United States v. De Bonchamps , 278 F.2d 127 ( 1960 )

MERRILL, Circuit Judge.

These three cases, consolidated for our decision, present the question whether legal life tenants are taxable either as owners or as fiduciaries on capital gains realized in sales of portions of the corpus. In all three cases, gains were realized by sales of estates assets. Taxes were paid thereon by the life tenants as owners; claims for refund were made and these actions were brought to recover such refunds. In each action the United States has counterclaimed for the amount of tax payable by the taxpayer as fiduciary of a trust.¹ In each case summary judgment by the trial court was rendered in favor of the taxpayer. Appeals have been taken by the United States.

The life estates were created by will under California law and grant broad powers to the life tenants to use and consume the corpus for their needs, maintenance and comfort.

In the De Bonchamps and Cowgill cases, the taxpayers are daughters of the testator. The will granted one-half of the estate to each daughter for her use during her life. Upon her death, the remainder was to go to her children then living and the issue of any deceased child per stirpes. It provided:

“Each of my said daughters may consume, use, invest and reinvest her share and the income therefrom for her needs, maintenance and comfort during her life without any restriction and her children and the issue of any predeceased child shall take only what remains of her share on her death.”

In the King case, the taxpayer is the wife of the testator. The will granted to her the entire estate for her use during her life, the remainder upon her death to go to the daughters of the decedent and the issue of any deceased child per stirpes. It provided:'

“My said wife in her discretion may convert any of said property into cash and she shall have and enjoy the rents, issues, income and profits during her life and she also shall be free to invade and use the corpus for her own needs, maintenance and comfort as well as for those of my daughters and their issue or any of them. I declare that it is my wish and intention to have my wife enjoy the free use of said corpus and income during her natural life and that my daughters or their issue, as heretofore provided, shall have and take what is left thereof at the time of her death.”

The first contention of the United States is that under these broad powers the life tenants are to be treated and taxed as the beneficial owners of the capital gains.²

Under California law, the estates so created are regarded as life estates with powers of consumption annexed. The power to consume does not enlarge the estate into a fee. Adams v. Prather, 1917, 176 Cal. 33, 167 P. 534; Luscomb v. Fintzelberg, 1912, 162 Cal. 433, 123 P. 247; In re Estate of Smythe, 1955, 132 Cal.App.2d 343, 282 P.2d 141. Capital gains accrue to the principal and, subject to the life tenant’s powers of use and consumption, belong to the remainderman. California Civil Code, § 730.05(2).

The United States refers to language in Corliss v. Bowers, 1930, 281 U.S. 376, 377, 50 S.Ct. 336, 74 L.Ed. 916, and Burnet v. Wells, 1933, 289 U.S. 670, 677-678, 53 S.Ct. 761, 77 L.Ed. 1439. In the former the Supreme Court stated:

“But taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed — the actual benefit for which the tax is paid.”

In Burnet v. Wells, the court stated [289 U.S. 677, 53 S.Ct. 763] :

“In these and other cases there has been a progressive endeavor by the Congress and the courts to bring about a correspondence between the legal concept of ownership and the economic realities of enjoyment or fruition. * * *

“ * * * Liability does not have to rest upon the enjoyment by the taxpayer of all the privileges and benefits enjoyed by the most favored owner at a given time or place. * * Government in casting about for proper subjects of taxation is not confined by the traditional classifications of interests or estates. It may tax, not only ownership, but any right or privilege that is a constituent of ownership. * * * Liability may rest upon the enjoyment by the taxpayer of privileges and benefits so substantial and important as to make it reasonable and just to deal with him as if he were the owner, and to tax him on that basis.”

The United States contends that the right of these taxpayers to create and consume statutory items of income renders it reasonable and just to deal with them as owners of such income items. It asserts that the power possessed by the life tenants here is similar to the power to dispose and the right to receive which were held sufficient for attribution of income in Helvering v. Horst, 1940, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75, and North American Oil Consolidated v. Burnet, 1932, 286 U.S. 417, 52 S.Ct. 613, 76 L.Ed. 1197.

