Conant
v.
Comm'r of Internal Revenue

Tax Court of the United States.Jul 31, 1946
7 T.C. 453 (U.S.T.C. 1946)
7 T.C. 453T.C.

Docket No. 5617.

1946-07-31

RALPH W. CONANT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Robert A. B. Cook, Esq., J. N. Welch, Esq., and Lawrence E. Green, Esq., for the petitioner. J. T. Haslam, Esq., for the respondent.


In 1939 petitioner established four trusts and named his wife principal beneficiary in each. He transferred to the four trusts a life insurance policy on his own life and shares of stock in a corporation, some of which shares were pledged to secure petitioner's personal indebtedness. In the taxable years 1940 and 1941, the trustee, upon the direction of the primary beneficiary, paid the premiums on the insurance policy and also paid off the indebtedness. Each trust invested the wife with power ‘to cancel or revoke this trust at any time, in whole or in part,‘ and in the event of such cancellation or revocation it was the duty of the trustee to pay to the wife the principal and undistributed income ‘free and discharged of all trusts. ‘ Held, the income of the four trusts is not taxable to petitioner, with the exception of that part of the income representing the dividends on the pledged stock. Robert A. B. Cook, Esq., J. N. Welch, Esq., and Lawrence E. Green, Esq., for the petitioner. J. T. Haslam, Esq., for the respondent.

The respondent determined deficiencies in petitioner's income tax for the calendar years 1940 and 1941 in the amounts of $7,145.68 and $9,568.93, respectively.

The deficiency for 1940 results from the addition to the net income as disclosed by petitioner's return of an item labeled ‘Income from fiduciaries‘ in the amount of $11,381.79; and the deficiency for 1941 results from a similar addition in that year in the amount of $14,760.82. In the statement attached to the deficiency notice the respondent explains the 1940 adjustment as follows: (a) Income from fiduciaries $11,381.79

Information on file in this office indicates that you received taxable income in the year 1941 (NOTE: Evidently this is a typographical error and should read 1940) of $11,381.79 through the following fiduciaries which was not reported in your return:

+-----------------------------------------------------------------+ ¦ ¦Insurance premiums ¦Discharge of indebtedness ¦Total ¦ +------+--------------------+---------------------------+---------¦ ¦Trust:¦ ¦ ¦ ¦ +------+--------------------+---------------------------+---------¦ ¦T-3116¦$503.24 ¦$2,002.67 ¦$2,505.91¦ +------+--------------------+---------------------------+---------¦ ¦T-3117¦503.23 ¦2,002.67 ¦2,505.90 ¦ +------+--------------------+---------------------------+---------¦ ¦T-3118¦503.23 ¦3,129.96 ¦3,633.19 ¦ +------+--------------------+---------------------------+---------¦ ¦T-3119¦503.23 ¦2,233.56 ¦2,736.79 ¦ +------+--------------------+---------------------------+---------¦ ¦ ¦2,012.93 ¦9,368.86 ¦11,381.79¦ +-----------------------------------------------------------------+

The above adjustment is necessary in order to show as taxable to you that portion of the income of four trusts created by you which has been used to pay life insurance premiums on your life (in the trust) and to discharge, directly or indirectly indebtedness originally incurred by and repaid out of trust income in accordance with the terms of the trust.

This income of the trusts was applied in accordance with the provisions and intent of the trust instruments to the payment of premiums and loans outstanding at the date of creation of the trusts, December 28, 1939, the policies being placed in the trusts and being on your life and the loans were your indebtedness at said date.

The income from these four trusts is payable to your wife, Mrs. Ruth G. Conant, during her life in the discretion of the trustee unless she exercises the power to designate and appoint such income. The trusts are to terminate one year after the decease of the survivor of you and your wife and then the trust property is payable to each of your four children as remaindermen.

Article 3 of the trust instrument gives Mrs. Ruth G. Conant the power to alter, amend, cancel, or revoke the trust in whole or in part at any time she may desire.

The 1941 adjustment was similarly explained by the respondent, except for different amounts.

Petitioner by appropriate assignments of error contests the correctness of both of the adjustments described above.

FINDINGS OF FACT.

