Leonard v. Commissioner

STEPHEN J. LEONARD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Leonard v. Commissioner Docket No. 65805. United States Board of Tax Appeals 36 B.T.A. 563; 1937 BTA LEXIS 689; September 28, 1937, Promulgated *689 On June 4, 1929, by separate instruments, one a separation agreement and the other a declaration of trust incorporated in the separation agreement by reference, petitioner provided for the maintenance and support of his estranged wife, and for the maintenance, support, and custody of his children. He retained no reversionary interest in the trust corpus or income upon termination of the trust. Prior thereto his wife had instituted proceedings for absolute divorce. On October 22, 1929, she received a final decree, which incorporated the provisions of the separation agreement and trust as a part of the court's judgment. Petitioner could revoke the trust if his wife did not prosecute her suit to final decree of divorce and thereafter he could alter or amend the trust agreement with his wife's consent and no vesting of any interest in his children was permitted under the trust that would prevent a change by him with his wife's consent. During the taxable year the trustee made distributions to the wife and children of trust income. Held, income of the trust distributed in the taxable year, except that portion thereof paid to his adult child, is taxable to grantor, since such*690 income was used to partially discharge his legal obligation to support and mantain his wife and minor children. J. Donald Duncan, Esq., for the petitioner. Dean P. Kimball, Esq., for the respondent. ARNOLD *563 This case involves an alleged income tax liability of petitioner for the year 1929 in the amount of $3,270.27. The deficiency arises from the proposed addition to the petitioner's taxable income for the year 1929 of: (a) The sum of $17,723.89 reported by the United States Trust Co. of New York as capital gains and profits to a trust fund from *564 the sale of bonds held as part of the trust corpus which was not distributable to the beneficiaries. (b) The sum of $16,191.34 income of the aforesaid trust fund, consisting of dividends and interest received by the trustee and distributable to Adelaide Shanahan Leonard (the former wife of the petitioner) and the three children of the petitioner. Both of these sums were reported for income tax purposes by the United States Trust Co. of New York as trustee in the taxable year. Respondent confessed error in including in petitioner's taxable income the capital gain reported by*691 the trustee from the sale of capital assets of the trust. Therefore, the only question presented is the taxability of the $16,191.34. FINDINGS OF FACT. At the date of execution of the instruments hereinafter mentioned the petitioner, an individual residing in New York City, was worth approximately $2,000,000. He and his wife, Adelaide Shanahan Leonard, were then living separate and apart. Three children had been born of their marriage, two of whom, Stephanie and Craigh, were minors during the taxable year, and one of whom, Jeanne, became 21 years of age July 18, 1929. Prior to the taxable year and on December 27, 1928, petitioner had been served with a summons in an action for absolute divorce instituted by his wife, Adelaide Shanahan Leonard. Thereafter, and on June 4, 1929, the petitioner, his wife, and the United States Trust Co. of New York executed an agreement of trust wherein the United States Trust Co. was made trustee, and the petitioner, as grantor, contributed securities, stock, and cash of the then value of $650,000, listed as Exhibit A, to the trust agreement, as a trust fund, the net income therefrom to be paid to the beneficiaries therein named in equal*692 monthly installments as far as practicable. The trust fund contained $400,000 principal amount of McCullough Oil Co. bonds which petitioner guaranteed as to principal and interest, and in case of default he agreed to substitute cash or securities in lieu thereof. The grantor reserved the right to amend or revoke the trust instrument until delivery to the trustee of a copy of summons and complaint in a proceeding for divorce by the wife against the husband, and upon such delivery the right to amend or revoke was to be suspended until a certified copy of a final decree of divorce was delivered to the trustee, or a stipulation of attorneys that the divorce action had been discontinued or dismissed was delivered to the trustee. Upon delivery of a certified copy of final decree of divorce to the trustee, grantor's right to amend or revoke was to terminate *565 and thereafter the trust was to be considered irrevocable so far as grantor was concerned. Upon discontinuance or dismissal of the divorce action, the right of revocation was to be in effect and the trust considered a revocable trust. Upon revocation the trust fund and accumulated income was to be fully restored to grantor. *693 From the net income of the trust during the life of the wife, $5,000 per year was to be paid by the trustee to each of the three named children, the minors' portion payable to the wife as natural guardian for the account of the minors during their minority. Should any child die during the life of the wife, such child's portion was payable to the wife during her life for her own separate use, the remaining net income of the trust to be paid