Hanover Bank v. Commissioner

The Hanover Bank, as Trustee Under Agreement Dated October 19, 1914, Made by Leona C. Howe, Deceased, et al., Petitioner, v. Commissioner of Internal Revenue, Respondent; Seymour W. Strong and Frances M. Strong, Petitioners, v. Commissioner of Internal Revenue, Respondent Hanover Bank v. Commissioner Docket Nos. 89166, 90208 United States Tax Court 40 T.C. 532; 1963 U.S. Tax Ct. LEXIS 100; June 14, 1963, Filed *100 Decision will be entered for the petitioner in Docket No. 89166. Decision will be entered under Rule 50 in Docket No. 90208. Held, a valid trust was created by the settlors by an agreement dated October 19, 1914, and the amounts distributed to petitioner Frances M. Strong by the trustee pursuant to the trust in 1953, 1954, 1955, 1956, and 1958 are taxable income to petitioners Frances and Seymour Strong. The amounts distributed by the trustee in 1954, 1955, and 1956 are deductible under section 661, I.R.C. 1954. Hewitt A. Conway, for the petitioner in Docket No. 89166. Moe D. Karash, for the petitioners in Docket No. 90208. Richard B. Nashel, for the respondent in Docket No. 89166. Eugene H. Ciranni, for the respondent in Docket No. 90208. Black, Judge. BLACK *533 *532 The respondent determined deficiencies in income tax of petitioners Seymour and Frances Strong as follows: Year Amount [1953] $ 38.46 [1954] 262.86 [1955] 2,153.84 [1956] 2,256.16 [1958] 2,593.58 The deficiency for 1953 resulted solely from the disallowance by the respondent of $ 150 of claimed charitable contributions totaling $ 697. The explanation of the adjustment is set forth in the notice of deficiency as follows: (a) Deductions for contributions*102 claimed on your returns for the taxable years ended December 31, 1953, December 31, 1954, December 31, 1955 and December 31, 1956 have been disallowed as follows: Dec. 31, 1953 Dec. 31, 1954 Contributions claimed $ 697 $ 612 Contributions allowed [512] Amount disallowed [100] Dec. 31, 1955 Dec. 31, 1956 Contributions claimed $ 612 $ 665 Contributions allowed [565] Amount disallowed [100] The adjustments to taxable income and the explanation of the adjustments for 1954 set forth in the notice of deficiency are inter alia as follows: Adjustments to taxable income Taxable income as disclosed by return $ 7,099.57 Unallowable deductions and additional income: (a) Trust income $ 816.81 (b) Contributions 100.00 (c) Medical expenses 232.68 1,149.49 Taxable income as corrected 8,249.06 Explanation of adjustments (a) It has been determined that in the taxable years ended December 31, 1954, December 31, 1955, December 31, 1956, and December 31, 1958 you received distributions of taxable income in the amounts of $ 8,004.69, $ 9,293.63, $ 9,217.54, and $ 10,000.00, respectively, from the*103 Trust u/a by Leona Crawford Howe, deceased, et al. Adjustment to income is made as follows: [1958] Amount received $ 8,004.69 $ 9,293.63 $ 9,217.54 $ 10,000.00 Amount reported 7,187.88 None None None Adjustment -- increase 816.81 9,293.63 9,217.54 10,000.00 *534 (b) See adjustment (a) for the taxable year ended December 31, 1953. (c) Deductions for medical expenses claimed on your returns for the taxable years ended December 31, 1954, December 31, 1955, December 31, 1956, and December 31, 1958 have been disallowed as follows: [1955] (1) Adjusted gross income as corrected $ 17,591.02 $ 17,411.61 (2) Total medical expenses (including drugs and medicines in excess of 1% of adjusted gross income) 4,328.34 1,989.23 Less: 3% of adjusted gross income 527.73 522.34 Medical deduction allowed 3,800.61 1,466.89 Claimed on return 4,033.29 2,038.62 Amount disallowed 232.68 571.73 [1958] (1) Adjusted gross income as corrected $ 17,820.58 $ 19,535.71 (2) Total medical expenses (including drugs and medicines in excess of 1% of adjusted gross income) 1,442.92 843.64 Less: 3% of adjusted gross income 534.61 586.07 Medical deduction allowed 908.31 257.57 Claimed on return 1,427.00 657.56 Amount disallowed 518.69 399.99 *104 The deficiencies for 1955, 1956, and 1958 are also explained by the above statements in the notices of deficiency for 1953 and 1954. Petitioners Strong do not contest the disallowance of $ 150, $ 100, $ 100, and $ 100 for 1953, 1954, 1955, and 1956, respectively, for unallowable charitable contributions and there is no issue before us concerning this matter. The unallowed deductions for medical expenses for 1954, 1955, 1956, and 1958 result from the inclusion of trust distributions in taxable income for