Docket No. 36138.
Dean H. Dickinson, Esq., for the petitioner. Douglas L. Barnes, Esq., for the respondent.
1. Real property held as tenants by the entirety, in the purchase of which the wife made no contribution, was conveyed to a trust under the terms of which the settlors reserved power to manage and control the property, collect the income therefrom, and amend or revoke the trust during their joint lives. Held, that the value of the property is includible in gross estate under the provisions of section 811(e), Internal Revenue Code.
2. Respondent's determination of a penalty for failure to file a timely return sustained because of lack of proof of error. Dean H. Dickinson, Esq., for the petitioner. Douglas L. Barnes, Esq., for the respondent.
This proceeding involves a deficiency of $32,038.38 in estate tax and a delinquency penalty of $8,268.68. The issues are whether all or one-half of the agreed value of certain property placed in trust is includible in gross estate, and whether the penalty imposed for failure to file a timely return is proper.
FINDINGS OF FACT.
The petitioner is a national banking association acting as trustee of the trust estate of Frank N. Derby, who died at Salem, Oregon, on January 26, 1945, at the age of 89. Petitioner had its principal office in Portland, Oregon, and operated branch banks throughout the State of Oregon. The decedent had been a resident of Salem for more than 40 years prior to his death. His wife, Marian A. Derby, survived him and died July 14, 1947, at the age of 85. There was no administration of decedent's estate.
About May 19, 1936, the decedent and his wife conveyed to petitioner five parcels of real property situated in Oregon without designating the grantee as trustee of the property, and with the intention of entering into a trust agreement with the grantee involving the property. There are no recorded conveyances of the real property from the decedent and his wife, except to petitioner.
On May 19, 1936, the grantors, designated as husband and wife, and petitioner, named trustee, executed a trust instrument, subject to the terms of which petitioner was to hold the property previously conveyed to it in absolute form.
The liability of the trustee was limited by the trust instrument to such interest as it received and for any collections made by it under the agreement. A declaration was made by the trustors in the instrument that each of them was the owner of an undivided half interest in the real property. The trustee was not required during the lifetime of either of the trustors to procure or maintain insurance on the property, pay any charge against the property except as provided in the deed, or protect the trust estate against any legal or equitable attack unless requested to do so by the trustors and then at their expense. The trustors reserved the right to rent the property, collect the income therefrom, and otherwise manage it, free of any responsibility of the trustee, as though no conveyance had been made to the trustee. The trustee was not to assume management of the property until the death of the survivor of the settlors, unless they, acting jointly, or the survivor in the event of the death of either, directed the trustee in writing to assume management at some prior time. The settlors reserved the right during their joint lives to amend or revoke the trust. Upon the death of the survivor of the trustors the income of the trust was distributable to specified individuals during their several lives, and upon the death of the last survivor of them the trust property and undistributed income was to be conveyed and delivered to three designated fraternal organizations as tenants in common. If any part of the estate remained undistributable for want of a designated beneficiary, the property was to go to the heirs at law of the trustors. Provision was made in the instrument for compensation to the trustee, including an annual fee of ‘1/10th of 1%‘ while the trustee had no duties to perform under the instrument. The property was conveyed and the trust deed was executed for the purpose of reducing estate tax liability.
The trustors amended the declaration of trust several times. By an amendment made December 20, 1938, article III was amended and a spendthrift clause inserted, reading as follows:
ARTICLE III— RIGHTS RESERVED BY TRUSTORS. The trustors have reserved the right and power:
(a) By their joint action during the lives of both to change or amend by written instrument filed with the Trustee any of the terms of this trust, or to revoke it in whole or in part, at any time, and to withdraw at one time, or from time to time, such portions of the trust fund, discharged of this trust, as shall be designated in written request filed with the Trustee by the Trustors. Any such partial or total revocation is to be effective only when all sums due the Trustee hereunder have been fully paid, and the Trustee has been fully released and discharged, or properly indemnified as to any liabilities or obligations affecting the Trustee and the property held hereunder. AFTER THE DEATH OF EITHER TRUSTOR, THIS TRUST SHALL NOT BE SUBJECT TO CHANGE, AMENDMENT OR REVOCATION BY THE SURVIVOR.
