Stavroudis v. Commissioner

Nicholas A. Stavroudis, Elizabeth W. Stavroudis, Petitioners, v. Commissioner of Internal Revenue, Respondent Stavroudis v. Commissioner Docket No. 56217 United States Tax Court 27 T.C. 583; 1956 U.S. Tax Ct. LEXIS 9; December 21, 1956, Filed *9 Decision will be entered under Rule 50. Petitioner Elizabeth W. Stavroudis is the widow of John C. Distler who died testate in December 1944. Two children were born of their marriage. During the taxable years here involved the petitioner was a beneficiary of a testamentary trust created by the will of Distler with respect to the residuary portion of his estate, consisting of property of a value of approximately $ 318,000, and to which trust petitioner, following the death of Distler and pursuant to an agreement with him prior to his death, contributed property of a value of approximately $ 311,000. Under the terms of the trust, petitioner is entitled so long as she shall live to receive from the "income and/or principal of the trust property" such sum or sums which with the income from her property, both within and without the trust, as shall amount to $ 25,000 a year after income taxes. In the event the income of all the trust property, in any year, should exceed the amount required to bring petitioner's income up to $ 25,000 after income taxes, one-third of such excess is to be paid by the trustees to the petitioner "and the balance unto such of my [Distler's] children and/or*10 descendants, in such amounts, proportion and manner as may be designated by" petitioner from time to time. In the event the petitioner fails to designate the recipients of all of such excess income within 30 days after the close of the year, such undisposed income thereupon is to be added to the principal of the trust property. During the taxable years here involved the trust income exceeded the amount required to bring petitioner's income up to $ 25,000 after income taxes. Respondent determined that all of such excess income was taxable to petitioner. Petitioner concedes that she was taxable on one-third of such excess income. Held, that petitioner is not taxable on the remainder of the excess income. Richard A. Mullens, Esq., and E. S. Robertson, Esq., for the petitioners. A. Russell Beazley, Jr., Esq., for the respondent. Withey, Judge. WITHEY *583 The Commissioner has determined deficiencies in the income tax of petitioners in the amounts of $ 10,262.28 and $ 4,544.52 for the years 1951 and 1952, respectively. The issue for decision is whether the Commissioner erred in adding to petitioners' income for those *584 years amounts of trust income distributable to the children of Elizabeth Stavroudis. FINDINGS OF FACT. The evidence in this case is composed in part of a stipulation of facts which are found as stipulated. Petitioners are husband and wife and timely filed joint income tax returns with the collector of internal revenue for the district of Maryland for the years 1951 and 1952, together with an amended return*12 for the year 1952 claiming an overpayment of tax for that year. Because Nicholas A. Stavroudis is a party only because of the filing of joint returns with Elizabeth W. Stavroudis, the word "petitioner" as hereinafter used has reference to Elizabeth. Petitioner is the widow of John C. Distler who died testate on December 10, 1944. Two children, Hope and Henry, were born to them and were living during the years at issue. Distler and petitioner each owned substantial properties of which the other was fully informed. Because she had no ability or knowledge with respect to the management of property, petitioner's property was managed by others who were experienced and capable in that respect. Among her income-producing properties were several trusts created for her benefit by Distler. Petitioner and Distler both desired that upon their deaths as much as possible of their properties should be available as an inheritance to the children who survived them. It was also their joint desire that in case Distler should predecease petitioner their properties should be so held and managed as to be conserved and to furnish petitioner sufficient income to permit the maintenance of the standard*13 of living to which she was accustomed. To this end, on January 11, 1943, petitioner and Distler entered into a written agreement which is as follows: This Agreement, made this 11th day of January, 1943, by and between JOHN CYRUS DISTLER, party of the first part, (hereinafter called "husband") and ELIZABETH W. DISTLER, party of the second part, (hereinafter called "wife") Witnesseth: EXPLANATORY STATEMENT The parties hereto are husband and wife and each has a separate estate of which the other is fully informed. A schedule of the holdings of the parties is attached hereto and made a part hereof. It is the desire to execute Wills, satisfactory to both, and to agree that, in the event the husband predeceases his wife, both estates will be managed by the Trustees under the husband's Will and that an income of Twenty-five Thousand ($ 25,000.00) Dollars a year after income taxes will be provided for the wife so long as she