Newman v. Commissioner , 15 B.T.A. 369 ( 1929 )

LLOYD D. NEWMAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

ANNA N. REBADOW, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

LLOYD D. NEWMAN, ANNA N. REBADOW, AND S. FAY CARR, EXECUTORS UNDER THE WILL OF LOUIS NEWMAN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

LILLIAN D. NEWMAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Newman v. Commissioner

Docket Nos. 15936, 15937, 15939, 15940.

United States Board of Tax Appeals

15 B.T.A. 369; 1929 BTA LEXIS 2875;

February 12, 1929, Promulgated

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The petitioners are beneficiaries of certain trust funds. The instruments creating the trusts provided that the income and profits thereof and the income and profits of and from any sale or sales or reinvestments of the proceeds of any sale or sales thereof were to be paid to the petitioners. It was the understanding of the donors and trustees, and the beneficiaries that capital losses from the sale of securities should be deducted from gross income of the trusts in ascertaining the net income distributable to the beneficiaries. The books of account of the trusts have consistently been kept upon that theory. Held, that the net income of the trusts distributable to the beneficiaries was the excess of the gross income from all sources over losses sustained on the sale of securities and operating expenses of the trust funds. Held, further, that petitioners were not entitled to deduct from gross income in their individual returns net losses sustained by the trusts.

Edward N. Mills, Esq., for the petitioners.

A. H. Fast, Esq., for the respondent.

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SMITH

These are proceedings for the redetermination of deficiencies in income tax as follows:

	Deficiency
	1920	1921
Lloyd D. Newman, Docket No. 15936	$1,015.25	$198.95
Anna N. Rebadow, Docket No. 15937	292.71	446.37
Louis Newman, Docket No. 15939		3,407.83
Lillian D. Newman, Docket No. 15940	315.41	276.68

These proceedings were consolidated for hearing and decision, the questions to be decided in each being identical. In the petitions to the Board, the taxpayers assign as the basis of their appeals identical errors as follows:

Error in not allowing as a deduction from petitioner's gross income, the amount of loss sustained during the taxable year.

FINDINGS OF FACT.

Louis Newman, the petitioner in Docket No. 15939, having died on February 21, 1928, subsequent to the initiation of these proceedings, an order was entered by the Board substituting Lloyd D. Newman, Anna Newman Rebadow, and S. Fay Carr, executors under the last will and testament of Louis Newman, as petitioners in place of Louis Newman, deceased.

The petitioners are beneficiaries of one or more of the following trusts:

Louis Newman Wife's Trust

Louis Newman Children's Trust

Lillian D. Newman Children's Trust

On April 15, 1918, Louis Newman, party of the first part, Lillian D. Newman, his wife, party of the second part, Lloyd D. Newman and Anna Newman Rebadow, children of the parties of the first and second part, as parties of the third part and fourth part, respectively, entered into a trust agreement, which was amended on December 31, 1918, under which two trusts were created. The substance of the agreement was that Louis Newman declared himself as possessed of certain securities in trust for the benefit of his wife, Lillian D. Newman:

* * * The income and profits thereof and therefrom and the income and profits of and from any and all proceeds of any sale or sales, or reinvestment of the proceeds of any sale or sales thereof, to be paid to my said wife during the term of her natural life, and upon her death the principal of said trust fund shall be distributed and paid over in accordance with the provisions of her last will and testament; or, in the event that my said wife shall die intestate, then, said principal shall be paid and distributed to the persons entitled to distribution of her personal estate under the laws of the State of New York.

The instrument also provided:

* * * The party of the first part [Louis Newman] shall have the right, during the continuation of the trust hereby created, to sell and dispose of any or all of the said stock and invest and reinvest the proceeds of any such sale or sales in stocks, bonds, mortgages and other property, real and personal, and that such investments and reinvestments need not be in property or securities in which trustees are permitted to invest under the laws of the State of New York.

In the same instrument of April 15, 1918, as amended on December 31, 1918, Louis Newman declared himself as possessed of certain other securities in trust for the benefit of his children, Lloyd D. Newman and Anna Newman Rebadow:

* * * The income and profits thereof and therefrom and the income and profits of and from any and all proceeds of any sale or sales or reinvestment of the proceeds of any sale or sales thereof to be paid to my said children, Lloyd Newman and Anna Newman Rebadow, in equal shares, during the term of the natural life of my wife, Lillian D. Newman, and upon the death of my said wife, Lillian D. Newman, the principal of said trust fund shall be distributed and paid over, in accordance with the provisions of her last will and testament, or in the event that my said wife shall die intestate, then said principal shall be paid and distributed to the persons entitled to distribution of her personal estate under the laws of the State of New York.