(b) Acting either jointly or individually, to devise, bequeath, convey, or otherwise transfer to the Trustee other property to become subject to the provisions of this trust, which, upon acceptance thereof by the Trustee, shall become a part of the trust fund hereunder, subject to all the terms hereof. Any beneficiary of this trust, or other interested party, shall also have the privilege of making additions to the trust fund, if approved by the Trustee.
(c) During the lives of both, and during the remainder of the lifetime of the survivor after the death of either, to manage and supervise the assets comprising the trust fund hereunder, and to receive and collect the income therefrom, without accounting therefor to the trustee, and during such time, the Trustee shall have no duty with respect to the management, supervision, collection of income, protection, maintenance, repairing or insuring of any such property, nor for the payment of any taxes, assessments, mortgages or other liens which may be or hereafter become a charge against any such property, and its sole duty shall be to hold and retain the same as a part of the trust fund. The Trustors, by their joint action during the lives of both, and the survivor of them after the death of either, may surrender to the Trustee in whole or in part the powers in this paragraph reserved to them, and may thereafter resume the exercise of such powers.
ARTICLE V— SPENDTHRIFT CLAUSE. Each beneficiary hereunder, other than the Trustors, is hereby restrained from alienating, anticipating, encumbering, or in any other manner assigning his or her interest or estate in either principal or income, and is without power so to do, nor shall such interest or estate be subject to his or her liabilities or obligations, nor to judgment or other legal process, bankruptcy proceedings, or claims of creditors or others.
During the entire life of the trust the trustors frequently exercised their right to deposit with or withdraw assets from the trust. Pursuant thereto, in 1938, 1939, 1942, and 1943, four parcels of real property, none of which is in controversy here, were conveyed by the trustee to, or to the order of, the trustors. Three of the parcels were conveyed to the decedent and his wife as husband and wife.
In accordance with powers reserved by them in the trust instrument, the trustors operated all of the properties in the trust, received the rents thereof, and included the income and deducted expenses incurred in operating all of the trust property in their individual income tax returns filed for 1936 and thereafter to the date of decedent's death. During that period the trustees made fiduciary returns for only the years 1939 and 1945, in which the only income reported was long-term gain on sales of real property. At the time of decedent's death the corpus of the trust consisted primarily of income-producing property and the personal residence of the decedent and his wife.
At the time of decedent's death the petitioner held six parcels of real property in the trust of the agreed value of $188,500, one-half of which was included in gross estate as the value of decedent's half interest in the property. When the property was acquired it was conveyed to the decedent and his wife as tenants by the entirety. There are no recorded conveyances of the property, with the exception of the deeds to the trustee, in which the grantors are described as husband and wife. No independent contribution was made by the wife to the purchase of the real estate.
In his determination of the deficiency respondent held that the full value of the property was includible in the gross estate under the provisions of section 811(d) and (e) of the Code and, accordingly, increased the amount returned as gross estate by $94,250.
During the last war a large number of the young men in the trust department of the main office of petitioner and the trust office, R. M. Alton, entered the military service. The duties of Alton were taken over by E. C. Pierce. Alton resumed his former duties with petition in April, 1945. Pierce died in July 1945. After the death of the decedent's wife on July 14, 1947, petitioner ascertained that no estate tax return had been filed for the decedent's estate. Thereafter petitioner prepared an estate tax return for the estate and filed it with the collector for the district of Oregon on August 9, 1948. The general practice of petitioner is to file estate tax returns promptly. Other than by the provisions of the trust agreement decedent made no testamentary disposition of his estate. There was no administration of his estate. Decedent's wife acquired, as survivor, the balance of $8,188.61 in a joint bank account in her and decedent's name.