shall live. It is the further intention that, in the event the wife predeceases her husband, her estate will be held in trust for the benefit of their children. The purpose of this Agreement, therefore, is (1) for the husband to agree to make a Will as aforesaid and*14 to agree to the wife's Will wherein her estate *585 will be left to their children, and (2) for the wife to agree to the provisions of her husband's Will and to agree to turn her estate over to the Trustees under her husband's Will in the event he should predecease her, and (3) for both parties to waive their dower and legal interests in the other's estate. AGREEMENT Now, Therefore, in consideration of the premises, the mutual covenants herein contained and of other good and valuable considerations, the parties agree as follows: 1. Husband agrees to make a Will providing for payments of income and/or principal to his wife in such amounts as may be necessary in order to bring her income to Twenty-five Thousand ($ 25,000.00) Dollars a year after income taxes, from all sources. 2. Husband further agrees to provide in his Will that no payments from income are to be made to beneficiaries other than his wife until she has received her Twenty-five Thousand ($ 25,000.00) Dollars a year after income taxes; further that any payments from income after she has received her Twenty-five Thousand ($ 25,000.00) Dollars a year after income taxes shall be as follows: one-third (1/3) to wife if*15 requested by her and the balance to her descendants in such amount and proportion as the wife shall decide upon from time to time. 3. A copy of the husband's Will as of even date, is attached hereto and made a part hereof and the terms and provisions and Trustees are satisfactory to wife and agreed to by her. 4. Wife agrees to make a Will leaving her estate in trust for the benefit of their children. 5. A copy of the wife's Will, as of even date, is attached hereto and made a part hereof and the husband agrees to its terms and conditions and to the fact that he is not a beneficiary thereunder. 6. Wife agrees that, in the event her husband shall predecease her, she will transfer all of her securities, cash, other investments, and property, real and personal, to the Trustees under her husband's Will for investment, management and distribution under the terms of her husband's Will, under the provisions of which she is guaranteed an annual payment of Twenty-five Thousand ($ 25,000.00) Dollars, after income taxes. It is not intended to include under this Agreement any personal chattels and effects owned by wife. It is the intention, however, to include all investments, cash and other *16 property except personal chattels and effects, under the control of wife, whether or not titled in her name, such as the investments in her trust account with the First National Bank, cash in Safe Deposit Boxes over and above Five Thousand ($ 5,000.00) Dollars, and the like. 7. Both parties agree not to renounce the other's Will and expressly waive all dower, legal and other interest in the other's estate. 8. Both parties agree to carry out the aforesaid terms and provisions to the best of their ability. 9. This Agreement shall be binding upon the heirs, administrators, personal representatives and assigns of the parties. In Witness Whereof the parties have hereunto set their respective hands and seals on the day and year first above written. Witness: /s/ Elizabeth Distler [Seal] /s/ John D. Wright /s/ John Cyrus Distler [Seal] /s/ John D. Wright *586 After specific bequests the will of Distler, attached to the agreement, conveyed the residue of his estate in trust to his two brothers, David Murphy, and the Equitable Trust Company, a Maryland corporation, as co-trustees. Pertinent portions of his will are as follows: FOURTH: * * * A. In the event my wife, ELIZABETH W. DISTLER, *17 survives me, it is my desire that she shall have an income after income taxes of Twenty-five Thousand ($ 25,000.00) Dollars per year from all sources, so long as she shall live. I therefore direct my Trustees to pay unto her from time to time from the income and/or principal of the trust property hereunder such sum or sums of money as may be necessary in order to make sure that she receives Twenty-five Thousand ($ 25,000.00) Dollars a year after income taxes in the aggregate from all sources, taking into consideration her income from sources other than the trust property hereunder. I would suggest that my Trustees make an estimate of the probably [sic] income of my wife from sources other than the trust property hereunder, at the time of my death, and at the beginning of each fiscal year thereafter, as well as probably [sic] taxes. I would further suggest that my Trustees pay unto her, from the income and [sic] and/or principal hereunder, beginning with each such fiscal year, such monthly sums as would seem likely and probable to bring her annual aggregate income up to Twenty-five Thousand ($ 25,000.00) Dollars after income taxes, making such adjustment as may be necessary*18 at the time her income tax return is filed and the amount of her income from other