Most of the facts were stipulated, and we adopt this stipulation as a part of these findings.

Petitioner is an individual and resides in the city of Newton, Massachusetts. He has his principal office and place of business in the city of Boston, Massachusetts.

On December 28, 1939, petitioner created four trusts, of which the Boston Safe Deposit & Trust Co. was at all material times the sole trustee. The trustee assigned Nos. 3116, 3117, 3118, and 3119 to the trusts. One of these trusts was created for the benefit of Ruth G. Conant, wife of petitioner, and their son, Gilman W. Conant, and it will sometimes hereinafter be referred to as the Gilman trust. The second trust was created for the benefit of petitioner's wife and their daughter, Virginia C. McEldowney, and it will sometimes hereinafter be referred to as the McEldowney trust. The third trust was created for the benefit of petitioner's wife and their son, Donald B. Conant, and it will sometimes hereinafter be referred to as the Donald trust. The fourth trust was created for the benefit of petitioner's wife and their daughter, Sylvia G. Conant, and it will sometimes hereinafter be referred to as the Sylvia trust. These trusts are identical, with the exception that in each trust the name of the appropriate child appears and the property conveyed to each trust was not the same in all the trusts.

The property which petitioner conveyed to the Gilman trust was described in a schedule attached thereto as follows:

175 Shares EMERY & CONANT COMPANY, INCORPORATED Common

Undivided 1/4 Interest in $100,000. New England Mutual Life Insurance Company, Boston, Massachusetts Policy #743140

5 year Term Policy on the life of Ralph W. Conant

The property which petitioner conveyed to the McEldowney trust was described in a schedule attached thereto as follows:

155 Shares EMERY & CONANT COMPANY, INCORPORATED Common

Undivided 1/4 Interest in $100,000. New England Mutual Life Insurance Company, Boston, Massachusetts Policy #743140

5 year Term Policy on life of Ralph W. Conant.

Equity in Twenty shares of Emery & Conant Company, Inc. Common, present Book Value of $135.00 subject to a loan of $2,000., now held by Allan C. Emery and contained in Certificate #C2 for 250 shares standing in the name of Ralph W. Conant.

The property which petitioner conveyed to the Donald trust was described in a schedule attached thereto as follows:

Undivided 1/4 Interest in $100,000. New England Mutual Life Insurance Company, Boston, Massachusetts Policy #743140

5 year Term Policy on the life of Ralph W. Conant

Equity in 175 shares Emery & Conant Company, Inc. Common contained in Certificate #C16 for 200 shares held by Allan C. Emery as security for a loan of $17,500.

The property which petitioner conveyed to the Sylvia trust was described in a schedule attached thereto as follows:

Undivided 1/4 Interest in $100,000. New England Mutual Life Insurance Company, Boston, Massachusetts Policy #743140

5 year Term Policy on the life of Ralph W. Conant

Equity in 175 shares of Emery & Conant Company, Inc. Common, present book value of $135.00 and subject to a loan of $17,500 now held by Allan C. Emery and contained in Certificate #C2 for 250 shares standing in the name of Ralph W. Conant.

The pertinent provisions of the Gilman trust are as follows:

1. This trust shall terminate at the expiration of one year from and after the decease of the survivor of Ralph W. Conant and his wife, Ruth G. Conant, provided their son, Gilman W. Conant shall then have attained the age of forty years; otherwise, this trust shall continue in force as hereinafter provided.

2. After making provision for the expenses of this trust, including the fee of the trustee as hereinafter fixed, and after setting up proper reserves for such taxes as may accrue hereunder, the net income of this trust fund shall be paid in equal quarterly installments, or oftener in the discretion of the trustee, to Ruth G. Conant, unless she shall have exercised the power to designate and appoint such income, either in whole or in part, for any portion or the whole of the term of this trust, which power is hereby expressly conferred upon her. Any exercise of this power shall not be limited to the single use thereof, but the same may be repeatedly employed with respect to any income theretofore accrued, but undistributed, and to any income thereafter accruing. Any written designation or appointment made by her, however informal in tenor or form the same may be, shall suffice and shall become operative upon its delivery to the Trustee herein named.

