Comm'r of Internal Revenue

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Tax Court of the United States.Jul 21, 1952
18 T.C. 761 (U.S.T.C. 1952)

Docket Nos. 30406 30407.



Eli Freed, Esq., and Scott Fleming Esq., for the petitioners. Charles W. Nyquist, Esq., for the respondent.

Held: Income derived from the sale and rental of construction equipment is taxable as community income to husband and wife who purported to give the equipment to husband's parents under an implicit agreement that the parents would give the income and property back to the husband and his family. Eli Freed, Esq., and Scott Fleming Esq., for the petitioners. Charles W. Nyquist, Esq., for the respondent.

The respondent determined deficiencies in income and victory taxes for the year 1943 as follows:

+----------------------------+ ¦Petitioner ¦Deficiency ¦ +---------------+------------¦ ¦Hilda M. Royce ¦$50,243.65 ¦ +---------------+------------¦ ¦Ken F. Royce ¦50,352.40 ¦ +----------------------------+

The sole question presented, after the stipulation of the disposition of other issues raised by the pleadings, is whether income from the sale and rental of construction equipment, which was made the subject of a declaration of gift, is to be attributed to the donor.


The facts stipulated are found accordingly.

Ken F. Royce, hereinafter referred to as the petitioner, and Hilda M. Royce, are husband and wife, and live in San Mateo, California. They filed income tax returns for the year in question with the collector of internal revenue for the first district of California. Ken Royce, formerly called Ken Rojek, was born in Berlin, Germany, where he lived with his parents, Herman and Martha Royce, and his brother, Fred. Herman Royce was born in 1872, and his wife, Martha, was 75 years old at the time of the hearing. The petitioner entered the construction equipment business when he was 17 years old and later became a partner in a firm. Hilda and Ken Royce were married in Germany in 1933. At that time the petitioner left his parents' home, where they conducted a tailoring business. Fred Royce, petitioner's brother, who was a graduate engineer, worked in the petitioner's construction equipment business in Berlin.

In December 1936, the petitioner and his wife and son, Peter, born in 1934, left Germany because of the persecution of Jewish people during this period. The petitioner was also accompanied by his parents, his brother and his brother's wife. The petitioner was able to sell his business at a loss and go to Switzerland and thence to San Francisco, California, in 1937. The petitioner and his wife applied to become naturalized citizens of this country and attained that status in 1942. In 1938 petitioner's father and mother, together with his brother and his sister-in-law, came to San Francisco from Switzerland with the petitioner's financial assistance. Petitioner further aided his parents financially after their arrival, and listed them as dependents for tax purposes, prior to October 15, 1942.

In this country the petitioner entered the construction equipment rental business. In 1941 he formed a partnership under the name of the Ken Royce Construction Equipment Rental Co., with Florence Silz, his mother-in-law, who became a minor partner, drawing no salary. The partnership rented tractors, motor graders, power shovels, cranes, and other similar machines, to W.P.A. contractors, the State of California, and the United States Army, among others.

On October 15, 1942, the petitioner executed a declaration of gift, transferring title to 28 pieces of construction equipment to his parents, Herman and Martha Royce, as joint tenants. The equipment consisted of truck cranes, tractors, shovels, and motor graders. The instrument stated that the gift was unconditional and that the donor's intent was to vest all of the property absolutely and irrevocably, as well as the control and dominion of the property, in his parents, who were to have the unrestricted right of possession and absolute enjoyment of the property. Florence Silz consented to the gift, as did Hilda Royce. A Federal gift tax return was filed by both Ken and Hilda Royce, reporting gifts by each to each parent. Each of the four gifts was valued at $7,257.64. By a second amended income tax return for the year 1942, Ken and Hilda Royce each reported $69,600.16 income from the partnership.

