Docket Nos. 3949 3950.
R. Clarence Ogden, Esq., for the petitioners. T. M. Mather, Esq., for the respondent.
Held, that a certain trust did not violate the rule against perpetuities—there being an immediate vesting in the beneficiaries as at the date of the death of the trustor of interest both in income and corpus. R. Clarence Ogden, Esq., for the petitioners. T. M. Mather, Esq., for the respondent.
The respondent determined deficiencies in the petitioners' income tax and imposed penalties as follows:
+-----------------------------------------------------+ ¦Petitioner ¦Docket¦Year ¦Deficiency¦Penalty¦¦ +--------------------+------+-----+----------+-------+¦ ¦ ¦No. ¦ ¦ ¦ ¦¦ +--------------------+------+-----+----------+-------+¦ ¦A. M. Standish ¦3949 ¦(1940¦$136.05 ¦$6.80 ¦¦ +--------------------+------+-----+----------+-------+¦ ¦ ¦ ¦(1941¦2,055.37 ¦102.77 ¦¦ +--------------------+------+-----+----------+-------+¦ ¦Beatrice M. Standish¦3950 ¦(1940¦136.03 ¦6.80 ¦¦ +--------------------+------+-----+----------+-------+¦ ¦ ¦ ¦(1941¦2,055.37 ¦102.77 ¦¦ +-----------------------------------------------------+
The issues are as follows:
(1) The proper amount of a bad debt due from the Yorkville Lumber Co. deductible in 1940.
(2) The deductibility in 1941 of a loss from the sale of timber properties for delinquent taxes.
(3) The propriety of a negligence penalty asserted by the respondent.
FINDINGS OF FACT.
The petitioners are husband and wife and reside in Milpitas, California. The husband will hereinafter be referred to as the petitioner. They filed their income tax returns for the years 1940 and 1941 with the collector of internal revenue for the first district of California.
The petitioners are partners in the ownership and operation of the property giving rise to the deductions claimed. The partnership was engaged chiefly in the operation of orchards. Its books of account were set up by a public accountant. The petitioner kept the books to the best of his ability. The books for prior years had been examined by the Treasury Department and no complaint has been made against the type of books, the impropriety of the method employed, or the petitioner's neglect in keeping them.
Miles Standish, father of the petitioner, died on June 22, 1932, a resident of California. At the time of his death he was the owner in fee simple of an undivided one-half interest in certain real property in Coos County and Douglas County, Oregon, having a value of $19,462.25 for his half interest, as finally determined by the respondent in estate tax proceedings. The decedent's interest in the Douglas County lands was valued at $9,201 and in the Coos County lands at $10,261.25. The Coos County holdings and their respective values were 520 acres of agricultural land, $14,560; 400 acres of timber land, $440; 1,000 acres of cut-over lands suitable for reforestation, $1,000; and 9,045 M feet of Douglas fir timber, $4,522.50, or a total of $20,522.50, the decedent's one-half being $10,261.25. The Douglas County property was all timber land.
In 1941 all the Douglas County land was sold for the nonpayment of taxes and the tracts of the Coos County land suitable for agriculture and the timber land were also sold at tax sales, leaving unsold only the reforestation land. Prior to the tax sale the petitioner and Henry B. Hickey, the owner of the other undivided one-half interest, had sold lands and timber therefrom for $3,521.95.
The loss to the Standish interests was $17,201.28, composed of loss on the Douglas County tax sale ($9,201) and loss on the Coos County lands ($8,000.28), computed by subtracting one-half of the value of the reforestation land unsold ($500) and one-half of the amount realized from the sale of timber and lands ($1,760.97) from the original value of the decedent's one-half interest ($10,261.25).
On June 17, 1932, Miles Standish executed a deed of trust the corpus of which included the Coos County and Douglas County lands. The trust directed that the corpus should be held by the trustees, who were to pay the net income therefrom to the grantor during his lifetime, and upon his death to the petitioner, his wife, and his two children in designated proportions. The trust instrument contained the following pertinent provisions:
This division of the net proceeds and income from the said property shall continue until the youngest grandchild shall have attained the age of thirty (30) years, when the Trustees shall convey to the Beneficiaries then living, all of the property then remaining in this trust, in such proportion as their respective interests are indicated by the percentages upon which the income has been paid to them, and the trust shall cease.
EIGHTH: In the event that I have any additional grandchild or grandchildren living at the time of my death, the shares of Patricia and Beatrice Standish shall be proportionately reduced so that such additional grandchild or grandchildren shall share equally with them.
NINTH: In the event that any grandchild shall die prior to the time that the respective beneficial interest due said grandchild shall become payable in whole or part as herein provided, then the invested beneficial interest due said grandchild shall revert as follows:
1. If said deceased grandchild shall leave lawful heir of his or her body then such legal heir or heirs shall become the beneficiary in the place and stead of his or her parent by right of representation.
2. In the event any deceased grandchild leaves no legal heirs, then the beneficial interest to which said grandchild would otherwise be entitled shall revert to the equal benefit of the surviving grandchildren, the legal issue of any deceased grandchild to take by representation.