3. The said Ruth G. Conant is hereby invested with the further power and authority to cancel or revoke this trust at any time, in whole or in part, by a writing to that effect addressed to the Trustee hereof, with the further and additional power to alter or amend this trust in such manner and at such time or times as she may see fit, such alterations or amendments to become operative, however, only when the Trustee herein named shall be supplied with a copy of each thereof. In the event of the cancellation or revocation by the said Ruth G. Conant, it shall be the duty of the Trustee forthwith to pay unto her the whole of the principal of this trust fund, or such part or portion thereof as she may designate, together with any accrued and undistributed income, less the charges thereagainst, free and discharged of all trusts.

4. Upon the decease of the said Ruth G. Conant without having exercised the full power of revocation or cancellation and without having exercised the power of designation or direction of net income hereinbefore conferred upon her, or if such latter power shall have been exercised but shall have been cancelled by her or relinquished by the appointee, the said net income shall be payable in equal quarterly installments to Gilman W. Conant * * * .

6. The Trustee acting hereunder shall have full power and authority throughout the continuance in effect of this trust to do and perform the following things:

(a) * * * to discharge any indebtedness which may exist against any property or interest in property conveyed into this trust, and for this purpose to make loans upon the trust res or any part thereof, and to pay such loans out of income; * * *

(i) To pay any and all premiums upon any and all policies of insurance of all kinds which may be transferred into this trust, particularly life insurance, and for this purpose to use such part of the trust income then in the hands of the Trustee as may be necessary therefor, and if there shall not be adequate trust income then in the hands of the Trustee for such purpose when the premiums become due, to use such part of the principal fund as may be necessary therefor, with the discretionary power to the Trustee to require the beneficiary or beneficiaries then participating in the income of this trust to pay such premium or premiums, and if such beneficiary or beneficiaries shall neglect or fail so to do and said policies of insurance shall lapse, no liability whatsoever shall attach to the Trustee because thereof. Nor shall the Trustee in any event be responsible for any sums which shall not be actually received by it under said policies, and the said Trustee may credit upon premiums any dividends which may be paid it, or, in its discretion, it may acquire paid-up additions to policies of life insurance, or the Trustee may dispose of such dividends in any other manner it may see fit.

12. The Donor does not reserve to himself any right, title or interest whatsoever in the property hereby conveyed or to any property which he may hereafter convey into this trust, but expressly divests himself of all thereof, nor does he reserve any rights whatsoever with respect to amending, varying, controlling or revoking this trust. Should any interest in the principal fund now or hereafter transferred into this trust ever in the future revert or accrue to the Donor, such interest is hereby irrevocably given to those persons who would constitute and be the heirs-at-law of the Donor had the Donor deceased at the time such interest became vested in him.

On December 28, 1939, Ruth G. Conant directed the trustee of the four trusts to apply the income therefrom in the following order of priority:

1. Expenses of administration

2. Payment of life insurance premiums

3. Payment of debts of the trusts

4. Ruth G. Conant

On August 14, 1940, Ruth G. Conant wrote the trustee of the four trusts relative to the premium on policy No. 743140 due on August 15, 1940, and directed the trustee to pay the premium for a period of six months rather than for the full year, as she might wish to convert a part of the insurance into permanent insurance before six months elapsed.

During 1940 petitioner loaned $15,500 to T-3119 and Ruth G. Conant placed $13,500 to the credit of T-3118. These amounts were used during 1940 to pay off a part of the Emery indebtedness.

On December 28, 1940, the trustee of the four trusts wrote Ruth G. Conant as follows:

We have the following income in the Ralph W. Conant trusts available for distribution:

+-----------------+ ¦T-3116¦$3,000.00 ¦ +------+----------¦ ¦T-3117¦3,000.00 ¦ +------+----------¦ ¦T-3118¦3,000.00 ¦ +-----------------+

after making allowance for Massachusetts income taxes and payment of insurance premiums.

Will you please advise us if you wish us to pay this income to you or whether you wish it to be applied toward the indebtedness still outstanding against Trust T-3119 consisting of the note of Ralph W. Conant for $13,396.40.

