Tonningsen Trust v. Commissioner

JOHN AND PAULINE TONNINGSEN TRUST, BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, TRUSTEE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Tonningsen Trust v. Commissioner Docket No. 99280. United States Board of Tax Appeals 43 B.T.A. 37; 1940 BTA LEXIS 855; December 10, 1940, Promulgated *855 1. Where corpus of trust was in fact invaded and payments therefrom made to life beneficiary, capital gains allocable to corpus under California law were not "permanently set aside" for charitable remaindermen so as to justify the deduction provided by section 162(a), Revenue Act of 1934. 2. Where trust instrument provided for the payment of estate taxes and attorneys' fees out of the income of the trust, income thus used held not paid to charities within section 162(a), Revenue Act of 1936. 3. Where trust filed information return 1041, adequacy of information given therein not being challenged, and regulations not clearly providing for filing of additional return, held imposition of penalty under section 291 of the Revenue Act of 1936 for failure to file return "required by this title" unauthorized. F. J. Kilmartin, Esq., and J. W. Radil, Esq., for the petitioner. Harry R. Horrow, Esq., for the respondent. OPPER *37 This proceeding was brought for a redetermination of deficiencies in income tax for the years 1935 and 1936 in the amounts of $4,610.65 and $1,713.74, respectively. A penalty of $428.44 is asserted for the*856 year 1936. The sole question involved with respect to the year 1935 is whether petitioner is entitled to a deduction under the provisions of section 162(a) of the Revenue Act of 1934 of capital gains realized by it during the year but covered into corpus as an accretion thereto and not distributed as net income to the life beneficiaries. With respect to the year 1936 the questions are whether by reason of provisions of the trust there should be included in petitioner's taxable income sums paid by it for legal expenses and Federal estate taxes or whether these items give rise to a deduction under the provisions of section 162(a) of the Revenue Act of 1936, and whether the asserted penalty for failure to file should be sustained. FINDINGS OF FACT. Petitioner, a national banking association with principal offices at San Francisco, California, is and at all times herein material was the duly qualified and acting trustee of the John and Pauline Tonningsen trust (hereinafter referred to as the trust), created under date of August 7, 1930. The trust names John Tonningsen as the first trustor and Pauline E. Tonningsen, his wife, as the second trustor and petitioner's predecessor, *857 the trustee. *38 Those parts of the trust agreement and the amendments thereto which are pertinent to the issues before us are as follows: ARTICLE IV. The Trustee shall take, collect and receive the income of the trust fund and estate, and after paying therefrom the costs and expenses of the trust, shall pay said net income to the First Trustor during his lifetime * * *. In the event that the Second Trustor should survive the Trustor, and this Trust becomes irrevocable under the provisions hereinafter contained, the Trustee shall pay to said Second Trustor, all of the net income of the trust fund and estate, in convenient installments, as nearly equal in amount as the condition of the Trust will permit, and should the said Second Trustor be in need of a greater amount than said net income for her care, maintenance and support, or by reason of illness or other emergency, the Trustee may, in its absolute discretion, pay to her, out of the principal of the trust fund and estate, such additional amounts as it may deem necessary and appropriate for the purposes aforesaid, and no one, howsoever interested in the Trust, shall be competent to object thereto. * * * ARTICLE*858 VII. If not revoked by the First Trustor, during his lifetime, the Trust shall become irrevocable upon the death of the First Trustor, and should the Second Trustor survive him, the Trust shall be administered for her use and benefit as hereinbefore provided, and upon the death of the survivor of the Trustors, the Trustee shall administer the trust thereof in the manner following, to-wit: (a) Out of the income of the trust fund and estate, if that be sufficient, or out of the principal thereof, if necessary, the Trustee shall pay the costs and expenses of the surviving Trustor's last illness and of his or her funeral and burial, unless other provision shall have been made therefor, and the inheritance tax upon all distributive shares of or interests in the trust fund and estate, if any be due, and any Federal Estate Tax due upon the whole thereof, and the costs and expenses of the Trust, including the compensation of the Trustee and all preferred claims or charges against the trust estate, including interest thereon, and the Trustee, during the continuance of this Trust, shall, in its absolute discretion, devote such