The six parcels of real property involved in the first issue, the value of which is not in dispute, were acquired by the decedent and his wife as tenants by the entirety. The petitioner concedes that inasmuch as the surviving spouse contributed nothing to the purchase of the property, the full value thereof would have been includible in decedent's gross estate if the tenancy had not been previously severed. It contends here that the effect of the conveyance to the trustee and the trust declared on the property was to convert, by the joint action of the owners, the entirety estates into tenancies in common, with the result that the decedent died seized of no more than a one-half interest in the property as a tenant in common. It asserts that no greater interest passed for taxation under section 811(d) or (e). The broad contention of the respondent is that the declaration was a passive trust for testamentary disposition of property and did not serve for estate tax purposes to sever the estates by the entirety. The parties are in agreement that the interest of the decedent in the property at the time of his death is controlled by the laws of Oregon.
To establish severances of the tenancies by the entirety in favor of tenancies in common, petitioner relies upon the deeds to the trustee and the declaration of trust. The deeds to the trustee for the original five parcels were absolute in form and did not designate it as trustee of the property. The trustors made a declaration in the trust instrument that ‘at the time of said conveyance each of them was the owner of an undivided half interest in and to the real property.‘ Petitioner asserts that the declaration of ownership in the instrument ‘indicates‘ a prior mutual agreement to convert the entirety estates into tenancies in common. There was no prior recorded conveyance of the property and there is no evidence of a written agreement previously entered into between the spouses for the severance of the estates into tenancies in common, or otherwise. Petitioner cites no decision of Oregon courts recognizing a right to sever a tenancy by the entirety by an oral agreement, and we find none. A provision in section 63-210, Oregon Compiled Laws Annotated that a ‘conveyance from husband or wife to the other of their interest in an estate held by them in entirety shall be valid and dissolve the estate by entirety,‘ indicates that an oral agreement between the spouses for conversion of their entirety interests into tenancies in common would not be effective. The real intent of the parties was to change the character of the estates without payment of consideration to reduce estate tax liability of decedent and make a testamentary disposition of the property.
The trust agreement did not diminish the right of control of the trustors or their economic interest in the corpus during their joint lives, for they reserved exclusive power to operate the property, collect the income therefrom, and amend or revoke the instrument. The reserved powers were exercised and to the extent of withdrawing real property by deeds to themselves as husband and wife, which created entirety interests in the property. Noblitt v. Beebe, 23 Or. 4, 35 P. 248; Marchand v. Marchand, 137 Or. 444, 3 P.2d 128.
The trustee did not receive more than bare legal title to the property, and power to manage and operate the corpus was not conferred upon it during the life time of decedent. The evidence does not establish that the declaration of trust was recorded.
In Coston v. Portland Trust Co., 131 Or. 7, 278 P. 586, the wife executed deeds conveying real property to a trustee with the provision that the instrument not be placed of record and a reservation of power to control the property and collect the income therefrom. The trust instrument was never recorded. Late the husband executed quit-claim deeds covering most of the property placed in trust. The court held that the instrument created an express passive trust; that the estate of the trust was liable for debts of the trustor created before and after the conveyance; that the trust instrument was no more than a testamentary disposition of property, and that no part of the trust estate passed to beneficiaries other than the trustor during the latter's life. A like situation prevails here.
In Estate of William Macpherson Hornor, 44 B.T.A. 1136, the decedent conveyed to himself and his wife as tenants by the entirety parcels of real property in Pennsylvania which he had inherited and purchased. The wife made no contribution to the cost of the properties and paid nothing to her husband for the entirety interest she acquired from him. In 1935 they conveyed the properties to themselves and another individual as trustees to manage and operate the property and distribute the net income jointly to the trustors, and upon the death of one to the other for life. Provision was made in the instrument for distribution of income after the death of the surviving settlor and of the corpus after death of the survivor of the income beneficiaries. The settlors reserved joint power of revocation and modification. Upon the death of either settlor the trust was irrevocable.
