Graff v. Commissioner

EVERETT D. GRAFF, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Graff v. Commissioner Docket No. 92212. United States Board of Tax Appeals 40 B.T.A. 920; 1939 BTA LEXIS 780; November 22, 1939, Promulgated *780 Where capital gains are accumulated under a trust providing for revocation by grantor with the consent of his wife, the income beneficiary, and for termination and distribution to grantor upon his surviving her, held, such accumulations are "held for future distribution to the grantor" within section 167, Revenue Act of 1934, and taxable as part of his income. Mary Ryerson Frost,38 B.T.A. 1402, followed. Laird Bell, Esq., William N. Haddad, Esq., and Carleton Blunt, Esq., for the petitioner. Dewitt M. Evans, Esq., J. M. Morawski, Esq., F. R. Shearer, Esq., and Gerald W. Brooks, Esq., for the respondent. OPPER *921 This proceeding was brought for a redetermination of a deficiency in petitioner's income tax for the calendar years 1934 and 1935 in the sums of $1,078.65 and $5,737.14, respectively. The sole question is the taxability to petitioner under sections 166 and 167 of the Revenue Act of 1934 of income of a trust created by him. FINDINGS OF FACT. Petitioner resides at Winnetka, Cook County, Illinois. His wife is Verde Clark Graff, and in 1930 they had three children, who ranged in age from about*781 seven to thirteen years. On September 26, 1930, petitioner executed a written instrument creating a trust and naming himself and his wife as trustees. By the terms of the instrument the trustees were to hold certain property in trust and pay the income thereon to petitioner's wife. Article II(1) provides: Upon the death of Verde Clark Graff, the Trustees shall pay, deliver and convey the Trust Estate to the Grantor, if he shall then be living, to be thereafter his absolutely. If petitioner had predeceased his wife the trustees, upon the death of the wife, were to divide the trust estate into funds for the children and eventually pay the funds over to the children or to their descendants. The trust instrument was revocable by petitioner, as grantor, with the written consent of his wife, the income beneficiary. The provision of the trust instrument permitting the revocation reads as follows: ARTICLE IV 1. This trust may be altered, amended or revoked at any time by an instrument in writing, signed by the Grantor, consented to in writing by Verde Clark Graff and delivered to the Trustees, who shall thereupon endorse upon such instrument, over their signatures, a certificate*782 stating the date upon which the same was delivered to them. 2. In the event of such revocation the Trustees shall pay, deliver and convey the Trust Estate to such person or persons as the Grantor may direct in such instrument. An amendment on December 28, 1935, provided that the trust was no longer revocable by the grantor and that upon the death of the wife the trust estate should be distributed to the children rather than to petitioner, if he were then living. The trust in its amended form is still in operation. During the year 1934 the trustees received dividends of $3,750 on securities held in the trust. This income was currently distributed to petitioner's wife, the beneficiary under the terms of the trust, and was reported as her income in her income tax return for the year 1934. *922 The trustees received dividends in 1935 amounting to $3,135 and capital gains amounting to $14,217. The expenses of the trust amounted to $158.13. The income from the dividends - $3,135, less expenses of $158.13, or $2,976.87 - was currently distributed to petitioner's wife, the income beneficiary of the trust, and reported as her income in her income tax return for 1935. *783 The trustees filed a return on form 1040, reporting the capital gains of $14,217 and paying the tax due thereon. The capital gains were not distributed to petitioner's wife, the income beneficiary, but were retained and added to the corpus of the trust. Petitioner, at the time the trust was created, was 44 years old and his wife was 37, and both were in good health. Petitioner had considerable property in addition to the securities he transferred to the trust, and also had a substantial income, both before and after the trust was created. The income of the trust distributed to petitioner's wife was deposited in her "general fund", out of which household expenses for the family were paid. The allowance which she received from petitioner and other income which she had of her own was likewise commingled and deposited in this account. These allowances were larger in 1929 and 1930 than they were in 1934 and 1935, due in part to a curtailment in their living expenses during the latter years. There was no express or implied agreement between petitioner and his wife as to what she was to do with the income from the trust. She was free to use this money as she desired and was*784 not required to expend any part of it for household and living expenses. Respondent added to petitioner's taxable income the $3,750 ordinary income for the year 1934 and $3,135 ordinary income plus the $14,217 capital gain for the year 1935. In 1935 respondent allowed a deduction of trust expenses of $158.13. OPINION. OPPER: Respondent can not be sustained in his principal contention, that the entire income of the trust is taxable to petitioner because some part or all of the income was used by his wife in defraying household expenses. We have found as a fact that there was no agreement, express or implied, included in the trust instrument or collateral to it, which placed any restriction upon the use of the trust income by the beneficiary. The doctrine of , is thus inapplicable, , at least unless we can combine with it the provisions of section 167 of the Revenue Act of 1934. And, since the most that can then be said is that the power to apply the trust income to the