Bankers Trust Co. v. United States , 156 F. Supp. 930 ( 1957 )

Maris, Circuit Judge,

sitting by designation, delivered the opinion of the court:

This is a suit to recover income taxes which the plaintiffs allege were erroneously paid for the taxable year 1948 in the amount of $1,718,504.43. The Bankers Trust Company, trustee of the Sumner Moore Kirby Trust, one of the plaintiffs, filed a Federal fiduciary income tax return for the trust for that year on the cash receipts and disbursements basis reporting a tax liability of $1,718,504.43 which it paid to the collector. Included in taxable income reported on the return was the sum of $3,428,419.77 as 50 percent of net gain from long term capital gain resulting from the exchange of capital assets, stock of Fremkir Corporation for stock of F. W. Woolworth Company. The gain resulted from the use of a cost basis of $635,066.73. If, as the plaintiffs now contend should be done, a cost basis of $8,228,403.76 were used, no income tax liability would have arisen for the year 1948.

The trustee timely filed a claim for refund of the entire amount of taxes paid by the Sumner Moore Kirby Trust for the year 1948. Gloria Kirby Conahay and the guardian of Helene Louise Kirby timely filed claims for refund for the purpose of protecting their respective interests in the alleged overpayment of 1948 taxes. All three refund claims were grounded upon the same issues presented in this suit. Before the statutory notices of disallowance of these three claims for refund were issued as provided in section 3772 (a) (2) of the Internal Revenue Code of 1939 plaintiffs commenced this suit. Consequently, the disallowance notices were not issued.

The circumstances out of which the issues presented in this case arise are that on September 15, 1931, Sumner Moore Kirby created a trust, with the Bankers Trust Company named as trustee. The corpus of the trust consisted of 30,000 shares of stock of the Fremkir Corporation which had been given to Sumner Moore Kirby by his father in 1923, when the corporation was organized. Prior to the death of Sumner Moore Kirby the basis for determining gain or loss of the stock in the hands of the trustee was $635,066.73, the sum which was used in determining the net long term capital gain reported in the fiduciary income tax return.

The trust instrument provided in Article First that the donor was to receive the first $80,000 of income for life, the next $12,000 was payable to Doris Kirby, his wife, for life, and the balance of income was payable to his daughter Gloria Kirby (now Gloria Kirby Conahay), for life. The trust instrument further provided by Article Eighth, as follows:

Eighth: Notwithstanding anything to the contrary herein contained, the Donor may, from time to time, during the continuance of the trust, by instrument in writing executed and acknowledged in the manner required for a deed of real property so as to enable it to be recorded in the State of New York and delivered to the Trustee, with the written consent of the Donor’s father, Fred M. KIRBY, his executors, administrators or legal representatives, modify or alter in any manner, or revoke in whole or in part, this Indenture and the trusts then existing, and the estates and interests in property hereby created, and in the case of such revocation said instrument shall direct the disposition to be made of the trust fund, or of the portion thereof affected by such revocation, and the Trustee shall make, execute and deliver such instruments, if any, and make such conveyances and transfers of property as may be necessary or proper in order to carry the same into effect, and no one shall have any right, interest or estate under this Indenture except subject to such proper modification, alteration or revocation thereof.

By an amendment made in the trust instrument under date of April 28, 1932, it was provided that in case of the death of Sumner Moore Kirby, two-thirds of the corpus should be divided between Gloria Kirby Conahay and his widow and any other issue surviving him. Subsequently on December 14,1934, Article Eighth of the trust instrument was amended by adding at the end of the article the following:

Provided, However, that this power of modification, alteration or revocation shall not be exercised so as to operate in any manner to increase the interest of the Donor or his estate in the income from the trust funds or to revest in the Donor or his estate title to any part of the principal of the trust funds or accumulated income thereon.

On April 7, 1945, Sumner Moore Kirby died at which time he was survived by his former wife, Doris Kirby Barbour, and his two daughters, Gloria Kirby Conahay and Helene Louise Kirby. Thereafter, one-third of the corpus of the trust was distributed to Gloria Conahay together with the accumulation of income and one-third to Helene Kirby. The remaining one-third of the corpus was held by the trustee for the continuing trust for the benefit of Mrs. Barbour and Gloria Conahay.