Of the cases relied upon by the United States, those appearing to us as most pertinent are cases dealing with tax problems arising in the Clifford area³ and, more specifically, under the Mallinckrodt case.⁴ The rules of these cases formed the basis for Treasury Regulations 118: §§ 22(a)-21, 22 (1945, amended 1947) and for the 1954 amendment of the Revenue Code, Subpart E of Part I of Subchapter J, dealing with estates, trusts, beneficiaries and decedents. By Section 671, the attributes of exclusiveness attach to these code provisions. They deal for the most part with situations in which the grantor, notwithstanding his having parted with ownership, is nevertheless treated as the owner for tax purposes. Section 678 deals with the situation which confronts us here. It provides in pertinent part:

“(a) General rule. — A person other than the grantor shall be treated as the owner of any portion of a trust with respect to which:

“(1) such person has a power exercisable solely by himself to vest the corpus or the income therefrom in himself * *

While Subpart E deals with trust situations, nevertheless we feel that Section 678 should be recognized as applicable to the instant cases. Here it is contended that, notwithstanding lack of ownership, a taxpayer is to be treated as owner by virtue of his beneficial interest in the capital gain. Congress, in Section 678, has spoken positively upon this subject. This Court, in 1949, recognized the Clifford regulations to have a persuasive effect in a non-trust case. Hawaiian Trust Company v. Kanne, 9 Cir., 1949, 172 F.2d 74.

The question then is whether the powers of these taxpayers may be said to constitute a power to vest the corpus in themselves.

We have concluded that, upon the record before us, the powers of these life tenants are not the equivalent of a power to vest in themselves the corpus of the estate or the capital gains in question. A life tenant under these testamentary provisions may not in any manner control the disposition of the corpus save by consuming it for the enumerated purposes. She may not give it away nor make testamentary disposition of it. She has no power of appointment. She may not change the beneficiaries nor reapportion their shares.

Nor has any one of these life tenants the unlimited power to take the corpus of the estate to herself. Her power to consume is expressly limited to her needs, maintenance and comfort. Nor may it be said that the boundaries of such power as so expressed are so vague as to constitute no real limitation upon the power to consume. Smither v. United States, D.C.S.D.Tex.1952, 108 F.Supp. 772, adopted by reference, United States v. Smither, 5 Cir., 1953, 205 F.2d 518.⁵

The power of the life tenant which is granted here is essentially the power to determine for herself her own personal mode of living. Such control as she may have over the disposition of the corpus is necessary to such purpose. Any beneficial interest she may have in the corpus is limited to the extent to which it is required to effectuate such purpose. It is not a situation where failure of the life tenant to take to herself a portion of the corpus may be regarded as a gift of such portion to the remainderman.⁶ There is no right to take which she has forborne to exercise.

Nor has it been contended that a remainder in any of these cases is in truth fictitious and that the expressed limitation upon its consumption is therefore falsely apparent rather than real. There is nothing in the record to indicate in any case that, by exercise of these limited powers, a full consumption of the corpus was reasonably to be expected. Nor is there any suggestion that these limitations have not been respected by these life tenants.

Upon the face of the record then, the bestowal of the powers of use and consumption would appear to be pursuant to legitimate and good faith estate planning: to the normal desire of a husband or father that, to the fullest measure within his control, his wife or daughter may realize the needs and comforts of life. Upon the face of the record, this arrangement does not suggest a device the choice of which has been directed by motives of tax avoidance. The choice between a grant in fee or a life estate with powers of consumption, from all that appears in this record, was based upon the desire of the testator to retain control over the disposition of the remainder while assuring to his wife or daughter the highly personal right to live her life as she might choose.

We conclude that the capital gains in question may not be taxed to these taxpayers as owners.

The alternative contention of the United States (in support of its counterclaims) is that the corpus of the estate, for purposes of income taxation, should in each case be recognized to constitute property held in trust and that the life tenant should be taxable as trustee for capital gains realized by the estate.

The United States relies on 26 U.S.C. § 641(a), which reads:

“Imposition of tax

“(a) Application of tax. — The taxes imposed by this chapter upon individuals shall apply to the taxable income of estates or of any kind of property held in trust, including—

“(1) income accumulated in trust for the benefit of unborn or unascertained persons or persons with contingent interests, and income accumulated or held for future distribution under the terms of the will or trust.” ⁷

In United States v. Cooke, 9 Cir., 1955, 228 F.2d 667, this contention was made by the United States and was rejected by this Court. The Court of Claims recently has reached the opposite result. Weil v. United States, Ct.Cl., 180 F. Supp. 407. The United States now suggests that in this respect Cooke should be re-examined and overruled. Such is the course we have chosen to adopt.

Cooke rejected the contention that property subject to a life estate should be treated as property held in trust upon the ground that the life estate there under scrutiny did not square with the definition of “trust” set forth in Regulation 118, § 39.3797-3:

“The term ‘trust,’ as used in the Internal Revenue Code, refers to an ordinary trust, namely, one created by will or by declaration of the trustees or the grantor, the trustees of which take title to the property for the purpose of protecting or conserving it as customarily required under ordinary rules applied in chancery and probate courts.”

