Opinion
Docket Nos. 5773 5774.
1945-11-13
FRANK E. JOSEPH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.FRANK E. JOSEPH-MARTHA J. JOSEPH, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
William B. Cockley, Esq., J. W. Reavis, Esq., and Arthur L. Dougan, Esq., for the petitioners. Lawrence R. Bloomenthal, Esq., for the respondent.
Petitioner's deceased wife was the beneficiary of a trust established by her father and had a general power of appointment, to be exercised by will, over the trust corpus. She died after having executed a will in which she left all of her property to her husband, petitioner, but the will was invalidated by the birth of a son after its execution and was never probated. After his wife's death the petitioner entered into an agreement with the Irving Trust Co. of New York under which all of the son's property and all of the estate of his deceased mother were transferred to the Irving Trust Co. as trustee. The agreement provided that all of the net income from this property was to be paid over to the petitioner for the ‘support, maintenance and education‘ of the son during his minority and the principal was to be distributed to the son, one-half at the age of 25 years and the balance at the age of 30 years. The petitioner received all of the income of the trust during the taxable years, but returned most of it to the trustee to be added to the trust principal. He paid all of the expenses of his son's support, maintenance, and education out of his personal funds. Held, that the petitioner is liable for income tax upon only such portion of the income as accrued upon the portion of the principal of the trust fund contributed by him. William B. Cockley, Esq., J. W. Reavis, Esq., and Arthur L. Dougan, Esq., for the petitioners. Lawrence R. Bloomenthal, Esq., for the respondent.
These proceedings, consolidated for hearing, involve deficiencies in income tax as follows:
+---------------------------------------------------------+ ¦ ¦Docket¦ ¦ ¦ +--------------------------------+------+------+----------¦ ¦Petitioner ¦No. ¦Year ¦Deficiency¦ +--------------------------------+------+------+----------¦ ¦ ¦ ¦( 1939¦$1,237.93 ¦ +--------------------------------+------+------+----------¦ ¦Frank E. Joseph ¦5773 ¦( 1940¦2,054.06 ¦ +--------------------------------+------+------+----------¦ ¦Frank E. Joseph-Martha J. Joseph¦5774 ¦1941 ¦2,491.58 ¦ +---------------------------------------------------------+
The petitioners in Docket No. 5774 are husband and wife, who filed a joint income tax return for 1941. Frank E. Joseph will be referred to hereinafter as petitioner.
The question in issue is whether petitioner is taxable on the income of a trust created by him in 1930, to which he transferred all of his deceased wife's estate and all of their minor son's property, reserving to himself only the right to receive the trust income for the support, maintenance, and education of the son.
FINDINGS OF FACT.
Petitioner is a resident of Cleveland, Ohio. He filed his income tax returns for the years in question with the collector of internal revenue for the eighteenth district of Ohio, at Cleveland.
Petitioner was married to Adele Unterberg, a resident of New York, on October 23, 1927. He and his wife established a residence at Cleveland, Ohio, where petitioner was engaged in the practice of law and lived until the wife's death on February 5, 1929. A son, Frank E. Joseph, Jr., was born on November 2, 1928.
At the time of her death Adele was the income beneficiary of a trust, hereinafter referred to as the Unterberg trust, which her father, Israel Unterberg, had created for her under the laws of the State of New York on August 31, 1921. The trust agreement provided, in so far as here material, that the trustees were to pay the net income of the trust to Adele quarterly during her life:
* * * and upon her death to transfer, convey and set over the principal in which said trust shall then be invested, to such person or persons, and in such shares and proportions as she shall, by last will and testament, or instrument in the nature thereof, direct and appoint; and in the absence of such testamentary disposition, to those who would be entitled to her personal estate according to the laws of the place of her residence at the time of death, if she had died intestate.
Adele's mother, Bella Unterberg, and her father's attorney, Harry Liebovitz, were named as trustees. The assets of the trust consisted originally of Israel Unterberg's promissory note for $100,000, payable July 1, 1941, with interest at 6 percent.
Petitioner's wife executed a will at Cleveland on January 9, 1928. The will reads in its entirety as follows:
LAST WILL AND TESTAMENT
KNOW ALL MEN BY THESE PRESENTS, that I, Adele Unterberg Joseph, of the City of Cleveland, County of Cuyahoga, and State of Ohio, hereby revoking any and all wills, testaments, and/or codicils by me heretofore made, do hereby make, declare, and publish this my Last Will and Testament, as follows:
ITEM I. I give, bequeath and devise absolutely my entire estate to my husband, Frank Emil Joseph.