Herman and Martha Royce filed a Certificate of Fictitious Name stating that they were doing business under the name of H. & M. Equipment Co. The registration of title to the gift property was transferred to the H. & M. Equipment Co. Notices of change of ownership were sent to the lessees of rented equipment. Decalcomanias with the words ‘H. & M. Equipment Co., San Francisco, Cal.‘ were attached to the equipment. The H. & M. Equipment Co. was not listed in the telephone directory but it was issued a state seller's permit. Its name was listed on a small directory at the office of the Ken Royce Construction Equipment Rental Co. The gift transaction was recorded on the ledgers of the Ken Royce Construction Equipment Rental Co. and the H. & M. Equipment Co. which were kept under separate tabs in the same account book. The values placed on the properties were the depreciated values as previously shown on the books of petitioner's firm. Regular financial statements were received by Herman and Martha Royce, who came to their son's office occasionally. The H. & M. Equipment Co. maintained a checking account upon which Martha Royce and Curt Elsbach, auditor of the Ken Royce Construction Equipment Rental Co., had the power to draw checks. The equipment owned by the H. & M. Equipment Co. was not kept physically segregated from that owned by the petitioner's partnership. Office records, however, maintained a distinction between the properties.

On the day that the gifts were made, October 15, 1942, the same parties entered into an ‘Equipment Rental Agreement.‘ By its terms all of the equipment received by Herman and Martha Royce was leased by the H. & M. Equipment Co. to the Ken Royce Construction Equipment Rental Co. The lessee was entitled to sublease the equipment and to retain 10 per cent of the gross rentals after deducting expenses. On November 23 of the same year, a superseding ‘Agency Agreement‘ was executed by the parties canceling the equipment rental agreement. The Ken Royce Construction Equipment Rental Co. was designated agent to contract for the rental of the H. & M. Equipment Co. machinery and equipment. The agent was to receive 10 per cent of gross rentals, and the agency authority could be canceled by the H. & M. Equipment Co. upon 24 hours' notice in writing. On October 1, 1943, the Ken Royce Co., a partnership, was substituted as agent in place of the Ken Royce Construction Equipment Rental Co. which had been dissolved. A similar agency agreement was entered into in December 1943, by the Ken Royce Co. for the rental of four pieces of equipment owned by the Roseville Gold Dredging Co.

Partnership returns were filed in the name of H. & M. Equipment Co. reporting income as follows:

+---------------------------------------------------+ ¦ ¦Ordinary ¦Capital ¦ +---------------------------+-----------+-----------¦ ¦Year ¦income ¦gains on ¦ +---------------------------+-----------+-----------¦ ¦ ¦ ¦sale of ¦ +---------------------------+-----------+-----------¦ ¦ ¦ ¦equipment ¦ +---------------------------+-----------+-----------¦ ¦Oct. 15, 1942-Dec. 31, 1942¦$37,376.28 ¦ ¦ +---------------------------+-----------+-----------¦ ¦1943 ¦76,681.65 ¦$130,739.54¦ +---------------------------+-----------+-----------¦ ¦1944 ¦(38,854.09)¦73,525.05 ¦ +---------------------------+-----------+-----------¦ ¦1945 ¦(30,282.78)¦73,758.21 ¦ +---------------------------+-----------+-----------¦ ¦1946 ¦(13,070.25)¦42,688.02 ¦ +---------------------------------------------------+

Herman and Martha Royce filed individual income tax returns for 1943 reporting $31,622.10 and $31,597.61, respectively, as total income and victory taxes due. Each claimed a deduction of $5,000 for contributions to the Ken Royce Foundation which was created on December 31, 1943, its only receipts or expenditures being the contribution of $10,000. In 1945 and 1946 Herman Royce reported income taxes due of $617 and $737.19, respectively.

