Willcuts v. Douglas

STONE, Circuit Judge. This is an appeal by the collector from a judgment according refund of income taxes, On the 15th of September, 1923, a decree of divoree was entered in favor of Ida M. Douglas, wife of Edward Bruce Douglas, appellee. Three days prior thereto, the above parties and the Minneapolis Trust Company entered into a trust agreement whereby appellee deposited certain securities of par or estimated value of $300,000 with the trust company as trustee, and further provided for the delivery to the trustee, on November 6, 1927, of further property to be received i'rom his father’s estate. The trustee was givon lull power of control, ^ reinvestment, and change of the securities m the trust fund, subjeet, however, to the consent and approval” of appellee and the further right in appellee to designate and determine investmente subject to the approval of the trustee (acting m that respect for the wire as to the reasonable safety and adequate income producing nature of the securities), Ihe dedared purposes of the trust were to pay to the wife during her life, from the income of the trust estate, $lo,000- annually from September 1., 1923 to November G, 1927, and tnereafter $21,000 annually, widh a provision that, m ease the net income from the trust fund should not prove sufficient to make any of the above payments, the husband, npon request, should make good such deficiency, or, in default thereof, the deficiency should be made up from the principal of the trust fund, In case the net income from the trust fund should exceed the annual payments required, the trustee should pay such excess to the husband or his successors, subject to the right °fiIle “e to reserve _ therefrom reason^ble amounts to fairly insure the prompt of foiure payments to the wile. ^ mcome” is , f irom the trust fund exclusive of profits from sale of items in the fund and exclusive of stock dividends (these exceptions to become a part of the principal of the trust fund) and less income tax paid by the trustee. Power to eh the trastee ig reserved ^ appdke and Hs successors. The trust is to terminate at the death of the wife an¿L the prinoipal of the trust fund then to revert to- appellee or his successors. Another provision is as follows: “It is expressly agreed by and between the parties hereto, and more especially by the party of the sec°nd part, that the^provisions heroin madeMor ^ are m hfaf> and f ** settlement of alimony, and of any and all dower rights or statutory interests in the estate of the party of the first part, and in lieu of any and all claims for separate maintenance and allowanee for her support.” Besides dissolving the marriage, the de~ cree of divorce provides: “It Is Further Adjudged and Decreed that the defendant provide and create the trust fund as set out in that certain agreement between said parties and the Minneapolis Trust Company as trustee now on file with s:aid trustee, and that the plaintiff have the provision therein made in lieu of all other alimony or interest in the property or estate of the defendant and that neither party have any costs or disbursemente heroin.” [n his individual income tax returns for ^ yearg 1927 Mld 192g appellee omitted ineome r0alized by the trust estate and paid wj£e thereunder. A redetermination by the Commissioiler resulted in tlie inclll„ ^ of tHg item in each of those yoars, and the tax thereon ^ paid under protest. T]iereai:ter, proper domand for refund was made) and tMg aetion seagonal)ly brought, wiih a small reduction in the tax for 1928, wbieh reduction is not in question here, the caurt adjudged recovery of the tax paid on aecoimt o£ the delusion of this item in ihe ab0Ye two years. As the matter comes here, the only thing invo3ved is the propriety of including suoh inoome £rom the trust estate £fl the persona£ income taxable to appellee, One contention of the Commissioner is that the entire income from this trust is taxable to the creator thereof because, under *132 its terms, the trust estate is to revert to the creator after it has served the purpose of its creation and also the creator is entitled to the surplus annual income of the trust above the required payments to the wife. We do not see why either or both of these provisions should, of themselves, have such result; however, they may hear upon the main contention in this appeal, hereafter to ho Aromad _ The bald fact that, after an irrevocable trust has served its purpose, the trust estate is to revert to the creator, does not, without more, make the income during the trust period that of the creator for tax or any purposes. The statute is aimed at taxation of income. It expressly- recognizes trust estates as taxable entities and specifically points out the trustee' or the beneficiary as the taxpayer for incomes from such estates. If the creator of the trust is beneficially entirely separated from that income under all allowable tax considerations, he is as though a total stranger thereto. The duration of the trust and the disposition of the corpus at the termination of the trust are, of themselves alone, usually quite immaterial. Also, it is unimportant, of itself, that the surplus income of a trust goes to the creator. If a well-disposed person desiring to assure the proper education of the child of a friend by providing an annual fund therefor of $1,-000 should create an irrevocable trust of $25,-000 with provisions that at the end of ten years the trust should terminate and the corpus return to him, and that during the trust any annual income above $1,000 should he paid by the trustee to him, it would require an inescapably clear expression of congressional intent to believe that a statute meant to tax, as income to the creator dnr-, ing the trust, anything beyond the