money or money's worth, there shall be included in the gross estate only the excess of the fair market value at the time of death of the property otherwise to be included on account of such transaction, over the value of the consideration received therefor by the decedent.

The parties are in apparent agreement that in the event we hold that decedent was the transferor of the assets to Trust 924, the value of such assets is includible in the gross estate unless the transfer of all or some part thereof was made for an adequate and full consideration in money or money's worth.

The question, then, is whether the transfer to Trust 924, or any part thereof, was made for "money's worth." In dealing with gift tax questions and questions involving claims deductible in determining gross estate where the statutory language is similar to the language used in section 811 (i) it has been held and recognized that transfers of property or contracts entered into for the support of children by the father are made for "money's worth". Weiser v. Commissioner, (C. A. 10) 113 F. 2d 486; Estate of Eben B. Phillips, 36 B. T. A. 752; Edmund C. Converse, 5 T.C. 1014">5 T. C. 1014, affd. 163 F. 2d 131; Roland M. Hooker, 10 T. C. 388. See also 1 Paul, Federal Estate and Gift Taxation (1942), pars. 11.20, 11.24. On this point both parties cite Helvering v. United States Trust Co., (C. A. 2) 111 F. 2d 576, reversing on another issue and remanding 39 B. T. A. 783, certiorari denied 311 U.S. 678">311 U.S. 678. Petitioners rely on that case and respondent seeks to distinguish it. On its facts, that case is as close as any we can find to the case before us, and we think the principle there established should govern the question here.

The United States Trust Co. case involved the question of whether any part of a trust fund was includible in the gross estate of decedent under the then equivalent of section 811 (d) (2) of the Internal Revenue Code. In that case decedent had become estranged from his wife some years before he died, and in contemplation of a divorce he made an agreement with her on January 31, 1929, by which he agreed to pay her $ 2,500 a month during her life, out of which she was to support herself without further recourse to him, and, in addition, to support, maintain, and educate her daughter during the time the said daughter resided with her. The child was to spend half her time with her father and half with her mother, and the testator agreed to assume certain of her expenses while she was with her mother. The amount of $ 2,500 per month was fixed by the parties as the approximate amount reasonably required for the support of the wife and daughter in accordance with their station in life and with the decedent's ability to furnish such support. The stipulation upon which the case was tried declared that it was established and fixed by agreement of the parties that of the said sum of $ 2,500 it was contemplated that approximately one-third thereof should be allocated and devoted to the support and maintenance of the daughter during her minority.

The agreement of 1929 also provided that the decedent might at any time commute the annuity by setting up a trust for $ 425,000, the income from which was to be paid to his wife for life, and which she should accept in satisfaction of any claims against him under the agreement. The parties were divorced in May 1929. In the following June the decedent exercised his option to discharge his obligations by setting up a trust, and transferred to trustees securities valued at about $ 414,000, the income from which was to be paid to the wife for life, she to have a power to appoint $ 200,000 of the principal by will. The balance of the corpus, or the entire corpus in case there was no valid exercise of the power of appointment, went to the daughter at the death of the wife or to her lawful issue, if any. If she left no issue, then the corpus went to decedent, or as he should appoint by will. Decedent reserved a joint power in himself and his wife at any time to terminate, modify, alter, or revoke the trust in whole or part. The property of the decedent in 1929 was worth more than $ 1,425,000. He died in May 1935. At the date of decedent's death the child was ten and one-half years of age.

The Board of Tax Appeals (now this Court) excluded the corpus from decedent's estate on the ground that the release by the wife was adequate and full consideration in money or money's worth. The Circuit Court of Appeals held that the release of the wife's marital right of support was not "money's worth," but that insofar as the trust was set up in consideration of a release of that part of the annuity for the support of the child, it was not set up in consideration of the release of a marital right, and was not includible in the gross estate. The Circuit Court of Appeals concluded:

* * * However, we cannot see that it makes any difference, other than one of the merest form, whether the wife's agreement was to support the child, whatever it cost, in exchange for the testator's promise to pay her $ 833.33 a month, and to support herself in exchange for a promise to pay her $ 1,666.66 a month; or whether she agreed to support both in exchange for a promise to pay her $ 2,500 a month. If the agreement took the first form the bargain would nevertheless have to be scrutinized to see whether $ 833.33 was more or less than a "full and adequate" consideration, and only so far as it was would the annuity be recognized as made for "money's worth". In either view the only relevant fact is what was the cost of the child's support; so far as the annuity paid for it, the annuity was given for "money's worth"; and so far as the trust fund was given to release that much of the annuity, it should not be included in the gross estate.

