Crile v. Commissioner

GRACE MCBRIDE CRILE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Crile v. Commissioner Docket No. 43136. United States Board of Tax Appeals 26 B.T.A. 1020; 1932 BTA LEXIS 1204; September 22, 1932, Promulgated *1204 1. Attorney fees and amount paid by the trustee in compromise and settlement of a lawsuit involving the trust and trust property held necessary and proper expenditures by the trustee under the trust instrument and the laws of the state, and not a part of the distributable net income of the trust. 2. Where, in a trustee's suit beneficiaries employ private counsel to protect their interests and authorize payment by the trustee from trust income, held, such payment was made from the distributable net income of the trust and was taxable to the beneficiaries. John B. Fackler, Esq., for the petitioner. T. M. Mather, Esq., for the respondent. GOODRICH *1020 This proceeding is for the redetermination of a deficiency in income tax for the year 1924 in the amount of $2,010.01. It is alleged that the Commissioner erred in refusing to allow as a deduction from gross income petitioner's pro rata share of certain amounts claimed to be deductible expenses incurred in the management of the trust estate by the trustee of the Harriet E. McBride trust, of which petitioner is one of the beneficiaries. FINDINGS OF FACT. Petitioner is an individual*1205 residing at Cleveland Heights, Ohio. This case was submitted on the following agreed statement of facts: On the 30th day of September, 1911, Harriet E. McBride transferred to The Cleveland Trust Company, as trustee, according to the terms of a trust agreement, a copy of which is attached hereto, made a part hereof and marked "exhibit b" certain securities described therein. Under the terms of said trust agreement, the entire net income from the property so transferred was to be paid by The Cleveland Trust Company to Harriet E. McBride during her life. After her death, certain of the securities, hereinafter referred to as the "McBride Securities" were to be retained by the trustee and the income therefrom accumulated until the same amounted to Thirty Thousand Dollars ($30,000.00), and said income then paid to Lakeside Hospital, a charitable institution located in Cleveland, Ohio. A portion of the McBride securities were then to be distributed equally among Malcolm McBride, Edith McBride Sherman, Donald McBride and Grace McBride Crile, (hereinafter referred to as the "McBride heirs"), and the balance of said securities retained by the trustee under the following provision in*1206 the trust agreement: "The trustee … shall pay the net income thereof in equal shares to said beneficiaries during their respective lives. Upon the death of each of said beneficiaries, the equal one-fourth part of said property so held by the Trustee shall pass and be distributed in accordance with the last will and testament of such beneficiary and in default of such testamentary disposition, then to his or her respective heirs." *1021 Harriet E. McBride died September 11, 1920, and her last will and testament gave to her brother, Herbert Wright, and beneficiaries other than the McBride Heirs, her entire estate subject to disposition by will. The Collector of Internal Revenue claimed that the property subject to the trust agreement of September 30, 1911, should be included in the property reported for the levy by the Federal Government of an Estate Tax, and an additional inheritance tax assessment based on this contention, amounting to more than Ninety Thousand Dollars ($90,000.00) was levied. The beneficiaries under the will of Harriet E. McBride claimed that under Title IV, Section 409 of the Revenue Act of 1918, the beneficiaries under the trust agreement were*1207 bound to reimburse the Harriet E. McBride Estate for the amount of tax to be paid to the Federal Government by reason of the inclusion in the gross estate of the property subject to the trust agreement. In order to settle this controversy and acting under authority of Section 10857 of the General Code of Ohio, The Cleveland Trust Company as trustee filed a petitioner against Herbert Wright and others in the Common Pleas Court of Cuyahoga County, Ohio (Docket No. 213,499 in said court) for the purpose of determining from interpretation of the trust instrument, the liability of the respective beneficiaries for payment of the inheritance tax aforesaid. The devisees and legatees of Harriet E. McBride also contended that the gift to the McBride heirs was void by reason of its being in violation of the Rule Against Perpetuities. This argument was based on the fact that the Thirty Thousand Dollars ($30,000.00), which was provided for Lakeside Hospital might never be accumulated, and consequently the subsequent interests might not vest within the lives of persons in being and twenty-one years thereafter. Upon hearing of the above mentioned case, it was determined by the Court of Common*1208 Pleas that the provisions contained in the trust agreement constituted a valid gift to the McBride heirs, and that the beneficiaries under the trust were not bound to reimburse the Estate of Harriet E. McBride for the amount of Estate Tax, which might be levied by reason of the inclusion in the estate of the property