In each of the years 1943, 1944, 1945, and 1946, Herman and Martha Royce made gifts to their son Ken Royce, his wife Hilda, and son Peter. The gifts were in the amount of $3,000 to each donee by each parent, although more was given in 1944. In that year each parent filed gift tax returns disclosing gifts of $39,000 by each to Ken and Hilda Royce. On January 8, 1943, Herman and Martha Royce executed a joint and mutual last will and testament bequeathing all their property to each other and to Ken Royce in the event of death by a common disaster. On November 18, 1943, this joint will was revoked by separate wills of Herman and Martha Royce. The new wills devised all the parents' property to Ken Royce, who was also named executor. It was provided that petitioner's wife, Hilda, would become the beneficiary if he was not living, and if she was also deceased, Peter Royce would receive all of his grandparents' property. In the event that none of the aforementioned persons were living, the next devisee was the other spouse. If all of these persons had died, Fred Royce became the beneficiary and if he was not living, the heirs of Ken Royce succeeded to the property.

In 1944 seven pieces of equipment received in the gift transaction of October 15, 1942, were sold by the H. & M. Equipment Co. to the Ken Royce Co. and to the H. M. Royce Equipment Rental Co. The latter name was used by Hilda Royce. The sales were as follows:

+----------------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦ ¦Reported ¦ +------------+-------------+----------+------------+----------+--------------¦ ¦Purchaser ¦Description ¦Book value¦Depreciation¦Sales ¦capital ¦ +------------+-------------+----------+------------+----------+--------------¦ ¦ ¦ ¦on receipt¦ ¦price ¦gain ¦ +------------+-------------+----------+------------+----------+--------------¦ ¦ ¦(Shovel ¦$2,062.50 ¦$1,562.50 ¦$11,896.50¦$11,396.50 ¦ +------------+-------------+----------+------------+----------+--------------¦ ¦Ken Royce Co¦(Shovel ¦515.00 ¦15.00 ¦13,271.10 ¦12,771.10 ¦ +------------+-------------+----------+------------+----------+--------------¦ ¦Co ¦(Truck crane ¦2,187.50 ¦1,587.50 ¦9,350.00 ¦8,750.00 ¦ +------------+-------------+----------+------------+----------+--------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +------------+-------------+----------+------------+----------+--------------¦ ¦ ¦(Motor grader¦755.06 ¦425.06 ¦4,599.32 ¦4,249.32 ¦ +------------+-------------+----------+------------+----------+--------------¦ ¦ ¦(Motor grader¦825.83 ¦475.83 ¦5,347.13 ¦(sic) 5,997.13¦ +------------+-------------+----------+------------+----------+--------------¦ ¦H.M. Royce ¦(Crane ¦333.34 ¦ ¦5,456.90 ¦5,123.56 ¦ +------------+-------------+----------+------------+----------+--------------¦ ¦Equip Co ¦(Motor grader¦1,630.84 ¦1,230.84 ¦5,270.00 ¦4,870.00 ¦ +----------------------------------------------------------------------------+

Herman Royce died on February 24, 1947, leaving a gross estate of $76,750.97 which was inherited by Ken Royce except for jointly owned property to which Martha Royce succeeded. At the time of the hearing Martha Royce owned three houses and an interest in an apartment house, as well as United States savings bonds and stock in the Ken Royce Co.

The transaction by which petitioner and his wife transferred certain property to petitioner's parents did not constitute a valid and bona fide gift of such property.



The sole issue in these proceedings is whether the income produced through the rental and sale of the construction equipment which was the subject of the declaration of gift is to be taxed to Ken and Hilda Royce as community income or to petitioner's parents. The determinative question is whether the petitioner and his wife made bona fide gifts of the property or whether the transaction was made under implied restrictions and was, therefore, ineffective for tax purposes.

Examination of the facts in the light of the criteria of a bona fide gift discloses that the petitioner was a competent donor. In the declaration of gift he stated his intention to give the construction equipment to his parents. The parents were capable of accepting the gift. There was sufficient evidence of delivery of property of this type.

