Docket Nos. 4453 4454.
Carroll J. Lord, Esq., for the petitioners. Gerald W. Brooks, Esq., for the respondent.
Husband and wife each created a trust naming their children beneficiaries. Each trustor gave his spouse power to alter, amend, or terminate the trust, although each indenture specifically prohibited the exercise thereof to the advantage of the settlor. In addition, each spouse was given the right to direct a corporate trustee as to the sale, retention or reinvestment of trust properties. The trusts were created within 13 days of each other, were of practically the same value, and contained substantially the same terms and conditions. Held, the respective petitioners are taxable on the income from the trust nominally created by the other under section 22(a) of the Internal Revenue Code. Carroll J. Lord, Esq., for the petitioners. Gerald W. Brooks, Esq., for the respondent.
These proceedings, consolidated for hearing and disposition, involve redetermination of deficiencies in income tax for the taxable years and in amounts as follows:
+----------------------------------------------------+ ¦Docket No.¦1939 ¦1940 ¦1941 ¦Total ¦ +----------+---------+---------+----------+----------¦ ¦4453 ¦$4,968.02¦$9,522.88¦$13,089.63¦$27,580.53¦ +----------+---------+---------+----------+----------¦ ¦4454 ¦4,016.75 ¦8,572.23 ¦12,060.26 ¦24,649.24 ¦ +----------------------------------------------------+
The issues herein are concerned solely with the taxability of each petitioner under section 22(a) and sections 166 and 167 of the Internal Revenue Code on the entire income from two trusts created one each by the petitioners, who are husband and wife, for the primary benefit of the four children of the couple.
FINDINGS OF FACT.
Werner A. Wieboldt and Pearl O. Wieboldt, husband and wife, are residents of Highland Park, Illinois. They filed separate income tax returns for the years 1939, 1940, and 1941 with the collector of internal revenue at Chicago, Illinois.
On December 13, 1934, petitioner Pearl O. Wieboldt, as settlor, entered into a trust agreement with the Northern Trust Co., an Illinois corporation, as trustee, conveying to it 10,000 shares of no par common stock of Wieboldt Stores, Inc., an Illinois corporation. These shares were valued at $150,000 by Mrs. Wieboldt on a gift tax return filed by her. On the same return Mrs. Wieboldt reported a gift of 350 shares of Wieboldt Stores common no par stock to her son, William H. Wieboldt, at a valuation of $4,637.50. The gift to this son was made in connection with the creation of the trust and was intended, in part, to equalize the value of the gifts as between her 4 children, who were the primary beneficiaries under the trust indenture. In 1935 Mrs. Wieboldt added to the trust, for the equal benefit of the 4 children, 200 shares of Wieboldt Realty Trust first preferred stock. At the time the trust was created the respective ages of the children were 24, 21, 10, and 8 years.
The trust indenture provided that the trustee should hold an equal portion of the trust property for the use and benefit of each of the named beneficiaries, although it authorized the trustee to make common investments and to hold the several portions as a common fund, dividing the net income proportionately, so long as it could be done advantageously. The income from each portion was to be accumulated and added to the principal of the several portions in equal shares until the beneficiary of that portion attained the age of 21 years. After each such child reached 21, the entire net income from his portion was absolutely distributable to him. The trust corpus was to remain intact until each beneficiary attained the age of 35 years, at which time one-half of his portion was distributable. The balance was to be distributed when the beneficiary reached 40. In the event of the death of a beneficiary, provision was made for distribution to his designee, or to his lineal descendants, or, in default of both, to the other children of the settlor.
The instrument gave the trustee the usual broad powers of management and control, and provided for the resignation of the trustee and for its removal by the settlor or by her husband after her death or incapacity.
Under the terms of Mrs. Wieboldt's trust, the trustee was to vote the capital stock of Wieboldt Stores, Inc., and shares or beneficial interests in the Wieboldt Realty Trust in accordance with the direction of the settlor's husband, Werner Wieboldt, so long as he was alive, competent to act, and so long as the corpus of the trust comprised such interests. It was also provided that the trustee should consult with and comply with the directions of Werner in reference to the sale or retention of any of the securities or properties of the trust and the reinvestment of the proceeds of any sale or maturity of trust properties. After Werner's death or incapacity, William Wieboldt, son of the settlor, was to assume the above powers. William was 24 years of age at the time the trust was created. The trustee was to be fully protected in following the directions of Werner or William, and while either Werner or William lived the trustee was relieved of all responsibility in connection with the holding, voting, or selling of such shares or beneficial interest.
William Wieboldt, elder son of the settlor, was given the right to purchase the shares of Wieboldt Stores, Inc., held by the trust, at any time after the death of his father, at a price to be agreed upon by the trustee and the adult beneficiaries.