actually accruing annual surplus income and, if such construction were compelled, the validity of , • 1,: • j , such an imposition would be widely open to ques ion. The main and more serious contention of the Commissioner is that the creator of this trust is taxable for the income therefrom because that income is “used to pay a legal and adjudicated obligation which he owed, and in so doing conferred the benefit upon him.” The argument is that the trust was created to provide an income in lieu of alimony or other interest in his estate, and was, by the court granting the divorce, speeifieally decreed in lieu thereof. Therefore it is said to follow that, since this trust was ereated to meet a personal and legal obligation he was hound to fulfill, and since the income therefrom was devoted to that purpose, it was 'so used for his benefit as to constitute it his income. In efforts to avoid income or estate taxes, various devices have come to the courts. From decisions thereon has evolved the general rule that, where the creator receives “the substance of enjoyment” (Burnet v. Wells, 289 U. S. 670, 677, 53 S. Ct. 761, 763, 77 L. Ed. 1439) of the income, it is regarded as his for taxation purposes. Instances where such enjoyment has been held to exist are contracts for assignments of income (Lucas v. Earl, 281 U. S. 111, 50 S. Ct. 241, 74 L. Ed. 731), assignments of future income (Burnet v. Leininger, 285 U. S. 136, 52 S. Ct. 345, 76 L. Ed. 665), contracts for payment cf obligations of the taxpayer by another (Old Colony Trust Co. v. Commissioner, 279 U. S. 716, 49 S. Ct. 499, 73 L. Ed. 918; United States v. Boston & Maine R. Co., 279 U. S. 732, 49 S. Ct. 505, 73 L. Ed. 929), and payment of premiums of insurance on the life of the taxpayer from income of a trust created by him which was revocable (Du Pont v. Commissioner, 289 U. S. 685, 53 S. Ct. 766, 77 L. Ed. 1447) or irrevocable (Burnet v. Wells, 289 U. S. 670, 53 S. Ct. 761, 77 L. Ed. 1439). Among the devices employed.to avoid ineome aild estete taxes n0?e 11213 been m°re ^sed *rfts deallllg ^ members of a family, and the courts have been alert to prevenl: .sueb avoidance by this means. The question here is whether this trust is of that character-irrespective of whether tax avoidaa ^pejlmg motive or was not. In determining flus, it is the effect upon, ^ f0*™ ?£> the crftor m formin the trust. In the majority opinion in Burnet v. Wells, 289 U. S. 670, 53 S. Ct. 761, 77 L. Ed. 1439 the validity of a statntory requirement (section 219 (h), Revenue Aet/of\924 and'1926 [26 USCA § 969 note]) that insurance premiums on the life 0£ the creator paid from the trust were taxable to him as income was upheld because there was recognized a benefit to the creator there from the performance of a pressing social duty and a usual manner of providing for dependents (page 681 of 289 U. S., 53 S. Ct. 761). The dissent was grounded on the view that the benefit to the creator must be “something more tangible than a purpose to perform a social duty, or the recognition of a moral claim as distinguished from a legal obligation” (page 683 of 289 U. S., 53 S. Ct. 761, 766); and that “the distinction *133 to be observed is between the devotion, of income to payments which the settlor is bound to make, and to those which he is free to make ’ , . or not make, as he may see fit” (page 684 of 289 U. S., 53 S. Ct. 761, 766). The contention here by the Commissioner is that the income of this trust was em-p oye o mee a eg a 0 ^ 1011 w ap pellee was bound to make. Whether this was % , . .e.i.j . •• the character ox this trust is the determining ,. T) „ ,,, tit problem. Before divorce, the legal obligaf. , .. . . x tion to provide maintenance for his wife rested upon appellee. Whether that obligation would continue after divorce would depend solely upon the orders of the court granting the divorce. As is not unusual, the parties agreed to a disposition having this sitúation in view. That disposition was clearly, as revealed in its terms, solely for the purpose of providing an annual income for the wife after divorce. It was not a transfer of title to property to the wife in lieu of what the court might order as alimony. The main practical and economic differences between f, . , t . , n tins arrangement and one for decreed or , 0 , „ agreed annual alimony payments by appellee n X1 , , J \ i . n t • are mat it segregated a definite portion of his , . & , 1 ,, K, n i property to which alone the wiie could look i , . » -to iiT for annual income from her former husband 7 ■, ,, , P . x i i and made the amount oi income to her largely dependent on the income from his property. The purpose and effect of this arrangemont was to provide a substitute for alimony. This effect became a finality when the decree of divorce specifically provided that appellee should «provide and create” the above trust fund and that the wife “have the provision therein made in lieu of all other alimony or interest in the property or estate” of appellee The only thing the wife received was income from the trust estate. She received this only because it was “in lieu of all other alimony” or interest. The trust was created for the sole purpose of furnishing such income. Its function was to provide a method of paying alimony. The payment of alimony was ordered and this method prescribed by the court. The payment of alimony in this form was a legal obligation which appellee was bound to meet. This took the form of “income.” It was taxable as income. It was taxable (under either opinion in Burnet v. Wells, supra) to appellee because it directly benefited him by discharging a legal obligation he was bound to perform. The judgment should be reversed and rernanded, with instructions to proceed in aecord with this opinion.