Merritt v. Commissioner

Marjorie M. Merritt et al., 1 Petitioners, v. Commissioner of Internal Revenue, Respondent Merritt v. Commissioner Docket Nos. 54563, 54564, 54565 United States Tax Court 29 T.C. 149; 1957 U.S. Tax Ct. LEXIS 51; October 29, 1957, Filed *51 Decisions will be entered for the petitioners. Petitioners (two sisters and a brother) plus their mother and another brother owned all the stock of B corporation. With a view towards restricting ownership of stock in B to members of their family, the stockholders on June 18, 1932, entered into an agreement reserving to each a life interest in the stock owned by each, with provisions for devolution of the remainder in the stock of each to his or her children or descendants or, in the case of petitioners and their brother, to their brothers and sisters, in the absence of children or descendants. They reserved the right to receive all dividends in money whether paid out of earnings or capital. Held, the agreement did not result in completed transfers subject to gift tax. Sec. 501, Rev. Act 1932. Benjamin Wiener, Esq., and Elias*52 Rosenzweig, Esq., for the petitioners. John M. Doukas, Esq., for the respondent. Raum, Judge. RAUM *150 The Commissioner determined deficiencies in gift tax and additions to tax for failure to file gift tax returns for 1932 as follows: Petitioner Deficiency Addition to tax Marjorie M. Merritt $ 9,548.89 $ 2,387.22 Lula Marion McElroy Pendleton 6,044.59 1,511.15 William R. McElroy 6,758.83 1,689.71 The principal issue is whether an agreement entered into by petitioners on June 18, 1932, resulted in the making of transfers subject to gift tax. FINDINGS OF FACT. A stipulation of facts filed by the parties is incorporated herein by reference as part of these findings. Petitioners and Edwin M. McElroy, their deceased brother, are the children of Robert L. and Lula McElroy. Each petitioner maintains his or her office in New York, New York. Marjorie M. Merritt and William R. McElroy are residents of Daytona Beach, Florida, and Lula Marion McElroy Pendleton is a resident of Charlottesville, Virginia. Bellemead Development Corporation (hereinafter referred to as Bellemead) was on June 18, 1932, and still is, a Delaware corporation. On June 18, 1932, *53 there were issued and outstanding 800 shares of the capital stock of Bellemead which were owned as follows: Shares Lula McElroy [100] Marjorie M. Merritt [175] Edwin M. McElroy [175] William R. McElroy [175] Lula Marion McElroy [Pendleton] [175] Bellemead was in 1932, and is at the present time, a family personal holding company. It owns real estate, both improved and unimproved, and also stocks and bonds of other corporations. On June *151 17, 1932, the day before the marriage of Lula Marion McElroy Pendleton, William R. McElroy and Marjorie M. Merritt discussed among themselves and with their father the advisability of taking some action to prevent persons who were not members of the McElroy family from becoming owners of stock of the corporation and interfering in its management. An attorney was consulted and asked to prepare an agreement which would restrict ownership of the stock to the present owners and their descendants. A draft agreement was submitted by the attorney to William R. McElroy and his father the following morning. At their suggestion some changes were made, one of which was to provide in paragraph (7) that the owners of the stock would be entitled*54 to dividends paid in money out of capital. The attorney told William R. McElroy that the parties to the agreement would not be liable for any gift tax and that no gift tax returns need be filed; William informed the other stockholders of the attorney's advice. No gift tax returns were filed. The agreement, which was executed by the parties thereto on June 18, 1932, at Charlottesville, Virginia, provided as follows: Agreement made this 18th day of June, 1932, by and between (Mrs.) Lula McElroy, (Mrs.) Marjorie M. Merritt, Edwin M. McElroy, William R. McElroy and Lula Marian [sic] McElroy, each severally with each other: Witnesseth: Whereas, said parties own stock of Bellemead Development Corporation as follows: Mrs. Lula McElroy, 100 shares; Marjorie M. Merritt, 175 shares; Edwin M. McElroy, 175 shares; William R. McElroy, 175 shares; Lula Marian McElroy, 175 shares; which aggregate of 800 shares constitutes the entire stock of said corporation issued and outstanding; and Whereas, said parties mutually desire to provide in respect to ownership and disposition of said stock as hereinafter provided, and to that end have mutually agreed with each other as hereinafter set out, Now, *55 Therefore, in consideration of the premises and of the mutual promises by each herein contained and of the provisions hereof and benefits to each from the others respectively moving, as well as in consideration of natural love and affection, said parties mutually promise and agree with each other as follows: That each of said parties respectively severally declares himself or herself trustee of said shares of stock so owned by each and agrees to hold said stock for the following uses and purposes: (1) That upon the death of Lula McElroy said stock standing in her name shall pass to the other parties hereto, who are her children, and descendants living at her death of any of the others who may have died, such descendants to take per stirpes the share their parent would have taken if living; (2) That upon the death of either Marjorie M. Merritt, Edwin M. McElroy, William R. McElroy or Lula Marian McElroy, stock standing in his or her name, and any of said stock which shall have passed to him or to her hereunder, shall pass to his or her children and descendants then living of any child or children who may have predeceased him or her, such descendants to take per stirpes the share their*56 parents would have taken if living, or if he or she shall die leaving no child or children surviving him or her, said stock shall pass to his or her surviving *152 brothers and sisters and descendants of any of them who may have predeceased him or her so dying, such descendants to take per stirpes the share their parent would have taken if living. (3) That likewise upon the death, occurring within the period hereinafter stated, of any person to whom said stock shall pass under the provisions of paragraph (2) or under the provisions of this paragraph (3) hereof, the stock so owned by the person so dying shall pass to his or her children and descendants of any of his or her children who may have predeceased such owner, such descendants taking, per stirpes, the share their parent would have taken if living, or in the event of death leaving no such issue surviving, to his or her brothers and sisters