ITEM II. I nominate, constitute, and appoint my husband, Frank Emil Joseph, executor of this my Last Will and Testament, and direct that no inventory or appraisement be made of my estate and that my said executor be not required to furnish bonds for the faithful performance of his duties as such executor.
IN WITNESS WHEREOF, I have hereunto affixed my signature at the City of Cleveland, Ohio, this 9th day of January, 1928.
The above will was revoked under the laws of the State of Ohio by the subsequent birth of the son (see sec. 10561, Ohio General Code, in force in 1929), and accordingly it was never probated. At the time of the wife's death her estate consisted of her personal effects, a checking account of about $1,700 with the Union Trust Co. of Cleveland, and her interest in the trust created by her father. At that time the corpus of the trust consisted of $4,500 cash and 1,000 shares each of class A and class B preferred stock of Unterberg Realty Corporation, which was a real estate holding corporation for the Unterberg family.
Within a short time after his wife's death petitioner discussed with her family the matter of disposing of her estate. He told her father, Israel Unterberg, and her brother, Clarence E. Unterberg, and others, that he did not want and would not claim or receive any of her property for his own use, but wanted it all held for the benefit of their son. Petitioner never attempted to have his deceased wife's will probated or established as an exercise of her power of appointment over the trust property in his favor, or otherwise to acquire in his own right any of the assets of her trust estate.
The advisability of having petitioner execute a formal renunciation of all his rights in the trust estate was discussed by petitioner and members of the Unterberg family, but that was thought inadvisable because it would necessitate the appointment of a guardian for the son and probably the distribution to him of a large amount of trust income when he should become twenty-one years of age. Also, it was thought that a judicially appointed guardian or trustee for the son would have been required by law to sell the Unterberg Realty Corporation stock which composed the corpus of the trust and reinvest the proceeds in legal securities. The Unterberg family did not want the stock sold. Israel Unterberg suggested that the property all be put in trust for the benefit of the son, to which petitioner agreed. Petitioner proposed that the trustees pay over the trust assets to him momentarily so that he could transfer them to another trust for the son's benefit. To carry out that purpose petitioner or his father, who was also engaged in the practice of law in Cleveland, had such a trust agreement drawn up in Cleveland, in which petitioner was named grantor and his son beneficiary. Petitioner sent a copy of the proposed trust agreement to Israel Unterberg in New York with a letter, dated December 26, 1929, reading in material part as follows:
I am enclosing herewith copy of proposed Trust Agreement by and between myself and The Bankers Trust Company which I hope you will find satisfactory. Please wire me if the same is agreeable to you, otherwise I suggest that you phone me and give me whatever suggestions you may have to offer.
I have tried to make the Trust Agreement as elastic as possible as my experience has been that it is extremely easy to get money and securities into a trust company and extremely difficult to get them out. I also have found that conditions change so over a period of years that it is unwise to tie money up too strictly. I am unable to have the income accumulated as this is not permitted under the laws of New York. However, whenever I receive income I intend to immediately turn it back to the Trustee to be added to the Trust Estate.
I have sent copies of the Trust Agreement both to Edgar and to The Bankers Trust Company and would appreciate your giving your copy to Clarence as I naturally also want his approval.
On January 13, 1930, petitioner wrote a letter to Henry Strack of the law firm of White & Case, New York City, attorneys for the Bankers Trust Co., which had been selected to serve as trustee of the proposed trust, stating in part:
In accordance with my telephone conversation with you of last week I would like to set before you the full facts in connection with the securities which I am now attempting to trustee at the Bankers Trust Company in New York for the benefit of my son, Frank E. Joseph, Jr.
Under Ohio law, should this property descend intestate, my son would be entitled to two-thirds and I to one-third. I am willing to waive all of my rights to the securities and merely desire to trustee the entire amount for my son's benefit with the Bankers Trust Company. My principal purpose in doing this is to avoid the burdens of Ohio personal property taxes. Under Ohio law I can easily probate the will, although I have not yet done so, and after one year it becomes indisputable. I would be glad to furnish you with a certified copy of the will, the trust deed, death certificate, or such other documents as you may require.
The Unterberg family approved the trust agreement as submitted to them by petitioner, but on the advice of its attorneys the Bankers Trust Co. refused to accept the trust. Israel Unterberg then discussed the matter with the president of the Irving Trust Co., with whom he was personally acquainted, and after consultation with the trust officer that bank agreed to accept the trusteeship of the trust.