Cooke reasoned that, by this definition, application of 26 U.S.C. § 641(a) had been limited to a particular kind of trust, namely, an ordinary trust; more specifically, one in which the duties of the trustee in protection and conservation of trust assets are those customarily required under ordinary rules of equity. It was held (228 F.2d at page 668):

“Assuming but not deciding that Mrs. Cooke took title to the property in which she is a life tenant she did not do so for the purpose of ‘conserving it as customarily required under ordinary rules applied in chancery and probate courts.’ ”

We address ourselves first to the proposition embraced by Cooke that the definition served to exempt from taxation under 26 U.S.C. § 641(a) all trusts save those in which the trustee’s duties of protection and conservation were those customarily required under ordinary rules of equity.

The United States contends, and we agree, that in Cooke undue emphasis and significance were read into the regulation’s reference to the customary requirements of protection and conservation. In searching for the meaning of the distinction which this regulation makes (between ordinary trusts and other types of trusts), we should be guided by the fact that this is a tax measure. The distinction intended then should be meaningful and purposeful in a tax context.

Certainly an active trust can be effectively created in which extraordinary powers or freedom from responsibility or liability are given to the trustee.⁸ Absent the regulation, we have no doubt that a trust estate so created would have been held a taxable estate. Under the regulation as construed in Cooke, however, such an estate would have been held not an ordinary trust and thus not taxable. The effect of the regulation so construed is thus to exclude from taxation property which theretofore was taxable. Such could hardly have been the intent in the light of the recognized “legislative design to reach all gain constitutionally taxable unless specifically ex-eluded.” General American Investors Co. v. Commissioner, 1955, 348 U.S. 434, 436, 75 S.Ct. 478, 479, 99 L.Ed. 504; see also Commissioner of Internal Revenue v. Glenshaw Glass Co., 1955, 348 U.S. 426, 429-430, 432, 75 S.Ct. 473, 99 L.Ed. 483. Nor can we find tax significance in isolating those trusts in which the duties of the trustee to conserve and protect the estate for others than himself are less strict than is customarily the ease.

The United States asserts that this definition should be construed as an effort to distinguish the so-called business trust from the ordinary type of trust. Reason would seem to support this construction. The regulation in question did not appear until eighteen years after the word “trust” was first used in the code with reference to a separate taxable entity⁹ and at a time when the problem of separating associations from trusts was receiving attention.¹⁰ The proposed construction has tax significance. It does not exclude property from taxation; rather, it aids in the determination of whether a taxable entity should be taxed as a trust or as a corporation.

Under the language of Regulation 118, then, our concern for what is “customary” should not be directed to the nature and extent of the required protection and conservation (in which event, the taxable status of property could be made to depend upon the existence of an infinite number of details, all of which might be said to be “customary”) but rather to the purposes of the arrangement.

Accepting such a construction, our final question is whether in these cases the corpus of the estate can be considered “property held in trust” under Section 641(a).

We may note that Cooke did not concern itself with labels. We did not there hold that, for tax purposes, a life estate as such cannot be regarded as a trust. As heretofore noted, our concern there was with the extent of the duties of that particular life tenant in comparison with those customarily imposed upon a trustee.

Nor have other courts, in construing the phrase “property held in trust,” felt themselves bound to regard Section 641(a) as applying only to “technical trusts.” Instead, they have remained mindful of the legislative design to reach all income constitutionally taxable and of the fact that the word "trust,” in the sense of a separate taxable entity, was originally used in the context of this design. General Investors v. Commissioner, supra; Commissioner of Internal Revenue v. Glenshaw Glass Co., supra; Smietanka v. First Trust & Savings Bank, supra, footnote 9. The inquiry has been whether the relationship created is one which might be said to be “clothed with the characteristics of a trust.”¹¹

In Weil v. United States, supra, it is stated [180 F.Supp. 411]:

“ * * * we believe that the tax-ability of the gains involved here should depend, not on whether there is a separation of the legal and equitable interests in the life estate, but on the relationship between the holder of the life interest and the owners of the succeeding future interests.”

The duties of a life tenant have been characterized by the California courts as “in the nature of a trust,” King v. Hawley, 1952, 113 Cal.App.2d 534, 538, 248 P.2d 491, 494, and, by Bogert, as a. “quasi-trust,” 1 Bogert, Trusts and! Trustees, § 27, pp. 214-219 (1951). See also Restatement, Property, § 204, Comment a (1936) and 1948 Supplement; Annotation, 137 A.L.R. 1054 (1942). The Restatement of the Law of Property, § 202, comment g, notes that the life tenant may be required to post security for the performance of his fiduciary duties by a court of equity. Section 202, comment d, indicates that, were the life interest alone in trust, the relationship between the trustee and the remainder-man would be identical to that obtaining between an ordinary life tenant and the remainderman.