The instrument contained the usual spendthrift provision and also provided that the trustee might use the principal of the share of any beneficiary to meet unusual expenses caused by illness, surgical operations, or other extraordinary demands, when the income to which the beneficiary was entitled under the terms of the trust, as well as income from all other sources, was insufficient to defray such expenses.
Article XVI provided as follows:
The Settlor has been advised that she may retain herein unlimited power to amend, alter or revoke this agreement, but she desires to and does hereby waive any and all right and power to alter, amend or revoke this agreement in whole or in part. It is agreed, however, that the said WERNER A. WIEBOLDT may, during his lifetime, and if competent to act, alter, amend or revoke this agreement, in whole or in part, and that after the death of the said Werner A. Wieboldt, or if he shall be living and incompetent to act, this agreement may be altered, amended or revoked, in whole or in part, with the unanimous consent and approval of all of the beneficiaries hereunder then entitled to receive the income from the trust estate and who shall be of legal age, according to the laws of the State of Illinois and competent to act, provided, however, that no alteration or amendment hereof shall hereby be authorized which shall result in giving the Settlor any interest in the trust estate or the income therefrom, it being the intention of the Settlor to hereby divest herself absolutely of any present or future interest in the trust estate and the income therefrom. Any amendment, alteration or revocation hereof shall be evidenced by an instrument in writing, duly signed and acknowledged by the person or persons authorized to make such amendment, alteration and revocation and delivered to the Trustee. In case of the amendment or alteration hereof, the powers, duties and liabilities of the Trustee shall not be substantially changed without its consent. In case the trust hereby created is revoked, as herein provided, the entire trust estate then in the hands of the Trustee, or the portion thereof as to which such revocation shall apply, shall be conveyed, transferred and assigned to the beneficiaries hereunder who are then entitled to the income from the trust estate and in the respective proportions in which they are entitled to such income.
On December 26, 1934, petitioner Werner A. Wieboldt, as settlor, also created a trust for the benefit of the 4 children, transferring to the Northern Trust Co., as trustee, certain real estate and $25,000 face value Wieboldt Realty Trust debentures, due August 1, 1939. On his gift tax return the realty was valued at $135,000 and the debentures, plus accrued interest, at $17,733.33. A gift tax based on such valuation was paid.
The provisions regarding the use and disposition of the principal and income were similar to those contained in Pearl's trust, except that article V, having to do with the distribution of income, provided that income might be distributed to a beneficiary upon his attaining the age of 17. The entire provision is as follows:
The entire net income from the portion set aside for the benefit of each child of the Settlor shall be paid to him or her in convenient installments, as nearly monthly as practicable, provided, however, that during the period in which any such child is under the age of seventeen years the entire net income arising from the portion of the trust estate so set apart for the benefit of such child shall be accumulated and shall be added to the several portions of the trust estate so set apart for all of the children of the Settlor, in equal shares, and provided, further, that from and after the time each child of the Settlor reaches the age of seventeen (17) years and until he or she becomes twenty-one (21) years of age, so much of the net income from the portion being held for his or her benefit as the Trustee thinks necessary shall be used for his or her support and education, in such manner as the Trustee deems best and the balance of such net income shall be added in equal portions to the principal of the respective portions of the trust estate set apart and held for the benefit of the four children of the Settlor as above provided. During the lifetime of PEARL O. WIEBOLDT, wife of the Settlor, the Trustee shall seek her advice as to such disposition of the said net income to which a child of the Settlor is entitled during the period in which he or she is between the ages of seventeen (17) years and twenty-one (21) years, and it shall be fully protected in paying the same outright to such child in case she deems it advisable.
The other provisions of Werner's trust are essentially the same as those in Pearl's trust, except in these particulars. The instrument provided that the trustee should consult with and comply with the directions of Pearl in reference to the sale or retention of any of the securities or other properties of the trust estate, if Pearl was willing and if, in the sole discretion of the trustee, she was competent to so direct the trustee. If Pearl was unwilling to act or not competent to direct the trustee or not living, then the trustee was to follow the directions of William, son of the settlor, if he was willing to act and if, in the sole discretion of the trustee, he was competent to act. While said Pearl or William was alive and competent to act the trustee was relieved of responsibility in connection with the holding, selling, or other disposition of Wieboldt Realty Trust debentures.
Werner's trust indenture gave Pearl, during her lifetime, the right to alter, amend, or terminate if she was competent to act. It was expressly provided, however, that no alteration or amendment could be authorized which would result in giving the settlor any interest in the trust estate or the income therefrom, it being the intention of the settlor to divest himself absolutely of any present or future interest in the trust estate and the income.