sums as it may deem necessary for the care and upkeep of the*859 PIERRE and PAULINE SOMPS VAULT in Holy Cross Cemetery, San Mateo County, California; said vault is presumably to be cared for under a contract providing for perpetual care thereof, but if, for any reason, said vault should not be properly cared for, the Trustee is urged to and authorized to make any necessary repairs thereto. (b) Out of any undistributed income and/or principal of the trust fund and estate, the Trustee shall make the following payments: [A direction for payment of $104,000 to specific individuals.] (c) Out of the net income of the trust fund and estate not required for any of the purposes aforesaid, the Trustee shall make the following payments: [A direction for payment of annuities aggregating $600 per month.] (d) The Trustee shall pay over all of the net income of the trust fund and estate, not required for any of the purposes aforesaid, in perpetuity, as follows: [A direction is made for the payment of the income in equal shares to six organizations qualifying as charitable organizations under the applicable provisions of the Revenue Act.] * * * *39 ARTICLE IX. The Trustee shall be compensated for its services as follows: * * * (e) *860 Reasonable compensation to the Trustee for any extraordinary services performed by it in defending the Trust or the trust estate, or the interest of any beneficiary hereunder, including the costs and expenses of the Trustee in so doing. John Tonningsen died November 28, 1933. At that time respondent valued the assets of the trust at $702,222.51. From that time until the date of her death on January 25, 1936, Pauline Tonningsen resided at the Hotel St. Frances, San Francisco, California, with her niece, Louise Weyer. They occupied a suite of four rooms, for which Pauline Tonningsen paid the rent. Prior to her husband's death Pauline Tonningsen had been paralyzed and from the date of his death until her own death she was confined to her bed and wheel chair. She was under constant care of physicians and had nurses continually in attendance. She was 81 years old when her husband died. The hotel books showed expenses incurred by her of $1,338.98 for November and December 1933; $8,210.22 for 1934; $8,744.05 for 1935: and $723.91 for January 1936. The above sums were for rent and meals for herself and Louise Weyer. She had no servants other than the hotel afforded and did not*861 entertain except to receive her close friends. Pauline Tonningsen's bills for physicians' services totaled $635, $796, and $122 for the years 1934, 1935, and 1936, respectively. After the death of John Tonningsen all of the income of the trust was paid to Pauline Tonningsen. Beginning February 1934, the trustee paid Pauline Tonningsen and amount of $5,000 per month without regard to the income received by the trust, the charities who were the remaindermen of the trust having given their consent. The agreement was renewed in December 1934, and again on April 3, 1935, for a period of one year from March 1, 1935, or a shorter period in the event of Pauline Tonningsen's death. The trustee had objected to making the payments unless it was held harmless by the remaindermen. By reason of this arrangement total payments out of the corpus amounting to $16,614.53 were made in 1934 and $9,545.80 were made in 1935. At the time of her death on January 25, 1936, at the age of 83 years, 7 months, and 3 days, Pauline Tonningsen had an individual separate estate subsequently appraised at $87,046.67 and bank accounts in joint tenancy with Louise Weyer in the sum of $103,067.06. Louise*862 Weyer was the recipient of Pauline Tonningsen's estate, bank accounts in joint tenancy, and gifts in contemplation of death in the total sum of $161,745.92. Pauline Tonningsen had no children. She had other relatives by blood and marriage but did not remember them in her will. *40 Petitioner paid out for the maintenance of the cemetery vault designated in the trust indenture the amount of $200. On July 26, 1936, the Superior Court of San Francisco County decreed that the clause of the trust providing for the care and upkeep of the cemetery vault was invalid and authorized the trustee to hold the trust free of any obligation to keep up and repair the vault. The trust estate was composed of real and personal property and yielded net income as follows: — 1931 — $70,970.00 — 1932 — 73,984.18 — 1933 — 47,693.67 — 1934 — 45,571.58 — 1935 — 45,938.85 Petitioner filed a return for 1935 on a cash basis. During that year, in addition to other income, it realized the sum of $32,785.40 as taxable income from capital gains. During 1936 petitioner realized gross taxable income of $74,989.57. Respondent concedes deductions of $3,146.74 miscellaneous expenses and $43,450.17*863 capital gains permanently set aside for charitable organizations. A deficiency in estate tax was proposed against the executors of the estate of John Tonningsen and the executors sought to have