Mitchell v. Commissioner ( 1938 )

ERNESTINE MITCHELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

J. A. MITCHELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Mitchell v. Commissioner

Docket Nos. 90710, 90711.

United States Board of Tax Appeals

38 B.T.A. 1336; 1938 BTA LEXIS 750;

December 8, 1938, Promulgated

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J. A. Mitchell and his former wife, Jewell L. Mitchell, residents of the State of Texas, created a trust in 1928, the income of which was to be paid in part on their mutual indebtedness, in part to J. A. Mitchell, and in part to Jewell L. Mitchell for the support of herself and their two minor children. Jewell L. Mitchell obtained a divorce in 1929 and in the divorce decree a division of the property then held by the trustee was made by the court and the trust agreement was in general approved. In income tax returns filed for 1933 Jewell L. Mitchell reported for tax one-half of the net income of the trust; the petitioners, husband and wife, reported as community income the remaining one-half of the net income of the trust. The respondent in the determination of the deficiencies has held that the total net income of the trust is taxable to petitioners upon a community property basis. Held, that, since under the laws of the State of Texas a husband is under no legal duty to pay alimony to his divorced wife and the divorced wife here had a vested title to a portion of the trust assets, the trust income payable to her for her own use is not taxable to the petitioner; held, further, that the portion of the trust income paid to the wife for the support of the minor children is taxable to the petitioners as community income.

Edwin H. Suhr, Esq., and H. I. Wilhelm, C.P.A., for the petitioners.

Francis S. Gettle, Esq., for the respondent.

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SMITH

The respondent has determined a deficiency of $289.28 in income tax against each of the petitioners for 1933. The deficiencies were determined upon the basis that the petitioners are liable to income tax upon the entire income of a trust, one-half of which was payable to J. A. Mitchell's former wife, Jewell L. Mitchell. The petitioners contend that they are not taxable upon any part of the income paid or payable to Jewell L. Mitchell.

FINDINGS OF FACT.

The petitioners are husband and wife and are residents of the State of Texas. Ernestine Mitchell is J. A. Mitchell's second wife. They were married subsequent to 1929 and prior to 1933. J. A. Mitchell's first wife, Jewell L. Mitchell, obtained a divorce from him in 1929.

The term "petitioner" is hereinafter used to refer to the husband, J. A. Mitchell.

On October 29, 1928, the petitioner and Jewell L. Mitchell, then husband and wife, executed a trust agreement by which they conveyed to the Public National Bank of Houston, Texas, as trustee, certain real estate, notes, and choses in action in trust for the benefit of themselves and their two minor children, Helen Mitchell and James Mitchell, approximately eight and six years of age. The express purposes of the trust were to pay off the debts and obligations of the settlors, to create a trust fund for the settlors' use for a period of twenty years, and to create a trust fund for the use and benefit for life of the settlors' children, Helen and James.

Out of the net income of the trust the trustee was directed to liquidate and pay off periodically all of the debts of the settlors. If to the best interests of the trust, the corpus also might be applied in payment of such debts. The trust instrument provided in part as follows:

(a) To Jerry A. Mitchell, during his life, the trustee shall pay the sum of five hundred dollars ($500.00) per month.

(b) To Jewel [sic] L. Mitchell, during her life and during the minority of James Mitchell and Helen Mitchell, children of the trustors, the sum of one thousand five hundred dollars ($1,500.00) per month, said sum to be paid to the said Jewel L. Mitchell for her individual use and the support of said children.

(c) As and when James Mitchell shall have reached the age of twenty-one (21) years, and from and after that time, the trustee shall pay to the said James Mitchell, out of the net income of this trust estate two hundred fifty dollars ($250.00) per month and the amount payable to the said Jewel L. Mitchell shall be correspondingly reduced.

(d) As and when Helen Mitchell shall have reached the age of twenty-one (21) years, and from and after that time, the trustee shall pay to the said Helen Mitchell out of the net income of this trust estate Two Hundred Fifty Dollars ($250.00) per month, and the amount payable to the said Jewel L. Mitchell shall be correspondingly reduced.

(3) When all of the above mentioned notes and indebtedness now owing by the trustors and/or either of them, and all of the indebtedness of this trust estate, shall have been liquidated, paid off and discharged and from and after the date of the final payment thereof, the net income of this trust estate shall be distributed as follows, to-wit:

(a) To Jerry A. Mitchell, during his life, the trustee shall pay one-half (1/2) of said net income.