On December 31, 1940, Ruth G. Conant acknowledged receipt of the above mentioned letter from the trustee of December 28, stating in part:

In reply, I would request that the income referred to of $9,000.00 be applied toward the indebtedness outstanding against Trust T-3119 consisting as you state of the note of Ralph W. Conant for $13,396.40.

On January 10, 1941, Ruth G. Conant wrote the trustee of the four trusts as follows:

I enclose herewith cashier's check for $12,000.00, which you will please credit to Income account of TRUST 3119 of Sylvia G. Conant and myself.

I direct that you pay the indebtedness standing against said Trust and accrued interest— and then equally divide the balance between the four (4) Trusts, viz: T 3116, T 3117, T 3118 and T 3119— and make the total assets of each of the four Trusts identical.

Will you please arrange to pay the six months' premium on New England Mutual Life Insurance Company Policy #743140 when due— about February 15th— unless I advise you to the contrary before the due date.

Now that the four Trusts are free of debt, please note that after (1) expenses of administration are paid, I direct you to (2) pay life insurance premium, and (3) to apply income to the capital account of said Trusts— until further notice.

On January 13, 1941, the trustee replied to the above mentioned letter of January 10, in part, as follows:

In accordance with your request, we have paid the balance of the obligation in favor of Ralph W. Conant held in this trust amounting to $4,409.78 and interest to date of $7.37. The balance of your check amounting to $7,582.85 we have added to the principal of the four trusts as follows:

+-----------------+ ¦T-3116¦$1,895.71 ¦ +------+----------¦ ¦T-3117¦1,895.71 ¦ +------+----------¦ ¦T-3118¦1,895.71 ¦ +------+----------¦ ¦T-3119¦1,895.72 ¦ +-----------------+

We are enclosing our official receipts covering these additions to principal.

We are also marking our records so that in the future the balance of income after making allowance for all charges, is to be added to the principal of these trusts until further notice. Unless we hear from you to the contrary, we will pay the insurance premiums due the New England Mutual Life Insurance Company on February 15th.

On August 11, 1941, Ruth G. Conant wrote the trustee of the four trusts relative to policy No. 743140 and requested the trustee not to pay the premium due on August 15, 1941, for a few days but to take advantage of the 30-day grace period, as she was considering canceling $50,000 of the policy. This letter was acknowledged on the following day. On August 28, 1941, the trustee wrote Ruth G. Conant, asking for her wishes in regard to policy No. 743140, and on September 2, 1941, she replied as follows:

In reply to your letter of Aug. 28th I have decided to carry less insurance in the trusts, and wish you to cancel $50,000 on expiration of the 30 day grace period, on September 15th.

You will please have the remaining $50,000 of the policy split in 3 policies as follows— 1 for $25,000— 1 for $15,000 and the other for $10,00 paying the premium for a six-month period. Will you kindly make a memorandum to advise me in January, before the next 6 months premiums are paid.

Each of the trusts was amended by Ruth G. Conant by instruments dated September 12, 1941, January 28, 1942, and June 7, 1944. In the case of each trust the amendments are identical, with the exception of the reference therein in each case to a different child. The amendment to the Gilman trust dated September 12, 1941, simply added a new paragraph thereto, numbered 13, which provided for the reduction of the life insurance policy from $100,000 to $50,000, and it need not be set out in further detail here.

In the amendment dated January 28, 1942, Ruth G. Conant requested and directed the trustee to deliver to her all the insurance policies on the life of petitioner which were owned by the four trusts, and to strike out and delete from each trust paragraph 6(i) thereof.

In the amendment dated June 7, 1944, Ruth G. Conant struck out all the paragraphs 1 to 13, both inclusive, and inserted in lieu thereof new paragraphs 1 to 14, both inclusive. Under this third amendment Ruth G. Conant surrendered her right to alter or amend, cancel or revoke, the trusts, and each of them, and to capture the principal of the trust fund in each trust contained, and also made certain other changes in the trust indentures, without, however, changing the basic characteristics or features of the trusts except as above mentioned. She did, however, join her son Gilman as cotrustee in each of said trusts with the said corporate trustee.

Petitioner did not include in his income tax returns for either of the years 1940 or 1941 any income from any of the trusts.

