Docket No. 8857-72.
Leon L. Rice, Jr., and Linwood L. Davis, for the petitioner.
Decedent was the beneficiary of a marital deduction trust established by her husband's will. Under that trust decedent was to receive the income for life and had a testamentary power of appointment over such assets as remained in the trust at her death. Pursuant to a discretionary power to use trust principal to meet decedent's reasonable needs the trustees made several distributions of trust principal during decedent's life. Held, the value of the assets distributed from the trust during decedent's life is not includable in decedent's gross estate under sec. 2041, I.R.C. 1954. Leon L. Rice, Jr., and Linwood L. Davis, for the petitioner.
Respondent determined a deficiency in the Federal estate tax due form the Estate of Betty Durham Council, deceased, in the amount of $648,052.83. Various concessions having been made, the only issue remaining for our determination is whether the value of cash and stock disbursed from the principal of trust during decedent's life is includable in her gross estate under section 2041 by virtue of a testamentary power of appointment possessed by decedent over assets remaining in the trust at her death.
All statutory references are to the Internal Revenue Code of 1954, as amended.
FINDINGS OF FACT
Some of the facts have been stipulated and the stipulation of facts, together with the exhibits attached thereto, are found accordingly.
Betty Durham Council (hereafter referred to as decedent) died testate on August 5, 1968, a resident of Durham, N. C. The duly qualified and acting coexecutors of decedent's estate (hereafter referred to as petitioners) are Frances Council Yeager, a citizen and resident of Massachusetts, C. Robert Yeager, a citizen and resident of Massachusetts, and North Carolina National Bank, a national banking association having its principal office and place of business in North Carolina. Petitioners filed a Federal estate tax return with the District Director of Internal Revenue, Greensboro, N. C.
Decedent's husband, Commodore T. Council (hereafter referred to as Council) diet testate on July 13, 1960. At the time of his death Council was one of the principal shareholders and the president of B. C. Remedy co. (hereafter referred to as B. C. Co.) of Durham, N. C. Council was also on the board of directors of Security National Bank of Greensboro, N. C., and chairman of the board of directors of its Durham branch. Shortly after Council's death Security National Bank was merged into North Carolina National Bank (hereafter referred to as the bank or N.C.N.B.).
Council left a will dated December 30,1959, which together with a codicil dated April 26, 1960, was admitted to probate in Durham County, N.C.D.S. Mims, a friend and business associate of Council, and N.C.N.B. qualified and served as the executors of Council's will and as trustees of each trust created by the will. Mims was the controller of B. C. Co. and became the president of the company after Council's death.
Council's will established two trusts: a martial deduction trust and a residuary trust. Except for payments of $1,000 per month to be made from the income of the residuary trust to Mataline Nye Council (Council's widowed daughter-in-law), decedent was to receive all of the income from both trusts for her life. On decedent's death the residuary trust was to benefit Council's daughter and four grandchildren. Frances Council Yeager (Council's daughter) was to receive the income generated by three-eights of the corpus for her life. Upon Frances' death that three-eights of the corpus was to be held in trust for her daughter. The remaining five-eights of the residuary corpus was to be held in trust for Council's four grandchildren. The income therefrom was to be accumulated until the grandchild reached the age of 21 and became payable quarterly until the grandchild reached the age of 35, at which time the trustees were to pay over to the grandchild the entire balance of the trust estate as then held for him.
In regard to the marital deduction trust, Article V(C) of Council's will provided:
C. If the income payable to my wife in accordance with the provisions of paragraph (B) above (income from marital deduction trust), supplemented by income (other than capital grains) available from other sources to her, shall not be sufficient to meet the reasonable needs of my wife in her station in life— as to all of which the judgment of my Trustees shall be conclusive—then, and in that event, I authorize my Trustees to pay to or apply for the benefit of my wife, so much of the principal of this trust as my Trustees in their sole discretion shall from time to time deem requisite or desirable to meet the reasonable needs of my wife,— even to the full extent of the entire principal of this trust.
The nature of the trustees' powers was further described in Article VII of Council's will as follows:
I hereby grant to my Executors and also to the Trustees of each trust established hereunder (including any substitute or successor personal representative or Trustees) the continuing, absolute, discretionary power to deal with any property, real or personal, held in my estate or in any trust, as freely as I might in the handling of my own affairs. Such power may be exercised independently and without the prior or subsequent approval of any court or judicial authority and no person dealing with the Executors or Trustees shall be required to inquire into the propriety of any of their actions. * * *
As to the disposition of the principal of the marital deduction trust on decedent's death, Article V(D) of Council's will provided:
D. So much of the principal of this trust as shall remain in the hands of my Trustees at the time of the death of my wife shall be transferred and delivered, discharged of the trust to such appointee or appointees of my wife (including my wife's estate) and in such amounts or proportions and upon such terms and provisions as my wife shall appoint and direct in an effective will or codicil specifically referring to this power of appointment. The Trustees may rely upon an instrument admitted to probate in any jurisdiction as the last will of my said wife, but if it has no written notice of the existence of such a will within a period of three months after her death, it may be presumed that she died intestate and the Trustees shall be protected in acting in accordance with such presumption. If this power of appointment shall not be effectively exercised as aforesaid as to all or any portion of such principal, so much of the said principal as shall not have been disposed of by the effectual exercise of such power of appointment shall pass as a part of the remainder of my residuary estate and be disposed of in accordance with the provisions of Article VI hereunder (relating to residuary trust), as if I had died on the date of my wife's death.