We have in the corpus of each estate an expressly created ascertainable entity. In each life tenant we have a person, notwithstanding her extensive powers of beneficial use, who occupies a fiduciary relationship with the remaindermen respecting that estate, with the duty to maintain for the remaindermen such as is not required for need, maintenance and comfort. Such a relationship, in our view, is clothed with the characteristics of a trust.

We conclude that the capital gain here involved is taxable as income of property held in trust under 26 U.S.C. § 641(a).

In each case: reversed and remanded with instructions that summary judgment be set aside and for further proceedings.

1 . The De Bonchamps case involves tax for the years 1954 ($6,622.17 as owner or $3,S06.07 as fiduciary) and 1955 ($9,612.-56 as owner or $6,690.31 as fiduciary). It has been stipulated that this case is representative of the Cowgill case, and no record on the latter case is before us. The King case involves tax for the year 1955 ($5,666.88 as owner or $3,027.69 as fiduciary).

2 . No issue is raised as to the ownership of income other than capital gains. It is apparently conceded that, under California law, the ownership of all such income under these facts is vested in the life tenant.

3 . Helvering v. Clifford, 1940, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788, dealing with powers held by the grantor of a trust estate.

4 . Mallinckrodt v. Nunan, 8 Cir., 1945, 146 E.2d 1, dealing with powers in one other than the grantor.

5 . California’s attitude with reference to these powers is indicated in King v. Hawley, 1952, 113 Ctd.App.2d 534, 248 P.2d 491, 496, where (quoting with approval from Corpus Juris) it is stated:

“A power to consume or dispose of property for the donee’s ‘benefit’ is broader than one for his support or maintenance, and, in general, includes whatever promotes his personal prosperity and happiness, so that he may consume or sell the property as he chooses, without limitation except that of good faith. Likewise, a power of sale or disposition for the donee’s ‘comfort’ is broader than one for his maintenance, and encroachment on the property is not restricted to the necessaries of life, but may include things which bring ease, contentment, or enjoyment to the donee, and, in general, such a power authorizes the expenditure of the property or its proceeds for any purpose, consistent with the donee’s former manner of living and station in life, and taking into consideration the value of the property, which the donee thinks will give him personal comfort.”

6 . Compare Smith v. United States, 5 Cir., 1959, 265 F.2d 834; Spies v. United States, 8 Cir., 1950, 180 F.2d 336; Mallinckrodt v. Nunan, supra, footnote 4; Jergens v. Commissioner, 5 Cir., 1943, 136 F.2d 497; Irish v. Commissioner, 3 Cir., 1942, 129 F.2d 468; Richardson v. Commissioner, 2 Cir., 1941, 121 F.2d 1.

7 . Subsection (b) of § 641 requires computation and payment of the tax by the fiduciary. § 6012(b) (4) requires the fiduciary of a trust to make a return and § 7701(6) defines fiduciary as meaning “a guardian, trustee, executor, ad- ■ ministrator, receiver, conservator, or any person acting in any fiduciary capacity for any person.”

8 . See, Restatement (Second), Trusts, § 187, comment j; § 222 ‘(1957); 1 Scott, Trusts, § 99.3 at 744 (2d Ed., 1956).

9 . See, Smietanka v. First Trust & Savings Bank, 1922, 257 U.S. 602, 607, 42 S.Ct. 223, 66 L.Ed. 391.

10 . Morrissey v. Commissioner, 1935, 296 U.S. 344, 56 S.Ct. 289, 80 L.Ed. 263.

11 . Hart v. Commissioner, 1 Cir., 1932, 54 F.2d 848, 851; Ferguson v. Forstmann, 3 Cir., 1928, 25 F.2d 47, 49; see Commissioner of Internal Revenue v. Owens, 10 Cir., 1935, 78 F.2d 768; Goforth v. Commissioner, 1935, 32 B.T.A. 1206, 1215-1217. But see Lee MeRitchie, 1956, 27 T.C. 65. We regard as distinguishable Shea v. Commissioner, 1934, 31 B.T.A. 513, and G.C.M., 14693, 14-1 Cum.Bull. 197 (1935) holding life estates not to be taxable as trusts. These appear to be situations in which vested remaindermen had present rights to the gain in question and thus were to be regarded as present owners and individually taxable as such. See Restatement Property, § 126(e) (1936); 1 Orgel, Valuation under the Law of Eminent Domain, § 118 (2d Ed., 1953).