sources is definitely ascertained. B. In the event the fiscal years income from the trust property hereunder shall be in excess of the amount needed to bring my wife's income up to the aforesaid Twenty-five Thousand ($ 25,000.00) Dollars a year after income taxes, my Trustees shall pay such excess income as follows: one-third (1/3) unto my wife and the balance unto such of my children and/or descendants, in such amounts, proportion and manner as may be designated by my wife from time to time. In the event my wife shall fail to designate the recipients of all of such excess income within thirty (30) days of the close of a fiscal year, my Trustees shall thereupon add such undisposed of income to the principal of the trust property and invest and reinvest the same as hereinafter provided. In the event my wife shall not desire any portion or all of the income payable to her hereunder, my Trustees shall dispose of the same in the same manner as provided in this Paragraph for excess income not payable to her. * * * * FIFTH: It is my desire and I expressly authorize and empower my said Trustees, in addition*19 to the aforegoing, to pay to or for the benefit of my said wife, and for any of my children, out of principal or corpus, such sum or sums, as my said Trustees, in their sole discretion, may think she or they have need of because of sickness, declining purchasing power or any other pressing emergency, charging any sum or sums so paid during my wife's lifetime to the principal of the trust property and charging any sums paid after her death to the share of the child so benefiting. All such payments so made under the provisions of this clause of my Will shall be so paid absolutely free, clear and discharged from the provisions of the trust hereby created and the receipt of my wife or child, as the case may be, shall be a full release, acquittance and discharge to my said Trustees. The trust was irrevocable and neither Distler nor petitioner retained a right to amend or modify it. The term of the trust was *587 not fixed but it was made terminable upon the death of petitioner's children. Petitioner retained no managerial power over the trust property and possessed no reversionary interest therein. Upon his death, Distler's will was duly probated and to the trust thereby created*20 there was transferred from his estate property of the value of $ 318,138.79. Paragraph 6 of the agreement of January 11, 1943, obligated petitioner, upon Distler's death, to transfer substantially all of her property to the Distler trust, but she was in disagreement with the children, Hope and Henry, and the trustees with respect to just which of her properties were required by the agreement to be so transferred. The dispute was settled on May 21, 1945, by agreement which was subject to the approval of the Circuit Court of Baltimore City which was granted on February 20, 1946. Subsequently in 1946 the property of petitioner so agreed upon was transferred to the trustees of the Distler trust at a value as of February 20, 1946, of $ 310,711.59. The records of the trust, including income accounts, have been maintained from its inception by the Equitable Trust Company on a separate basis with respect to the properties comprising the corpus which originated with petitioner and Distler. Distributions have been made to petitioner first from the income of properties attributable to her and the difference between such income and the sum of $ 25,000, plus income tax, has been paid from the*21 income of properties attributable to Distler. Since the transfer of her properties to the trust, petitioner has received from trust income monthly payments aggregating $ 25,000 per year after income tax. In both of the years in issue she also received one-third of the amount computed by the trustees as the excess of distributable trust income over such amount as was necessarily paid to bring her annual income after income tax to $ 25,000. During 1951, the trustees of the Distler trust, in accordance with its provisions, distributed $ 33,694.58 to petitioner and $ 7,317.36 each to Hope and Henry, or a total of $ 48,329.30. During 1952, $ 38,174.93 was so distributed to petitioner and $ 4,448.73 each to Hope and Henry, or a total of $ 47,072.39 for 1952. The distributions in 1951 of $ 7,317.36 each to Hope and Henry and a like amount to petitioner and the distributions in 1952 of $ 4,448.73 each to Hope and Henry and a like amount to petitioner were from the income of the Distler properties transferred to the trust. No distribution of trust corpus has been made to the beneficiaries either prior to or during the years at issue. During 1953, petitioner brought suit in the Circuit *22 Court of Baltimore City asking the court to direct the trustees to make emergency payments to her from the trust estate pursuant to clause Fifth of *588 Distler's will. Petitioner was unsuccessful in that litigation. The trustees successfully took the position that so long as petitioner had not exhausted her personal assets, she was not entitled to receive emergency payments from the trust. In her income tax return for 1951, the