subject to the McBride trust. Subsequently to this decision the beneficiaries under the will of Harriet E. McBride gave notice of appeal. Pending appeal, and under date of April 30, 1924, the various parties at interest agreed upon a settlement under the terms of which the McBride heirs authorized the trustee to pay to the beneficiaries under the will of Harriet E. McBride, in settlement of their claim, the sum of Eleven Thousand Six Hundred Seventy-one Dollars and 00/100 ($11671.), and to the attorneys representing the trustee and the McBride heirs, the sum of Seventeen Thousand Six Hundred Seventy-three Dollars and 60/100 ($17,673.60) as fees for, and costs incurred in conducting the litigation and arranging the above mentioned compromise. The attorneys' fees were divided as follows: Fackler & Morgan, representing Grace McBride Crile and Edith McBride Sherman, *1209 $8,038; Horace Andrews, representing Malcolm McBride and Donald McBride, $8,000; J. E. Morley, representing The Cleveland Trust Company, $1,635.60. Thereupon the beneficiaries under the will of Harriet E. McBride dismissed their appeal then pending. During the above mentioned litigation and until final settlement thereof on April 30, 1924, the Cleveland Trust Company had postponed all distribution of income to the McBride heirs. The sum ($29,344.60) which the trustee was authorized to pay under the terms of the settlement, was disbursed by The Cleveland Trust Company from the accumulated income then held by it, and the balance thereof distributed to the McBride heirs during the year 1924. *1022 The trust agreement provides: "From the income of this trust, the Trustee shall pay all taxes, assessments and public charges upon said property and all other property hereafter covered by the trust, and all necessary expenses incurred in connection therewith, together with all such insurance premiums as may be necessary to have and keep all buildings thereon insured in such amount as it may deem advisable, against loss or damage by fire. The trustee may, from income or principal, *1210 as it may deem proper, keep the building located on such property in reasonable repair …" At the time settlement was made with the executor of the Estate of Harriet E. McBride, counsel representing said executor claimed that if the government's assessment of inheritance taxes were to be sustained, including the taxes on account of the 1911 trust, the estate would be insolvent. In arriving at the net income of the trust for the year 1924, the $11,671 paid to Herbert Wright in compromise of the claim of the beneficiaries under the will and attorneys' fees aggregating $17,673.60 were claimed as deductions. The petitioner, who was one of four beneficiaries to the trust, claimed as a deduction from her income one-fourth of this sum, or $7,336.15. Respondent denied the deductions, and from that action results the deficiency here in question. OPINION. GOODRICH: Petitioner contends that $7,336.15 should not be included in her 1924 income, first, because she did not, in fact, receive it and, next, because it was not distributable to her from the trust. In the alternative she contends that, if it was distributable to her and a part of her income, the amount should be treated*1211 as a capital expenditure made to acquire and retain the right to income of the trust estate and she should be allowed to recoup this capital expenditure from the income thereafter so received by her from the trust estate. In view of section 219(b)(2), Revenue Act of 1924, which contains special provisions relating to the determination of the taxable income of a trust, it is clear that there must be included in petitioner's income the amount of income of the trust which is concurrently distributable to her. The issue before us is, therefore, resolved into the question of whether the amount here in question was income of the trust which was currently distributable to the beneficiaries. This trust was subjected to serious attack, both as to its validity and as to a claim against its assets, and the respondent concedes that the trustee acted under authority of the law of Ohio in filing a petition for the purpose of determining under the trust instrument the liability of the beneficiaries for the payment of the estate tax (sec. 10857, General Code of Ohio), and we think it was not only the right, but the duty of the trustee to defend the trust from the attack upon its validity which, *1212 if successful, would have destroyed it. *1023 Of the $29,344.60 paid out by the trustee in connection with this suit, the trustee paid its attorney $1,635.60, and in settlement thereof, $11,671, a total of $13,306.60. By this settlement the entire controversy was ended. This was a necessary expense incurred by the trustee in connection with the trust property, and, under the terms of the trust instrument and the decisions of the Ohio courts (cf. Weir v. Weir, 18 O.C.D. 199; Ingham v. Lindeman,37 O.S. 218; Merrick v. Merrick,37 O.S. 127; Jackson v. O'Brannon,14 O.S. 177), was properly payable by the trustee from the income of the trust before any income was distributed to the beneficiaries, and, since only the "net income" from the trust was distributable to the beneficiaries, this amount was never income distributable