Paolozzi v. Commissioner

Alice Spaulding Paolozzi, Petitioner, v. Commissioner of Internal Revenue, Respondent Paolozzi v. Commissioner Docket No. 46543 United States Tax Court 23 T.C. 182; 1954 U.S. Tax Ct. LEXIS 54; October 29, 1954, Filed *54 Decision will be entered for the petitioner. On June 21, 1938, petitioner created a trust of which she was the sole life beneficiary. Under the terms of the trust, the trustees were to pay to petitioner during her lifetime so much of the net income as they, in their absolute discretion, deemed best for her interest. Provision was made for gifts of the remainder interest following petitioner's death. Held, under Massachusetts law, petitioner's creditors had recourse to the full amount of the trust income for settlement of their claims. Ware v. Gulda, 331 Mass. 68, 117 N. E. 2d 137 (1954). Held, further, petitioner, therefore, retained the beneficial use and enjoyment of such trust income for her lifetime and properly deducted the value of such life estate for gift tax purposes. Philip B. Buzzell, Esq., for the petitioner. Joseph Landis, Esq., for the respondent. Van Fossan, Judge. VAN FOSSAN *183 Respondent determined a deficiency in gift tax of petitioner for the calendar year 1938 in the amount of $ 24,511.97. The only question presented is whether petitioner is taxable on the entire value of property transferred by her in trust, or whether she retained a life interest necessary to support a deduction therefor. FINDINGS OF FACT. The stipulation of facts*56 filed by the parties with exhibits attached is adopted, and, by this reference, made a part hereof. The petitioner is Alice Spaulding Paolozzi, an individual, who, prior to her marriage to Lorenzo Paolozzi, an Italian citizen, in Rome on October 30, 1938, was resident at Beverly, Massachusetts. Petitioner filed a gift tax return for the taxable year 1938, here involved, with the collector of internal revenue for the district of Massachusetts on December 21, 1949. The petitioner was born of American parentage in the United States on May 12, 1917. She lived in this country continuously until the time of her aforementioned marriage. Petitioner's father, William S. Spaulding, died on August 15, 1937. Petitioner spent the winter of 1937-1938 in Europe primarily in Italy, where she became engaged. She returned to the United States early in June 1938 and spent the summer in this country. She departed again for Italy early in August; her engagement was announced on August 17, 1938; and she was married in Rome on October 30, 1938. Thereafter, except for a brief visit to the United States and another in Switzerland, she made her home in Italy until 1943, in which year she moved to Switzerland. *57 By virtue of her marriage, petitioner, under Italian law, became an Italian citizen. At various dates between May 1934 and August 1935, the then Italian Government had subjected foreign securities owned by Italian citizens to various restrictive measures, including registration, deposit with the Bank of Italy, and exchange for 5 per cent Italian Treasury Bonds. In 1938, petitioner was one of the life beneficiaries of a trust created by her father on November 26, 1920 (hereinafter referred to as the 1920 trust). As of January 1, 1938, the assets of petitioner's share of this trust had a market value of $ 752,826. She was also the life beneficiary of a trust created by her father on August 5, 1935 (hereinafter referred to as the 1935 trust). As of January 1, 1938, the assets of this trust had a market value of $ 287,562. Petitioner was also a life beneficiary subject to the rights of her mother during the latter's lifetime, of one-third of another trust created under the will of her father (hereinafter referred to as the testamentary trust), which proved to have assets in excess of $ 1,000,000. The trustees in each of the foregoing trusts could withhold income in their discretion*58 adding it to *184 principal. Petitioner's brother and sister each had a similar beneficial interest in the 1920 and the testamentary trusts. In addition to her interests in the above trusts, petitioner owned outright cash and securities with a value, as of January 1, 1938, of $ 316,256, which became distributable to her on May 12, 1938, her 21st birthday. Because petitioner was unfamiliar with business affairs, it was suggested that she place her assets in an agency account or trust and, because her mother and her financial and legal advisers believed that she might be required to turn her assets over to the then Italian Government, it was suggested that the trust device would be preferable and that such trust should provide for discretionary payment of income and should contain a spendthrift clause. Thereafter, the trust of June 21, 1938 (hereinafter referred to as the 1938 trust), was created with cash and securities to which petitioner had become entitled on her 21st birthday. The fair market value on June 21, 1938, of the property transferred to the trust was $ 276,821.66. The 1938 trust provided in material part, as follows: After deducting all necessary charges and*59 expenses including reasonable compensation