A new trust agreement was drawn which was substantially the same as the one petitioner had submitted, naming the Irving Trust Co. trustee and petitioner as donor. It provided that petitioner had ‘contemporaneously with the execution hereof, assigned, transferred, conveyed and delivered to the Trustee, In Trust for his son, Frank E. Joseph, Junior,‘ 1,000 shares of class A and 1,000 shares of class B stock of the Unterberg Realty Corporation and $4,500 cash. The trustee was directed to pay the net income of the trust ‘when and as received, unto the Donor, for the support, maintenance and education of the Beneficiary, in such manner as the Donor in his sole discretion may see fit.‘ One-half of the principal of the trust was to be distributed to the beneficiary at the age of 25 and the other half together with any undistributed income at the age of 30.
It was further provided that:
ARTICLE II.
If the Donor and Clarence E. Unterberg, now of New York City, shall at any time deliver to the Trustee notice in writing that in their judgment the income of the Trust Estate is not sufficient for the support, maintenance and education of the Beneficiary, then the Trustee shall transfer and deliver to the Donor, for the support, maintenance and education of the Beneficiary, such part of the Trust Estate as said Donor and said Clarence E. Unterberg shall stipulate. The Trustee, having transferred and delivered to the Donor such part of the Trust Estate as aforesaid, shall not be obligated or privileged to supervise or inquire into the proper application thereof. Upon the death or incapacity of said Clarence E. Unterberg, the Donor may alone deliver said written notice.
Article VII of the 1930 trust agreement provided for the retention of a certain measure of control of sales and exchanges of the trust estate, as well as of changes in investments of the trust estate, by providing that:
No sales or exchanges of any part of the Trust Estate, and no changes in the investments of the Trust Estate, shall be made by the Trustee except on written directions from the Donor and said Clarence E. Unterberg; and such sales, exchanges and changes in investments shall be made by the Trustee upon such written directions from the Donor and said Clarence E. Unterberg and the Trustee shall not be liable in any way for depreciation or loss incurred by reason of any such sales, exchanges, or changes in investments. Upon the death or incapacity of said Clarence E. Unterberg, the Donor shall have the sole right of controlling and directing such sales, exchanges, and changes in investments as aforesaid.
The trust was to terminate immediately upon the death of the beneficiary and the assets were to be turned over to his executor or administrator.
No changes could be made in the investments of the trust estate without the written consent of the donor and Clarence E. Unterberg.
The donor reserved no right to alter, amend, or revoke the trust except to add to the principal, if he should so desire, and no power over or interest in the trust corpus or income except those mentioned above.
The active trustee of the Unterberg trust, Harry Liebovitz, refused to transfer the assets to petitioner even momentarily. However, he did agree to transfer them directly to the Irving Trust Co. as trustee, provided petitioner would personally agree to indemnify him against any financial loss in the matter. Petitioner so agreed and the transfer was made. The new trust agreement was finally executed in New York on February 24, 1930.
Prior to the death of petitioner's wife and after the birth of their son a savings account was opened up for the son at the Union Trust Co., Cleveland, Ohio. Soon after his wife's death petitioner caused all of her cash assets, including her checking account of approximately $1,700, to be deposited in that account. At the time the above described trust was established with the Irving Trust Co. there was a balance of $5,606.13 in the son's account. Petitioner transferred that balance to a new checking account which he opened in his own name at the Irving Trust Co. at about the time the trust was executed. Upon opening that account petitioner wrote in his check book for the account as follows:
All moneys deposited in this account is derived from Frank E. Joseph, Jr.'s trust fund at Irving Trust Co. and belongs to him. As income cannot lawfully be accumulated in New York beyond the minority of the Beneficiary, I am taking the income from the trust fund, but immediately adding it to the corpus of the trust.
Thereafter petitioner deposited in the account all of the income distributed to him by the trustee and drew upon the account to pay his son's income and personal property taxes. From time to time petitioner drew funds out of the account and transferred them to the trust account to be added to trust corpus. The following statement shows the deposits made in the account and the disbursements or withdrawals therefrom through 1944:
+-------------------------------------------------------------------------+ ¦Total income received ¦$68,163.04¦ +--------------------------------------------------------------+----------¦ ¦Disposition of income: ¦ ¦ +--------------------------------------------------------------+----------¦ ¦Used to pay individual federal income taxes of Frank, Jr ¦14,733.31 ¦ +--------------------------------------------------------------+----------¦ ¦Used to pay Ohio personal property taxes of Frank, Jr ¦4,112.43 ¦ +--------------------------------------------------------------+----------¦ ¦Used to pay a part of a pledge of Mrs. Bella Unterberg, Frank,¦ ¦ +--------------------------------------------------------------+----------¦ ¦Jr.'s deceased grandmother, to the Young Women's Hebrew ¦ ¦ +--------------------------------------------------------------+----------¦ ¦Association ¦700.00 ¦ +--------------------------------------------------------------+----------¦ ¦Contributed to the perpetual care of the cemetery lot in which¦ ¦ +--------------------------------------------------------------+----------¦ ¦Adele Unterberg Joseph is buried ¦300.00 ¦ +--------------------------------------------------------------+----------¦ ¦Invested in life insurance on the life of Frank, Jr ¦6,446.35 ¦ +--------------------------------------------------------------+----------¦ ¦Added FN* Both “income” and additions to trust include $5,606.13 transferred from the Frank E. Joseph, Jr., account at the Union Trust Co., because it was run through the Irving Trust checking account, and, also $75 given to Frank, Jr., by Emil Joseph.