The principal of the residuary trust consisted of 859 shares of B. C. Co. The marital deduction trust was funded with 342 shares of B. C. Co. and all other assets of Council's estate.
In 1961 decedent decided to help her daughter and son-in-law who were in the process of building a new home. On June 22, 1961, decedent wrote the trustees of the marital deduction trust requesting that they pay to her the sum of $100,000 from the trust principal under the provisions of Article V(C) of Council's will. Decedent's letter indicated that she intended to loan this money to her daughter for the purpose of building a new home. At that time the trustees were N.C.N.B. and D. S. Mims. Milton E. Hogan, the head of the bank's trust department, acted for the bank in this matter. The trustees requested a legal opinion from Allston Stubbs, who had prepared Council's will and who was also council for the bank, as to whether or not a distribution of this kind would fall within the trustees' power to invade principal to meet decedent's reasonable needs. Without citing legal authority, Stubbs rendered an opinion to the effect that such a distribution would be within the discretionary powers given the trustees under Article V(C) of Council's will. Stubbs advised the trustees that Council did not intend for the standard of ‘reasonable needs' to be limited to his wife's personal needs but rather that Council contemplated that upon his death his wife would become the head of the household and would meet the needs of both their daughter, Frances, and their daughter-in-law, Mataline, and their families. Stubbs' opinion merely affirmed what Hogan already understood to be Council's intent with respect to the trustees' powers to invade the principal of the marital deduction trust. From conversations Hogan had with Council, he understood that Council wanted the trustees to do whatever Mrs. Council wished as long as it would be in her best interest. Hogan understood that Council intended for the trustees to serve as ‘a buffer’ and not as ‘policemen’ with regard to the principal of the marital deduction trust.
In response to decedent's request and pursuant to the advice rendered by Stubbs and in accordance with their own understanding of Council's will, the trustees authorized the disbursement to decedent of $100,000. This amount was paid to decedent by two deposits of $50,000 each made to her personal checking account at N.C.N.B. on June 23, 1961, and July 3, 1961. Of this amount, $94,000 was charged as a distribution from the principal of the marital deduction trust and $6,000 was charged as a distribution from the income of the marital deduction trust. At or about the time of the receipt of these funds, the decedent transferred a total of $100,000 to her daughter and son-in-law, both of whom signed a note in that amount payable to the order of decedent. The note was retained by N.C.N.B. in its capacity as one of the trustees of the marital deduction trust. Decedent's daughter made two payments on the note in amounts of $2,000 and $1,000, respectively, which were transferred by decedent back into the marital deduction trust. On February 15, 1963, at the request of decedent, the bank's assistant trust officer delivered the note to decedent and obtained her receipt for it. Decedent then wrote on the face of the note ‘Paid in Full Feb. 15, 1963, Mrs. C. T. Council, Sr.‘ and delivered the note to her daughter.
In the spring of 1962 the decedent received her first personal income tax return to be filed after the death of her husband. She called Hogan (head of trust department at N.C.N.B.) and said she thought the accountant who prepared the return had made a mistake. She was appalled at the amount of taxes and wanted to do something about them. Hogan advised her to call the accountant and discuss the matter with him. Decedent then called Norwood A. Thomas, who was a senior member of the accounting firm which had prepared the return, and expressed her surprise and dismay at the amount of income tax which she was paying. at decedent's request Thomas promised to look into the matter in order to determine whether decedent could give the money to her children instead of paying it to the Government.
After studying the situation, Thomas wrote decedent a letter dated August 1, 1962, in which he advised her that if, through her power of invasion of the marital deduction trust, she made gifts of 336 shares of B.C. Co. stock, her taxable income would be reduced. Thomas suggested that this plan would not materially alter decedent's after-tax income and would provide enough savings in income tax over a 3-year period to pay the gift tax.