3. In the event that all of said grandchildren die without legal issue prior to the vesting of all of said trust estate, so much as remains shall be paid or delivered to any heirs of the first party under the law of succession as the same exists at the date of this instrument.
In 1941 a fiduciary return was filed for the Miles Standish Trust in which a loss of $14,943.60 was reported from the sale of the Coos County and Douglas County lands.
Miles Standish left a will dated January 7, 1930, which established a testamentary trust. The will made specific bequests and then contained the following paragraph:
FOURTH: I give, devise and bequeath to my said son, ALLAN M. STANDISH, all of the residue of my property and estate of every kind and nature, and wherever situate, of which I may die seized or possessed or in which I may have an interest, in trust, nevertheless, for the following uses and purposes, that is to say: To have, hold, manage and control, bargain, sell, transfer, exchange, invest and reinvest the proceeds thereof; to collect the income therefrom, and out of said income pay over one-half thereof to the Trustees of a certain Trust created by agreement in writing, dated the 7th day of January, 1930, made and executed by Miles Standish, the party of the first part therein named, and Miles Standish and Allan M. Standish, his son, the parties of the second part therein named, their successors and survivors, which said trust agreement is hereby referred to and made a part hereof, in trust, nevertheless, for the use and benefit of my grandchildren, PATRICIA STANDISH, and BEATRICE STANDISH, the children of my said son, ALLAN M. STANDISH, and for the use and benefit of any other child or children hereafter born to my said son ALLAN M. STANDISH, in equal shares, as provided by the terms of said last named trust, and to pay over the remaining one-half of said income to my said son ALLAN M. STANDISH, in his own right and for his own use and benefit; and as fast as said property is sold and the proceeds thereof collected, pay over and distribute the same in the manner and in the same proportions as said income is to be paid over and distributed; * * * in any event, this Trust shall terminate and division of the property shall be made as aforesaid, not later than fifteen (15) years from the date of my death.
The will was not probated in Oregon. No administrator of the decedent's estate was appointed in that state. The decedent had no debts in Oregon. The will was probated in California on June 29, 1932. The estate was not distributed until July 24, 1942. In the decree ordering the final distribution thereof, the Superior Court of the State of California for Santa Clara County decreed that the petitioner was entitled to one-half of the corpus of the specified property of the estate for his own use and benefit, and the other one-half should go to him in trust for the benefit of his two children, Patricia Standish and Beatrice Standish, at that time adult persons.
In 1934 the petitioner loaned $5,000 to the Yorkville Lumber Co. Hickey also made a loan to it which, in 1940, amounted to $8,000. The loans by the petitioner and Hickey were secured by a lien on all of the physical assets of the company. The company went out of business and a trustee sold all of its assets for $1,975.31. On December 16, 1940, the trustee notified the petitioner that all of the company's assets had been turned into cash and that the petitioner's maximum recovery would be $760. Later the company denied the validity of the lien, a lawsuit followed, and in 1943 the petitioner and Hickey obtained a judgment for $1,957.56. On November 1, 1943, the petitioner had expenses against the judgment aggregating $966.76, leaving an ultimate net recovery of $990.80 on the judgment. Hickey had previously recovered payments on the debt in which the petitioner had not shared. Accordingly, Hickey's executors agreed to a settlement whereby the petitioner received the entire amount of the judgment.
The respondent held that ‘the loss of $10,512.92 claimed as sustained by the Miles Standish Trust upon the loss of certain timber property because of failure to pay taxes owing to the State of Oregon is disallowed on the ground that any loss sustained is deductible by the Estate of Miles Standish, Deceased, or trusts created by him, either prior to death or in his will.‘
The respondent also reduced the bad debt deduction claimed on a loan made to Yorkville Lumber Co. by $1,215.31, computed as follows:
+--------------------------------------------+ ¦Loan made June 22, 1934 ¦ ¦$5,000.00¦ +----------------------------+-----+---------¦ ¦Proceeds in liquidation ¦ ¦1,975.31 ¦ +----------------------------+-----+---------¦ ¦Bad debt worthless in 1940 ¦ ¦$3,024.69¦ +----------------------------+-----+---------¦ ¦Amount claimed on the return¦ ¦4,240.00 ¦ +----------------------------+-----+---------¦ ¦Amount disallowed ¦[sic]¦$1,235.31¦ +--------------------------------------------+
VAN FOSSAN, Judge:
We consider first the issue as to the correct amount of the bad debt against the Yorkville Lumber Co. which became worthless in 1940. The petitioner claimed a loss of $4,240, based on the recovery of $760 as the partnership's share of the amount paid to the trustee in that year. The respondent charged against the loss of the original loan of $5,000 the entire amount ($1,975.31) of the payment held by the trustees.
The petitioner's contention is supported by the record. The evidence is uncontroverted that on December 16, 1940, the trustee had sold all of the assets of the company and that the company had no other source from which its debt to the petitioner and Hickey could be paid. The trustee held the fund for the benefit of the petitioner and Hickey. The worthlessness of the debt was definitely established at that time. Hickey and the petitioner were the creditors to whom the amount of the recovery was payable in the proportions then known and accepted as the basis of the division between them.