those years and the disallowance of $ 200, $ 200, and $ 150 for 1954, 1955, and 1956, respectively. Petitioners Strong do not contest the disallowance of the latter amounts and the remaining adjustments concerning medical deductions depend on our determinations concerning trust income. Petitioners Strong by appropriate assignments of error allege that $ 3,485.57 was erroneously reported by them as taxable income from a trust distribution in 1953. It is further alleged that $ 7,187.88 was erroneously reported by them as taxable income in 1954 and that respondent erred in determining that this amount and an additional sum of $ 816.81 should be included in taxable income for 1954. *105 Petitioners Strong also allege that the respondent erred in determining that taxpayers received distributions of taxable income from the trust in 1955, 1956, and 1958, which sums were not reported by them on their returns. In the alternative, respondent determined deficiencies in the income tax of petitioner Hanover Bank, as trustee, for 1954, 1955, and 1956 of $ 1,966.84, $ 2,479.43, and $ 2,403.85, respectively, wherein respondent disallowed distribution deductions pursuant to section 661 of the 1954 Code 1 of the amounts paid to Frances Strong. *106 *535 The first question presented is whether an agreement dated October 19, 1914, created a valid trust for the benefit of petitioner Frances thereby making the distribution from the trust taxable to her in 1953, 1954, 1955, 1956, and 1958. In the alternative, should we fail to find a valid trust, should Hanover Bank, as trustee, be denied distribution deductions for 1954, 1955, and 1956 for the amounts paid to Frances Strong. FINDINGS OF FACT The evidence in these consolidated proceedings consists of two stipulations. These stipulations, together with the exhibits attached thereto, are incorporated herein by this reference. Only those facts which are necessary to an understanding of the issues will be set forth hereinafter. Petitioners Seymour W. Strong and Frances M. Strong, husband and wife, reside at Katonah, N.Y. They filed joint income tax returns for the year 1953 with the district director of internal revenue, Albany, N.Y., and for the years 1954, 1955, 1956, and 1958 with the district director of internal revenue, Manhattan, N.Y. Petitioner Hanover Bank has since the commencement of this proceeding merged into Manufacturers Trust Co. and changed its name to Manufacturers*107 Hanover Trust Co. It filed fiduciary income tax returns for 1954, 1955, and 1956 with the district director of internal revenue, Manhattan, N.Y. On October 19, 1914, Hanover Bank's predecessor, Union Trust Co. of New York, and Grace Masury, as trustees, entered into an agreement with Leona Crawford Masury, hereinafter sometimes referred to as Frances' mother, John W. Masury, Frances' father, and Grace Masury, Frances' paternal grandmother (hereinafter referred to as Grace), by the terms of which certain property described in such agreement was transferred to said trustees upon the trust provided *536 therein, and certain provisions were made for the benefit of Leona Crawford Masury and Frances Crawford Masury, petitioner herein, during their lives, and the life of their survivor. John W. Masury died on August 16, 1931, Grace Masury died on September 6, 1932, and Leona died on March 14, 1954. Frances' mother, the then Leona Crawford Masury, entered into the agreement dated October 19, 1914, whereby Leona gave up her right of dower and other claims in and to the property of Frances' father, John W. Masury. John, in consideration of his then wife (Frances' mother) giving up her*108 right of dower and other claims in and to his property, covenanted "for himself, his executors, administrators and assigns, * * * that he will pay or cause to be paid" to Leona the sum of $ 20,000 per year until Frances, who at that time was an infant, reached the age of 21 years; thereafter, Leona was to receive the sum of $ 15,000 per year for the rest of her life and Frances was to commence receiving $ 5,000 per year. Upon the death of Leona, Frances was to receive the sum of $ 10,000 per year for the rest of her life. Frances' paternal grandmother Grace guaranteed that during her lifetime the payments specified in article second of the agreement dated October 19, 1914, would be made as set forth therein. John and Grace transferred certain property to Grace and the predecessor of the present holder of the property, the Hanover Bank, as trustees. The income