surviving him or her and descendants of any who may have died, such descendants taking per stirpes the share their parent would have taken if living, or if there be then none such surviving, stock so owned by the one so dying shall pass to the nearest collateral kindred of the one so *57 dying, and the descendants of any equally near collateral kindred who may have died, such descendants taking per stirpes the share their parent would have taken if living. (4) That in the event of sale, or other disposition, voluntary or involuntary, of the interest in such stock vested hereunder, said stock, for the life of the person in whom such stock prior to such disposition shall be vested shall pass to those who would take hereunder had he or she died at the time of such disposition. (5) The provisions of this agreement and declaration shall be operative and effective until twenty-one (21) years after the death of the last survivor of the following who are children now living of the parties mentioned at paragraph (2) hereof: Alice M. Merritt, John I. Merritt, Jr., Robert McElroy Merritt, Marian Virginia McElroy, Robert L. McElroy, 3rd. (6) During minority of any person owning stock hereunder, the stock of such person shall be held by the other owners of stock of said corporation who at the time are adult, with full power in a majority of such trustees to vote said stock and apply the income therefrom for the benefit of the infant for whom the same is held. (7) Respective owners*58 of stock shall be entitled to all dividends paid in money, whether out of earning or capital, but stock dividends shall be held and pass as herein provided in respect to holding and passing of the original stock. (8) A copy of this agreement and declaration shall be filed with said corporation, and all shares of stock issued to any person hereunder shall bear endorsement or notation to the following effect: "The shares of stock represented in this certificate are held subject to the provisions of an agreement and declaration of trust, dated June 18th, 1932, filed with this corporation, and are transferable only in accordance with the terms thereof." The members of the board of directors of Bellemead and the period served by each were as follows: Robert L. McElroy From prior to June 1932 until August 17, 1941. Lula McElroy From prior to June 1932 until December 30, 1936. William R. McElroy From prior to June 1932 to date. Edwin M. McElroy From 1936 to January 1, 1943. Marjorie M. Merritt From 1937 to date. Lula Marion McElroy Pendleton From 1941 to date. *153 No persons other than those named above have served as directors of Bellemead from June 18, 1932, *59 to the present time. On June 18, 1932, Lula Marion McElroy Pendleton was 22 years old and unmarried, William R. McElroy was 26 years old and unmarried, and Marjorie M. Merritt was 38 years old. On June 18, 1932, each share of stock of Bellemead had a value of $ 3,000. The respondent determined that gifts of remainder interests in stock of Bellemead were made by each of the petitioners on June 18, 1932, and that the value of the gift made by each was as follows: Lula Marion McElroy Pendleton $ 137,224.50 William R. McElroy 148,212.75 Marjorie M. Merritt 191,136.75 The notices of deficiency herein were mailed to petitioners on or about June 14, 1954. OPINION. The Commissioner contends that when the petitioners executed the 1932 agreement they made gifts of remainder interests in trust which were subject to tax under section 501 of the Revenue Act of 1932. Petitioners concede for the purposes of argument that the agreement created remainder interests in the stock of Bellemead. They urge, however, that no completed gifts were made which would subject them to gift tax because the reservation in the agreement of the right to receive distributions of capital, coupled with their*60 power to cause the corporation to make distributions, gave them the power to divest the remaindermen of the substance of their interests, and thus, in effect, to recall the property transferred in trust. We agree with petitioners' contention. They, together with a brother and their mother, since deceased, were the sole owners of the stock of Bellemead. The agreement which they executed on June 18, 1932, had as its purpose merely the continuation of family control of the stock. However, they explicitly reserved the right to all dividends in money whether paid out of earnings or capital. And, as sole stockholders, the signatories to the agreement were in a position to cause reductions in capital followed by the distribution of dividends paid out of surplus or capital. Paragraph (7) of the agreement was specifically reworded in the drafting stage so as to make this result possible. The gift tax operates only with respect to transfers that have the quality of finality. Cf. ; (C. A. 1), affirming in part and reversing in part .*61 In our opinion, the alleged transfers herein fail to qualify as completed gifts. The fact that the parties *154 to the agreement had to act in concert in causing corporate distributions to themselves is not material in the circumstances of this case. Cf. . Since each of the life tenants was a "donor," and since at least each of the petitioners was a potential "donee" with respect to the remainders, we cannot say on the facts here presented that their interests were substantially adverse to one another. Such offsetting reciprocal interests were absent in , and other similar cases relied upon by the Commissioner. The Government points to the fact that the petitioners did not have the power to recapture ownership of the remainders in the shares themselves. That is quite true. But they did have the power to strip the shares of value by causing distributions of capital to themselves, and in determining whether there is a completed transfer for gift tax purposes we must consider substance rather than form. We conclude that the agreement of June 18, 1932, *62 did not result in transfers having that degree of finality required by the gift tax statute. In the light of that conclusion it becomes unnecessary to consider the Government's contention that petitioners are liable for the 25 per cent addition to tax for failure to file a return regardless of their good faith, although it does appear to be correct in its position that good faith is not a defense where no return at all is filed whereas it may be a defense in the case of a tardy return. See sec. 519, Rev. Act 1932; art. 52, Regs. 79. Decisions will be entered for the petitioners. Footnotes 1. Proceedings of the following petitioners are consolidated herewith: Lula Marion McElroy Pendleton, formerly Lula Marion McElroy Parker, Docket No. 54564; William R. McElroy, Docket No. 54565.↩