Hexter v. Commissioner , 47 B.T.A. 483 ( 1942 )

STEPHEN HEXTER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Hexter v. Commissioner

Docket No. 105467.

United States Board of Tax Appeals

47 B.T.A. 483; 1942 BTA LEXIS 685;

August 6, 1942, Promulgated

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1. The petitioner set up an irrevocable trust, with his wife as sole beneficiary and cotrustee with him, and with no rights in the petitioner to corpus or income. No provision was made for payment of trust income upon life insurance premiums or upon petitioner's obligations. The wife had for three years been paying premiums upon life insurance policies assigned absolutely to her by the trustor, and after the formation of the trust she continued to pay from a bank account into which the trust income was deposited both the insurance premiums and certain household expenses. Held, that trust income was not taxable to the petitioner.

2. The petitioner owned stock in corporations and actively engaged in the internal affairs of such corporations. Held, that expenses are deductible as of trade or business to the extent shown not to be mere investment expense.

Richare H. Levin, Esq., and Harry N. Wyatt, Esq., for the petitioner. Jonas M. Smith, Esq., for the respondent.

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DISNEY

This proceeding involvis income taxes for the calendar years 1936 and 1937. Deficiencies were determined by the Commissioner in the amount of $11,756.93 for 1936 and $5,700.10 for 1937. By amended answer the Commissioner asks for increase in deficiency in both years to the extent caused by error alleged in the allowance of deductions of $2,849.50 for the year 1936 and $2,795.03 for the year 1937. The only issues presented are whether the petitioner is taxable upon the income of a trust set up by him and whether the Commissioner erred in allowing claims of deduction of expenses as ordinary and necessary expenses of trade or business. From evidence adduced we make the following findings of fact.

FINDINGS OF FACT.

The petitioner, an individual living in Chicago, Illinois, filed his Federal income tax returns for 1936 and 1937 with the collector of internal revenue for the first district of Illinois.

Prior to 1932 petitioner had taken out life insurance policies in the aggregate face amount of $205,000 upon his life, the Equitable Life Assurance Co. being the insurer. On May 26, 1932, petitioner transferred such life insurance policies to his wife, Carolyn r. Hexter. The petitioner made the application for transfer. One of the reasons for making the transfer was to avoid the payment of Federal gift taxes. Among other reasons were the fact that the petitioner had been ill, that his wife had been considerate and thoughtful in taking care of him, and that he wanted to make her a present.

On August 9, 1935, the petitioner set up a trust of which he was the grantor an he, his wife, and an attorney were trustees. The attorney shortly thereafter was succeeded as trustee by his wife's brother. The brother died prior to the taxable years and since his death the trustees have been the petitioner and his wife. They have had, under the trust instrument, equal powers in the management of the trust, including power to invest the trust estate, to reinvest it and keep it invested in bonds, stocks, mortgages on improved incomebearing properties, and securities of all kinds, to sell, convey, and assign the trust property as the trustees see fit, to borrow money on the security of the trust property, to determine (with certain exceptions not material here) what is income and what is principal; to determine the mode in which expenses are to be borne as between capital and income, and to determine how all receipts and disbursements shall be credited, charged, or apportioned as between income and principal; to value and appraise the trust estate for the purpose of making any distribution of principal, and to distribute in kind or in cash; and to make payments of income at convenient intervals, not less frequently than quarter-yearly.

The trust instrument provides further that all net income of the trust estate shall be paid by the trustees to Carolyn R. Hexter during the term of her natural life; that in case of her death prior to that of the trustor she can by will appoint and dispose of the net income of the trust from the time of her death to the death of the trustor, but that, in the event of her death prior to the death of the trustor without exercising such power of appointment, the net income shall after her death and until the death of the trustor be paid to the trustor's sister, or the sister's children after her death, until the death of the trustor; that after the death of the trustor, in the event that Carolyn R. Hexter and the trustor's sister shall have died prior thereto, the net income shall be divided among the sister's children and their lawful issue per stirpes, the principal to be paid to such children one-third at the ago of 30 years, one-third at the age of 35, and the remaining one-third at the age of 40 years; that in the event of the death of the sister and of all of her children and the issue thereof prior to the death of Carolyn R. Hexter, the trust shall terminate and the entire trust estate shall be the sole and absolute property of Carolyn R. Hexter forever; and if Carolyn R. Hexter shall have already died, the trust estate should be distributed to the heirs at law of the trustor under the laws of Illinois, and if the trustor shall not have died at that time and Carolyn R. Hexter shall have failed to appoint and dispose of the net income, the trustees shall accumulate the net income until the trustor's death (the accumulations to become principal) and upon his death to pay the trust estate to his heirs in accordance with the laws of Illinois; that if in the opinion of Carolyn R. Hexter the income is insufficient to provide for her needs and requirements in the manner to which she has been accustomed, then upon her sole request and demand the trustees shall pay to her from the principal such sums as she in her sole, absolute, and uncontrolled discretion deems necessary or desirable.