and the principal of the transferred property were to be used to make the payments required by article second of the agreement unless the sums for such payment had otherwise been provided or supplied by John or Grace. In the event that the required payments were made by John or Grace, then the income from the transferred *109 property (or any surplus after making payments) was to be paid to Grace during her lifetime. Upon the death of the survivor of Frances or Leona, the remainder of the transferred property was to be paid over to Grace, her assigns or legal representatives. The agreement in question was construed by the Supreme Court of New York in a judgment dated June 24, 1935, in a controversy between the then trustee and the defendants hereinafter listed. The judgment provided in part as follows: CENTRAL HANOVER BANK AND TRUST COMPANY, as sole surviving Trustee of the trusts created by agreement dated October 19, 1914, * * * Plaintiff, -- against -- LEONA CRAWFORD IVES; FRANCES CRAWFORD REDFIELD; JOHN M. STURGES, EDITH MASURY STURGES and RALPH A. STURGES, JR., as Executors of the last will and testament of Grace Masury, deceased; BROOKLYN TRUST COMPANY, as Trustee under the last will and testament of John W. Masury, deceased; and BROOKLYN TRUST COMPANY, as Administrator *537 with the will annexed of the goods, chattels and credits of John W. Masury, Jr., deceased, Defendants. * * * * ORDERED AND ADJUDGED that a certain memorandum of agreement dated October 19, 1914, between Leona Crawford*110 Masury (now Ives), party of the first part, John W. Masury (now deceased), party of the second part, Grace Masury (now deceased), party of the third part, and Grace Masury and Union Trust Company of New York (now Central Hanover Bank and Trust Company), as Trustees, parties of the fourth part, be, and the same hereby is, construed and interpreted to be binding upon the estate of John W. Masury (also known as John W. Masury, Jr.), now deceased, during the continuation of the trusts created by said memorandum of agreement, * * * * * * * FURTHER ORDERED AND ADJUDGED that said memorandum of agreement, dated October 19, 1914, be and it is hereby further construed and interpreted to require defendant Brooklyn Trust Company, as Trustee under the Will of said John W. Masury, deceased, and as Administrator with the Will annexed of the Goods, Chattels and Credits which were of said John W. Masury, deceased, to protect said beneficiaries Leona Crawford Masury (now Ives) and Frances Crawford Masury (now Redfield) against the possible exhaustion of the trust estate and to require said defendant, if and when the trust estate shall be materially invaded by payments out of principal and/or depreciation*111 of securities to such an extent that the principal thereof shall be insufficient to insure the making of all payments which then or thereafter may become due to said beneficiaries as determined by the then value of the trust estate, * * * FURTHER ORDERED AND ADJUDGED that said memorandum of agreement, dated October 19, 1914, be and it is hereby further construed and interpreted to authorize and empower the plaintiff, as Trustee, from time to time to sell stocks and securities now held or which may hereafter be held by it as such Trustee, and to reinvest the proceeds thereof in securities that are legal for the investment of trust funds whenever in its judgment such sale and/or investment shall be for the best interests of the trust estate; * * * Later, by a decree dated March 22, 1937, of the Surrogates Court of Suffolk County, N.Y., the administrator of the estate of John W. Masury was fully and finally discharged of all liability and all assets of his estate were paid out. Frances received the following distributions from the Hanover Bank, as trustee: Year Amount [1953] $ 3,485.57 [1954] 8,004.69 [1955] 9,293.63 [1956] 9,217.54 [1958] 10,000.00 OPINION Petitioners Strong contend*112 that the agreement between Frances' mother, father, paternal grandmother, and the predecessor of the present trustee, entered into on October 19, 1914, did not *538 create a trust fund for the benefit of Frances and that the agreement only provided for the creation of a collateral mortgage security arrangement for the benefit of Frances' mother in lieu of dower. Petitioners Strong further contend that since the amounts received by Frances' mother were in lieu of dower the amounts therefore are incidents of inherited property to Frances and her mother. We do not agree with