for the care of the property the Trustees shall pay to said Alice O. Spaulding so much of the net income as they shall in their absolute discretion decide as best for her interest, quarterly or oftener in the discretion of the Trustees for and during her life. Any accumulations of income may be invested from time to time in the discretion of the Trustees and at any time and from time to time during the lifetime of said Alice O. Spaulding may and upon her death shall be added to the principal of the trust fund. After the death of said Alice O. Spaulding the Trustees shall pay so much of the net income as the Trustees shall in their absolute discretion deem advisable in equal shares, quarterly or oftener in the Trustees' discretion, to and among such of her children as are living at the time of each payment, the issue then living of any child of hers then deceased to take by right of representation until the date of termination of the trust. Any accumulations of income may be invested from time to time in the discretion of the Trustees and may be added to the principal of the trust fund at any time. At the date of termination, the Trustees*60 shall pay over and distribute the principal of the trust fund together with all accumulations of income to and among the issue of Alice O. Spaulding then living, such issue to take by right of representation; in default of her issue then the same shall be paid over to such of her sister Katrina S. Kirkbride and brother William S. Spaulding as are then living, the issue of either of them who may be then deceased to take by right of representation; and in case all the issue of said Alice O. Spaulding and her said brother and sister and all their issue shall have died at the date of termination the Trustees shall pay over and distribute the same to and among those persons who would have been entitled to the property of said Alice O. Spaulding under the laws of the Commonwealth of Massachusetts then in force, if she had then died intestate and a resident thereof and in the proportions determined by said laws. No part of the income payable to any beneficiary hereunder shall be paid by way of anticipation or be assignable either voluntarily or by operation of law or attachable or trusteeable by the creditors of the beneficiary or be liable *185 to be come at or reached or applied to*61 the payment of any claim against her or him. At the time of creating the trust, the taxpayer was assured by the trustees that they would give her the income if she wanted it unless they had reason to believe that she was acting under compulsion. At the same time, it was explained to petitioner that under the provisions of the trust she had no absolute right, as a matter of law, to demand and receive the income, and that the trustees must take all beneficiaries into consideration. During the period June 21, 1938, to December 31, 1953, the 1938 trust had total gross income of $ 364,881.43, of which $ 60,706.77 has been withheld from income and added to principal, and the balance (after taxes and administrative expenses), has been paid over to or expended for the benefit of petitioner. A large proportion of the accumulation of income took place during the war years when foreign income restrictions prevented larger distributions. During the same period, June 21, 1938, to December 31, 1953, the 1920 trust distributed to petitioner a total of $ 410,526.51 in varying amounts of not less than $ 9,000 annually, except for 1948 when the distributions amounted to $ 5,000, and during the same*62 period withheld from income and added to principal a total of $ 176,501.04. The 1935 trust has never made any distribution of income to the petitioner, but has withheld from income and added to principal a total of $ 185,622.81. The testamentary trust has made no distribution to petitioner. Petitioner reported in respect of the transfer to the 1938 trust of property having a value on June 21, 1938, of $ 276,821.66, total gifts of $ 71,021.37, which amount was the value on June 21, 1938, of a remainder of $ 276,821.66 after a life estate of an individual then of petitioner's age. OPINION. The question is whether petitioner retained dominion and control over any interest, susceptible of valuation, in the property transferred in trust by her on June 21, 1938. Petitioner established the trust in controversy, of which trust she was, during her lifetime, the sole beneficiary, at a time when she was contemplating marriage to an Italian citizen. By virtue of such marriage she would, under Italian law, become an Italian national. The then Italian Government was, at that time, subjecting foreign securities held by its nationals to stringent restrictions. To avoid such restrictions and *63 thwart possible confiscation of the considerable property which was distributed to her on her 21st birthday, a few weeks before, petitioner, on the advice of her mother and counsel, created the subject trust and effected the transfer in question *186 thereto. The trustees thereof were empowered by the terms of the trust instrument to hold, manage, invest, and reinvest the property as a trust fund until the