Pursuant to this advice, decedent mailed a letter to the trustees on August 3, 1962, requesting that they exercise their discretion under Article V(C) of her husband's will and transfer 336 shares of B. C. Co. stock to her. Before making this request she discussed the matter with her family. All members of the family readily and understandably agreed to the proposal. Decedent agreed with her family that the gifts would be made to them in the same proportions as they would have taken under the residuary trust in default of the exercise of decedent's testamentary power of appointment.
Excerpts from the letter decedent sent the trustees requesting the distribution:‘It has been my custom and practice in my station in life to make substantial gifts from time to time to my daughter and grandchildren, which gifts have been made by me primarily from my income, which, in addition to the income from the Trust above referred to, includes income from the residuary trust of Article VI of my late husband's will.‘The substantial taxes to which I have been liable on this income as well as the program of gifts from income which I have been liable on this income, as well as the program of gifts from income which I have been following, has resulted in my being able to have and retain insufficient income to meet my reasonable needs in my station in life. If the Trustees in their judgment and discretion should elect to transfer and deliver a portion of principal to me, it would be my purpose to continue my program of gifts to my daughter and grandchildren out of such principal; which would enable me to free my income from this demand; and the reduction of income chargeable to me from the Trust in Article V, would likewise reduce my tax liability. The net effect of both these factors would be to enable me to have and retain a larger net income to meet my reasonable needs in my station in life.‘I Request, therefore, that you exercise your judgment and discretion to transfer and deliver to me 336 shares of the common stock of B. C. Remedy Company held in the principal of the Trust under Article V.’
By the time the trustees received decedent's request, Hogan had left the bank and was employed by the B. C. Co. He continued to serve, however, as decedent's personal representative in her dealings with the bank. Hogan's successor as head of the bank's trust department was A. L. Featherston. After receiving decedent's request, Featherston contacted J. Benjamin Bostick, head of the bank's statewide trust operations at the executive headquarters in Charlotte, and sought advice as to what the bank's response should be. Bostick and Featherston deliberated over the matter for several months before making a final decision. Rather than having house counsel, it was the bank's policy to consult the attorney who drafted an instrument when questions arose regarding interpretation of that instrument. In this instance Bostick and Featherston relied on Stubbs' written opinion regarding the earlier distribution of $100,000 and did not feel it necessary to request a second opinion covering the proposed transfer of B. C. Co. stock. In arriving at a decision, Bostick and Featherston considered the following factors:
(1) The language of Article V(C) of Council's will giving the trustees sole discretion to determine decedent's reasonable needs and giving the trustees discretionary power to make payments of principal which the trustees deemed requisite or desirable to meet those needs;
(2) The language of Article VII of Council's will giving the trustees absolute discretionary power to deal with the trust property as freely as Council might in handling his own affairs without prior or subsequent court approval;
(3) The fact that the property requested comprised approximately 20 percent or less of the total value of the assets held in trust;
(4) The legal opinion rendered by Stubbs regarding the propriety of the earlier distribution to the decedent;
(5) The fact that decedent's after-tax income would not be materially affected;
(6) The use to which the decedent intended to put the distributed shares of stock (gifts to family members); and
(7) The decedent's high income taxes and the personal concern these taxes caused her.
After considering these factors, Bostick and Featherston concluded that the distribution would be a proper exercise of the trustees' discretionary power. In light of the amounts involved, however, they decided it would be prudent to request decedent, her daughter, and her adult grandchildren to sign an indemnity agreement holding the trustees harmless against any and all claims made against the trustees on account of having exercised their discretionary power in making this transfer of principal to the decedent.
Mims (the individual trustee under Council's will) had some concern as to the authority of the trustees to make the requested distribution. Hogan requested James L. Newsom (attorney for B. C. Co. as well as decedent's personal attorney) to advise Mims as to what the position of the trustees would be if the distribution was made. In a letter to Mims dated October 30, 1962, Newsom expressed the opinion that inasmuch as decedent, the trustees, and the beneficiaries of the residuary trust were the only ones who could have any possible interest in the marital deduction trust, he could see no party who could have a valid position to raise any question regarding the distribution. Newsom emphasized that the gifts were to be made to the same beneficiaries and according to the same proportions as provided for in the residuary trust established by Council's will. When Newsom rendered this opinion he had no knowledge of the proposed indemnity agreement.
In December 1962 the trustees decided to make the requested distribution. Accordingly, on December 18, 1962, the bank sent a letter to B. C. Co. requesting that it reissue the block of stock held by the bank and Mims as trustees under Council's will. This letter requested that 336 of the 342 shares held in the marital deduction trust be issued directly under the names of decedent's prospective donees. The B. C. Co. had always been a closely held corporation and had transferred its stock on only a few prior occasions. Upon receiving this request, the company's secretary-treasurer. C. J. Jones, requested advice from Hogan as to the mechanics of effecting the transfer. Hogan informed Jones that the request had not been properly framed by the trustees. Hogan advised that it would be necessary for the trustees to first make a distribution to decedent who should then request that the shares be reissued to her donees. Pursuant to this advice a second letter was drafted by the bank and sent to B. C. Co. on December 18, 1962, requesting that 336 shares be reissued in decedent's name. Concurrently the bank directed a letter under decedent's name to B. C. Co. requesting that 336 shares (reissued in her name at the trustees' request) be then reissued in the names of her prospective donees. Satisfied that the last two letters had established the proper audit trail, B. C. Co. reissued the shares as requested.
