Morehead v. Commissioner

KATHARINE BOYD MOREHEAD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. MARY BOYD EVANS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Morehead v. Commissioner Docket Nos. 95441, 97432. United States Board of Tax Appeals 42 B.T.A. 851; 1940 BTA LEXIS 955; September 27, 1940, Promulgated *955 Under an irrevocable trust a specified portion of the trust income was distributable to the grantor and the balance was to be accumulated to build up corpus. In the event the distributable income was insufficient to properly provide for grantor's support, maintenance, and benefit the trustee was empowered to pay out of principal so much as should be required to make up such insufficiency. Such contingency never occurred. Held, that during the taxable years there was no power vested in the trustee to revest any part of the corpus in the grantor or to make future distributions of accumulated trust income to the grantor and, further, that respondent erred in taxing undistributed trust income to the grantor, under sections 166 and 167 of the Revenue Acts of 1934 and 1936. J. S. Y. Ivins, Esq., for the petitioners. Philip A. Bayer, Esq., for the respondent. TYSON *851 These consolidated proceedings involve income tax deficiencies for the years, and in the amounts, as follows: Year Deficiency Katharine Boyd Morehead [1936] $30,057.92 [1934] 5,690.04 Mary Boyd Evans [1935] 2,780.42 [1936] 32,479.26 *852 *956 Each case presents the issues (1) of whether respondent erred in taxing to the petitioner, under sections 166 and 167 of the Revenue Acts of 1934 and/or 1936, the income of a trust which was accumulated in each taxable year by the trustee under the terms of the trust instrument, and (2) in the alternative, whether respondent erred in taxing to petitioner the amount reported in the fiduciary return as a capital gain derived from the sale of securities in 1936. FINDINGS OF FACT. The petitioner, Katharine Boyd Morehead, is a resident of Tucson, Arizona. Her individual income tax return for the year 1936 was filed with the collector for the district of Arizona. At the time of her creation of the trust hereinafter mentioned she was the wife of William C. Morehead, from whom she was divorced in 1933. The petitioner Mary Boyd Evans is a resident of Greenville, Delaware. Her individual income tax returns for the years 1934, 1935, and 1936 were filed with the collector for the district of Delaware. She is the wife of Elwyn Evans and has been since the creation by her of the trust hereinafter mentioned. The petitioners are the daughters of Lloyd T. Boyd and his wife, Susan A. *957 Boyd. Lloyd T. Boyd died testate in 1914 and his will was admitted to probate in Wisconsin in 1915. Under the decedent's will and the decree of the County Court for Milwaukee County, Wisconsin, dated December 22, 1915, all of his personal and real property was to be distributed to Susan Boyd for life, or until she remarried, with full right and power to use, enjoy, sell or dispose of the same during such period. Also, under that will and decree, in the event of Susan Boyd's remarriage, two-thirds of decedent's estate, and upon her death, all of decedent's estate then remaining undisposed of and in her hands, was to be distributed, in equal shares, to the petitioners. Up to the time of the hearing on these proceedings Susan Boyd was living and had not remarried and the property of decedent was distributed to her in accordance with the provisions of decedent's will and the decree of the County Court. The principal asset embraced in the decedent's estate consisted of 500 shares of stock of the Journal Co., having an appraised value of $80,000, as set forth in the above mentioned decree of the County Court. For a period of years up to November 1931, such 500 shares stood in the*958 individual name of Susan Boyd on the records of the Journal Co. Over a period of about three years prior to 1931, Susan Boyd considered the advisability of placing in trust, during her lifetime, a portion of the 500 shares of Journal Co. stock for the protection and benefit of each of her two daughters and their children. In the fall of *853 1931, after several conferences with members of the family and her attorneys, Susan Boyd proposed to transfer her life interest in 166 shares of Journal Co. stock to each of petitioners, with the understanding that they would each immediately thereafter execute the trust instrument which she had had drawn for each of them as grantor, respectively, and each of the petitioners agreed to such proposal. On November 2, 1931, Susan Boyd, as the first party, and Katharine Morehead and May Evans, as the second parties, executed an agreement whereby the former sold, assigned and transferred all her right, title, and interest in 166 shares of Journal Co. stock to each of the latter two, free from any right, claim, or interest therein of Susan Boyd. By the same agreement Katharine Morehead and Mary Evans each agreed that such transfer was in*959 full satisfaction and discharge of any and all obligation of Susan Boyd to divide any portion of her deceased husband's estate with them, except that they retained their vested remainder interest in the remaining 168 shares of Journal Co. stock as to which Susan