to the wife "during her life to be used by her for her maintenance and support and in her sole discretion for the support, maintenance and education of the children by herself and grantor." Upon the death of the wife the trust fund was to be divided into as many equal parts as there were then living children and receased children of the wife by the grantor leaving issue. Each part was to constitute a separate trust fund for the benefit of each living child as life beneficiary and during the minority of each child, so much of the net income as the trustee deemed proper was to be used for the support, maintenance, and education of such minors. The unexpended net income was to be accumulated for such child's benefit upon reaching majority. Upon*694 a child's attaining 21 years, the accumulations and the whole of the net income of such child's portion was to be paid that child in monthly payments during life, and upon the death of such beneficiary, whether before or after attaining 21 years, the principal, together with the accumulations thereon, was to be paid as such life beneficiary may have directed by will, or in default of such direction, to his or her issue surviving, and if no issue survived, then to the other descendants then living of the wife by the grantor, per stirpes, or if none, to the descendants of the grantor per stirpes. Should any child die before the wife, having directed by will to whom the payment of his or her portion should be made, payment was to be made in accordance with such direction. In default of any such direction, payment was to be made to his or her issue then living, and if none were living at the time of the wife's death, then to the other descendants of the wife by the grantor, and, if no such other descendants, then to the descendants of grantor. It was further provided that, notwithstanding any of the terms or provisions rendering the trust irrevocable after a certificate of final*695 decree of divorce was delivered to the trustee, the trust agreement or any of its terms could be changed or amended during the life of the grantor with the consent of the wife and that nothing *566 in the trust agreement should be decreed to vest any interest in the children prior to the death of the grantor or his wife and that no child should have the right to object to any change that might be made by the grantor with his wife's consent. On the same day, June 4, 1929, a separation agreement was entered into, in which it is recited among other things: Whereas the parties hereto desire to enter into an agreement by the terms of which they may hereafter continue to live separate and apart and by the terms of which proper and reasonable provision shall be made for the maintenance and support of the party of the first part [wife] and the maintenance, support and custody of the aforesaid two daughters and son, and Whereas, by separate trust agreement bearing even date herewith by and between second party as grantor and United States Trust Co. of New York, of 25 Wall Street, Borough of Manhattan, City and State of New York, as trustee, some provision has been made by the*696 second party for the maintenance and support of the first party and the aforesaid two daughters and son, which trust agreement is incorporated herein by reference thereto as though fully and at length set forth and is market Exhibit A. Summarized, so far as material here, the separation agreement states that the second party (husband) has by the trust agreement established a trust fund with principal amount of $400,000 McCullough Oil Co. 3-year 6 percent first mortgage sinking fund gold bonds of March 1, 1929, and $250,000 cash or other securities, the net income of which trust is payable to the first party (wife) subject to a prior charge of $15,000 in favor of the three children of the parties. That in addition to the establishment of the trust fund the wife received in the past by way of gifts from the husband personal property then of the value of $350,000 which was acknowledged to have a present income value of at least $15,000 and the wife agreed that her income would be at least $30,000 a year from the aggregate net income of the property given her by her husband and from the trust fund, subject only to the necessity of providing therefrom for her support and the support, *697 maintenance, and education of the three children. The petitioner further agreed to pay his wife the sum of $35,000 per year, $10,000 payable on the 15th day of June in each year, beginning with the year 1929, and $25,000 payable in equal monthly payments so far as arithmetically possible on the first of each month, beginning with the month of July 1929. Such payments in the aggregate sum of $35,000 were to be made by the husband to the wife during her life, provided his circumstances and ability to pay continued to be as good or better than of that date, making the aggregate net income receivable by the wife to be used by her for her maintenance and support and that of the three children approximately $65,000 per year from property represented by gifts received from *567 the husband, the trust fund, and the yearly payment under the separation agreement. He further agreed to pay all the extraordinary medical expenses of the wife and children until each child reached the age of 25 years. Either party had the right to apply to the court for readjustment of