Pursuant to the bank's second letter of Dec. 18, 1962, the company reissued 336 shares in the name of decedent.Pursuant to the letter drafted by the bank under decedent's name, dated Dec. 18, 1962, the bank reissued the 336 shares, previously issued to decedent, as follows:
The stock was issued to decedent's donees in the same proportions they would have taken under Council's will had decedent failed to exercise her testamentary power of appointment. The stock issued to Frances Council Yeager (decedent's daughter) was, however, issued to her outright, whereas under the terms of Council's will she would have taken only a lifetime interest in the income generated by this stock with a discretionary power of invasion as to the principal. The stock issued to N.C.N.B. as trustee for Betty Durham Yeager (decedent's granddaughter) was put in a revocable trust established by Betty Durham Yeager as grantor whereas the terms of Council's will would have required that the stock remain in trust until she reached the age of 35. The stock issued in the name of N.C.N.B. and Mims as trustees for Carol Frances Council, John Thomas Council and Commodore Thomas Council III, was placed in a trust established by decedent which had the same provisions as the trust under Council's will except that the trustees had discretion during the beneficiaries' minority to apply income toward support of the beneficiaries.
The decedent filed a Federal gift tax return and a North Carolina gift tax return for 1962 reporting the gifts of B. C. Co. stock made to her daughter and four grandchildren. The Federal gift tax shown to be due by the return in the amount of $81,590.76 was paid by cash from the principal of the marital deduction trust. Pursuant to an examination of the Federal gift tax return by respondent, the Federal gift tax liability was increased by $23,289.24, exclusive of interest, which was paid by the decedent personally and not from the principal of the marital deduction trust. The North Carolina gift tax, in the amount of $11,042.92, was paid from the principal of the marital deduction trust.
Following the transfer of the B. C. Co. stock, the new holders received the dividends paid on the stock and reported the dividends as taxable income. The shares held outright by Frances Council Yeager were noted by her husband. The bank voted the shares held by it as trustee under the trusts established for each of the grandchildren.
On July 13, 1967, all of the outstanding stock of B. C. Co. was acquired by Block Drug Co. at a price of $3,503.33 per share. Included in the shares sold were the 336 shares which had been transferred to the decedent from the marital deduction trust and thereafter reissued to her daughter and grandchildren. Decedent's daughter and grandchildren each paid Federal and State income taxes on the gains realized from the sale.
Frances Council Yeager reported the gain from sale of stock held outright by her on a joint return filed with her husband.Betty Durham Yeager (Powell) reported the gain from the sale of stock, held in a revocable trust, on her individual return.The gains realized from the sale of stock held in trust for Carol Frances Council, John Thomas Council, and Commodore Thomas Council III, were reported by the trusts.
Under the stock purchase agreement each of the sellers warranted that he had good and marketable title and absolute right to sell the shares free and clear of all liens, pledges, encumbrances, restrictions, or rights of third parties. With respect to this warranty, Newsom rendered an opinion to the Block Drug Co. under date of July 13, 1967, that each of the selling shareholders did have good and marketable title to the stock.
The cash received with respect to the 336 shares of stock, less selling expenses and Federal and State income taxes, was reinvested by the respective sellers. On August 5, 1968, the date of decedent's death, such reinvestments had an aggregate value of $978,416.
Behind decedent's home there was an undeveloped tract of land which she wanted to develop for the purpose of giving one lot to each member of her family and one lot for the purpose of building a church. On August 23, 1963, $8,729.38 was paid in cash from the principal of the marital deduction trust for the construction of a road through this property. After the road had been completed, the property was divided into building lots and decedent gave one such lot to each member of her family.
Decedent's will, dated December 19, 1962, as amended by codicils dated July 20, 1965, April 20, 1966, and August 25, 1967, was duly admitted to probate in Durham County, N. C. By item XVI of her will decedent bequeathed and devised her residuary estate including any property over which she had a power of appointment under the will of her late husband. She left three-eighths thereof outright to her daughter, Frances Council Yeager, one-sixteenth outright to her granddaughter, Betty Durham Yeager, and nine-sixteenths to N.C.N.B. to be held in trust for the use and benefit of Mataline Nye Council and her three children.