Boyd retained her life interest. Pursuant to the understanding with their mother, and under date of November 12, 1931, Katharine Morehead and Mary Evans, each as trustor, executed a separate trust agreement wherey they each, as owner, transferred 166 shares of Journal Co. stock to the Wilmington Trust Co., a Delaware corporation, as trustee. Those two trust instruments were drafted pursuant to Susan Boyd's ideas, which were, inter alia: (1) To provide a sufficient income for the maintenance of each of her daughters for life and thereafter to their children; (2) to provide for the accumulation and investment of a portion of the trust income to build up the corpus so as to guard against the hazard of the Journal Co. stock becoming worthless at some future date; and (3) to provide her daughters with the right, during their lifetime, to direct the trustee to divide the trust fund into shares for the benefit of their respective*960 issue. The two trust instruments contain similar provisions and only the portions thereof pertinent to the issues herein will be briefly set forth. Each trust is irrevocable. The corporate trustee is given broad powers to hold, manage, sell, invest, and reinvest the trust corpus and any accumulated income under the direction, or with the consent, of a named "advisor" other than the trustor, except that it may dispose of the trusteed Journal Co. stock only upon the written direction or consent of Susan Boyd during her lifetime. The "advisor" and a majority of the adult beneficiaries of the trust may remove the trustee and appoint as a successor a bank or trust company having a capital of at least $1,000,000. The corporate trustee, so long as it holds any shares of Journal Co. stock, is directed to accumulate annually and add to the corpus a *854 certain portion of the income of the trust fund (including the income from any shares into which the trust fund may be divided for the benefit of the trustor's children) namely, the portion by which the net income of the trust fund shall exceed $20,000, until the fair market value of such accumulations amount, in the aggregate, *961 to $1,000,000; but not more than one-third of such net income in any one year shall be so accumulated. The corporate trustee is directed to pay over to the trustor during her life so much of the net income of the trust fund, or of her share in such trust fund if the trust fund has been divided into shares, as shall not be subject to accumulation. The trustor, during her lifetime, is given the right to direct the trustee to set aside certain portions of the trust fund as "shares" for the benefit of her issue. Upon the trustor's death the income, and eventually the trust fund or the "shares" thereof, go to the trustor's issue and their descendants in a certain manner not material here. The trust instrument further provides: 9. (a) It is the intent hereof that the income of the trust fund shall be used only for the personal benefit of the beneficiaries herein named or described and their dependents, and said income shall not be susceptible of anticipation, assignment, attachment, garnishment, seizure or other diversion from said purposes. No part thereof shall be paid to any assignee of any beneficiary. * * * 10. If, during the continuance of this trust, the income*962 currently payable hereunder to or for the benefit of any beneficiary, together with his or her income from other sources, should be insufficient to properly provide for the support, maintenance, benefit and/or education of such beneficiary and his or her dependents, Trustee is authorized and empowered, in its sole discretion, to pay over unto or for the benefit of such beneficiary so much of the principal of any part or the whole of the trust fund from which such beneficiary may then be receiving the income or the benefit thereof, as may from time to time be required to make up such insufficiency of income. The receipt of any beneficiary for or evidence of the application to the benefit of any beneficiary of any payment made in conformity with the foregoing provision shall fully discharge Trustee from any further liability in connection therewith. The above quoted paragraph 10 of the trust agreement is the only provision contained therein whereby any portion of the trust corpus, including accumulations added thereto, could be turned over to the trustor. Since the creation of the trusts the trustee has made no distributions to either of the petitioners under the provisions of paragraph*963 10. Neither of the petitioners has ever directed a division of the trust fund into "shares" and up to December 31, 1936, all of the income of each trust that was not subject to accumulation has been distributable to petitioners, respectively. *855 During the taxable years each of the petitioners was the owner of separate property and had income other than that received from the trusts. At no time from the creation of the trusts to the end of the year 1936 has the income of either of the petitioners, by distributions of income from the trusts and from other sources, been insufficient to properly provide for her support, maintenance, benefit, and/or education, or for that of her dependents. On December 30, 1936, the trustee sold for each trust 33 shares of