It was also provided that as long as the trustees should be three in number a majority should have full power to act; also that the trust may be modified, amended, changed, revoked, or terminated by Carolyn R. Hexter during the lifetime of her brother by an instrument in writing consented to by him.

The Northern Trust Co. was made custodian of the trust assets at the time of the creation of the trust and that company has since that time managed the trust income and property. The Northern Trust Co., pursuant to the agreement of custody, has deposited, at all times material, the trust income in the checking account which Carolyn R. Hexter has maintained in the Northern Trust co. The amount so deposited during the year 1936 was $20,130.93 and in 1937 was $22,211.20. From other income Carolyn R. Hexter also deposited in such checking account during the two years the total sum of $50,144.56. From the same bank account Carolyn R. Hexter paid premiums upon the life insurance policies upon the life of Stephen Hexter, to which reference is above made, in the amount of $9,888.90 in 1936, and $10,409.50 in 1937. From the same bank account Carolyn R. Hexter paid household and family expenditures totaling $11,379.59 in 1936 and $14,558.07 in 1937, or a total of $25,937.66 for the two years. In 1936 the petitioner deposited in the bank account to the credit of his wife $9,000 and during the year 1937 deposited therein the sum of $6,000.

While the petitioner was ill he asked his wife to look after numerous bills for nurses, medicine, and things not in the regular category of household expenses, asked her to keep track of them, and stated that she would be reimbursed. A complete record was kept, amounting to about $19,400. Petitioner paid the amount down to $18,000 and gave his wife a note for that amount with 3 percent interest, on October 25, 1940. The deficiency notice involved in this proceeding is dated August 13, 1940, and the petition herein was filed on November 7, 1940. The note above referred to was paid on October 4, 1941, in the amount of $15,000, $3,000 having been paid at an earlier date.

Two of the life insurance policies provided for disability payments of $2,400 per year and five were ordinary life policies. The transfers of the policies recited that all rights were vested in Carolyn R. Hexter only during her lifetime and upon her death prior to that of petitioner the rights of owner were to vest in Lillie Benedikt, sister of the petitioner, and upon the death of the survivor of Carolyn R. Hexter and Lillie Benedikt prior to the death of petitioner the rights of owner were to vest in the executors or administrators of such survivor. After the transfet, the disability payments on the two policies were always made to Carolyn R. Hexter and the checks came to her. Her income, aside from trust income, has always been sufficient to pay the premiums on the policies. Petitioner never exercised any control over the policies after the transfers. The petitioner and his wife never had any agreement that the income of the trust was to be used for paying the insurance premiums or that she was to use any of the trust income for household expenses. The only discussion on the subject was that the income was absolutely that of the wife and should be used as she saw fit for herself. Petitioner never intended that his wife should use the trust income to pay household expenses or for insurance premiums.

The matter of the formation of a trust was first discussed in the early part of 1935. Petitioner had been a speculator and wished to put some money out of his reach. He knew that the formation of the trust would reduce his personal income to some extent, but tax possibilities did not occur to him. He wished to insure financial independence for his wife by getting money out of his hands, so that he could not waste it by speculation.

Petitioner was for many years in the drug business, as an officer and director of Buck & Rayner, a corporation. That company owned four office buildings in Chicago, one with seven floors, two with fifteen floors each, and one with six floors. The drug business was sold in 1928 and the president of the corporation, one Eckstein, was in complete charge of the real estate until he died in November 1935. No president was elected to succeed him, but the petitioner has at all times been a director, treasurer, and vice president of Buck & Rayner. There were four other directors. Petitioner acts as chairman of the board of directors. Three of the other directors are inactive. One Gundaker is vice president, director, and secretary. The four buildings have from 175 to 200 tenants. Gundaker has general supervision of the buildings, and solicits and interviews possible tenants. Petitioner moved his office in the early spring of 1936 from one building owned by Buck & Rayner to another in order to keep in complete touch with what was going on, and in connection with supervising and looking after things. Buck & Rayner has an office, consisting of five rooms and a vault. One room is devoted to petitioner's use and another small one to the use of petitioner's secretary. Buck & Rayner has three girls, and usually one solicitor, as an office force in addition to many employees such as janitors and elevator men in the buildings. Petitioner pays no rent for his offices. He receives no salary from Buck & Rayner nor from any other company in which he has stock. His capacity is an advisory one in Buck & Rayner. He is the authority to whom Gundaker refers questions of policy affecting the interests of that company. He consults with Gundaker with reference to all leases entered into by the corporation and investigates the qualifications of prospective tenants and passes upon and signs practically all of the leases. The petitioner is consulted on practically every phase of Buck & Rayner's activities, including matters of wage agreements, matters of construction work for tenants, adjustment of rents, and charge-off of uncollectible accounts. The corporate bylaws limit Gundaker's expenditures, without approval of another director, to $500 and he practically always consults with the petitioner. Gundaker has been in charge of the buildings since 1928, when the drug business was sold out. The petitioner does not hire or fire the employees of the corporation.