The issue in this case is whether decedent possessed at her death a general power of appointment over the cash and stock which had been disbursed from the principal of the marital deduction trust some years prior to her death. If we determine that decedent did possess at her death a general power of appointment over the cash and stock, their date of death values are includable in decedent's gross estate under section 2041. Respondent has conceded that a credit should be allowed, under section 2012, for the Federal gift tax paid with respect to the prior transfer of the stock, if the value of the stock is includable in decedent's gross estate.
Insofar as relevant to the issue in this case, section 2041 provides;
SEC. 2041. POWERS OF APPOINTMENT.
(a) IN GENERAL.— The value of the gross estate shall include the value of all property
(2) POWERS CREATED AFTER OCTOBER 21, 1942.— To the extent of any property with respect to which the decedent has at the time of his death a general power of appointment created after October 21, 1942, or with respect to which the decedent has at any time exercised or released such a power of appointment by a disposition which is of such nature that if it were a transfer of property owned by the decedent, such property would be includible in the decedent's gross estate under sections 2035 to 2038, inclusive. * * *
Decedent was the primary beneficiary of the marital deduction trust established by her husband's will. She was granted under that trust the right to all the income during her life and the right by her last will and testament to exercise a general power of appointment over so much of the principal as remained in the hands of the trustees at her death. Council's will provided that his daughter and grandchildren would take the remainder in the marital deduction trust should decedent fail to exercise her testamentary power of appointment. Additionally, the trustees were authorized and empowered, in their sole discretion, to pay over to decedent during her life part or all of the principal of the marital deduction trust in the event that her income would not be sufficient to meet her reasonable needs in her station in life as to which the judgment of the trustees was to be conclusive. During decedent's life the following disbursements were made by the trustees from the principal of the marital deduction trust:
+------------------------------+ ¦Date ¦Description ¦Amount ¦ +------+--------------+--------¦ ¦ ¦ ¦ ¦ +------------------------------+
June 23 and July 3, 1961 $94,000 cash paid to the decedent $91,000.00
from the Estate of Commodore T. Council, charged as a disbursement from the principal of the marital deduction trust, less $3,000 cash received by the marital deduction trust on Apr. 3, 1962, and Nov. 26, 1962 Dec. 18, 1962 336 shares of common stock 453,600.00
of B.C. Remedy Co. valued at $1,350 per share, being the value thereof as determined for gift tax purposes pursuant to the Federal gift tax return of the decedent for the taxable year 1962 and the examination thereof by respondent Apr. 11, 1963 Cash payment of gift taxes shown 92,633.68
to be due on Federal and State gift tax returns of the decedent for the taxable year 1962; Federal tax, $81,590.76; North Carolina tax, $11,042.92 Aug. 23, 1963 Cash payment for construction 8,729.38
of a road on decedent's property in Hope Valley, Durham, N.C.
The only power of appointment possessed by decedent at her death was that created by her husband's will over the principal of the marital deduction trust. On August 5, 1968, the date of decedent's death, the value of the assets comprising the principal of the marital deduction trust as reflected in the trustees' records was $1,176,624.85. In a timely filed Federal estate tax return petitioners included this amount in decedent's gross estate as being the value of all property with respect to which decedent had a power of appointment at her death. Respondent determined that at the time of her death decedent still possessed a general power of appointment over the economic worth of the cash and stock which had been disbursed from the principal of the marital deduction trust during decedent's life. Respondent accordingly asserted a deficiency in petitioner's estate tax resulting from the inclusion in the gross estate of the value of the cash and stock. The additional values included by respondent were:
+----------------------------------------------------------------+ ¦ ¦ ¦Value included ¦ +---+-------------------------------------------+----------------¦ ¦ ¦Description ¦by respondent ¦ +---+-------------------------------------------+----------------¦ ¦ ¦ ¦ ¦ +---+-------------------------------------------+----------------¦ ¦(1)¦Cash disbursed from marital deduction ¦ ¦ +---+-------------------------------------------+----------------¦ ¦ ¦trust principal in 1961 to decedent for ¦ ¦ +---+-------------------------------------------+----------------¦ ¦ ¦the purpose of making a loan to her ¦ ¦ +---+-------------------------------------------+----------------¦ ¦ ¦daughter; the loan being later canceled ¦$91,000.00 ¦ +---+-------------------------------------------+----------------¦ ¦(2)¦336 shares of B.C. Co. stock, disbursed ¦ ¦ +---+-------------------------------------------+----------------¦ ¦ ¦from marital deduction trust to decedent, ¦ ¦ +---+-------------------------------------------+----------------¦ ¦ ¦in 1962, and the subject of gifts by ¦ ¦ +---+-------------------------------------------+----------------¦ ¦ ¦decedent to members of her family in 1967 ¦978,416.00 ¦ +---+-------------------------------------------+----------------¦ ¦(3)¦Cash disbursed from marital deduction ¦ ¦ +---+-------------------------------------------+----------------¦ ¦ ¦trust principal in 1963 to pay Federal ¦ ¦ +---+-------------------------------------------+----------------¦ ¦ ¦gift tax on gifts of B.C. Co. stock ¦92,633.68 ¦ +---+-------------------------------------------+----------------¦ ¦(4)¦Cash disbursed from marital deduction ¦ ¦ +---+-------------------------------------------+----------------¦ ¦ ¦trust principal in 1963 to pay for ¦ ¦ +---+-------------------------------------------+----------------¦ ¦ ¦construction of road through property which¦ ¦ +---+-------------------------------------------+----------------¦ ¦ ¦was given to members of decedent's family ¦8,729.38 ¦ +----------------------------------------------------------------+
Respondent concludes that these amounts are includable in decedent's gross estate solely on the ground that at decedent's death she possessed a power of appointment with respect to the economic worth of the cash and stock. Respondent does not contend that decedent at any time exercised or released her power of appointment by a disposition which was of such a nature that if it had been a transfer of property owned by decedent, such property would have been includable in the decedent's gross estate under sections 2035 to 2038, inclusive.