petitioner reported ordinary income of $ 33,694.58 as having been received by her from the Distler trust during that year and, in her return for 1952, she reported ordinary income of $ 38,174.93 as having been received from the same source during such year. She did not include in her income any portion of the distributions of trust income made to Hope and Henry during those years. In determining the deficiencies here involved, the respondent determined that in 1951 the Distler trust realized ordinary net income in the amount of $ 47,423.05 and net long-term capital gain in the amount of $ 4,469.78, that in 1952 it realized ordinary net income of $ 46,330.22 and net long-term capital gain of $ 369.30, and that the foregoing amounts constituted distributable*23 income taxable to the petitioner in the respective years in which realized by the trust. OPINION. Respondent has taken the position that the entire income and capital gain realized by the trust here in question during 1951 and 1952 are taxable to petitioner, either as the possessor of a power of disposition over the income of the trust or as the substantial owner thereof within the meaning of section 22 (a) of the Internal Revenue Code of 1939, or as grantor within the meaning of sections 166 and 167 of the Code. Petitioner contends that the income of the trust for 1951 and 1952 is taxable to her only to the extent of the amounts actually distributed to her, and that the excess income is taxable to the persons to whom it was distributed. Respondent first asserts that petitioner has acquired such dominion and control over the trust property as to vest in her substantial rights of ownership therein, as in Helvering v. Clifford, 309 U.S. 331, and Edward Mallinckrodt, Jr., 2 T. C. 1128, affd. (C. A. 8) 146 F. 2d 1, certiorari denied 324 U.S. 871, and that petitioner *24 consequently is taxable on the entire income of the trust as a person other than the grantor, under section 22 (a) of the Code. 1 *589 The question whether petitioner is taxable on all of the trust income under section 22 (a) of the Code depends for its resolution*25 upon the nature and extent of her control over the income and corpus thereof. Helvering v. Clifford, supra;Edward Mallinckrodt, Jr., supra;Ella E. Russell, 45 B. T. A. 397; Jergens v. Commissioner, 136 F. 2d 497, certiorari denied 320 U.S. 784. If petitioner possesses unfettered command over the trust, she is taxable on the entire income therefrom. H. S. Richardson, 42 B. T. A. 830, affd. 121 F. 2d 1; Funk v. Commissioner, 185 F. 2d 127; Edward Mallinckrodt, Jr., supra. Respondent appears to contend that since under paragraph Fifth of the trust instrument, the trustees are given power, in their sole discretion, to invade the corpus of the trust in the event of financial need, they, in effect, have unlimited discretion to distribute trust corpus to petitioner in accordance with her desires. Petitioner, however, is not a trustee of the trust in question and possessed no power, under the terms of the trust instrument, *26 arbitrarily to direct the trustees to make disbursements to her from either principal or income, beyond the amounts specified as her guaranteed annual income. The trust instrument specifically provides that the trustees shall have power, in their sole discretion, to invade the corpus of the trust in the event petitioner, or Hope or Henry Distler, are in "need" of funds because of "sickness, declining purchasing power or any other pressing emergency." The trust instrument therefore creates a standard limiting the power of the trustees to invade the corpus of the trust on behalf of petitioner, thus restricting the rights of petitioner in the trust principal to the extent that she cannot be held to be the substantial owner thereof. Eva V. Townsend, 5 T. C. 1380; Lewis Hunt Mills, 39 B. T. A. 798; Funk v. Commissioner, supra.In fact, petitioner here has brought suit in the Maryland courts, without success, to compel the trustees to make disbursements to her as emergency payments under paragraph Fifth of the trust instrument. The trustees have successfully maintained the position that they*27 are without authority to make emergency payments to petitioner until she has exhausted her personal resources. In view of the decisions of the Maryland courts, in adversary proceedings, in thus construing the power of the trustees to invade the corpus of the trust on petitioner's behalf, together with the explicit language of the trust instrument itself, it is clear that petitioner was not vested with a right arbitrarily to recapture any portion of the trust principal, as respondent suggests. Cf. Eva V. Townsend, supra. Respondent further maintains that petitioner possesses a power of disposition over the income of the trust by virtue of her power to designate the amounts, if any, and proportions of the two-thirds excess trust income payable to Hope and Henry Distler, and in default thereof *590 to cause the remainder of the excess to be added to corpus. It is settled that a power to direct the distribution of trust income to others is not alone sufficient to justify the taxation of