The Circuit Court of Appeals also concluded that it was necessary to find the prospective yearly cost of the child's support when the trust was set up in 1929; then find the commuted value of the cost and what proportion it represented of the value of the trust fund when it was set up; and exclude from the gross estate that proportion of the value of the trust fund when the decedent died.

In the case before us both parties agree that the trust was for the primary benefit of the children and that no marital rights are involved. Nevertheless, in its essentials, it seems to us that the purposes and terms of the trust instrument executed by decedent here are substantially similar to those involved in Helvering v. United States Trust Co., supra, and that the question is what was the prospective value of the children's support.

Petitioners contend that the full value of the transferred assets is to be taken as "money's worth" since the settlement agreement and the terms of the trust were agreed upon at arm's length and only after bitter negotiations between decedent and Lenore and their attorneys. We cannot accept this contention. It is apparent that decedent went beyond his legal obligation to his children in creating the trust. At most, Delos was entitled to his father's support for about four years when the trust was established; Nedra for about 12 years. In 1931 the corpus of the trust was worth at least $ 220,000 and it produced net income ranging from some $ 28,000 in 1931 to $ 33,500 in 1943. In 1936 the income was $ 65,000 while in 1933 it amounted to but $ 8,578.90. That decedent thought this income alone was more than necessary for the support of the children is shown by the fact that provision was made for the accumulation of unused income in the event of Lenore's death before the children attained their majority. Furthermore, after majority, when decedent's obligation to support would cease, the children were still entitled to certain amounts of income and on reaching the age of 35 the trust corpus was distributable to them. Also, the recital in decedent's will in connection with bequests of $ 5 to each child that "my reason for such bequest is that I have previously made a settlement upon (them) from my estate," is evidence that decedent was doing more in setting up the trust than merely meeting his legal obligation of support. The arrangement had aspects of a testamentary disposition. Certainly, in these circumstances, we cannot say that the entire value of the trust assets was transferred for "money's worth." Cf. Roland M. Hooker, supra.Only that portion of the value which represents the children's right to support is to be so treated. Helvering v. United States Trust Co., supra.

The question of the proper valuation of the children's support has given us pause. The evidence on this point is meager at best. Respondent argues that petitioners have failed in their burden of proof and that nothing whatever should be allowed. Nevertheless, it seems incumbent on the Court to place a reasonable prospective value on the children's support and after carefully considering the evidence, and "bearing heavily" on the petitioners "whose inexactitude" raises the problem, we have found that value to be $ 30,000. Cohan v. Commissioner, 39 F. 2d 540, 544; Edith M. Bensel, et al, Executors, 36 B. T. A. 246, 255, affd. 100 F.2d 639">100 F. 2d 639.

Accordingly, pursuant to section 811 (i), there should be included in the gross estate only "the excess of the fair market value at the time of death" of the assets of Trust 924 over the sum of $ 30,000 which we have found to be the value of the children's rights to support at the time the trust was set up.

On the income tax phase of the questions before us, respondent contends that the income of Trust 924 is taxable to the grantor either under the doctrine of Helvering v. Clifford, 309 U.S. 331">309 U.S. 331, or sections 166 or 167 of the Internal Revenue Code or a combination of them.

We dismiss respondent's contention with regard to the applicability of the Clifford case. It is not pressed with conviction on brief and we do not think the facts here would support its application.

On the other hand, we believe that both sections 166 and 167 are called into play by the circumstances present in this case. The primary contention advanced by petitioners against their applicability is that the extensive powers to change, amend, and revoke the trust in whole or in part reserved to decedent in Article VI of the trust agreement could only be exercised in conjunction with Lenore, and that she had a "substantial adverse interest" in the corpus or income.

We fail to see that Lenore had such an interest as required in order to prevent the application of those sections. It has been said that this is largely a question of fact to be determined with proper regard to the legal principles applicable to the interests created by the trust instrument. Mertens, Law of Federal Income Taxation, section 37.13 and cases there cited. Petitioners rely on Meyer Katz, 46 B. T. A. 187, affd. (C. A. 7) 139 F.2d 107">139 F. 2d 107, which was followed in Estate of Leon N. Gillette, 7 T.C. 219">7 T. C. 219, a gift tax case. But we think the facts here present contingencies not involved in those cases, which preclude their pertinency.

As pointed out in Clair R. Savage, 4 T.C. 286">4 T. C. 286, in the Katz case "the grantor and his wife jointly could terminate the trust and revest the corpus in the grantor. * * * the wife would benefit from the trust only if the minor beneficiary should predecease her and the grantor, leaving no issue." The children were unmarried and had no issue during the taxable years. We held this right gave the wife a "substantial adverse interest."