the $35,000 annual payment as ability to pay varied, but in no case to exceed that amount. In addition to the $650,000*698 property and cash contributed to the trust fund by grantor, the wife deposited three insurance policies, each of $100,000, in the trust fund, on the life of the husband in which she was the beneficiary. Premiums were to be paid by the wife, and in case of default, grantor could pay them and deduct the amount so paid from the payments due her. The furniture and personal property in a dwelling on Long Island and the city apartment then occupied by the wife were to be her property, including the automobiles, and she was to have the sole care, custody, and control of the children. Paragraph 8 of the separation agreement provided as follows: EIGHTH: The first party hereby accepts the establishment of the Trust Fund (Exhibit "A") and the payments to be made by the second party pursuant to this Agreement in lieu of all dower, and hereby releases the second party and his estate from any claim of dower in the property of the second party as now or hereafter constituted. The insurance policies were surrendered in 1931 and the cash surrender value of $54,640 was paid into the trust fund and became part of the principal of the trust pursuant to the agreement of the parties. Three*699 changes or amendments were made to the trust agreement in accordance therewith with the wife's consent, none of which are material so far as the issues here involved are concerned. Subsequent to the execution of the trust agreement and the separation agreement, and on July 22, 1929, petitioner's wife obtained an interlocutory decree of divorce from the petitioner. This decree became final October 22, 1929, and a copy of the final decree of divorce was served on the United States Trust Co. October 23, 1929. The court incorporated the agreements in the decree as follows: ORDERED, ADJUDGED AND DECREED that the agreement, Exhibit 3, dated June 4, 1929, providing for the custody of the minor children, Craig Leonard and Stephanie Leonard, issue of said marriage, as well as providing for the support and maintenance of the plaintiff, be and hereby is approved and affirmed and made a part of the judgment herein, and as provided in said agreement, Exhibit 3, dated June 4, 1929, it is ORDERED, ADJUDGED AND DECREED that the plaintiff herein, Adelaide S. Leonard, have the sole care, custody and control of the infant children Craig Leonard and Stephanie Leonard and that the defendant herein, *700 Stephen J. Leonard pay to the plaintiff herein, Adelaide S. Leonard, for and during the term of her natural life the sum of thirty-five thousand dollars ($35,000) per year; * * *. *568 During the period June 4 to December 31, 1929, the United States Trust Co. under the trust agreement received income in the sum of $16,191.34 as dividends and interest, and $17,723.89 as capital gain from the sale of the oil company bonds in the trust corpus. Of the distributable income the trustee from June 4 to the end of the calendar year 1929 distributed $5,200 to the wife, $2,083.33 to petitioner's adult daughter, Jeanne Leonard, directly, and to Stephanie and Craigh, minors, each $2,083.33, the minors' portion being paid to their mother as guardian for their account. This left a balance on hand at the close of the calendar year which was not distributed. OPINION. ARNOLD: The question for our determination is whether all or any part of the $16,191.34 received as income by the trustee from June 4 to December 31, 1929, is taxable to petitioner. The Commissioner included it all in his assessment of deficiency and petitioner claims no part of it is taxable to him. At the time*701 the separation agreement and the trust agreement were executed, June 4, 1929, petitioner and Adelaide Leonard were husband and wife. An action for divorce was pending by the wife against petitioner. The marriage relationship imposed on petitioner a legal obligation to support and maintain his wife. As a father he was under legal obligation to support and maintain his children during their minority. The court has authority in dissolving the marriage relationship to make provision for the future support and maintenance of the wife and minor children. In arriving at a suitable amount for this purpose the court takes into consideration the wealth and standing of the parties, their habits of living and surrounding circumstances, and what the parties themselves consider a suitable allowance in view of their agreements. Pending the divorce proceedings negotiations were conducted between the husband and the wife for the adjustment of this legal obligation. These negotiations culminated in the execution of the separation agreement and the trust agreement of June 4, 1929. Thereafter and on July 22, 1929, petitioner's wife obtained an interlocutory decree of divorce, which became*702 final October 22, 1929. The petitioner was a wealthy individual with an estate valued at about two million dollars. His family consisted of his wife and three children, two of whom were minors. The separation agreement recited that some provision had been made in the trust agreement for the maintenance and support of the wife and children and the trust agreement was incorporated therein as though fully and at length set forth. *569 By the trust agreement petitioner put up cash and securities in the amount of $650,000, from