During the year 1940 the trustee of the four trusts paid premiums upon the above mentioned policy No. 743140 amounting to $2,012.93 for all four trusts. These payments were made by the trustee out of income, pursuant to directions given by Ruth G. Conant. The respondent added the $2,012.93 to the income reported by petitioner for the year 1940.

The fiduciary of the four trusts reported for the year 1940 as follows:

+------------------------------------------------------------------------------+ ¦1940 ¦#3116 ¦#3117 ¦#3118 ¦#3119 ¦Total ¦ +---------------------------+---------+---------+---------+---------+----------¦ ¦Dividends ¦$4,200.00¦$4,200.00¦$4,200.00¦$4,200.00¦$16,800.00¦ +---------------------------+---------+---------+---------+---------+----------¦ ¦Deductions ¦566.81 ¦569.48 ¦598.89 ¦1,495.29 ¦3,230.47 ¦ +---------------------------+---------+---------+---------+---------+----------¦ ¦Net ¦3,633.19 ¦3,630.52 ¦3,601.11 ¦2,704.71 ¦13,569.53 ¦ +---------------------------+---------+---------+---------+---------+----------¦ ¦Distributable to ¦3,129.95 ¦3,127.29 ¦3,097.88 ¦2,201.48 ¦11,556.60 ¦ ¦beneficiary ¦ ¦ ¦ ¦ ¦ ¦ +---------------------------+---------+---------+---------+---------+----------¦ ¦Taxable to fiduciary ¦503.24 ¦503.23 ¦503.23 ¦503.23 ¦2.012.93 ¦ +------------------------------------------------------------------------------+

The amount of $11,556.60 was reported by the beneficiary.

In the year 1941 the trustee of the four trusts paid premiums on the said life insurance policy in a total amount of $1,351.04. Said payments were made by the trustee out of income, pursuant to directions given by Ruth G. Conant. The respondent added said sum to the income of the petitioner for the year 1941.

The fiduciary of the four trusts reported for the year 1941 as follows:

+------------------------------------------------------------------------------+ ¦1941 ¦#3116 ¦#3117 ¦#3118 ¦#3119 ¦Total ¦ +---------------------------+---------+---------+---------+---------+----------¦ ¦Dividends ¦$7,000.00¦$7,000.00¦$7,000.00¦$7,000.00¦$28,000.00¦ +---------------------------+---------+---------+---------+---------+----------¦ ¦Deductions ¦391.92 ¦391.92 ¦391.92 ¦394.83 ¦1,570.59 ¦ +---------------------------+---------+---------+---------+---------+----------¦ ¦Net ¦6,608.08 ¦6,608.08 ¦6,608.08 ¦6,605.17 ¦26,429.41 ¦ +---------------------------+---------+---------+---------+---------+----------¦ ¦Distributable to ¦6,270.32 ¦6,270.31 ¦6,270.32 ¦6,267.42 ¦25,078.37 ¦ ¦beneficiary ¦ ¦ ¦ ¦ ¦ ¦ +---------------------------+---------+---------+---------+---------+----------¦ ¦Taxable to fiduciary ¦337.76 ¦337.77 ¦337.76 ¦337.75 ¦1,351.04 ¦ +------------------------------------------------------------------------------+

The amount of $25,078.37 was reported by the beneficiary.

The petitioner transferred to the four trusts 700 shares of Emery & Conant Co. capital stock, of which 370 shares were pledged to secure an indebtedness of petitioner to Emery in the total principal amount of $37,000. The value of the 370 shares was at all material times in excess of the indebtedness of $37,000. During the year 1940 the trustee of the four trusts paid such indebtedness in full; and, to the extent that income was available to make such payments, namely $9,368.86, the respondent increased the reported income of petitioner for 1940. The amount of dividends received in 1940 by the trustee of the four trusts from the pledged stock was in the total sum of $8,880.

In 1941 the trustee of the four trusts, pursuant to directions given by Ruth G. Conant, made payments in the sum of $13,396.40 from 1941 income in discharge of the indebtedness owed by one of the trusts to petitioner, and $13.38 in payment of interest thereon. The respondent increased the reported income of petitioner for the year 1941 by adding thereto the sum of $13,396.40 and $13.38, or $13,409.78.