the petitioner pay all or part thereof out of the trust property, contending that the trust was liable for all or part of the Federal tax due from the estate by reason of the inclusion in the gross estate of the corpus of the trust because of the provision for payment of estate tax appearing in article VII (a) of the trust agreement. The trustees denied liability on the ground that the payments specified in article VII (a) were to be made upon the death of the survivor of the trustors, and, Pauline Tonningsen still being alive, no payments could be made. A similar issue arose under the California estate tax. The trustees realized they might be liable, so they employed counsel and sought to be recognized by the Commissioner as a taxpayer and evidenced a willingness to pay their share of the tax. A reduction was obtained in the amount of the deficiency. In determining the amount of the deficiency a deduction of $472,672.74, being the value of the remainder interest in the corpus, was allowed*864 as permanently set aside for charitable uses. After Pauline Tonningsen's death and on June 12, 1936, the executor of the estate of John Tonningsen and the petitioner herein reached an agreement relative to the amount of Federal and California estate taxes which the trustees would pay, which was two-thirds of the deficiency, plus interest. Consent to this agreement and a waiver *41 of any claims against the trustees were made by the charities which were the remaindermen. On June 30, 1936, petitioner paid the executors of the estate of John Tonningsen, pursuant to the above mentioned agreement, on account of Federal estate taxes, $15,616.24, being two-thirds of the deficiency, and $1,436.70, being two-thirds of the interest thereof, together with $1,480.92, being two-thirds of the California estate tax. This, petitioner charged to principal on its records. The executors paid the deficiency and interest in June 1936. The sum of $7,500 was paid to the attorney representing the petitioner in connection with the dispute over the estate tax liability. This was charged to income on the records of the trust and taken as a deduction from gross income on the fiduciary return*865 for the year 1936. In July and December of 1936, petitioner paid to charities designated in the trust instrument the total sum of $17,178.44, which amounts were charged against income on the records of the trust. During 1936 petitioner also made payments totaling $102,000 under article VII(b) of the trust indenture to parties named therein, which payments were charged to principal on petitioner's records. Petitioner filed a return for the year 1936 on Form 1041. Its gross income for that year was in excess of $5,000. No return on Form 1040 was ever filed by petitioner for the year 1936. In determining the deficiency for 1936, respondent allocated the payments of estate tax and attorneys' fees between taxable and taxexempt income and denied the deduction for payment to charitable institutions of the proportionate amount. OPINION. OPPER: The first question is whether capital gains of the petitioner trust concededly allocable to corpus under California law were so "paid or permanently set aside" for charitable purposes as to be exempt from income tax under Revenue Act of 1934, section 162(a). 1 *866 *42 There is no contention that any amounts were actually paid, and the question arises by reason of provisions in the trust instrument granting to certain individuals such rights to income and possibly to principal as to cause the parties to disagree whether it can be said that the capital gains in question were permanently set aside for the use of the charities, so as to be beyond the reach of distribution to the individual beneficiaries and thus to comply with the requirements of section 162(a). A cognate question has arisen from time to time as to exemption from estate tax under Revenue Act of 1926, section 303(a)(3), and similar provisions of other acts. See e.g. . It is suggested that the tendency in considering such cases has been for the courts to ascertain as nearly as may be the extent to which a gift may reasonably be considered as destined for charitable purposes and to permit the exclusion of an estimated value thereof as the nearest approximation that can be made to a necessarily final result. See *867 ; certiorari denied, . In cases dealing with income, however, where questions identical to that now before us were involved, a more rigorous approach has been adopted on occasion, and the deduction has been denied unless enjoyment by the charitable beneficiaries is shown to be almost certain and virtually inevitable. See e.g. ; ; ; . But see ; affd. (C.C.A., 10th Cir.), . See also . Whether or to what extent the two rules are in fact different, however, or which of them is more properly applicable to such a case as this, we find it unnecessary to decide. For even if we adopt the*868 approach suggested by petitioner and endeavor to determine, on the