to the principal of the trust at the Irving Trust Co.¦ ¦ +--------------------------------------------------------------+----------¦ ¦for Frank, Jr ¦41,694.05 ¦ +--------------------------------------------------------------+----------¦ ¦Balance in account 12-31-44 ¦176.90 ¦ +--------------------------------------------------------------+----------¦ ¦Total ¦68,163.04 ¦ +--------------------------------------------------------------+----------¦ ¦ ¦ ¦ +-------------------------------------------------------------------------+
Petitioner has filed income tax returns for his son for all years since the trust was created, including therein the income received by him from the Irving Trust Co. as trustee of the trust. For the first few years he paid the tax shown to be due on the returns with his own funds, but in later years, as the amounts of such taxes increased, he paid them out of trust income.
The petitioner actually expended for the support and maintenance of his son out of his individual earnings $2,650.27 in 1939, $1,727.95 in 1940, and $1,868.65 in 1941. Those amounts were all that were expended for the support and maintenance of the son during those years.
By a letter to petitioner's attorney dated January 8, 1945, the Commissioner extended the period within which an election may be made under section 167(c) with respect to the trust created by Frank E. Joseph until 60 days after a final decision or a stipulation of settlement is entered in these proceedings.
OPINION.
SMITH, Judge:
In his deficiency notices the respondent determined that petitioner is taxable on all of the income of the trust in question, under the provisions of sections 22(a) and 167 of the Internal Revenue Code. On brief his argument is that the trust income is taxable to petitioner under section 167 and the rule of Helvering v. Stuart, 317 U.S. 154, because as grantor of the trust he had the right to receive and did receive all of the trust income for the support, maintenance, and education of his minor son.
In Helvering v. Stuart, supra, it was held that the grantor of a trust for the benefit of minor children was taxable on the entire income of the trust which could be used by him for the support and maintenance of his minor children, and not merely on that part actually used to relieve him of his parental obligations. The trustees of the R. Douglas Stuart trust had discretionary authority to apply so much of the net income of the trust for the support, maintenance, and education of the minor children ‘as to them shall seem advisable and in such manner as to them shall seem best.‘
We do not think it can be doubted that under the above cited case the petitioner is taxable as determined by the respondent, provided he was the grantor of the trust. The petitioner submits that he was only the nominal grantor; that he never came into possession or control of the assets of the Unterberg trust; and that therefore he could not have transferred such assets to the Irving Trust Co. and can not be regarded as the grantor of the trust in respect of such assets. He further submits that he renounced all of his rights to his deceased wife's property for the benefit of his son and that all of his actions have been consistent with such renunciation.
Considering the last contention of the petitioner first, we do not think the evidence shows that the petitioner renounced all of his rights to his deceased wife's property in favor of his son. By the terms of the trust instrument executed by the petitioner with the Irving Trust Co. on February 24, 1930, he reserved the entire income of the trust to himself for the ‘support, maintenance and education‘ of his son. We are here dealing with that income.
The respondent does not question the fact that under the laws of the State of Ohio Adele Unterberg Joseph's will executed by her on January 9, 1928, was revoked by the birth of her son on November 2, 1928. See sec. 10561 of the 1928 Ohio General Code. The respondent contends, however, that:
* * * even though not operative as a will this document was an instrument ‘ * * * in the nature thereof, * * * ‘ which was legally sufficient to exercise the power of appointment over which she had the right of testamentary disposition.
We see no merit in this contention. It was either a will or a nullity. We hold that it was a nullity. It would indeed be a curious commentary on the law of Ohio if the provision of law for the revocation of a will upon the subsequent birth of issue, which was clearly designed for the protection of an after-born child, should be interpreted to deprive petitioner's son of practically all of his mother's estate.