During the taxable years the petitioner went to the office two or three times a week, when he was physically able. In 1936 he did not come to the office at all possibly 25 out of the 52 weeks. In 1937 he came oftener and was there about three-fourths of the time. When he was not able to come, Gundaker visited his house on the average of once a week and conferred with him by telephone on the average of two or three times a week. When he came to the office, the petitioner wrote to companies in which he was interested, and telephoned giving them advice upon questions about which they asked him. He was interested as a heavy stockholder principally in Buck & Rayner, in the Chicago Mail Order Co., and in the Consolidated Magazine Corporation; also in the Milwaukee Boston Store, a large department store. He has never been a director of the Boston Store of Milwaukee, being unable to go to Milwaukee for meetings on account of his health. Petitioner has, since about 1929, been in very bad condition of health, and has had many operations. His mind is very active and his illness is only physical. He is not able to move around or walk to any extent, although there are periods when he can walk around the block and get to his office by taxicab. He has difficulty in climbing steps.

Petitioner received dividends from 54 corporations in 1936. In that year he made 22 purchases and 22 sales of securities, and in 1937 there were 21 purchases and sales.

The petitioner employed a secretary. She attended to matters both for the petitioner and his wife and the Hexter trust, of which the petitioner's wife was beneficiary. The secretary kept the records with reference to all three in one office. She wrote about 48 checks a month for petitioner's wife. Petitioner's checks averaged about 11 a month. The situation was similar in 1937. Petitioner received dividends of $55,992.82 in 1936 and $54,993.69 in 1937. He reported upon his income tax return for the year 1936 that his principal occupation was director and in his report for 1937 that it was director and investor. Petitioner had been too active in his work to wish to simply be a "play boy." He wanted to have something to do that would produce results and make a greater profit for Buck & Rayner. Among other things done by him was to lease space for signs upon one of the buildings belonging to Buck & Rayner. In that connection hundreds of letters were written to prospective lessees. The letters were written by the petitioner's secretary. Buck & Rayner did not pay petitioner's secretary and she does no work for Buck & Rayner. She was paid personally by the petitioner. Most of petitioner's income comes in March, June, September, and December.

The net income and the Federal income tax paid for the petitioner for the years 1932 to 1935, inclusive, were as follows:

Year	Net income	Federal income tax paid
1932	$65,016.47	$2,541.30
1933	26,675.10	199.66
1934	57,092.05	9,077.62
1935	87,220.10	21,455.13

The petitioner deducted for the taxable years as expense of doing business a total of $2,657.66 for 1936 and $2,795.03 for 1937, including $40 a week for his secretary and other items including $175 for an accountant to make up his income tax report for 1936 and $100 for accountant's service in 1937 for preparation of income tax return; also $378 in 1936 and $368.50 in 1937 for subscriptions to financial news and services; and $16.84 in 1936 and $12 in 1937 for rental on a safety deposit box, where petitioner kept his personal papers and securities.

OPINION.

DISNEY: The prime question presented to us in this proceeding is whether the petitioner is taxable upon the income of a trust set up by him. The deficiency notice recites in that respect, in substance, that the income could be and was used to discharge the trustor's obligations and to pay insurance premiums on policies on his life; therefore it is held that the trustor is subject to tax on the income under section 167(a)(3) and section 22(a) of the Revenue Act of 1936. The latter contains the familiar general "definition" or statement as to what is included in income, and need not be set forth at length here. The more particular section, 167(a)(3), is shown in the margin. ^{*699 , to the discharge of petitioner's household obligations by trust income, and that exactly under the words of section 167(a)(3) trust income paid premiums on life insurance policies on the trustor, but also suggests that there was reallocation of family income and the , requires taxation thereof to the trustor. The petitioner argues that he may not be taxed on the trust income in the absence of a requirement in the trust instrument requiring application of such trust income either to payment of insurance premiums upon his life or to discharge of his obligations, and urges that the life insurance policies belonged, and had for about three years belonged, wholly to his wife, who, after the trust was set up, paid the premiums from a bank account containing other moneys, sufficient for that purpose, as well as the trust income; also, that the wife was reimbursed by the petitioner for any trust income temporarily used by her for household obligations of the petitioner. On this issue the petitioner has the burden.}