the net income of which $5,000 per year was payable to each of the three children of the wife and petitioner, and the remaining net income to the wife "during her life to be used by her for her maintenance and support, and in her sole discretion for the support, maintenance and education of the children by herself and the grantor", the portion of income of any child that might die during the lifetime of the wife likewise to be paid the wife. We think the purpose of both instruments was to make suitable provision for the support and maintenance of the wife and minor children, that they should be construed to that end, and that in so far as provision*703 was made in the trust agreement for the future support of the wife and minor children it was in fulfillment of the legal obligation the marriage relation imposed on petitioner and the natural obligation a father has to support his minor children. The court had both the separation agreement and the trust agreement before it when it entered its order in the divorce proceeding. When the court by its order and drcree approved and affirmed the separation agreement and made it a part of its judgment, in accordance with its provisions, the trust agreement likewise became a part of the decree and was approved and affirmed, as the separation agreement referred to the trust agreement in the following language: * * * some provision has been made by the second party [petitioner] for the maintenance and support of the first party [wife] and the aforesaid two daughters and son, which trust agreement is incorporated herein by reference thereto as though fully and at length set forth, and is marked Exhibit "A". Considering the extent of petitioner's estate, it is reasonable to suppose that, but for the benefits accruing to the wife and minor children from the trust income, she would have*704 asked for and the court would have awarded an amount in excess of that provided in the separation agreement for her support and maintenance and that of the children. Furthermore, the establishment of the trust fund was dependent upon an absolute decree of divorce, as petitioner reserved the power to alter, amend, or revoke in case the divorce was not made final and could have revoked it at any time had the wife not prosecuted her suit to a successful conclusion. This is inconsistent with petitioner's contention that the establishment of the trust was an independent property settlement separate and apart from any obligation to support growing out of the marriage relationship. Petitioner argues that as the court by its decree only ordered the husband to pay $35,000 per year to the wife during her life, as *570 provided in the separation agreement, and did not specifically order the payments to be made under the trust, the payments of income under the trust were not intended for alimony and support. Payments of income from the trust were to be made by the trustee in accordance with the terms of the trust instrument, and approval of the separation agreement in which was incorporated*705 the trust instrument, in effect, carries with it approval of the payments to be made for the purposes provided in the trust agreement, hence no necessity existed for specific reference in the decree for payment of the trust income for the support and maintenance of the wife and minor children. A husband has a legal obligation for the support and maintenance of his wife and minor children, and in New York the courts will enforce an agreement for alimony entered into between husband and wife prior to divorce, Daggett v. Daggett, 5 Paige, 509; 28 Am.Dec. 442; Hamlin v. Hamlin,230 N.Y.S. 51. This legal obligation arises from the relation of marriage. This general obligation for support and maintenance is made specific by the decree of the court of appropriate jurisdiction. Audubon v. Shufeldt,181 U.S. 575; Romaine v. Chauncey,129 N.Y. 566; 29 N.E. 826. Agreement between the parties for support and maintenance executed during the pendency of the divorce proceeding, incorporated in the decree, becomes merged in the judgment, *706 Kunker v. Kunker,246 N.Y.S. 118. The decree of the court for the future maintenance and support of the wife may be in the form of annual payments of alimony or a part of the husband's estate. Gould v. Gould,245 U.S. 151. The establishment of a trust fund does not destroy the effect of the payments being for support and maintenance, Mary R. Spencer,20 B.T.A. 58. Douglas v. Willcuts,296 U.S. 1, involved a trust quite similar to the one here. A trust fund was set up a few days before the wife obtained a divorce, the income from which was to be used for the purpose of paying alimony. It was held that as the income of the trust was to be used for that purpose the husband received the benefit of the trust income in discharge of his legal obligation to support and maintain his wife and the income was taxable to him. The Supreme Court held a settlor of a trust taxable with the trust income where it was used to pay his debts in Helvering v. Blumenthal,296 U.S. 552, in reversing the *707 Second Circuit (76 Fed.(2d) 507), and where it was used to discharge his obligation to maintain and support his minor children in Helvering v. Schweitzer,296 U.S. 551, in reversing the Seventh Circuit (75 Fed.(2d) 702), and in Helvering v. Stokes,296 U.S. 551, in reversing the Third Circuit (79 Fed.