The fact that the parents did not become active participants in the business of renting construction equipment is not determinative that there was no valid gift. It has been held that a parent may give members of his family property which is used in the parent's business and although he manages and supervises the property and its sale so that it is productive of income, this income may still be taxable to the donee. Visintainer v. Commissioner, 187 F.2d 519. Although the rule set out by Lucas v. Earl, 281 U.S. 111, is that income is taxed to him who earns it, the fact that income-producing property is managed by the donor does not preclude taxation of the donee. If property is managed for the benefit of the donee he will be taxed upon the income. Alexander v. Commissioner, 190 F.2d 753. If the parents possessed the right of dominion over the property and the income derived therefrom, the actual day to day control by the petitioner would not affect our determination. Such everyday supervision and management, with the consent of the owner, would not change the tax burden. Henson v. Commissioner, 174 F.2d 846.

A valid gift requires, however, not only the aforementioned elements but also a bona fide intent by the donor to give away absolutely and irrevocably the ownership, dominion, and control of the property. The transaction must be in reality what it purports to be on its face. Lacking this essential element of bona fides and reality, there is no gift. Sewell's Estate v. Commissioner, 151 F.2d 806. A further requisite is the irrevocable and permanent transfer of legal title and dominion and control of the property to the donee. Adolph Weil, 31 B.T.A. 899, affd. 82 F.2d 561. On the evidence before us we are unable to find that the transaction was a valid and unrestricted gift. We cannot escape the conviction that from the beginning there was a plan to give the property and income derived therefrom back to the petitioners after his parents had paid the income taxes. In our opinion, a plan to give the property and income back to the petitioner as soon as possible with the least tax burden would deprive the gift to his parents of the necessary quality of an absolute and irrevocable transfer. True, the parties undertook to comply with meticulous care with the outward legal requirements of a gift. The gift instrument declared that the intention of the donor was to vest the property unconditionally, absolutely, and irrevocably in the donees. The formalities were fully served. However, the transfer and delivery of property are not conclusive if surrounding circumstances, including subsequent acts, indicate a contrary conclusion. Theodore C. Jackson, 32 B.T.A. 470. Even though the forms executed and the acts performed by the petitioner at the date of the alleged gifts would ordinarily manifest gifts, his later acts may indicate a failure to divest himself of title, dominion, and control. Oscar G. Joseph, 32 B.T.A. 1192. We are of the opinion that subsequent actions demonstrate and fully confirm the fact that the petitioner did not intend the gift of the equipment to his parents to be absolute and unrestricted but envisaged the return to himself and his family of the income produced by it with the eventual retransfer of the property itself. By this method his parents would receive the funds necessary to support themselves. They would also pay the taxes on the income produced at a lower rate than would petitioner, who had previously taken them as dependents. The parents would hold the property as it produced income and give back a substantial portion of this income each year and all of it on their death.

The gift transaction occurred in October 1942, and in the next 2 1/2 months the property which had been valued for gift tax purposes at $29,030.56 produced income of $37,376.28. In the following year the property was productive of $76,681.65 and gains from the sale of equipment aggregated $130,739.54. In 1943, $18,000 was given by Herman and Martha Royce to petitioner and his family by means of $3,000 gifts from each donor to Ken, Hilda, and Peter Royce. In 1943, Herman and Martha Royce each claimed a deduction of $5,000 contributions to the Ken Royce Foundation created on December 31, 1943. In 1944, the sale of construction equipment by the parents, a substantial quantity of which was sold to the Ken Royce Co. and the H. M. Royce Equipment Rental Co., produced capital gains of $73,525.05. An operating loss of $38,854.09 was incurred in 1944. In that same year, petitioner's parents each gave $39,000 to Ken and Hilda Royce, a total of $78,000. In 1945, capital gains on the sale of construction equipment by Herman and Martha Royce aggregated $73,758.21 and a loss of $30,282.78 was sustained through operations. In the same year petitioner's parents gave $18,000 to petitioner's family by gifts of $3,000 to each member. In 1946, capital gains of $42,688.02 were received on the sale of equipment while an operating loss of $13,070.25 was incurred. In 1946, another $18,000 was given by his parents to petitioner and his family. The sales of equipment to the Ken Royce Co. by the H. & M. Equipment Co. enabled the petitioner to receive the property back at an increased basis for depreciation while his parents were taxed at capital gains rates.