We hold that Adele Unterberg Joseph died intestate. Section 8592 of the 1928 Ohio General Code provides:
When a person dies intestate and leaves no children or their legal representatives, the widow or widower, as next of kin, will be entitled to all of the personal property which is subject to distribution upon settlement of the estate. If the intestate leaves any children or their legal representatives, the widow or widower will be entitled to one-half of the first four hundred dollars and to one-third of the remainder of the personal property subject to distribution.
If there had been an administration of the estate of Adele the petitioner would have received slightly more than one-third of his deceased wife's estate and Frank E. Joseph, Jr., the balance. After the settlement the petitioner would be taxable upon income from his share and the son upon income from his share.
Upon the creation of the trust with the Irving Trust Co. of New York on February 24, 1930, the petitioner caused to be transferred to that company in trust all of his son's property and all of the petitioner's property inherited by himself and his son from his deceased wife. If no provision had been made in the trust instrument that all of the income of the trust should be paid to petitioner periodically for the ‘support, maintenance and education‘ of his son, the petitioner would be taxable upon his share of the income and the son upon his share. We do not see how the petitioner can escape liability to income tax upon his share of the income which was actually received by him during the taxable years, albeit it was received only for the support, maintenance, and education of his son and none of it was used by petitioner for that purpose.
We hold that the petitioner was the grantor of the 1930 trust to the extent of property owned by him which was transferred to the trust. He was also the grantor with respect to his share of the income of the trust paid over to him annually which he turned back to the trustee to augment the principal of the trust. Under Helvering v. Stuart, supra, he was clearly taxable upon such income. He was not the grantor of the trust to the extent of his son's property conveyed to the trustee. See Allison L. S. Stern, 40 B.T.A. 757; Stern v. Commissioner, 137 Fed.(2d) 43; Buhl v. Kavanagh, 118 Fed.(2d) 315; Stockstrom v. Commissioner, 148 Fed.(2d) 491; certiorari denied, 326 U.S. 719. Cf. Sunderland v. Commissioner (C.C.A., 3d Cir.), 151 Fed.(2d) 675. The son is taxable upon that income and for the taxable years it was properly reported for taxation by him.
The petitioner contends that he was not taxable upon any of the income of the trust fund because none of it was used for the ‘support, maintenance and education‘ of his minor son during the taxable years. In support of such contention he cites Hopkins v. Commissioner (C.C.A., 6th Cir.), 144 Fed.(2d) 683, where it was held that the grantor of trusts for the benefit of his two minor sons was liable for income tax upon the income of the trusts only to the extent that it was used or usable for their maintenance and support. That case has no application to the proceeding at bar, for here the entire amount of the income of the 1930 trust was paid over to the petitioner during the taxable years and was available to him for the ‘support. maintenance, and education‘ of his minor son.
The next contention of the petitioner is that he is relieved from any tax liability in respect of the income of the 1930 trust for the taxable years under section 167(c) of the Internal Revenue Code. Under the amendment, however, the income of a trust is not taxable to the settlor merely because such income in the discretion of another person, other than the settlor or the trustee, may be applied or distributed for the support or maintenance of the beneficiary whom the settlor is legally obligated to support or maintain to the extent that such income is so applied or distributed. In Hopkins v. Commissioner, supra, the court observed:
The amendment has no application where the trust income may, in the settlor's sole discretion, be applied to the support of his legal dependent. This construction is made clear by the report of the Senate Finance Committee, wherein it is said, ‘Subsection (c) is not applicable if discretion to apply or distribute the trust income for support, maintenance or education rests solely in the grantor or in the grantor in conjunction with other persons unless the grantor has such discretion as trustee.‘ Sen. Rep. No. 627, 78th Cong. 1st Sess. (1943) 56.
Plainly the amendment has no application here.
It is our opinion that under section 167 of the Internal Revenue Code and Helvering v. Stuart, supra, the petitioner is liable to income tax upon the portion of the trust income allocable to the trust principal contributed by him.
In his brief the respondent does not argue the application to this case of section 22(a) of the Internal Revenue Code. That is the provision of the tax law which taxes to an individual income received from any source whatever. That section was applied to the income of a trust in Helvering v. Clifford, 309 U.S. 331. Even if the section were applicable to the proceeding at bar, the petitioner would not be taxable upon more than the income of the trust which flowed from his contribution of property to it. Since we have held in the circumstances of this case that the petitioner is taxable upon such income under section 167, it is not necessary to consider the application of section 22(a).
Reviewed by the Court.
Decision will be entered under Rule 50.