We first consider the question as to payment of premiums on life insurance policies on the life of the grantor of the trust. It is wholly true, as the respondent says, that the text of section 167(a)(3) plainly provides for taxation to the grantor of a trust, of trust income "applied to the payment of premiums upon policies of insurance on the life of the grantor"; and it is true that here the premiums paid were upon such policies on the grantor's life. Nevertheless, a reading of the cases on the subject convinces us that, even if we assume that trust income paid the premiums, the statute does not apply here, where there appears in the trust instrument no requirement that the trust income be so expended, and where the petitioner had, some three years before the trust was formed, transferred the policies absolutely to his wife, who is also the trustee-beneficiary who paid the premiums. Of the fact of such absolute transfer there can be no doubt, for although the respondent points out that the transfer was to the wife for her lifetime, the instrument of transfer recites that "all rights vested" in the petitioner's wife only during her lifetime, but thereafter "the said rights of owner shall vest" in Lillie Benedikt, and after death of the survivor of the wife and Lillie Benedikt "said rights of owner" shall vest in the executors or administrator of such survivor. It is plain that no rights could revert to the transferor or his estate, ane we think that the respondent erroneously invokes , as indicating an interest in the policies continuing in petitioner. There the Court said, "The controversy is one as to the boundaries of legislative power", and finding the statute plain, did not construe it. (975). In any event, the case did not involve policies assigned by the assured some year prior to the trust, and did involve a trust instrument making specific provision for use of trust income upon premiums. We find in that case no assistance on this point. Nor do we find it in , strongly relied on by the respondent because of the fact that the policies there had been assigned by the trustor and the trust instrument did not require use of trust income upon premiums; for there it is emphasized that the suggestion was made by the trustor that trust income be used for insurance premiums, the beneficiary's husband, the grantor, exercised control over the trust income, the use of trust income for the premiums was of benefit to the trustor, and the beneficiary had never before paid the insurance premiums. All of these elements are negatived in the instant case, where there was no suggestion and no control by the grantor, the wife had for about three years herself paid the premiums, and was amply able to do so from her own funds in the taxable years, and the payments were of no benefit to the grantor. In (reversed on other grounds, ), we distinguished the Dunning case and held the trustor not taxable on trust income where, as here, the beneficiary paid the premiums on a policy on grantor's life, but owned by the beneficiary, and there was no restriction on the use of the trust income. In , we commented upon the fact that payments by the beneficiary of a trust of premiums upon policies on the trustor's life were voluntary, not required of the beneficiary by provision of trust, or agreement, and, though finding that the beneficiary may have used some trust income to pay premiums, held the amount of the premiums should not be taxed to the trustor. In , the trustor, as here, could never receive anything from the accumulation or proceeds of life insurance, and the court held the trustor not taxable on the amount of premiums paid on life insurance, saying of section 167(a)(3):

We think it plain, construing the whole section, that it is only when part of the income of the trust is held or accumulated or held for future distribution to the grantor, or be distributed to the grantor, that premiums paid on life insurance policies donated to the trust are to be considered income of the grantor. In this case the grantor could never receive anything from accumulations or the proceeds of the insurance. To hold that the grantor had an economic interest in policies would require adding conjecture to conjecture as to what might happen in the future. We agree with the conclusions of the Board.

We conclude and hold that the petitioner was not taxable upon the amounts applied upon life insurance premiums.

Nor do we find in the facts here grounds for holding that the trust income should be taxed to the trustor, under the doctrine of temporary reallocation of income within an intimate family group, under True, the family group appears, but there is no right of revocation, no discretion vested alone in the grantor as to use of the trust fund or income, no possible reversion to him. He can benefit in no manner, presently or prospectively, by the trust, but parted permanently from all economic benefit from the corpus and income thereof. To say that because of the facts of husband-wife relationship and joint trusteeship the grantor retained control, despite the fact that a sole beneficiary was cotrustee, is to be blind to the reasons behind the respect paid, in section 167, to the position of one with substantial adverse interest - which the wife here had. With all ownership and co-equal trustee powers in the wife, the fact of family relationship should not, we think, be given the effect desired here by the respondent. In our view the Clifford case does not reach so far.