There, as here, the taxpayer sought to prevent the imposition of estate tax on entirety estates because of the intervening trust. In holding that the value of the property was includible in gross estate under section 302(e) of the Revenue Act of 1926, corresponding to section 811(e) of the Code, we said:
But, other than the creation of a purely legalistic title in the spouses and their son as trustees instead of the spouses alone as owners, the trust, for present purposes, accomplished nothing. Until the first decedent died, it was revocable; and until both settlors died, the income was distributable to them. These reservations deprived the trust of substance sufficient to withhold it from the gross estate. A trust created by joint tenants or tenants by the entirety has no greater force to keep the property from the gross estate of one of the settlors than would a similar trust created by an individual. Revocability and reservation of income for life leave the property in the settlor's gross estate as effectively in one case as in the other. Property held in a revocable trust is within the gross estate, Porter v. Commissioner, 288 U.S. 436; Reinecke v. Northern Trust Co., 278 U.S. 339; Chase National Bank v. United States, 278 U.S. 327. So is property of which the decedent has a possibility of reversion, Helvering v. Hallock, 309 U.S. 106.
On appeal the decision was affirmed upon the ground that the transfer to transfer to the trustees was ‘squarely within the provisions of Section 302(e). ‘ 130 F.2d 649.
Petitioner seeks to distinguish the Hornor case upon the ground that no conveyance of title was made because the grantors transferred the property to themselves and that the avails were held as tenants by the entirety. The property was, in fact, conveyed to themselves and another individual as trustees and the trust instrument provided for distribution of the net income jointly to the settlors. In Pennsylvania either spouse may rent real property held as tenants by the entirety without an accounting to the other. Wakefield v. Wakefield, 149 Pa.Super. 9, 25 A.2d 841; Lohmiller v. Gotwals, 150 Pa.Super. 539, 29 A.29 206.
The petitioner cites Sullivan's Estate v. Commissioner, 175 F.2d 657, in connection with its discussion of the creation of tenancies in common out of the entirety estates but makes no contention that it controls the answer here. That case arose in California and involved the application of section 811(c) to the conversion of joint estates into tenancies in common. The court held that the conversion was bona fide for money's worth and recognized that the factual situation differed from the Hornor case.
Accordingly, we hold that respondent did not err in including the full value of the property in gross estate under the provisions of section 811(e).
The decedent died January 26, 1945, and the estate tax return was due April 26, 1946. Sec. 821(b), I.R.C.; Regs. 105, sec. 81.63. There was no administration of the estate. The return was filed by petitioner on August 9, 1948. The respondent imposed a delinquency penalty of 25 per cent of the tax because of the failure to file a return within the prescribed time. The difference between the parties on the penalty question is whether the failure to file a timely return ‘was due to a reasonable cause and not to willful neglect.‘ Section 3612(d)(1).
Petitioner asserts that its failure to file a timely return resulted from oversight due to alleged administrative difficulties in its trust department because of the absence in the war of Alton, the trust officer, and some of the young men employed in the department, and the death in July 1945 of Pierce, who took over the work of Alton during his military service.
The trust officer returned to duty in April 1945 and hostilities in the war ended in August 1945, both of which dates are well within the time allowed for filing. Assuming that the reason assigned could be regarded as reasonable, there is no proof that the administrative problem was not completely remedied soon enough after the return of Alton for the filing of a timely return. It was ascertained after the death of the wife on July 14, 1947, that no return had been made, yet almost 13 months elapsed before the return was filed.
The petitioner is a banking institution operating a trust department for the administration of estates. As such it is presumed to know when estate tax returns should be filed and its customary practice was to file estate tax returns promptly. Estate of Charles Curie, 4 T.C. 1175, 1185. An examination of its records, before being prompted by the death of the wife two and one-half years after decedent died, would have revealed that no return was filed and shown the fallacy of any assumption Alton might have had that arrangements had been made to have a timely return filed by a personal representative of the estate. There was no administration of the estate, and it does not appear that petitioner endeavored to ascertain the fact until after the death of decedent's wife.
Petitioner, in our opinion, has failed to establish that there was reasonable cause for the delinquency and that it was not due to willful neglect.
Decision will be entered for the respondent.