OPINION.

KERN, Judge:

Petitioner created four trusts, with his wife as primary beneficiary of each. She was given the absolute power to cancel the trusts at any time and to take over their corpus and undistributed income. The income-producing corpus of the trusts consisted of 700 shares of corporate stock owned by petitioner at the time the trusts were created. Of this stock, 370 shares were at that time pledged by petitioner to a business associate to secure the repayment of some $37,000 which petitioner had borrowed. In 1940 the trust received dividends from the stock in the total amount of $16,800, of which $8,880 represented dividends on the pledged stock. The trustee paid the premium on an insurance policy insuring the life of the petitioner and assigned to the trust, pursuant to instructions given by petitioner's wife and the power granted to it by the trust instruments. Pursuant to the same instructions and power, it also paid in full the debt of petitioner secured by the pledge of the stock. This payment was made from trust income, and from advances made by petitioner and his wife to the trusts. In 1941 the trustee again paid the insurance premium out of trust income, and also repaid to petitioner the amount of the advances made by him to the trusts in the previous year. These payments were made pursuant to the instructions given to the trustee by petitioner's wife.

Respondent added to petitioner's reported taxable income for 1940 and 1941 the amounts paid by the trustee on account of the insurance premiums, and the remaining income of the trusts which would have been distributed to the beneficiaries had it not been, as it was, used in the payment of the obligation of petitioner secured by the pledge of the stock (in 1940) and the repayment of the advances made by petitioner to the trustee (in 1941). The question now before us is whether respondent erred in adding the whole or any part of these amounts to petitioner's reported income for the taxable years.

Respondent relies principally upon section 167(a) of the Internal Revenue Code, and he states that this is a companion case of Clifton B. Russell, 5 T.C. 974, and involves an issue similar to issue 1 in that case.

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(2) may, 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, be distributed to the grantor; or(3) 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, applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23(o), relating to the so-called ‘charitable contribution‘ deduction);then such part of the income of the trust shall be included in computing the net income of the grantor.

Petitioner contends that, because of the unqualified power and authority given to his wife in paragraph 3 of the trusts ‘to cancel or revoke this trust at any time, in whole or in part‘ and because, in the event of such cancellation or revocation, ‘it shall be the duty of the Trustee forthwith to pay unto her the whole of the principal * * * together with any accrued and undistributed income * * * free and discharged of all trusts,‘ he is not taxable on any of the income of the four trusts here involved, but that all of such income is taxable to his wife.

As to all of the income which the trusts were entitled to receive by reason of the property transferred to them, petitioner's position is unassailable. Such an unqualified power of revocation gives to the person who possesses it such unfettered dominion and control over the trust property as to make such person taxable on the income therefrom under section 22(a) of the Revenue Acts of 1936 and 1938, as the owner of it. Jergens v. Commissioner, 136 Fed.(2d) 497; certiorari denied, 320 U.S. 784. Richardson v. Commissioner, 121 Fed. (2d) 1; Ella E. Russell, 45 B.T.A. 397; Elsie C. Emory, 5 T.C. 1006.

The basic reasoning of those cases is that, because of the powers over trust corpus and income granted to the beneficiary of a trust, the beneficiary must be considered for tax purposes as the owner of the income, rather than the trust itself. Consequently, the income which was nominally that of the trust, but which was, in reality, that of the beneficiary, was held taxable to the beneficiary under section 22(a) of the Internal Revenue Code rather than to the trustee under the provisions of section 161. In Edward Mallinckrodt, Jr., 2 T.C. 1128, we concluded (at p. 1136) that ‘ * * * the benefits held by and belonging to petitioner, directly or indirectly, were such as to require the conclusion that he was the owner of the income here in question, within the meaning of section 22(a), supra.‘ In the opinion of the Circuit Court of Appeals, which affirmed our decision, Mallinckrodt v. Nunan, 146 Fed.(2d) 1, that court said that this affirmance was ‘because the power of petitioner to receive this trust income each year, upon request, can be regarded as the equivalent of ownership of the income for purposes of taxation. ‘ In Richardson v. Commissioner, supra, the court, at page 3, stated the question there involved as follows: ‘ * * * whether an unfettered control over the corpus of a trust either in the grantor or in the donee of a power of revocation, who may appropriate it to his personal use, is not the equivalent of ownership of the property for tax purposes.‘ The court held that it was. In Jergens v. Commissioner, supra, at p. 498, the court said ‘with respect to the shares of stock, which were the only income-producing properties of the trust estate, and the income therefrom, the taxpayer was given control so absolute as to be consonant with full ownership.‘ In Sydney R. Newman, 5 T.C. 603, we said of these cases: ‘Each of those cases involved the ownership for tax purposes of trust income by persons other than the grantors. In each case it was held that the taxpayer, because of his power and control over the trust property and the trust income, was taxable as the owner.‘