that income to the possessor of such a power. Agnes K. May, 8 T. C. 860; John Danz, 18 T. C. 454, affd. *28 (C. A. 9) 231 F. 2d 673; Regs. 118, sec. 39.22 (a)-21 (d) (2). Respondent's contention, however, is that because of the requirement that funds accruing to corpus be invested and reinvested, it was within petitioner's power, by failure to direct that any amount be paid the children, to derive a benefit to herself through her one-third interest in the excess trust income which would be increased thereby. Respondent further contends that petitioner could realize an additional benefit because of her failure to designate the proportions of the two-thirds excess income payable to Hope and Henry Distler, by virtue of the trustees' power to invade the corpus of the trust on her behalf. However, respondent has cited no decision involving facts similar to those here present, and we are aware of none. The trust here in issue was irrevocable and petitioner retained no power to amend or modify its provisions. The period of the trust's duration was indefinite. Petitioner retained no managerial powers over the trust property and possessed no reversionary interest therein. Neither petitioner's power to direct the distribution of the two-thirds excess trust income *29 between her children, nor her right, in the event of financial need, to receive disbursements from principal in the sole discretion of the trustees, nor the combination of the two, are sufficient to give petitioner unfettered command over the trust income or principal. In our opinion, respondent's arguments in support of his contention that petitioner possesses a power of disposition over the income of the trust by virtue of her power to designate the amounts, if any, of the two-thirds excess payable to the children, are tenuous and point to so remote a possibility of recapturing trust income they do not warrant a conclusion that she has acquired control over such income. We note also that by construction the trust instrument contains the mandatory provision that in the event of the failure of the trust corpus to produce income, that portion thereof which is attributable to Distler is to be completely exhausted in fulfilling the trust requirement to pay $ 25,000 yearly amounts to petitioner and that upon its exhaustion such yearly payments are to be made from that portion of the corpus which is attributable to her. However, that right in petitioner, over which she has no discretionary*30 power, is likewise contingent as to either portion of the trust corpus and the happening of the event too unlikely to be given great weight under these facts. Petitioner does not possess such dominion over *591 the income or corpus of the trust as to justify taxing the income in issue to her under section 22 (a) of the 1939 Code. With respect to the taxation to petitioner of the income in question under sections 166 and 167 of the 1939 Code, 2 since petitioner contributed property valued at $ 310,711.59 to the trust, she is a grantor of the trust within the meaning of those sections, to the extent of the value of her contribution to the trust corpus. Allison L. S. Stern, 40 B. T. A. 757, affd. (C. A. 2) 137 F. 2d 43; George S. Gaylord, 3 T. C. 281, affd. (C. A. 9) 153 F. 2d 408; Frank E. Joseph, 5 T. C. 1049; Crosset v. United States, 30 F. Supp. 802. Accordingly, if petitioner is otherwise qualified under the terms of sections 166 and 167, she nevertheless is not chargeable with the income resulting*31 from the property transferred to the trust under the will of John C. Distler, deceased, but is taxable only with the income attributable to her contribution to the trust. George S. Gaylord, supra, and Frank E. Joseph, supra. *32 The record herein discloses that separate records have been kept with respect to the property contributed to the trust by petitioner and by Distler. The income produced by the property transferred by petitioner to the trust was distributed to her and reported on her income tax returns for 1951 and 1952, and the income in question, paid to Hope and Henry Distler, is traceable to property contributed by Distler. Since all of the income in issue was produced by property transferred to the trust under the will of Distler, petitioner is not a grantor as to the trust property in question and further inquiry as to her qualification under the terms of sections 166 and 167 of the Code becomes unnecessary. Accordingly, we hold that petitioner is taxable only to the extent of the trust income distributed to her and reported for the years in issue. Decision will be entered under Rule 50. Footnotes 1. SEC. 22. GROSS INCOME. (a) General Definition. -- "Gross income" includes gains, profits, and income derived from salaries, wages or compensation for personal service (including personal service as an officer or employee of a State, or any political subdivision thereof, or any agency or instrumentality of any one or more of the foregoing), of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *↩ 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. 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; * * *↩