The subsequent suit resulting in judgment and the adjustment made between the petitioner and Hickey's executor relating to items not in the record are not pertinent to the issue. The respondent has overlooked the fact that the recovery in 1940 was for the benefit of both the petitioner and Hickey and has misstated the amount of the ‘proceeds of liquidation.‘ The partnership is entitled to the deduction of the bad debt in the sum of $4,240.27 ($5,000 minus five-thirteenths of $1,975.31). If any part of the ultimate net recovery in 1943 represented income to petitioner, it was a matter for accounting in that year.
The second issue calls into question the validity of a trust instrument executed by Miles Standish on June 17, 1932, and also the effect of a testamentary trust established by the will of Miles Standish. The petitioner contends that the provisions of the first trust were void as violating the rule against perpetuities and that no testamentary trust was set up as to the residue devised to Allan Standish under paragraph fourth of the will. He argues that the will makes a direct devise of one-half of the estate to him as held by the California court. He does not discuss the status of the other half, but appears to concede that the will created a trust as to it.
The respondent argues that no judicial determination of the validity of the inter vivos trust (of June 17, 1932) has been made; that the trust did not violate the rule against perpetuities; that in case the trust should be declared invalid by this Court the property would revert to Miles Standish, subject to the testamentary disposition made by the will; and that the fact that the beneficiaries entitled to the trust income may ultimately receive the corpus does not invalidate the trust.
It appears clear that if the trust of June 17, 1932, did not violate the rule against perpetuities, as contended by the petitioners, a valid trust was created, which trust fixed the ownership of the property in question and accordingly fixes the liability for income taxes and the rights to losses arising from such property. For aught that appears, the trust has been in effect for all the years since its creation and has been recognized by the parties, the present instance being the only time its validity has been questioned.
It is elemental that the law favors the vesting of estates. It is also elemental that the law tends to support the intention of a grantor or a trustor, if such intention can be ascertained. Here it is obvious that by the trust Miles Standish was planning the future of his son Allan and his wife and their two children. The same intention involving the same parties is evident in his will dated two years prior. By the trust he left the income as at the date of his death (which occurred five days later) 51 percent to Allan Standish, 17 percent to Beatrice M. Standish (Allan's wife), and 16 percent each to the two grandchildren, Patricia and Beatrice. This was to continue until the youngest grandchild became 30 years of age, when the trustee was to convey the corpus of the trust to the beneficiaries then living, in the same proportions as the income payments. Any additional grandchild living at the date of the death of the trustor was to share equally with those then living.
In Simes Law of Future Interests, vol. II, p. 103, appears the following:
Sec. 356. Intermediate Gift of Income.
An intermediate gift of the income to the legatee or devisee who is to receive the ultimate gift on attaining a given age is an important element tending to show that the gift is vested and not contingent. This would seem to be for the reason that the gift of income shows that the testator intended the legatee or devisee to take some benefit from the gift of the principal immediately on the testator's death, and that the postponement of possession was merely for the benefit of the donee. The same presumption in favor of the vested character of the gift obtains where only a portion of the income is to be given for maintenance.
The following statement from the opinion of the Pennsylvania Supreme Court in Appeal of Reed, 118 Pa.St. 215; 11 Atl. 787, is also in point:
* * * And while it is true as a general rule, as before observed, that where the time or other condition is annexed to the substance of the gift and not merely to the payment, the legacy is contingent, yet it is equally true that a well recognized exception to the rule is, that where interest, whether by way of maintenance or otherwise, is given to the legatee in the meantime, the legacy shall, notwithstanding the gift appears to be postponed, vest immediately on the death of the testator.
It is clear that there was a vesting in possession of the beneficiaries of the income of the trust as of the date of the grantor's death. We are of the opinion that by the terms of the trust, under the law, there was also, as of that date, an immediate vesting of interest in the corpus or remainder. The fact that as of the date of the trust there was a possibility of divesting of the estates of the grandchildren and a redistribution to accommodate an after-born child does not affect the vesting or make it contingent. It is our opinion that, looking to the four corners of the trust, the grantor contemplated immediate vesting of interest of the corpus of the property in the several beneficiaries.
The consequence of our ruling that the property had vested as of the date of the grantor's death is that petitioners are not entitled to deduct the loss sustained on the Coos County and Douglas County properties.
The situation is not, in anywise, affected by the decree of the California Court of Probate entered in 1942. This adjudication dealt with wholly different specified property and does not purport to deal with or affect in any way the property here in question.
The record discloses no evidence to warrant the imposition of penalties for ‘negligence or intentional disregard of rules and regulations,‘ as charged by the respondent. The petitioners disclaimed any such act or intent. The notices of deficiency reveal no more than the ordinary difference of opinion between taxpayers and the Treasury Department. Therefore, no such penalties will attach.
Reviewed by the Court.
Decision will be entered under Rule 50.