(b) To Jewel L. Mitchell, during her life and during the minority of James Mitchell and Helen Mitchell, children of the trustors, for the individual use of said Jewel L. Mitchell and for the support of said children, the trustee shall pay one-half (1/2) of said net income.

(c) As and when James Mitchell shall have reached the age of twenty-one (21) years and from and after that time, the trustee shall pay to the said James Mitchell out of the net income of this trust estate Two Hundred Fifty Dollars ($250.00) per month, and the amount payable to the said Jewel L. Mitchell shall be correspondingly reduced.

(d) As and when Helen Mitchell shall have reached the age of twenty-one (21) years and from and after that time, the trustee shall pay to the said Helen Mitchell out of the net income of this trust estate Two Hundred Fifty Dollars ($250.00) per month, and the amount payable to the said Jewel L. Mitchell shall be correspondingly reduced.

(4) In the event that the said Jerry A. Mitchell should die within twenty (20) years after the date of this instrument, then that part of the net income of this trust estate which would otherwise go to him shall be paid to the person, or persons, and in such shares as the said Jerry A. Mitchell may nominate and appoint by his last will and testament and in default of same, such income which would otherwise go to the said Jerry A. Mitchell shall accrue, accumulate to, for and be set over into the corpus of this trust estate for the carrying out of all other provisions hereof.

(5) In the event of the death of the said Jewel L. Mitchell within twenty (20) years after the date of this instrument, then and in that event, and from and after her death, all of that part of the income of this trust estate that would otherwise be paid to her during the minority of James Mitchell and Helen Mitchell, except the sum of $500.00 per month, shall be paid to such person, or persons, and in such shares as the said Jewel L. Mitchell may nominate and appoint by her last will and testament and in default of the same, shall accrue, accumulate to, for and be set over into the corpus of this trust estate for the carrying out of all other provisions hereof, and the remaining $500.00 per month of such portion of said income, which would during the minority of Helen Mitchell and James Mitchell otherwise go to the said Jewel L. Mitchell, shall be paid to James Mitchell and Helen Mitchell, share and share alike, or to their legally appointed guardian or guardians.

(6) In the event of the death of James Mitchell within twenty (20) years after the date of this instrument, then that part of the income of this trust estate which would otherwise be payable to him or to his legally appointed guardian shall accrue, accumulate to, for and be set over into the corpus of this trust estate for carrying out of all other provisions hereof.

(7) In the event of the death of Helen Mitchell within twenty (20) years after the date of this instrument, then that part of the income of this trust estate which would otherwise be payable to her, or to her legally appointed guardian, or guardians, shall accrue, accumulate to, for and be set over into the corpus of this trust estate for the carrying out of all other provisions hereof.

(8) All payments out of the income of this trust estate above provide to be paid to Jerry A. Mitchell and Jewel L. Mitchell, or either of them, shall cease on the 29th day of October, 1948, and the said James Mitchell and Helen Mitchell shall receive only such income as shall be payable to them out of the net income of that portion of this trust estate retained and held in trust by the trustee from and after October 29, 1948, as hereinafter provided.

At the expiration of the twenty-year period or on or before October 29, 1948, the trustee was directed to liquidate and pay off all notes and indebtedness of the trustors and all indebtedness owing by the trust estate and then to distribute certain particularly described property to Jewell L. Mitchell:

* * * if she be then alive; otherwise to such person, or persons as she may nominate and appoint by her last will and testament; and in default thereof, then to her legal heirs, if said property shall be and remain the property of this trust estate at that time, otherwise the said trustee shall deliver to the said Jewel [sic] L. Mitchell funds and/or property of a value equal to the net sale price paid to the trustee for said property at the sale thereof.

It was also provided that on or before October 29, 1948, the trustee should:

* * * deliver, pay over and convey to Jerry A. Mitchell, if he be then alive, otherwise to such person, or persons, as he may nominate and appoint by his last will and testament; and in default thereof, then to his legal heirs, one-half (1/2) of the corpus and accrued and undistributed income of this trust estate, exclusive of the above described property stipulated to be set over and delivered to the said Jewel L. Mitchell.