Journal Co. stock for $3,500 per share. Such shares were a part of the 500 shares of Journal Co. stock embraced in the estate of Lloyd T. Boyd at the appraised value of $80,000, $160or per share. In determining the deficiencies in controversy herein, the respondent has determined that the petitioners, as grantors, are taxable upon the entire income of their respective trusts, under sections 166 and 167 of the Revenue*964 Acts of 1934 and/or 1936. To the distributable and distributed trust income reported by each of petitioners in their respective individual tax returns, the respondent has added the following amounts, representing the accumulated trust income for each taxable year, which were reported on the fiduciary returns as being taxable to the trustee under section 161 of the applicable Revenue Acts: Amount Year Katharine Morehead $60,441.10 [1936] 19,822.98 [1934] Mary Evans 14,154.53 [1935] 60,144.18 [1936] OPINION. TYSON: Under the facts in the instant proceedings it is clear that sections 166 and 167, supra, have no application unless the above quoted paragraph 10 of each of the trust agreements has vested in the trustee, as a person not having a substantial adverse interest, the power to revest in the petitioners, as grantors, any part of the corpus of their respective trusts, or the income therefrom, or, the discretion to hold and accumulate any part of the income of the respective trusts for future distribution to the petitioners as grantors. Under the provisions of that paragraph 10, it is only in the event that trust income currently distributable*965 to each petitioner, together with her other income, should be insufficient to properly provide for the support and maintenance of herself and her dependents or for their benefit that the trustee alone, "in its sole discretion", is empowered to make any payments out of the "principal" of the trusts to the petitioners, respectively, and then only in such amount as may be required to make up such insufficiency. *856 The record discloses that very substantial amounts of trust income have been distributed to each of the petitioners during each year, from the creation of the trust up to the end of the year 1936, and that the contingency provided for in paragraph 10 of the trust agreements has never arisen. In , the Board had under consideration the effect of a provision in a trust instrument similar to that contained in paragraph 10 in the trust instruments in the instant proceedings. In that case, after reviewing numerous cited authorities, the Board held that the limited power of the trustee to distribute any portion of the trust corpus to the grantor did not vest and was no power at all until and unless there*966 occurred the contingency upon which such power could be exercised. In that case, however, since the taxpayer failed to adduce proof to contradict the occurrence in the taxable year of the contingency upon which the trustee's power to revest corpus depended, the Board held that the taxpayer had failed to establish error in the respondent's determination that the entire trust income was taxable to the grantor, under section 166 of the Revenue Act of 1934. In the instant case it is clearly established that the contingency had not occurred in any of the taxable years here involved. Thus, in those years, there was no power vested in the trustee of the two trusts to revest any part of the corpus of the trusts in either of the petitioners, or to make future distributions to them of accumulated trust income, ; cf. ; nor was there such a power vested in any other person. The case of , is distinguished from the instant case in that there the terms of the trust instrument providing for an invasion of trust corpus and accumulated income were*967 so broad that they reserved to the grantor, in conjunction with a disinterested trustee, the power to revest in the grantor both the income and the corpus of the trust. Here a reasonable construction of the trust instrument in its entirety - as it must be construed - leads to the contrary conclusion, which has been reached. On the first issue we hold that the respondent erred in his determination as hereinbefore set forth. This conclusion obviates the necessity of considering the second, or alternative, issue. Reviewed by the Board. Decision in each proceeding will be entered under Rule 50. MELLOTT MELLOTT, dissenting: The corporate trustee was not a person "having a substantial adverse interest in the disposition * * * of the corpus or the income therefrom" (Reinecke v. Smith,289 U.S. 172); the *857 settlor was a beneficiary; both the "distributable income" and the corpus could be distributed to her at any time that her income from other sources "should be insufficient to properly provide for" her support, maintenance or benefit (see discussion of "benefit" in Helvering v. Hormel, 111 Fed.(2d) 1, and note*968 the use of the same word in the heading of section 167); and she, like Mary E. Wenger,42 B.T.A. 225, could have the income and, if necessary, the corpus distributed to her at any time. In the Wenger case we held that the petitioner was taxable under both sections 166 and 167. (42 B.T.A. 232.) A similar holding, I think, should be made here. DISNEY, HARRON, and OPPER agree with this dissent.