grantor's obligations was derived from a voluntary discretion exercised by the wife, who *923 is undeniably*785 adversely interested in that same income, there is no foundation for the application of section 167. ; . See . The alternative contention is that at least the capital gains of the trust which were retained as additions to principal under the local law are taxable to the grantor under section 167, 1 as being accumulations of income held for future distribution to him. This is resisted on the ground that petitioner's ultimate enjoyment of the accumulations is dependent under the terms of the trust on his survival of his wife. There is no room for speculation as to the fact of accumulation. We know that*786 the capital gains existed; that they were retained; and that for purposes of Federal taxation they constitute accumulated income. (C.C.A., 8th Cir.); certiorari denied, ; . It remains only to consider whether under the unambiguous language of the trust such accumulations were, within the statute, held "for future distribution to the grantor." In , we ruled unequivocally, under facts substantially identical with those before us, that they were. This decision was, as we said in , "affirmed in principle", (C.C.A., 1st Cir.). In , and in , under comparable facts, we came to a similar conclusion. See also . Section 167, unlike 166, deals with the interest of a grantor in trust income. Since, by definition, the act of creating the trust constitutes a severance from the grantor's*787 property of whatever is assigned to the trustees, the subject matter of 167 may otherwise be described as the taxation of certain retained interests of the grantor in the income of the trust. Prior to the transfer the grantor's legal and beneficial right to receive income from the property was absolute. By the trust he parted with that interest to some extent. Whether section 167 comes into operation thus depends on whether the beneficial interest with which he parted was, as a matter of law, great enough so that it can be said that the accumulations of income did not continue to be held for his benefit. *924 By article IV of the present deed of trust, the 1935 amendment being admittedly inapplicable to these years, it is provided that during the lifetime of petitioner's wife he may revoke the trust with her consent, and upon such revocation the trust estate is to pass as petitioner directs; and by article II that upon her death the trust property becomes petitioner's absolutely, if he shall then be living. What we said in *788 , applies with equal force here: "This is literally within section 167 and also harmonious with its intendment as interpreted by the First Circuit Court of Appeals in the Kaplan case. Furthermore, this is not a mere possibility of reversion. Cf. (on review C.C.A., 9th Cir.); , for the right to control the use of the * * * [accumulation] does not lie inchoate pending the grantor's survivorship of the husband, but is a power existing at all times in her, first in conjunction with her husband and then alone." In other words, petitioner failed to dispose of the beneficial interest in the capital gains which he possessed prior to the declaration of trust, "the remainder being retained by the grantor", see . By retaining that interest, first in conjunction with the life tenant and thereafter absolutely, the grantor has himself created an arrangement whereby the accumulations of income to which section 167 refers are being held for future distribution*789 to him. They would continue to be so held except for the possible happening of a condition subsequent, namely, his prior death. That event would for the first time terminate his continuing beneficial interest in that part of the trust income with which we are here concerned. . The fact that in the Frost case the accumulations would pass to the grantor only upon her revocation, while here they come to the petitioner by the express provisions of the trust without his affirmative act, constitutes no distinction between the two cases. In the former the effect is to provide that at the end of the accumulation period (the husband's life) the grantor's power to revoke gave her discretionary control over the accumulations; whereas here at the end of a similar period resumption of control over the accumulations by the grantor is automatic. But section 167, 2 in its present from, operates as effectively upon accumulated trust income where it "is * * * held * * * for future distribution to the grantor" as it does where that future distribution may be contingent upon the exercise of a nonadverse discretion. See Report of Ways*790 and Means *925 Committee, 72d Cong., 1st sess., House Report 708, p. 25. 3 Cf. (C.C.A., 2d Cir.); , decided under earlier acts. For the foregoing reasons, the accumulations may not be said to be held for any person other than the grantor, and we conclude that the income represented by the capital gain is within the purview of section 167. Reviewed by the Board. Decision*791 will be entered under Rule 50. ARUNDELL and VAN FOSSAN dissent. Footnotes 1. 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 * * * then such part of the income of the trust shall be included in computing the net income of the grantor. ↩ 2. As distinguished from section 166, see . ↩ 3. "The present law taxes the income of a trust to the grantor when in his discretion * * * the trust income may be held or accumulated for future distribution to him * * *. Trusts have been established in which income is held or accumulated for the grantor which fact it is contended removes such trusts from the operation of this section. Here again it is not at all certain that the courts will uphold such devices; yet the statute may well be clarified to remove any doubt that the income of such trusts is to be taxed to the grantors. Accordingly, the section has been amended * * *." ↩