The trust instrument further provided:

The trustee shall retain and continue to hold in trust such portion of this trust estate as shall remain in the possession of the trustee after said trustee has delivered and conveyed to Jerry A. Mitchell and Jewel [sic] L. Mitchell the property to be conveyed and delivered to the said Jerry A. Mitchell and Jewel L. Mitchell on October 29th, 1948, as heretofore provided. Such portion of said trust estate so remaining in the possession of the trustee shall be held in trust and administered by said trustee, subject to and in accordance with the applicable conditions and provisions of this instrument and the net income of said portion of this trust estate so retained and held in trust by the trustee from and after Oct. 29th, 1948, shall be distributed as follows, to-wit:

(a) If both James Mitchell and Helen Mitchell, the above named children of the trustors, be living on October 29th, 1948, then and in that event and from and after said date, the net income of such portion of this trust estate as shall be retained and held in trust by the trustee from and after October 29th, 1948, as herein provided, shall be paid to the said James Mitchell and Helen Mitchell, share and share alike, until the death of said children, or either of them, and upon the death of one of said children and from and after the death of said child and after payment by the trustee to such person, or persons, as the deceased child may nominate and appoint in its last will and testament, or to deceased child's legal heirs of one-half (1/2) of the trust estate, as it then exists, as hereinafter provided, all of the net income of the trust estate then remaining in the hands of the trustee shall be paid to the surviving child during the life of said surviving child and upon the death of said last surviving child, this trust shall terminate as hereinafter provided.

(b) If either James Mitchell or Helen Mitchell, the above mentioned children of the trustors, shall die before Oct. 29th, 1948, and the other shall be living on said date, then and in that event and from and after said date, the net income of that portion of this trust estate retained and held in trust by the trustee from and after October 29th, 1948, shall be paid to such surviving child during the life of said surviving child.

The trust instrument further provided that either or both of the settlors might add to the corpus of the trust. Pursuant to this provision of the trust instrument, J. A. Mitchell turned over to the trustee on October 31, 1928, eight life insurance policies by which his life was insured for an aggregate amount of $300,000, and on November 9, 1928, he turned over to the trustee 666 shares of the capital stock of the J. L. Mitchell Jewelry Co. The property thus transferred became a part of the corpus of the trust.

By a supplemental agreement entered into between the settlors of the trust and the trustee dated June 12, 1929, it was provided that thereafter the trustee should pay to J. A. Mitchell the amount of $1,000 per month and that the monthly payment to Jewell L. Mitchell should be reduced to $1,000 per month.

The supplemental agreement provided that:

This instrument is intended to and does hereby vest and pass title and settle all community differences and property rights of the parties, present or future, real, personal, or mixed. In the event a decree of divorce is entered in any suit therefor filed by either party, this agreement shall be admitted in evidence and the court shall decree the rights of the parties to the property covered hereby in accordance with said trust agreement as medified herein.

Jewell L. Mitchell obtained a divorce from the petitioner, J. A. Mitchell, on August 5, 1929, and was given custody of their two minor children, Helen and James. In its divorce decree the court ratified the trust agreement of October 29, 1928, and the supplemental agreement of June 12, 1929, and, as it was required to do under the laws of the State of Texas (art. 4368, Vernons's Annotated Texas Statutes), made a division of the property, awarding to Jewell L. Mitchell as her separate estate the properties which under the trust agreement were to be distributed to her or her devisees or heirs upon termination of the trust. These properties remained in the trust subject to the trust agreement throughout the taxable year 1933.

On December 5, 1931, the Second National Bank of Houston, Texas was appointed trustee in place of the Public National Bank of Houston, Texas, which had been placed in liquidation by the Comptroller of the Currency.

The gross income of the trust for 1933, as shown by the books of the trustee, consisted of rents $78,901.23, interest $271.50, recovery on fire loss $35.50, and insurance premium refunded $23.88. The total deductions amounted to $54,815.91, including interest paid of $39,092.62.

The net income of the trust amounting to $24,416.20 was reported, one-half, or $12,208.10, by Jewell L. Mitchell, and $6,104.05 by each of the petitioners in separate returns.

OPINION.

SMITH: The respondent has determined that all the income of the trust for 1933 is taxable as community income of petitioner and his present wife, Ernestine Mitchell. The correctness of this determination is the sole issue before the Board.

The petitioner's contentions are that the amount paid to Jewell L. Mitchell in 1933 out of the income of the trust fund created by her and J. A. Mitchell prior to their divorce in 1929 was not the income of the petitioner; that the payments were not made in lieu of alimony or in discharge of any legal obligation of the petitioner; that under the laws of the State of Texas the wife has no dower right in the estate of the husband and is not entitled to any alimony payments in the case of divorce.