At all times material herein, William A. Wieboldt, father of petitioner Werner A. Wieboldt, and his five children have owned voting control of Wieboldt Stores, Inc. In 1934, when the trusts were created, Werner owned 24,652 shares and Pearl owned 25,875 shares of the 236,500 shares of capital stock. This joint holding amounted to about 21 percent. In 1939, 1940, and 1941, the years herein question, the petitioners, their children, and the two trusts owned approximately 19 percent. Werner had been president of Wieboldt Stores, Inc., for some years before 1934, when he became chairman of the board of directors. The president was the chief executive officer. The chairman's duties were of an advisory character. The stock placed by Pearl O. Wieboldt in trust was not a controlling block and could not affect the retention by Werner of his position with or relation to the company.
The trust officer who acted for the Northern Trust Co. in working out the terms of the trust herein with Werner and Pearl informed them that the corporate trustee was unwilling to assume any responsibility in connection with any Wieboldt securities and the trustee lowered its fee to correspond with the lessening of its responsibility for said securities. The officer told petitioners that the trustee was loathe to assume a trust that could never be changed, particularly where minor beneficiaries were concerned, and insisted that there be some basis in the trust whereby the principal distributive provisions could be either postponed or accelerated and that some power to change be vested in some member of the family other than the settlor of the trust.
Pearl and Werner had previously considered the idea of providing for their children. They had a special problem in that their second son, Werner, Jr., then 21 years of age, was afflicted with osteomyelitis, a bone disease, which had required constant care and many surgical operations. They both desired to see him properly cared for. In establishing the trusts, the petitioners did not consider that one trust was being established in consideration of the other. Each settlor intended to divest himself completely of all interest in the trust property and intended the trust as an outright gift to the children. At the suggestion of the trust company's official each petitioner gave the other authority in connection with the management of the Wieboldt interests held by the trustee and the power to alter, amend, or terminate. Said powers were never exercised to any advantage for either petitioner. Accumulated earnings and reinvestable capital have been invested in government bonds by the trustee.
In 1942 Werner's trust indenture was modified by Pearl to remove Werner's right to appoint a successor trustee, to provide that Werner should not in any event be named trustee and that a new trustee could be appointed by Pearl with the consent of adult beneficiaries, and to provide that the accumulated income should be added only to the portions of the principal held for the minor children, and the instrument was amended to provide that the right of alteration, amendment, and termination could be exercised only with the consent of all the adult beneficiaries. The same amendments were made to Pearl's trust by Werner. In 1944 each relinquished completely the right to alter or amend or terminate. These are the only changes which have ever been made in the trust instruments.
The income from the portion allocated to the adult children, William and Werner, Jr., has been distributed to them monthly and the income from the portion allocated to the minor children has been accumulated and added to the principal of the 4 portions, except the sum of $1,168.53, which was distributed to a daughter, Pearl Anne Wieboldt, in 1941, she having become 17 years of age. This distribution was made in accordance with the provision of Werner's trust— and at the suggestion of Mrs. Wieboldt. The money, representing the income of the daughter's portion from June 16, 1941, to the end of that year, was placed in a joint account (mother and daughter) and was later used to purchase bonds. No part of the money was used to defray expenses of her support or education.
The total income from the two trusts during the years in question was as follows:
+-----------------------------------------------------------------------------+ ¦ ¦1939 ¦1940 ¦1941 ¦ +----------------------------------------------+----------+---------+---------¦ ¦Income from Werner A. Wieboldt trust (# ¦$10,498.33¦$8,622.75¦$9,098.93¦ ¦13380-13384) ¦ ¦ ¦ ¦ +----------------------------------------------+----------+---------+---------¦ ¦Income from Pearl O. Wieboldt trust (# ¦3,127.82 ¦8,212.79 ¦10,796.87¦ ¦12445-12448) ¦ ¦ ¦ ¦ +----------------------------------------------+----------+---------+---------¦ ¦Total ¦13,626.15 ¦16,835.54¦19,895.80¦ +-----------------------------------------------------------------------------+
The Northern Trust Co. filed fiduciary returns for each individual trust under each trust agreement and reported as taxable to it, as trustee, the accumulated income. It reported the distributed income and the beneficiaries thereof, in turn, filed returns and paid the taxes thereon.
The Commissioner held each petitioner taxable on the entire income of each trust.
Each of the petitioners created a trust for the primary benefit of his (her) children. Neither trustor retained in his trust indenture any right or power of real significance in the circumstances over the management of the fund or over the distribution of the income or corpus. Each instrument expressly provided that in no event was any interest in the principal or income of the trust estate ever to accrue to or for the benefit of the settlor. A trust company was named trustee.