death of the petitioner and to pay to her, during her lifetime, so much of the net income as they in their absolute discretion should deem to be to her best interest. Any income not distributed could be added to principal at any time. Provisions were made for remainders over to the issue of petitioner, or in failure thereof, to her sister or brother or their issue. Subsequent to the transfer here involved, petitioner filed a gift tax return in which she reported as a taxable gift only the value of the remainder after a life estate of one then of her age. Respondent has determined and here maintains that such transfer was a complete gift of the entire amount of the property so transferred, inasmuch as petitioner reserved no interest in and control over any beneficial interest*64 therein, susceptible of valuation by actuarial methods; that, at most, she had but an expectancy, which expectancy is not the equivalent of a life estate; and that, therefore, no amount is to be deducted from the value of the property transferred for purposes of computing the gift tax pursuant to section 501 of the Revenue Act of 1932. 1 Petitioner, on the other hand, argues that under the law of Massachusetts, by which the trust is governed, petitioner's creditors, both prior and subsequent, could reach the maximum amount, which, under the trust, the trustees could, *65 in the exercise of their discretion, pay to her or apply for her benefit. Therefore, petitioner reasons that she could and can at any time realize all of the economic benefit of the income accruing to the trust during her lifetime by the simple expedient of borrowing money or otherwise becoming indebted, and then relegating the creditor to the trust income for reimbursement. Petitioner's interpretation of current Massachusetts law on the point appears correct. See Ware v. Gulda, 331 Mass. 68, 117 N. E. 2d 137 (1954), wherein the Supreme Judicial Court of Massachusetts, Suffolk, held that a creditor of a settlor beneficiary of a discretionary trust, the terms of which are for all practical purposes indistinguishable from those of the trust at hand, could reach for satisfaction of a claim the maximum amount which the trustee could pay to the beneficiary or apply for the benefit thereof. The fact that the trustee had not exercised the discretionary power would not preclude such creditor from looking to the trust and obtaining therefrom *187 payment out of the trust property to which the debtor, but for such failure, was entitled. *66 In so ruling, the court said, inter alia: "The established policy of this Commonwealth long has been that a settlor cannot place property in trust for his own benefit and keep it beyond the reach of creditors. Pacific National Bank v. Windram, 133 Mass. 175; Jackson v. Von Zedlitz, 136 Mass. 342; Taylor v. Buttrick, 165 Mass. 547, 551, 43 N. E. 507; Forbes v. Snow, 245 Mass. 85, 89, 140 N. E. 418." The rule we apply is found in Restatement: Trusts § 156 (2): "Where a person creates for his own benefit a trust for support or a discretionary trust, his transferee or creditors can reach the maximum amount which the trustee under the terms of the trust could pay to him or apply for his benefit." It has substantial support in authority. Greenwich Trust Co. v. Tyson, 129 Conn. 211, 224, 27 A. 2d 166; Warner v. Rice, 66 Md. 436, 8 A. 84; Hay v. Price, 15 Pa. Dist. R. 144; Menken Co. v. Brinkley, 94 Tenn. 721, 728-729, 31 S. W. 92;*67 Petty v. Moores Brook Sanitarium, 110 Va. 815, 817, 67 S. E. 355; 27 L. R. A., N. S., 800; Scott, Trusts, § 156.2; Griswold, Spendthrift Trusts (2d ed.) § 481. * * * But cf. Herzog, Trustee v. Commissioner, 116 F. 2d 591, affirming 41 B. T. A. 509, criticizing Restatement, Trusts (1935), sec. 156 and 1 Scott, The Law of Trusts (1939), sec. 156.2. See further 1 Scott, supra, 1954 supplement, sec. 156.2, n. 3, and 6 American Law of Property, sec. 26.123, n. 3. However, Herzog, Trustee v. Commissioner, supra, aside from being otherwise distinguishable, is interpretative of New York law and is, therefore, not controlling here. In view of the clear exposition of Massachusetts law set out in Ware v. Gulda, supra, it cannot be gainsaid that petitioner's creditors could at any time look to the trust of which she was settlor-beneficiary for settlement of their claims to the full extent of the income thereof. This being true, it follows that petitioner, as she points out, could at any time obtain*68 the enjoyment and economic benefit of the full amount of the trust income. Under the circumstances, therefore, we answer the question posed in the affirmative, and hold that petitioner correctly returned the transfer for gift tax purposes. Respondent's determination to the contrary is reversed. Decision will be entered for the petitioner. Footnotes 1. SEC. 501. IMPOSITION OF TAX. (a) For the calendar year 1932 and each calendar year thereafter a tax, computed as provided in section 502, shall be imposed upon the transfer during such calendar year by any individual, resident or non-resident, of property by gift. (b) The tax shall apply whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible; * * *↩