to the beneficiaries. The fact that the beneficiaries authorized the payment of the compromise sum and the expense of trustee's counsel is not controlling. The trustee had authority to make such payments without their acquiescence, which served merely to indicate that the parties interested deemed the settlement*1213 necessary and to protect the trustee from any future question about the matter. In determining the distributable net income of the trust for 1924 there should be deducted the items of $11,671 and $1,635.60, totaling $13,306.60, and from petitioner's gross income, one-fourth thereof, or $3,326.65. In the disallowance of the fees totaling $16,038 paid to counsel employed by the individual beneficiaries, we sustain respondent. This expense was incurred, not by the trustee, but by the individuals. It was not a charge against nor a necessary expense of the trust. The fact is that these attorneys were employed not by the trustee which had other counsel, but by two beneficiaries of the trust to look after their personal interests. No doubt their services were valuable, and very likely were of benefit to the trustee and its counsel as well as to the beneficiaries, but that does not make them representatives of the trustee. Consequently, the charges for their services can not be classed as necessary expenses in connection with the trust, nor deducted in determining the distributable net income of the trust. They were personal expenditures of the individual beneficiaries, made in*1214 an effort to protect their rights to income from the trust, and, as such, have no place in the provisions of the statute setting out specifically allowable deductions from the gross income of an individual and therefore must be classed as a nondeductible personal expense. The fact that the charges were paid, upon authorization of the beneficiaries, by the trustee from their shares of the distributable income of the trust is not material. In this situation the trust income may be said to have been constructively distributed to them, *1024 cf. Marion Stone Burt Lansill,17 B.T.A. 413; Emma Burt Hutchins,20 B.T.A. 1227; and, under section 219(b)(2) of the Revenue Act of 1924, the amounts should be included in computing their individual net incomes whether distributed or not. Nor do we agree with petitioner's contention that these payments may be classed as capital expenditures to be thereafter recouped, in support of which counsel cites, among other cases, Allen v. Brandeis, 29 Fed.(2d) 363; *1215 Dobbins v. Commissioner, 31 Fed.(2d) 935; Frederick McLean Bugher,9 B.T.A. 1155. The two decisions first cited are clearly distinguishable from the case at bar and have no bearing here. In the Bugher case the taxpayers were engaged in carrying on a trade or business, in connection with which the expenditures were made for the purpose of acquiring or enlarging the rights to income or in property. Here, even should we regard the operation of the trust as a business, the beneficiaries were not so engaged, but were merely passive recipients of income from the trust, and expenditures made to retain such income must be regarded as a personal cost of protecting one's property, for which the statute makes no allowance. The payments did not serve to create, change, or acquire any rights to the income, for these were granted by the trust instrument, and the relinquishment of these sums by the beneficiaries served merely to remove the threat to take away the rights which they had. The issue before us is similar in principle to that which was before the Circuit Court of Appeals in *1216 Commissioner v. Field, 42 Fed.(2d) 820, reversing, on this point, Marshall Field,15 B.T.A. 718. In disposing of the question, L. Hand, Judge, said: * * * All that happened was that field and the trustees got into a dispute about the meaning of the will; and Field succeeded in getting the court to take his view. We cannot for that reason say that the court's action changed what had all along been his rights; it did not create them; he had them already. We do not of course forget that a disputed right is not for practical purposes an available right at all; or that in fact Field was helpless until the decree passed. Nevertheless, we cannot take the judgments of a court as creating property without confusing their function, and substituting juristic metaphysics for these conventions on which in the end most of the law stands. For instance, precisely as good an argument might be made in favor of fees paid in the defense of property in possession, a freehold or a share of stock. Without them the possessor's rights would succumb to the attack; it would follow that any subsequent income is acquired at that cost. Again, if the property be a leasehold*1217 or an annuity, it is a "wasting asset," and the fees must be somehow prorated; if it be not "wasting," they will be part of the cost upon a sale. So put, we should suppose that nobody would be hardy enough to maintain that an attorney's fee was a "capital expenditure." We cannot make over fundamental notions in the interest of a more searching theoretic analysis. Cf. Clara A. McKee,19 B.T.A. 430; Bliss v. Commissioner, 57 Fed.(2d) 984; Clara Hill Lindley,26 B.T.A. 741. Judgment will be entered under Rule 50.