In the indentures each trustor gave his (her) spouse the right to alter, amend, or terminate and the right to direct the trustee with reference to the sale, retention, and reinvestment of trust properties. In Pearl's trust Werner was given the right to direct the voting of the capital stock and shares or beneficial interests in the Wieboldt corporations. The trustee was to be relieved of responsibility in following directions given it by the respective spouses.
The trusts were created within a few days of each other. The value of the properties in each trust was practically the same, and the terms and conditions of the indentures were substantially similar.
The respondent has determined that each petitioner is liable to tax on the entire net income of each trust under section 22(a) and the Clifford case, and under sections 166 and 167 of the Internal Revenue Code. The petitioners, of course, deny liability under any of the above statutes or cases.
Helvering v. Clifford, 309 U.S. 331.
We think it is apparent that neither petitioner, as trustor of the trust created by him, is taxable under section 166 or 167. Under each instrument the grantor thereunder gave away his whole interest in the trust property and income, and the indenture provided that the trust could not be altered, amended, or terminated in such a way as to give him any interest or benefit in the income or corpus of the trust. See Knapp v. Hoey, 104 Fed. (2d) 99; Phebe Warren McKean Downs, 36 B.T.A. 1129. Under Pearl's trust none of the income was distributable to a minor child in any event. Under the indenture executed by Werner, the income could be distributed to the beneficiaries at the age of 17, if Pearl so directed. The sum of $1,168.53 was distributed to their daughter, Pearl, in her 17th year. However, the evidence is uncontroverted that such money was not used to defray expenses of the child's support and maintenance, but was used to purchase war bonds in her name. At all times herein the petitioners have supported and maintained their minor children from their personal funds, without any recourse whatsoever to the trust income. Since none of the income from Werner's trust was used for the support and maintenance of the minor beneficiaries, we must conclude that no income tax liability attaches to him under section 167. J. O. Whiteley, 3 T.C. 1265, and David Small, 3 T.C. 1142. The necessary consents have been filed by petitioners. Hence, section 167(c) is applicable to the taxable years here involved.
While there may be some doubt whether, if either of the trusts herein stood alone, there would be a proper basis for the application of the Clifford principle, such doubt is dispelled when the trusts are considered together. The significant factor is that each settlor gave the other the right to alter, amend, or terminate the trust. Such power, though not exercisable for the benefit of the grantor, otherwise seems to be a general one. However, it is argued by petitioners that it was exercisable only in a fiduciary capacity and not to the advantage or benefit of the holder. Even if this be so, it remains that the power did carry with it, at least, the right to increase or diminish the beneficial interests of the respective named beneficiaries. As a matter of fact, the respective indentures were altered in that respect. If either grantor had retained such power, along with the right to direct the trustee with respect to the sale, retention, or reinvestment of trust property, although as a trustee, he would have been subject to tax on the income under Stockstrom v. Commissioner, 148 Fed.(2d) 491. Certainly the effect of that case may not be circumvented by a simple expedient on the part of a husband and wife of exchanging the rights with each other.
While it may be true that neither petitioner had any beneficial interest in either of the trusts and that each of them was motivated to create a trust by a desire to provide for his (her) children, the power and control over the distribution of income and principal and the power to direct the management of the trust properties, although lost to each under his own indenture, were regained under the indenture of the other. In the circumstances of this case, it might well be that such rights were the most satisfying ones to the petitioners. Certainly they are among the important attributes of property ownership.
We are constrained to concern ourselves with the reality of the situation and not with the mere form. The practical result of the exchange of rights was to leave each petitioner with powers as absolute and real as would have been the case had each provided for their exercise by himself in the instrument he executed. In the circumstances, we think the respective petitioners should be treated as the settlor of the trust estate which he (she) dominated. Cf. Lehman v. Commissioner, 109 Fed.(2d) 99; certiorari denied, 310 U.S. 637; and Purdon Smith Whiteley, 42 B.T.A. 316. As such settlor, each petitioner is taxable on the income of that trust during the years in question. Louis Stockstrom, supra.
In our disposition we have given the powers in question their most limited application. However, it may not be amiss to point out that the power given each spouse may well be held to be far more comprehensive than the petitioners are willing to concede. In Reinecke v. Smith, 289 U.S. 172, the Supreme Court pointed out that the right of modification or revocation exercisable by a grantor and one of two other trustees was not a trusteed power and that the trustee owed no duty to the beneficiary to resist alteration or revocation of the trust. Here, the right to alter, amend, or terminate the trust is not in terms limited (except that the income and corpus may not be given to the grantor) and it would appear that respondent's argument that there exists a power to substitute others for the present beneficiaries is an entirely respectable one. But we need not decide whether that be so. Nor do we think it necessary to consider whether the aspect of reciprocal trusts would, in the circumstances here, warrant taxing the respective petitioners under section 166 or 167 of the Internal Revenue Code.
Decisions will be entered under Rule 50.