But let us look at the facts here. Lenore was approximately 42 years of age when Trust 924 was amended, Delos was 17, and Nedra 6. At the beginning of the first taxable year involved, 1944, Lenore was 54, Delos 29, and Nedra 18. Delos was married in 1936 and remained so during the taxable periods. He had a child born in 1941. Nedra was married in February 1944 and had one child born in March 1945. Any interest Lenore had in the trust was contingent upon the death of either of her children, without issue surviving, before arriving at the age of 35. As argued by respondent, we think Lenore's possibility of benefiting from the trust was much more remote than the wife's in the Katz case. Though perhaps more difficult of accomplishment, we also think the Gillette case distinguishable on its facts.

But even if we were unable to distinguish the Katz and Gillette cases, that would only preclude the application of section 166 and would not necessarily prevent respondent from taxing the trust income to decedent under section 167 (a) (2). In the Katz case section 167 was held inapplicable principally because the trust income could never be distributed to the grantor even in the event of revocation of the trust. No such situation here exists. It seems clear that through the exercise of the broad powers of revocation and alteration reserved to decedent, the income of the trust could be distributed to him, and unless Lenore had a substantial adverse interest in the disposition thereof, section 167 would make that income taxable to decedent. Cf. Lillian M. Newman, 1 T.C. 921">1 T. C. 921.

The question then is whether Lenore had such an interest in the disposition of the trust income. We do not think she had. While Lenore had a substantial interest in the income during the early years of the trust, during the taxable years, the critical period, neither decedent nor Lenore had any vested right in the income. During those years the instrument required the income to be paid over to Delos and Nedra and it was being so paid. The only interest Lenore could possibly have had was under Article V (g) of the amended trust which provided that the share of any deceased beneficiary "in any accrued or undistributed net income as of the date of death of such beneficiary shall be distributed to the beneficiary entitled to the next successive interest." No provision for the accumulation of income before Lenore's own death was contained in the instrument. It was currently distributable and was being currently distributed. Thus the only possibility that Lenore had of benefiting from the income was in the event Delos or Nedra should predecease her, leaving no issue, at a time during the year when income had been earned but remained undistributed. In the circumstances and in view of what we have heretofore said concerning her possibility of benefiting from the corpus, we cannot say that her interest in the income during the taxable years was substantial.

We hold that respondent was correct in taxing the income of the trust to decedent during the years 1944, 1945, 1946, and the period January 1, 1947, to May 16, 1947.

Decedent's income tax return for 1944 was filed March 15, 1945. The deficiency notice was mailed January 17, 1949. The gross income stated in decedent's return was $ 47,416.65 and the income of Trust 924 for 1944, which we hold is taxable to decedent, was $ 35,000. This amount is in excess of 25 per cent of the amount of gross income properly includible in the return. Section 275 (c) is therefore applicable and assessment of the deficiency in income tax for 1944 is not barred.

One other item should be disposed of. Respondent has added $ 62,935, the income of Trust 924 for the full year 1947, to decedent's income for that period in determining the deficiency. Decedent died May 16, 1947. The income of the trust for the period January 1, 1947, to May 16, 1947, has been stipulated as $ 42,000. It is this amount which should be used in determining the deficiency for the period January 1, 1947, to May 16, 1947.

Decisions will be entered under Rule 50.

---

Footnotes

• 1. Proceedings of the following petitioners are consolidated herewith: Estate of D. G. McDonald, Deceased, Eileen June McDonald, Executrix; and Estate of D. G. McDonald, Deceased, Eileen June McDonald Thompson, Executrix.↩

• 2. On brief, this figure is taken to be $ 47,702.30.↩

• 1. Stock dividend.↩

• 2. Capital increase.↩

• 1. SEC. 811. GROSS ESTATE.

  (d) Revocable Transfers. --

  * * * *

  (2) Transfers on or prior to June 22, 1936. -- To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke, or where the decedent relinquished any such power in contemplation of his death, except in case of a bona fide sale for an adequate and full consideration in money or money's worth. Except in the case of transfers made after June 22, 1936, no interest of the decedent of which he has made a transfer shall be included in the gross estate under paragraph (1) unless it is includible under this paragraph;

• 2. SEC. 166. REVOCABLE TRUSTS.

  Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested --

  (1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or

  (2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom,↩

  then the income of such part of the trust shall be included in computing the net income of the grantor.

• 3. SEC. 167. INCOME FOR BENEFIT OF GRANTOR.

  (a) Where any part of the income of a trust --

  (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor; or

  (2) may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; * * *

  * * * *

  then such part of the income of the trust shall be included in computing the net income of the grantor.