The parties agree that during decedent's life the cash and stock were ‘disbursed’ from the marital deduction trust principal. Respondent maintains, however, that the disbursements were not effective ‘distributions' with the result that the economic worth of the cash and stock remained part of the trust principal and, therefore, subject to decedent's power of appointment at her death. In reaching this conclusion respondent relies on the provisions in Council's will which granted the trustees the power to invade the trust principal in order to meet decedent's reasonable needs if her income from other sources was insufficient to meet those needs. Respondent asserts that as the disbursements were not made to meet decedent's reasonable needs the trustees were not acting within the scope of their authority to invade trust principal. In respondent's view the disbursements, not authorized by Council's will, were ineffective except to pass decedent's interest in the income. Respondent would characterize the disbursements as only an exercise of the trustees' power to place trust principal in the hands of third parties for investment purposes, leaving the cash and stock subject to decedent's power of appointment.
Petitioners, on the other hand, maintain that decedent's power of appointment over the cash and stock was extinguished when the trustees, in the exercise of their discretion and within the intent of Council's will, made the disbursements from the trust principal. Petitioners alternatively contend that decedent's power of appointment over the cash and stock was extinguished by an effective release of that power which occurred when decedent requested the distributions and joined with the takers in default of the exercise of her power in transferring the cash and stock to some or all of the takers in default.
Respondent's determination is presumptively correct; petitioners have the burden of proving that decedent did not have at her death a power of appointment over the cash and stock here at issue. Rule 142(a), Tax Court Rules of Practice and Procedure.
Although for purposes of Federal taxation the classification of rights and powers is a matter of Federal law, the existence and nature of the interests to be classified is a matter of State law. Helvering v. Stuart, 317 u.s. 154(1942); Morgan v. Commissioner, 309 U.S. 78 (1940); Blair v. Commissioner, 300 U.S. 5 (1937). We must determine under North Carolina law, therefore, whether decedent retained the power to appoint the cash and stock after they had been disbursed from trust principal.
In analyzing the parties' arguments, we begin with the observation that this Court is not faced with the question of whether a State court would determine in advance of the trustees' actions that the proposed distributions would fall within the intent of Council's will. The issue before this Court is whether the cash and stock disbursed from the trust principal during decedent's life remained subject to her power of appointment at her death. Decedent's power of appointment extended only to the assets remaining in the hands of the trustees at her death. In order to find that decedent had the power to appoint the cash and stock, here in issue, we must find that a State court would determine after the fact that the distributions were ineffective to remove the cash and stock from the trust principal.
Respondent asserts that a North Carolina court would invalidate the distributions because they were not made within the intent of the testator as expressed in his will. In North Carolina a testator's intent is to be ascertained from the actual words used in the will. Wachovia Bank & Trust Co. v. Green, 239 N.C. 612, 80 S.E.2D 771 (1954). As an aid in construction, a will may be considered in light of the conditions and circumstances existing at the time the will was executed. Cannon v. Cannon, 225 N.C. 611, 36 S.E.2D 17 (1945); Heyer v. Bulluck, 210 N.C. 321, 186 S.E. 356 (1936). The circumstances which may be considered are the relationships between the testator and the beneficiaries named in the will and the condition, nature, and extent of the testator's property. Hubbard v. Wiggins, 240 N.C. 197, 81 S.E.2D 630 (1954); Heyer v. Bulluck, supra. Parol evidence of a testator's declarations made before, after, or at the time the will was executed is not competent, however, as an aid in the construction of a will. Wachovia Bank & Trust Co. v. Wolfe, 245 N.C. 535, 96 S.E.2d 690 (1957); Raines v. Osborne, 184 N.C. 599, 114 S.E. 849 (1922). Pursuant to these rules, only the actual words used in Council's will together with the factual circumstances surrounding him at the time he executed it may be considered in ascertaining his intent.