In the instant case insurance premiums were paid out of income which was nominally the income of the trusts on a policy of insurance on the life of the grantor irrevocably assigned to the trusts. If the income in question is to be considered for tax purposes as the income of the trusts, then that part of it so used might be taxable to the grantor under the literal provisions of section 167(a)(3). However, the same reasons which persuade us that all of the income which was nominally that of the trusts is taxable to the grantor's wife rather than taxable to the trustees under section 161, or taxable to the grantor under section 167(a), compel us to the conclusion that that part so used for insurance premiums is also taxable to the wife rather than to the grantor under section 167(a)(3). For tax purposes, the income in question was not the income of the trusts; it was the income of the grantor's wife. Section 167 by its terms applies only to the income of a trust, i.e., the income from property held in trust which would be taxable to the fiduciary under section 161, were it not for the provisions of section 167. It does not apply to income which is nominally the income of a trust but which is in reality, and for tax purposes, the income owned by a beneficiary having such powers, dominion, and control over the trust corpus as justify her taxation upon such income under the provisions of section 22(a).

The income of the trusts must be considered for tax purposes as the income of petitioner's wife and, consequently, the payments of premiums on policies of insurance on petitioner's life made from this income at the direction of his wife must be considered, for tax purposes, as if made by his wife from her own income. Under this construction, these payments can not be considered as constituting income taxable to petitioner under section 167(a)(3). See Stephen Hexter, 47 B.T.A. 483.

However, with respect to that part of the trust receipts which was derived in 1940 from dividends on the pledged stock and was used to pay the personal obligation of the grantor, we arrive at a different conclusion. The schedules attached to the trust instruments described the interest in these shares conveyed to the trusts as ‘equity in‘ the number of shares of pledged stock which was in each case transferred. Thus it was recognized that the grantor gave to the trusts only that interest in the stock which he then possessed, which was a general property right, subject to a lien of the pledge securing the grantor's debt. These shares were pledged for the payment of the grantor's personal indebtedness, and, so far as the record discloses, were held in the possession of the grantor's creditor, whose rights with respect thereto were prior and superior to the rights and powers created by the trust instrument. The pledgee's rights could not be divested by any later act of the pledgor or his assignees.

A pledgee who holds pledged stock as security for a debt has, in the absence of special agreement to the contrary (and none is shown to have existed here), the right to (and some courts hold the duty to secure) possession and control of the stock and to the dividends thereon for application against the debt. Fletcher's Cyclopedia of Corporations, Permanent Ed., vol. 11, sec. 5382, and cases there cited; Railroad Credit Corporation v. Hawkins, 80 Fed.(2d) 818; 18 C.J.S.,sec. 469(b).

We must assume that the pledgee of the stock here had such rights, by contract with the grantor, antecedent and superior to any interest of the primary beneficiary, of the trusts later created. By her power of revocation Mrs. Conant could have prevented the execution of any of the trustee's powers, so that any payments made by the trustees pursuant to their powers, being always subject to her overriding veto power, might be said to have been made on her behalf and at her direction. But the pledgee's right to receive the dividends did not arise out of the trust instrument, was in no sense subject to it, and could not be divested by reason of any power contained therein. Even if Mrs. Conant had revoked the entire trust and received as her own all the trust property, her action would not have touched the pledgee's right to the possession of the stock and the receipt of the income arising therefrom. That right existed prior to the time her rights were created, and she took whatever interest she had subject to the pledge. Her power over the property, great as it was, stopped short of unfettered control over the pledged stock and the dividends paid thereon. She had no right at any time to such dividends, and she can not therefore be held liable for tax thereon.