It is true and is admitted by the respondent that the laws of the State of Texas do not provide for alimony payments or any other payments by a husband to his divorced wife except an allowance during pendency of the divorce suit if the wife does not have sufficient means of her own. See art. 4637, Vernon's Annotated Texas Statutes, vol. 13, p. 364. Article 4368 provides that the court in pronouncing a decree of divorce shall make a division of the property such as is just and right, having due regard to the rights of each party and their children. A division of the property between petitioner and Jewell L. Mitchell was ordered by the court in its decree of August 5, 1929, Jewell L. Mitchell being awarded the identical properties which under the trust agreement were to be distributed to her or her devisees or heirs upon the termination of the trust. These properties were at the time held by the trustee and, the trust agreement having been ratified by the court, were so held during 1933. In these circumstances we think that the petitioner is right in his contention that the payments made to Jewell L. Mitchell out of the income of the trust for her own use were not payments in lieu of alimony and were not made in satisfaction of any legal obligation of the petitioner. The payments were, at least in part, distributions to Jewell L. Mitchell of income from her own separate properties which, under the trust agreement and the decree of the court, remained in the trust with properties belonging to the petitioner. The petitioner had no present or reversionary rights in any of the properties which were awarded to Jewell L. Mitchell by the court's decree, and, consequently, he had no rights in respect to the income from the properties so set apart for Jewell L. Mitchell.

In holding the petitioner taxable upon the income of the trust paid to Jewell L. Mitchell, the respondent relies upon . We are of the opinion, however, that the rule in , is not applicable to the facts in the instant proceedings. There a divorce had been obtained in the State of Minnesota, where alimony for the wife may be decreed out of the husband's income. Payments to the divorced wife were made from the income of a trust created solely by the husband out of his own property in contemplation of the divorce and were, as the court found, "in lieu of alimony." The court pointed out that there was a recognized preexisting legal duty on the part of the husband to support the divorced wife and that the payments made to her from the income of the trust were in discharge of that duty. The court said in its opinion:

* * * The creation of a trust by the taxpayer as the channel for the application of the income to the discharge of his obligation leaves the nature of the transaction unaltered. Burnet v. Wells, supra. In the present case, the net income of the trust fund, which was paid to the wife under the decree, stands substantially on the same footing as though he had received the income personally and had been required by the decree to make the payment directly.

In the instant case, as shown above, the petitioner was under no obligation to make any alimony payments to his divorced wife after the divorce and under the court's decree the wife had her separate estate, which comprised a portion of the properties held in the trust. We think that the trust income which was paid to her for her own use was her separate income. It was not paid in satisfaction of any legal obligation of J. A. Mitchell and it is not taxable to him.

The respondent further points out in his brief that under the laws of the State of Texas a father is under a legal obligation to support his minor children, citing ; ; ; ; . He contends that, since some portion of the income of the trust which was paid to Jewell L. Mitchell was used for the support of petitioner's minor children and the exact amount is not shown by the evidence, the petitioner must be held taxable on all of the trust income.

The laws of the State of Texas as pronounced in the cases cited by the respondent and in others which we have reviewed place the legal obligation on the husband to support his minor children. Under the decisions of the Supreme Court of the United States in ; , decided upon authority of ; and of the Circuit Court, , a husband is taxable on the income from a trust fund created out of his own property which is used to support his minor children. We believe that the principle announced by the court is as applicable in a community property state as in a noncommunity property state. The trust agreement herein in question provides that the payments to be made to Jewell L. Mitchell were "for her individual use and the support of her said children." The trust instrument does not say just how much of the amounts to be paid to the wife is for the support and maintenance of the children but we think it is a fair inference that it was the intention of the settlors that $500 per month of the amount to be paid to Jewell L. Mitchell was for the support and maintenance of the minor children. The trust instrument does provide that in case of the death of Jewell L. Mitchell during the minority of the children $500 per month was to be paid for their support and maintenance. Furthermore, it is to be noted that when the minor children attained their majority each was to receive out of the trust fund an amount of $250 per month, which was to be deducted from the allowance made to Jewell L. Mitchell. Since these provisions of the trust agreement were approved by the court in its divorce decree, it must be assumed that the trust income payable for the support of the children was derived from or was allocable to the income from the property of J. A. Mitchell, on whom rested the legal obligation for the children's support.

In our opinion it must be assumed that $6,000 of the trust income payable to Jewell L. Mitchell was community income of the petitioners. The respondent has held that the entire amount of the income of the trust fund payable to Jewell L. Mitchell ($12,208.10) was taxable to the petitioners as community income. We find the correct amount to be $6,000. The deficiencies will be recomputed accordingly.

Reviewed by the Board.

Judgments will be entered under Rule 50.