We next consider the taxability to petitioner of trust income with respect to use upon the trustor's legal obligations. There is evidence that the wife paid household bills from the same bank account into which the trustee income was deposited to her credit, and was reimbursed, in part currently and in part later by cash, note and payment thereof at a date after issuance of the deficiency notice, and the respondent impugns the reliability of such froof of late payment. Except to the extent that, due to petitioner's illness, the wife paid household bills and was currently reimbursed, pursuant to agreement by the petitioner, we do not rest our conclusion upon evidence other than the trust instrument. That agreement made no requirement that trust income be utilized to discharge the trustor's obligations, of any nature. Absent such provision, the mere fact of payment from trust income is not alone sufficient to cause taxation to the trustor, even if we assume, without deciding, that payment from the account into which the trust income went is payment from such income. In , we distinctly held that lack of agreement or provision of the trust agreement for application of trust income to trustor's obligation was sufficient to cause denial of taxation of trust income to him. There is no contention here that there was such agreement; only such fact of payment in discharge of obligation is urged. , and , are also both to the effect that mere payment, without trust agreement, of trust income upon trustor's debts, is not the criterion and does not require taxation to him. (reversed on other grounds ), refers to the two cases last cited and comes to the same conclusion. It is our opinion that under the trust agreement here involved the petitioner is not taxable upon trust income upon the ground that it was used to discharge the trustor's obligations.

We come now to consider whether the respondent erred, as affirmatively alleged by him by amended answer, in allowing certain items claimed by the petitioner as business expenses. The principal item is salary paid to a secretary, with minor matters, including subscriptions to financial publications, rental on safe deposit boxes, telephone and telegraph. The burden here is of course upon the respondent. The evidence on the point is conflicting. The petitioner in his Federal income tax return for 1936 stated that his principal occupation or profession was that of "Director", for 1937 "Director or investor." He has been in a serious physical condition since 1929, and during the taxable years was ill for weeks at a time. His condition prevented his moving around or walking to any great extent, though at times he could walk around the block, and could go to his office in a taxicab. His ability to write was affected most of the time during the taxable years. However, directors' meetings were held at his home when he was unable to attend. The petitioner testified, with reference to his activities in causing the leasing of advertising space for Buck & Rayner, that he "presumed to do it", that he liked to work, and had been active too long to be a "play boy", that he "wanted to have something to do that would produce results and make a greater profit for Buck & Rayner. " The company received several thousand dollars income through his efforts in that regard. Although one Gundaker was the active executive officer in charge of the business of Buck & Rayner, he consulted the petitioner on practically all important matters, including wage agreements, construction work for tenants, adjustments of rents, and accounts. In an advisory capacity the petitioner was consulted in general on all matters. The corporate bylaws forbade Gundaker to spend any item above $500 without approval of another director, and he practically always consulted the petitioner. Considering all of the evidence upon this issue, we think that it can not be held that the respondent has shown error on his part in allowing deduction for expense of business. Though the petitioner was an investor, and so testified, yet, it does not appear that his activities were confined merely to "doing only what is necessary from an investment point of view." . The petitioner, in our opinion, in some things went further and comes within the ambit of those cases holding that business activity includes activity in the affairs of companies in which investments are owned. Petitioner to some considerable extent at least partook in the internal affairs of such corporations. To that extent we consider him engaged in business. However, this does not justify allowance of all items asked. The evidence shows that in 1936 to the extend of $378 and in 1937 to the extent of $368.50 items deducted were for subscription to financial news and services; also, that $16.84 in 1936 and $12 in 1937 were for rental on petitioner's personal safety deposit box. These items we consider shown by the evidence to be without basis in activities in the affairs of petitioner's corporations, but rather ordinary expenses of investment, and disallow them. Also, the record shows that the petitioner's secretary, for whose salary deductions were taken of $2,080 for 1936 and $2,120 in 1937, spent time not only on matters relative to corporations in which the petitioner was interested, but handled as well his investments, investments for his wife, and for the Stephen Hexter trust, above herein considered. It is obvious that to some extent her salary should not be charged alone to matters relative to the corporations in which petitioner was interested; and it is upon the ground of such interest and activity and to that extent that we consider him in business. Therefore we allow the secretary's salary only to that extent; and estimating as well as we are able from the evidence, we find that one-fourth of the salary items should be, and they are, allocated to investment matters, and disallow them to that extent.

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 167. INCOME FOR BENEFIT OF GRANTOR.

  (a) Where any part of the income of a trust -

  * * *

  (3) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23(o), relating to the so-called "charitable contribution" deduction);

  then such part of the income of the trust shall be included in computing the net income of the grantor. ↩