In Adolphus Busch III, 3 T.C. 547, we recognized this rule, although in that case the pledge agreement specifically provided for a different disposition of the dividends.

In J. Gregory Driscoll, 3 T.C. 494, the lessee of an oil lease mortgaged it to secure payment of his personal indebtedness, and assigned the oil to be produced to his mortgage creditor. He later assigned his interest, subject to the mortgage, and we held the assignee, who had not assumed the mortgage debt, was not taxable on the income applied to its satisfaction, since she never at any time had unfettered control of the income. See also Herbert A. Loeb, 5 T.C. 1072.

Petitioner relies on Henry A. B. Dunning, 36 B.T.A. 1222; Ralph L. Gray, 38 B.T.A. 584; and Stephen Hexter, supra, which hold that, where a beneficiary who is entitled to receive income without restriction on its use applies the income voluntarily to payment of the grantor's legal obligation, the grantor can not be taxed on such income. This contention overlooks the point which we have tried to develop above, that the beneficiary here, having received no more than the grantor's equity in the stock, subject to the preexisting pledge for the grantor's personal obligation, did not receive and was not at any time entitled to the unrestricted use of the dividends produced by the pledged stock, and for that reason can not be taxed thereon. Such income was previously and effectively disposed of by the grantor, for his own economic benefit, and is taxable to him.

Under this reasoning only the amount of the dividends paid on the pledged stock while the stock was held by the pledgee would constitute income taxable to the petitioner. All of the other income received by the trust was, in reality, the income of petitioner's wife and was taxable to her, regardless of the purposes for which she permitted the trustee to spend it. Consequently, the dividends paid on the stock in 1941, after the debt secured by pledge was satisfied, would be taxable to petitioner's wife and not to the petitioner.

In Clifton B. Russell, 5 T.C. 974, as here, the grantor's equity in certain shares of stock was transferred to the trust involved there. The stock was, at the time of the transfer, pledged as security for the payment of a personal indebtedness of $25,000 of the grantor. However, in that case, the indebtedness was completely retired early in the first tax year, and the stock redeemed, by the use of $20,000 loaned to the trust by the grantor, and the balance from undistributed trust income. The loan to the grantor was later repaid by the trust out of dividends. We held that the grantor was taxable on the amounts so used, under section 167, on the theory that they were used to discharge petitioner's own obligation at the discretion of trustees who had no adverse interest. It should be noted that the beneficiary there had no power to revoke the trust and thus acquire the trust property without the assent of the trustees. Therefore, it could not be said in that case that the income of the trust was, in reality, and for tax purposes, the income of the beneficiary, and it is accordingly distinguishable from the instant case, in which the debt of the petitioner was not paid in 1941 from the income of the trust, but from the taxable income of the beneficiary of the trust.

Reviewed by the Court.

Decision will be entered under Rule 50.

HILL, J., dissents.

BLACK, J., concurring in the result: I am convinced that the principle involved in the instant case is the same as was involved in Jergens v. Commissioner, 136 Fed.(2d) 497; Richardson v. Commissioner, 121 Fed.(2d) 1; and Elsie C. Emery, 5 T.C. 1006, all of which are cited in the majority opinion.

I am, therefore, in entire accord with the majority opinion of the Court wherein it holds that none of the income of the four trusts is taxable to petitioner, the settlor of the trusts, except that part of the income representing the dividends on the pledged stock. As to this latter exception, I am not so sure. Among the cases cited by the majority opinion in support of its conclusion that petitioner should be taxed with the dividends on this pledged stock which were applied to the indebtedness secured by the stock is J. Gregory Driscoll, 3 T.C. 494. It must be conceded there are some similarities in the facts and circumstances of the Driscoll case to those which are present in the instant case. It is for that reason alone that I concur with the majority opinion on that point, though with some doubt that any of the income of the four trusts should be taxed to petitioner under the doctrine of the Jergens case and other cases referred to above.

DISNEY, J., agrees with the above.