At the time he executed his will Council was a millionaire. He and his wife were accustomed to the possession and use of wealth and to a standard of living which reflected that wealth. They had a practice of making substantial gifts to their children and grandchildren. Decedent received income from property in her own name. Considering Council's will in its entirety it is evident that he intended for his wife to be the primary beneficiary of his estate so long as she was alive. Except for the $1,000 per month payment to Council's daughter-in-law, decedent was to receive all the income from both trusts. If the income from all sources available to decedent was insufficient to meet her reasonable needs in her station in life, the trustees were given the authority and power to use so much of the principal of.the marital deduction trust as they in their discretion deemed requisite or desirable to meet those needs. Council's will provided for payments to other members of his family only after decedent's death.
Considering the words used in Council's will, together with the factual circumstances surrounding him at the time the will was executed, we are unable to conclude that a State court would have approved the distributions had it been asked to do so in advance. It is not clear, to the point of certainty, that the distributions fall within the testator's intent. As indicated previously, however, a conclusion on this point is not necessary for the resolution of the issue presented here. The distributions were in fact made and we believe that a North Carolina court would view the question after the fact in a different light.
Faced with the question of whether these distributions were effective to remove the cash and stock from the trust principal, the State court would have to balance its interpretation of the testator's intent against the fact that the testator gave his trustees sole discretion to interpret his will and to determine when distributions should be made. Generally, the North Carolina courts will not undertake to control the exercise of a trustee's discretionary power absent an abuse of discretion. Woodard v. Mordecai, 234, N.C. 463, 67 S.E.2d 639 (1951). The Supreme Court of North Carolina reviewed the nature of trustees' powers and the circumstances under which the courts should undertake to control those powers in Woodard v. Mordecai, supra at 644:
The powers of a trustee are either mandatory or discretionary. A power is mandatory when it authorizes and commands the trustee to perform some positive act. Brummett v. Hewes, 311 Mass. 142, 40 N.E.2d 251; In re Carr's Estate, 176 Misc. 571, 28 N.Y.S.2d 12, 15. A power is discretionary when the trustee may either exercise it or refrain from exercising it, Welch v. Wachovia Bank & Trust Co., 226 N.C. 357, 38 S.E.2d 197, Bennett v. Norton, 171 Pa. 221, 32a. 1112; or when the time, or manner, or extent of its exercise is left to his discretion. Doe ex dem. Gosson v. Ladd, 77 Ala. 223; City of San Antonio v. Zogheib, Tex. Civ. App., 70 S.W.2d 333.
The court will always compel the trustee to exercise a mandatory power. Albright v. Albright, 91 N.C. 220. It is otherwise, however, with respect to a discretionary power. The court will not undertake to control the trustee with respect to the exercise of a discretionary power, except to prevent an abuse by him of his discretion. The trustee abuses his discretion in exercising or failing to exercise a discretionary power if he acts dishonestly, or if he acts with an improper even though not a dishonest motive, or if he fails to use his judgment, or if he acts beyond the bounds of a reasonable judgment The American Law Institute's Restatement of the Law of Trusts, section 187; Carter v. Young, 193 N.C. 687, 137 S.E. 875; 65 C.J., Trusts 539.
The trustees' power to use the principal of the marital deduction trust to meet decedent's reasonable needs falls within North Carolina's definition of discretionary powers. Under Council's will, the power could either be exercised or not exercised, and the time, manner, and extent of its exercise was left to the trustees' discretion. The power could not be exercised without the application of a certain degree of prudence and judgment. Welch v. Wachovia Bank & Trust Co., 226 N.C. 357, 38 S.E.2d 197 (1946). The will gave the trustees the discretionary power not only to invade trust principal, but also the discretionary power to determine what were decedent's reasonable needs and to determine whether her income from all sources was sufficient to meet those needs. The trustees have exercised their discretion and made distributions pursuant to their discretionary powers. As a North Carolina court would not reverse the trustees' actions, absent an abuse of discretion, we must determine whether the trustees abused their discretion.
An abuse of discretion occurs when the trustees act with improper motives, or fail to use judgment, or act beyond the bounds of reasonable judgment. Woodard v. Mordecai, supra. Also recognized as an abuse of discretion are actions by the trustees which are clearly contrary to the testator's intent. Greer v. United States, 448 F.2d 937 (4th Cir. 1971); Campbell v. Jordan, 174 N.C. 233, 162 S.E.2d 545 (1968).