This instrument also provided that Louis Newman -

* * * Should have the right, during the continuation of the trust hereby created, to sell and dispose of any or all of the said stock and invest or reinvest the proceeds of any sale or sales in stocks, bonds, mortgages and other property, real and personal, * * *

Under date of August 17, 1921, another trust agreement was entered into between Lillian D. Newman and Louis Newman, which provided in substance that Lillian D. Newman declared herself possessed of certain stocks and bonds in trust:

* * * To invest, reinvest and keep invested the principal thereof and to pay the income and profits thereon and the income and profits of and from any sale or sales or reinvestment of the proceeds of any sale or sales thereof, to my said husband, Louis Newman, during the term of his natural life and upon his death the principal of said trust fund shall be distributed and paid over in equal shares to my said children, Lloyd D. Newman and Anna Newman Rebadow, and to their children per stirpes and not per capita if either of my children shall then be deceased.

During the taxable years in question each of the trusts sustained losses on the sale of capital assets consisting of securities. Such losses were in each instance charged to the profit and loss account on the books of the respective trusts. The income of each of the trusts consisted of items of interest, dividends, and the like, the amounts of which were credited to profit and loss account. The profit or loss represented by the difference between the income so credited and the losses on the sales of securities so charged to profit and loss account was at the close of each of the taxable years carried to the account of the beneficiary or beneficiaries on the books of the trusts.

During 1920 losses totaling $16,566.23 were sustained on the sale of securities by the trust known as "Louis Newman Wife's Trust." The items of income of this trust were as follows:

Interest - bank	$65.75
Dividends	17,392.68
Bond interest - taxable	428.33
Bond interest - tax-free covenant	725.16
Bond interest - foreign	289.81
Bond interest - exempt	252.22

The 1920 fiduciary return of Louis Newman, which includes both the wife's and children's trusts, reflects the above items. The individual return of Lillian D. Newman for 1920 shows income from trusts funds of $725.16, interest on tax-free covenant bonds, and $17,392.68 dividends. From the total income there was deducted $15,782.34 as a loss sustained by the trust. This loss was computed in the following manner:

Loss on sale of securities		$16,566.23
Less:
Bank interest	$65.75
Bond interest - taxable	428.33
Bond interest - foreign	289.81
		783.89
Net loss - shown as "other income"		15,782.34

The income item of $252.22 realized by the trust from exempt bond interest was not used by the petitioner to reduce the loss claimed.

The amounts of the losses sustained by the trust funds from which the petitioners received, or were entitled to receive, the distributable income, if any, during the taxable years, as affecting each of the petitioners, are stipulated to have been as follows:

	1920	1921
Lloyd D. Newman	$7,207.85	$5,837.87
Anna N. Rebadow	7,207.85	5,837.87
Louis Newman		25,333.98
Lillian D. Newman	16,566.23	4,172.50

In 1921 the loss sustained on the sale of securities by the Lillian D. Newman Children's Trust exceeded the income. The net loss of that trust in the amount of $24,235.40 was claimed by the beneficiary, Louis Newman, as a deduction on his original return under the heading of "Income from Fiduciary Sources." The effect of claiming this loss on the original return was to reduce income reportable from sources outside the trust.

In the determination of the deficiencies in question in these proceedings the respondent has disallowed the deduction of net losses from the sales of securities by the trusts in the determination of the net incomes of the trusts distributable to the beneficiaries and has computed the distributive share of each beneficiary as his aliquot part of the income of each trust computed without the allowance of such net losses.

OPINION.

SMITH: Section 219(d) of the Revenue Act of 1918 provides in part:

* * * There shall be included in computing the net income of each beneficiary his distributive share, whether distributed or not, of the net income of the estate or trust * * *.

Section 219(d) of the Revenue Act of 1921 provides in part:

* * * There shall be included in computing the net income of each beneficiary that part of the income of the estate or trust * * * which, pursuant to the instrument or order governing the distribution, is distributable to such beneficiary, whether distributed or not * * *

The first question for our consideration is the amount of the net income of the trust funds which, under the provisions of the instruments creating the trusts, is distributable to the beneficiaries. The petitioners contend that only the excess of the income from interest and dividends over losses on sales of securities and operating expenses of the trusts is the income distributable to the beneficiaries. The respondent, on the other hand, takes the view that the entire income of the trust funds before the deduction of any losses on the sales of securities is distributable to the beneficiaries.

For the purpose of determining the question of the distributable income of the trusts a friendly suit was instituted before the Supreme Court of Erie County, Buffalo, N.Y., in 1926, in which Lloyd Newman and Anna Newman Rebadow were plaintiffs and Louis Newman, as trustee, was defendant. At the hearing of the proceeding it was stated to the court that the action was a friendly one and that the parties were asking for a declaratory judgment interpreting a certain trust instrument; that the parties were aligned as plaintiff and defendant merely for the purpose of the suit and that there was no real controversy between them.