basis of the probabilities as they existed in the years involved, the reasonable likelihood that these capital gains were protected from invasion in favor of the individual beneficiaries, we are forced to conclude that the weight of evidence is contrary to petitioner's contention. Likelihood that corpus would be devoted to noncharitable purposes appears from the most cogent of circumstances, the compelling logic of actual events. It is shown that in all the relevant years such large payments were made to the individual beneficiary that a substantial amount in each year was taken from the corpus. *43 And of course if it happened in one year there is the more reason for expecting a repetition. There is no indication that the years before us were exceptional or that the needs of the individual beneficiary were greater or the trust income less than could be anticipated in any typical period. It follows that petitioner has failed to show that the corpus, of which these capital gains became an indistinguishable part, was so protected from invasion as to enable us to say that they were permanently set aside for*869 the benefit of the charities. The evidence indicates the contrary. Petitioners contend that since this invasion of corpus had the consent of the remaindermen, the charitable institutions, it is no proof that the life tenant was within her legal rights in demanding the payments from corpus. This may or may not be true, since the consent of the beneficiaries in despite of their financial interest might well proceed from a recognition on their part that a litigated contest would result unfavorably to them. But, be that as it may, our question is "a factual one", ; not what were the legal rights of the parties but what were the actual probabilities. And if the consent of the remaindermen to the invasion of corpus was obtained in one year, there would be no reason to assume that it would not be forthcoming, as in fact it was, in the next. It is unnecessary to add that there were also individual remaindermen for the payment of whose specified shares corpus would have to be used. See We conclude that the capital gains which were added to corpus in 1935 can not be said to*870 have been paid or permanently set aside for charitable purposes. For the year 1936 a different question arises. Payments of estate tax on the estate of the grantor of the trust and of attorneys' fees were made by petitioner, the former being charged to corpus. An amount equal to the income of the trust was paid as such to the charitable organizations, and is claimed as a deduction in the full amount under section 162(a). It is respondent's position in disallowing that deduction that the payments of estate tax and attorneys' fees were actually payments out of income and to the extent thereof reduced the current income available for distribution to the charities, so that in effect what was paid to them was in reality not income but corpus and hence not deductible. The deduction which is permitted is of "any part of the gross income, without limitation, which, pursuant to the terms of the will or deed creating the trust, is during the taxable year paid" for charitable purposes. If, as respondent contends, the parts of the gross income in question were not, pursuant to the deed creating the trust, paid to the charities, the deduction would not be available. The *44 issue, *871 therefore, narrows to the question whether the trust instrument provided that the payments of estate taxes and attorneys' fees should be made from income or whether it directed that the income should be used for the payments to charity. According to the deed of trust the payments to the charitable institutions were to be the net income "not required for any of the purposes aforesaid." This is provided by article VII(d). Article VII(a) requires the trustee "out of the income of the trust fund and estate, if that be sufficient, or out of the principal thereof, if necessary" to pay "the inheritance tax upon the distributive shares of or interests in the trust fund and estate, if any be due, and any Federal estate tax due upon the whole thereof and the costs and expenses of the trust." These provisions appear to be so clear as to offer small room for construction. The income of the trust for the year 1936 was sufficient to pay the estate taxes and attorneys' fees in question. The trust deed requires that under those circumstances they be paid out of that income. It provides for the distribution to the charities of only the income not so required, thus precluding any distribution*872 to them "pursuant to the terms of the will or deed creating the trust" of income which had already been used pursuant to those terms for other purposes. The deduction in question accordingly finds no support in section 162(a). See It is not entirely clear whether the payment of attorneys' fees is also claimed as a deduction on the ground of ordinary and necessary business expense. Such a claim, if made, must be denied in the complete absence of any showing that the trust was engaged in a trade or business. ; . The final issue involves the proposed imposition of a penalty for petitioner's failure to file a return. The question raised is whether omission to file Form 1040 covering taxable net income of the trust, although concededly Form 1041, the information return, was duly filed, subjects petitioner to the penalty imposed by section 291 of the Revenue Act of 1936. 