There has been no suggestion that the trustees acted with improper motives or that they failed to exercise their judgment. We do not believe that the trustees' decisions went beyond the bounds of reasonable judgment. The trustees' decisions to make the various distributions were not arbitrary or capricious. They sought the legal advice of the attorney who drafted Council's will. They took into consideration the effect the distributions would have on the amount of income available to decedent. They determined that the distributions would not have an adverse effect upon those who would take in default of the exercise of decedent's power of appointment. Finally, the trustees took into consideration their own understanding of Council's intentions with regard to the administration of his estate. In good faith the trustees believed that their role with respect to the principal of the marital deduction trust was to protect decedent from unreasonable demands that might be made upon her by members of her family. The trustees believed that Council intended that decedent be able to assist various members of her family through the use of the marital deduction trust principal, so long as the decedent's interests were protected. Concluding that decedent's ‘reasonable needs in her station in life’ included her desire to help members of her family, the trustees felt that the distributions would be within the intent of Council's will. The trustees' understanding of Council's will may have differed from what a State court would have advised them to be Council's intent. We do not believe, however, that the trustees' interpretation and their actions based on that interpretation went beyond the bounds of reasonable judgment.
Nor do we believe that the trustees' actions were clearly contrary to the testator's intent. In Campbell v. Jordan, supra, the North Carolina Supreme Court determined that an invasion of corpus for the benefit of an income beneficiary would be an unreasonable departure from the terms of the trust. The trust instrument in Campbell provided that the testator's wife and children were to be income beneficiaries, and the remainder was to pass to his grandchildren. The trustees were authorized, however, (if they in their judgment deemed it necessary or best for the welfare of the cestui que trust and consistent with the welfare of the testator's family and estate) to convey part of the principal to the income beneficiaries. The testator's daughter requested that the principal generating her share of the income be distributed to her outright. The court held that a distribution could not be made absent a showing of substantial economic need or circumstances indicating that the income beneficiaries' best interest required a conveyance of principal. The question of whether or not a distribution would go beyond the reasonable bounds of judgment in that case differs, however, from the situation here at issue. In Campbell v. Jordan, supra, the trust instrument provided for definite remaindermen who would take the principal on the death of the income beneficiary. The trustees were, therefore, charged with the responsibility of protecting the interests of all beneficiaries. The court cited the Restatement of Law on Trusts, section 232 and note ‘b’ thereunder, to the effect that, ‘If a trust is created for beneficiaries in succession, the Trustee is under a duty to the successive beneficiaries to act with due regard to their respective interests.’
The situation here is distinguishable from that in Campbell in the following respects. First, under Council's will the remaindermen had only a contingent interest subject to the nonexercise of decedent's power of appointment. As the decedent had the power to appoint trust principal to anyone she chose, the trustees had no obligation to any beneficiary other than decedent. Secondly, the distributions made here ultimately inured to the benefit of the remaindermen. Under these circumstances, we believe the trustees acted with due regard to the interests of all possible beneficiaries who were specifically named in Council's will. We see no material frustration of the testator's intent.
In conclusion, we find the power of the trustees to invade principal of the marital deduction trust was a discretionary power. The trustees acted within the bounds of reasonable judgment in exercising their discretion and making the distributions. The trustees' acts would not be reversed by a North Carolina court. The distributions, therefore, effectually removed the cash and stock from the principal of the marital deduction trust. Decedent's power of appointment extended only over so much of the principal as remained in the marital deduction trust at her death. The cash and stock were not part of the principal at her death and were not subject to her power of appointment. The value of the cash and stock is not, therefore, includable in her gross estate.
Being able to find favorably for petitioner on these grounds, we do not reach the issue of whether decedent released her power of appointment over the cash and stock.
In order to reflect concessions on other issues,
Decision will be entered under Rule 155.
+-------------------------------------------------------+ ¦126 shares—¦Frances C. Yeager ¦ +-----------+-------------------------------------------¦ ¦21 shares— ¦N.C.N.B. as trustee for Betty Durham Yeager¦ +-----------+-------------------------------------------¦ ¦63 shares— ¦N.C.N.B. and D. S. Mims as trustees for ¦ +-----------+-------------------------------------------¦ ¦ ¦Carol Frances Council ¦ +-----------+-------------------------------------------¦ ¦63 shares— ¦N.C.N.B. and D. S. Mims as trustees for ¦ +-----------+-------------------------------------------¦ ¦ ¦Commodore Council, III ¦ +-----------+-------------------------------------------¦ ¦63 shares— ¦N.C.N.B. and D. S. Mims as trustees for ¦ +-----------+-------------------------------------------¦ ¦ ¦John Thomas Council ¦ +-------------------------------------------------------+