these contentions. It seems to us that the intent of the settlors was manifest in the agreement to create a valid trust. The other essential elements of a valid trust are all present, including designated beneficiaries and a trustee, and sufficiently identifiable property, title to which was delivered and passed to the trustees. The mere fact that Frances' mother gave up her right to dower and thereby gave consideration to one of the settlors does not destroy an otherwise valid trust, Restatement, Trusts, sec. 29 (2d ed.). There does not appear to be any ambiguity in the agreement concerning the creation*113 of the trust and, in fact, all the parties to that agreement, including Frances, have long treated the agreement as creating a valid trust. Petitioners Strong reported as trust income in 1953 and 1954 most of the amounts paid to them by the trustee. Long-standing interpretations should be given consideration and will not lightly be set aside even when there is ambiguity in the instrument, Babette B. Israel, 11 T.C. 1064 (1948). Furthermore, the Supreme Court of New York previously construed the agreement as creating a valid trust and the material parts of that judgment are set forth in our Findings of Fact. Judicial constructions by State courts are conclusive as to the legal extent and character of the interests created under such an agreement, Louise Savage Knapp Trust A, 46 B.T.A. 846 (1942). The situation here is distinguishable from cases such as Lyeth v. Hoey, 305 U.S. 188, and Chase National Bank et al., Executors, 40 B.T.A. 44 (1939). In each of those cases the taxpayer threatened to take contrary to a will and in each case compromised his claims. *114 The Courts determined that the property received in compromise was the substitute for an inheritance. In the instant case, Frances did not contest the disposition and the amounts she received were not in compromise of any claim she may have had. It follows that the distributions set forth in our Findings of Fact are to be included in the gross income of the beneficiary Frances in accordance with section 662, 1954 Code, and section 162 of the 1939 Code. Respondent determined deficiencies against petitioner Hanover Bank for purposes of protecting the revenue as an alternative measure should we fail to sustain the deficiencies determined against Seymour *539 and Frances Strong. In view of our determinations wherein we sustained the respondent's determinations as to petitioners Strong, we find for the petitioner Hanover Bank. Decision will be entered for the petitioner in Docket No. 89166. Decision will be entered under Rule 50 in Docket No. 90208. Footnotes 1. SEC. 661. DEDUCTION FOR ESTATES AND TRUSTS ACCUMULATING INCOME OR DISTRIBUTING CORPUS. (a) Deduction. -- In any taxable year there shall be allowed as a deduction in computing the taxable income of an estate or trust (other than a trust to which subpart B applies), the sum of -- (1) any amount of income for such taxable year required to be distributed currently (including any amount required to be distributed which may be paid out of income or corpus to the extent such amount is paid out of income for such taxable year); and (2) any other amounts properly paid or credited or required to be distributed for such taxable year; but such deduction shall not exceed the distributable net income of the estate or trust. (b) Character of Amounts Distributed. -- The amount determined under subsection (a) shall be treated as consisting of the same proportion of each class of items entering into the computation of distributable net income of the estate or trust as the total of each class bears to the total distributable net income of the estate or trust in the absence of the allocation of different classes of income under the specific terms of the governing instrument. In the application of the preceding sentence, the items of deduction entering into the computation of distributable net income (including the deduction allowed under section 642(c) shall be allocated among the items of distributable net income in accordance with regulations prescribed by the Secretary or his delegate. (c) Limitation on Deduction. -- No deduction shall be allowed under subsection (a) in respect of any portion of the amount allowed as a deduction under that subsection (without regard to this subsection) which is treated under subsection (b) as consisting of any item of distributable net income which is not included in the gross income of the estate or trust.↩