2 *873 *45 The penalty is for failure to file a return "required by this title." Section 142 entitled "Fiduciary Returns" requires "every fiduciary" to "make under oath a return for * * * (4) every estate or trust the net income of which for the taxable year is $1,000 or over; (5) every estate or trust the gross income of which for the taxable year is $5,000 or over." Nothing is said as to the form on which the return must be filed and there is no contention here that the respondent was not given all the necessary information on the form which the petitioner filed. Under the respondent's regulations 3 it is by no means clear that more than one return was required in the present case, nor on which form the income should be returned by the fiduciary. It is clear that a return of Form 1041 would be required if deductions were sought under sections 162(b) or (c), but the deductions claimed by petitioner were those described in section 162(a), a situation as to which the regulations are silent. Nor, on the theory of either party to this proceeding, would the case fall within the condition that a portion of the income is retained by the fiduciary and the remainder distributed, since*874 on petitioner's theory none of the taxable income was retained and, on the respondent's, all. We are accordingly unable to say that the missing return was required by the specified title of the revenue act, even though its provisions be amplified by reference to respondent's regulations. That being so, the necessary prerequisite for the application of the penalty provision is absent. See . We do not purport to pass upon a case disclosing a failure to file a return clearly called for by the statute or even by respondent's regulations, whether or not that return is an additional return to one otherwise required. See ; . Questions of that kind must be left open for determination on a record and under circumstances more favorable to respondent's contention than those appearing here. *875 Decision will be entered under Rule 50. Footnotes 1. SEC. 162. NET INCOME. The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that - (a) There shall be allowed as a deduction (in lieu of the deduction for charitable, etc., contributions authorized by section 23(o)) any part of the gross income, without limitation, which pursuant to the terms of the will or deed creating the trust, is during the taxable year paid or permanently set aside for the purposes and in the manner specified in section 23(o), or is to be used exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, or for the establishment, acquisition, maintenance or operation of a public cemetery not operated for profit; * * * ↩ 2. SEC. 291. FAILURE TO FILE RETURN. In case of any failure to make and file return required by this title, within the time prescribed by law or prescribed by the Commissioner in pursuance oa law, unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the tax: 5 per centum if the failure is for not more than thirty days with an additional 5 per centum for each additional thirty days or fraction thereof during which such failure continues, not exceeding 25 per centum in the aggregate. The amount so added to any tax shall be collected at the same time and in the same manner and as a part of the tax unless the tax has been paid before the discovery of the neglect, in which case the amount so added shall be collected in the same manner as the tax. The amount added to the tax under this section shall be in lieu of the 25 per centum addition to the tax provided in section 3176 of the Revised Statutes, as amended. ↩ 3. ART. 142 - 1. Fiduciary returns. - Every fiduciary, or at least one of joint fiduciaries, must make a return of income - (b) For the estate or trust for which he acts if the net income of such estate or trust is $1,000 or over, or if the gross income of the estate or trust is $5,000 or over, regardless of the amount of the net income, or if any beneficiary of such estate or trust is a nonresident alien. The return in case (a) shall be on Form 1040 or 1040A. In case (b) a return is required on Form 1040 with respect to any taxable net income of the estate or trust computed in accordance with section 162 and a return on Form 1041 with respect to any income deducted under section 162(b) or (c). If a portion of the income of the estate or trust is retained by the fiduciary and the remainder is distributable or distributed to beneficiaries, both Forms 1040 and 1041 will be required. * * * ↩