The agreed statement of facts filed in the court provided in part:

III. That the defendant [Louis Newman] in computing the income payable to plaintiffs [Lloyd D. Newman and Anna N. Rebadow] under the foregoing agreement of trust and amendment thereto has, since the commencement thereof, deducted all losses however sustained from the ordinary income of the said trust fund and has thereby kept the corpus of said trust estate intact and has paid to plaintiffs only the net income after deducting such corpus losses. IV. That plaintiffs have at all times accepted the net income as hereinbefore found and have acquiesced in the interpretation of said trust agreement and amendment thereto by the defendant and have received each year the net income after deducting corpus losses from the operation of said trust, without objection, and have consented thereto.

V. That the plaintiffs are entitled to a judgment determining, construing and declaring the legal rights and relations of the parties hereto with respect to the trust agreement dated April 15th, 1918 as amended by the trust agreement dated December 31st, 1918, alleged herein.

Upon such agreed statement of facts the court decided on June 14, 1927:

I. That under the trust agreement dated the 15th day of April 1918, made by and between Louis Newman, Lillian D. Newman, Lloyd Newman, and Anna Newman Rebadow, and the amendment thereto dated December 31st, 1918, the defendant, Louis Newman, is required to compute and pay over the income of the said trust to the plaintiffs, Lloyd Newman and Anna Newman Rebadow, beneficiaries therein named, after deducting the cost of operation and losses from the gross income, the balance so distributable as herein found being the net income from said trust.

II. That the defendant, Louis Newman, under and by said trust agreement dated April 15, 1918 and the amendment thereto dated December 31, 1918 is required to keep the principal or corpus of said trust fund intact by the addition thereto of sufficient gains to make good any and all deficiency occasioned by losses of such principal before the plaintiffs are entitled to receive any profit or income from said trust estate.

III. That the plaintiffs, Lloyd Newman and Anna Newman Rebadow, have received in each year from the defendant, Louis Newman, as trustee under the said Trust, all the income to which they are entitled under said trust agreement and amendment thereto.

In the construction of a trust the purpose and intent of the parties must control, this being determined from the terms of the instrument itself if it be plain and unambiguous. But where the instrument is indefinite or inconsistent the court can look at the declarations of the donor and consider the surrounding circumstances in determining just what the intention of the donor was.

The evidence in the instant proceeding all goes to show that the donors, as well as the trustees and beneficiaries, understook that the capital losses from the sale of securities were to be deducted from income before any income was distributable to the beneficiaries and that the trustee was to withhold income from the beneficiaries until capital losses had been made good. The books of account of the trusts have been kept upon the basis of such an understanding. In the construction of a trust instrument all of the facts must be considered. . "The intention of the statute is to let the tax be imposed in accordance with what actually transpired." .

The Revenue Acts of 1918 and 1921 do not attempt to tax beneficiaries upon income from trust estates which has not been received by such beneficiaries or which may not be received by them. It is only the income properly distributable in accordance with the terms of the trust agreements which is taxable to the beneficiaries. ; .

We can not doubt that under the terms of the instruments creating the trusts involved in these proceedings and under the construction placed thereon by all parties concerned, the distributable income of each trust is the net income obtained by deducting from the gross income expenses of administering the trusts and losses upon the sales of securities. The petitioners must be and are sustained in their contentions upon this point.

The assignment of error contained in each petition involved in these proceedings requires that we consider the merit of the contention of the petitioners that they are entitled to deduct from gross income in their individual returns net losses sustained by the trusts from which they receive income. For instance, in the return of Louis Newman for 1921, the taxpayer claimed the right to deduct from gross income received from many sources a net loss of the Lillian D. Newman Children's Trust under which he was entitled to receive for life the income of the fund. The deduction of such net loss was disallowed by the respondent. The petitioners claim the right to deduct the loss.

In , the Circuit Court held that the life beneficiary of the income of the trust estate was taxable on the income actually received by or distributable to him, without deduction for losses to the capital of the estate incurred during the year. The court citing , emphasized the fact that "the fiduciary and the beneficiary are separate taxable persons."

In ; affd., , it was held that a life tenant receiving her share of net distributive income under a testamentary trust was not entitled under the Revenue Act of 1918 to deduct from taxable income an allowance for exhaustion and wear and tear of depreciable assets of the estate, on the ground that it represented a distribution of capital, since capital losses fall on reversioners or remaindermen, and payment to the life tenant therefor consisted in no part of capital depreciation restored to her, notwithstanding that the trustee was entitled to enter deductions for capital losses in his return for the trust estate as a single entity. To the same effect see ; ; and , and cases therein cited. See also , and

A reading of the relevant provisions of the trust instruments herein involved does not convey any idea that the capital losses are chargeable against the beneficiaries. At most, such losses are deductible only from the gross income of the trust sustaining such losses. The disallowance by the respondent of the deduction of the capital losses of the trust estates on the individual returns of the petitioners is sustained.

Reviewed by the Board.

Judgment will be entered under Rule 50.

STERNHAGEN concurs in the result.