There is, of course, no limitation on the petitioner's right to make gifts to his parents nor a barrier to gifts by the parents to the petitioner and his family. When, however, an entire series of transactions discloses systematic and regular gifts of property and income from one person to others and back again to the original donor, we cannot close our eyes to the tax consequences. Other factors tend to show that there was no intent to make a bona fide gift but merely to acquire as many tax advantages as possible. The donor's employee was given the power to draw checks against the donee's bank account. A very low value was attributed to the gift property for gift tax purposes in the light of the fact that $8,000 more than the stated value was received from rental of the property in the 2 1/2 months following the gift transaction. Each year, with one exception, there was received back from the parents the maximum exclusionary amount of gifts. Approximately a year after the transaction, in November 1943, the parents revoked their joint wills and made petitioner and his family their devisees in preference to each other and their other son. In 1947 petitioner's father died and petitioner received all of the estate except for the property to which his mother succeeded as the surviving joint tenant. This property and the mother's estate would, in turn, descend to petitioner or his family upon the death of his aged mother. It may be argued that the petitioner's father and mother possessed the right and ability to keep for themselves the income produced by the equipment and to revoke their second wills. They were, however, elderly, newly arrived immigrants who had been dependent upon this son for their livelihood in a strange country. In Richardson v. Smith, 102 F.2d 697, 699, the court summed up the attitude of the courts, as follows:

* * * It is of course always possible that the parties to a formal transaction, like a deed or a written contract, may agree between themselves that it shall not have the effect upon their rights or obligations which it purports to have, or indeed any effect whatever; that it shall be a sham, a fetch, a disguise. So in this case the transfer may in fact have been intended only to deceive the taxing authorities. It is not necessary that such a mutual understanding shall be explicit or verbal; it may be gathered from the conduct of the parties in a series of transaction, or in any other way. Johnson v. Commissioner, 2 Cir., 86 F.2d 710. All that need appear is that the donor did not intend to divest himself of control over the res, that the donee knew of the donor's intent and assented to it, and that the donor knew of the donee's assent. If all this is fairly inferable (sic) from the relations, the gift, however formal, is a sham; but the donor's belief, though well founded, that he can prevail upon the donee to comply with his demands, is alone not enough; it does not put the donee's will under any constraint, and the property becomes unconditionally his. * * *

In the present instance the facts disclose that the petitioner held more than a belief that his parents would return the income and property. They went so far as to insure the return of all this property by executing new wills.

We do not have here a gift with a condition subsequent that does not affect the donee's title. The petitioner's intention, as construed from the facts, was to give his parents no absolute right of dominion and control over the property, which is required of a valid gift. The rule we follow has been well stated in Paul G. Green, 7 T.C. 142, 150:

It is axiomatic that the reach of the income tax law is not to be circumscribed by refinements of legal title. The rule finds expression in the oft repeated admonitions that taxation is an intensely practical matter, concerned with economic realities; that tax consequences flow from the substance of a transaction rather than from its form; and that command over property or enjoyment of its economic benefits marks the real owner for income tax purposes. Commissioner v. Court Holding Co., 324 U.S. 331; Helvering v. Clifford, 309 U.S. 331; Gregory v. Helvering, 293 U.S. 465; Corliss v. Bowers, 281 U.S. 376. * * *

In view of all the circumstances, we conclude that, despite its formalities, the gift by petitioner to his parents was not absolute and irrevocable. The petitioner's intent to have the income and property returned to himself and his family rather than vest irrevocably under the control of his parents, deprives the gift of validity for our purposes.

Albeit, intent is a state of mind, it is to be proved, as are other facts. In the search for a taxpayer's intent we must weigh all pertinent facts and circumstances and their consequences. When this is done we come to the conclusion that respondent should be sustained.

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