(2d) 256), and where the beneficiary of a trust irrevocably assigned a part of the trust income to his wife who subsequently obtained a divorce in which the decree made no provision for alimony in Helvering v.*571 Coxey,297 U.S. 694, in reversing the Third Circuit (79 Fed.(2d) 661). These decisions are predicated on Douglas v. Willcuts, supra, and establish the proposition that where the income of a trust is to be used in discharge of any legal obligation which the settlor would otherwise have to satisfy, the settlor is taxable with such income to the same extent as if it were personally received. See also *708 Helvering v. Grosvenor, 85 Fed.(2d) 2; Commissioner v. Hyde, 82 Fed.(2d) 174; Albert C. Whitaker,33 B.T.A. 865. In Helvering v. Brooks, 82 Fed.(2d) 173, the Second Circuit had before it an irrevocable trust, created the day before the divorce decree was granted. The decree made no provision as to alimony or property rights of the wife. It was stipulated, however, that the husband and wife had agreed upon the trust indenture as a settlement of their property rights "arising from the relationship of marriage." The taxpayer sought to make a distinction between an agreement to pay alimony and an agreement for settlement of property rights. In reversing the Board of Tax Appeals and holding the income taxable to the husband, the court said: * * * Whether the trust income is used to discharge the husband's duty, made specific by agreement, to support the wife, or to discharge an obligation to pay her agreed sums for a release of rights in his property, cannot be material in determining the taxability of the husband. The creation of a trust the income of which is to be used to discharge any legal obligation*709 of the settlor enables him to enjoy the benefit of the income; hence the income is properly taxable to him. Compare Helvering v. Blumenthal,296 U.S. 552, 56 S.Ct. 305, 80 L.Ed. ; Helvering v. Schweitzer,296 U.S. 551, 56 S.Ct. 304, 80 L.Ed. ; Helvering v. Stokes,296 U.S. 551, 56 S.Ct. 308, 80 L.Ed. ; Helvering v. Coxey,297 U.S. , 56 S.Ct. 498, 80 L.Ed. ; all of which have been recently decided on the authority of Douglas v. Willcuts. Indeed, in the Douglas Case itself the trust provisions for the wife were in settlement not only of alimony but also "of any and all dower rights or statutory interests in the estate" of the husband, and the court pointed out (296 U.S. 1, at page 8, 56 S.Ct. 59, 62, 80 L.Ed. ) that this did not affect the essential quality of the payments. On the authority of the cases above cited, the order of the Board is reversed. Petitioner cites and relies on the case of Commissioner v. Tuttle, 89 Fed.(2d) 113, as controlling here. There an irrevocable trust was set up by the husband as a property settlement which included*710 settlement and discharge of all claims of the wife for alimony, support, and maintenance of the wife and a complete settlement of all property rights forever under all circumstances and regardless of the outcome or disposition of the divorce proceeding by the wife then pending against her husband. In the instant case the trust was conditioned on a final decree severing the marriage relation. The reservation of the power to amend or revoke in the event the divorce was not made final or the divorce proceeding was discontinued or dismissed, or to change or amend with his wife's consent after the decree *572 became final, destroys the argument of petitioner that the trust was an independent property settlement having no connection with his marital obligation to support and maintain his wife. The effect of the creation of the trust was the appropriation of a portion of petitioner's property for the uses and purposes specified in the trust instrument the income from which, in so far as it was payable for the maintenance and support of the wife and minor children, was in discharge of an obligation of petitioner, existing at that time. This obligation was made permanent by the*711 decree of the divorce when it was approved and affirmed and incorporated in the decree as a part of the separation agreement. Petitioner argues that he completely divested himself of all interest in the trust corpus and income and as no part would ever revert to him, the income is not taxable to him as income used to discharge his legal obligation. Petitioner did not part with all present interest. Under the facts and circumstances here the income distributed was charged with serving a beneficial use of the grantor, i.e., a partial discharge of his legal obligation for the support and maintenance of his wife arising by reason of the marriage relation and the support and maintenance of his minor children by reason of his parental obligation. Furthermore, he had the power with the consent of his wife to change or amend the trust agreement after the decree of divorce became final, and it is an established fact that he did exercise this power on three separate occasions. We are of the opinion and hold that the income of the trust distributed during the taxable year, except that portion paid to Jeanne Leonard in the amount of $2,083.33, is taxable to petitioner. *712 Robert Glendinning et al., Executors,36 B.T.A. 486. The undistributed portion of the income received during the taxable year is not taxable to petitioner, E. E. Black,36 B.T.A. 346; G.C.M. 18972, I.R.B. Vol. XVI - No. 33, p. 6. Decision will be entered under Rule 50.