During his lifetime the entire income of the trust was taxable to Sumner Moore Kirby and the Federal income tax due and payable thereon was paid to the United States accordingly.

The trust property was not reported as part of the gross estate on the Federal estate tax return filed by the executor. Upon examination of the Federal estate tax return, the Commissioner of Internal Kevenue determined that the trust should be included in the gross taxable estate. Subsequently a compromise was effected, whereby the estate tax liability arising from the inclusion of the trust in the taxable estate was fixed at $3,088,180.47. This compromise was made on the basis of a 25 percent reduction from the ascertained value of the 30,000 Fremkir Corporation shares which comprised the principal of the trust. Thus the ascertained value of the Fremkir shares, $8,288,403.76, was reduced to $6,171,302.84 and estimated trust administration expenses of $185,063.34 were subtracted, leaving a final valuation of $5,986,239.50. Based upon these figures a closing agreement was signed by the trustee, the executor and the various beneficiaries under the trust on January 7, 1949, and was signed by the Acting Commissioner of Internal Revenue on February 14, 1949, and approved by the Acting Secretary of the Treasury on March 21, 1949.

The decedent’s estate was insolvent and the burden of paying the Federal estate tax accordingly fell upon the Sumner Moore Kirby Trust under the provisions of section 827 (a) and (b) of the 1939 Internal Revenue Code. To enable the trust to pay the tax, it was necessary for it to liquidate a large part of its holdings. Inasmuch as the 30,000 shares of Fremkir stock owned by the trust constituted the only holding in the trust principal account and it had no ready market value, being a family corporation, it was decided that the only way of getting marketable assets was through the Fremkir Corporation. Accordingly, negotiations were instituted with the officers of the Fremkir Corporation. This resulted in the exchange with such corporation on September 10,1948, of the 30,000 shares of Fremkir Corporation owned by the trust for 173,500 shares of F. W. Woolworth Company stock. It is upon this exchange that the trustee reported a gain and paid the tax for the recovery of which the present suit was brought.

Having provided itself with necessary funds by effectuating the exchange of the Fremkir Corporation stock for stock which was marketable, the trustee made payment of $3,100,000 to the collector of Internal Revenue on November 1, 1948. This payment was on account of the estate tax liability asserted against it under section 827 (a) and (b) of the Internal Revenue Code.

The fair market value of the Fremkir Corporation stock held by the trust on April 7,1945, the day of Sumner Moore Kirby’s death, was $8,228,403.76. The fair market value of the F. W. Woolworth Company stock received by the trust in exchange for the Fremkir Corporation stock on September 10, 1948, was $7,493,031.25. This valuation figure was used in determining the net long term capital gain reported as taxable from the exchange in the fiduciary income tax return of the trust for the year 1948.

The principal question which this case presents, and the only one we need consider, is whether the basis for computing gain or loss on the exchange of the Fremkir stock in the hands of the trustee after the death of Sumner Moore Kirby was the fair market value of that stock at the date of Kirby’s death, or whether that basis continued to be the same as it had been in the hands of the trustee prior to Kirby’s death. The plaintiffs assert that the fair market value of the stock at the time of Kirby’s death must be taken as its basis for determining the gain or loss upon its subsequent exchange and they rely upon section 113 (a) (5) of the Internal Revenue Code of 1939, as amended, which provides as follows:

Seo. 113. Adjusted basis for determining gain or loss—

(a) Basis (unadjusted) of property. The basis of property shall be the cost of such property; except that—

sfi tfi # * *

(5) Property transmitted at death. If the property was acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent, the basis shall be the fair market value of such property at the time of such acquisition. In the case of property transferred in trust to pay the income for life to or upon the order or direction of the grantor, with the right reserved to the grantor at all times prior to his death to revoke the trust, the basis of such property in the hands of the persons entitled under the terms of the trust instrument to the property after the grantor’s death shall, after such death, be the same as if the trust instrument had been a will executed on the day of the grantor’s death. * * *

We think that the plaintiffs’ contention is correct and must be sustained. It will be seen that the effect of section 113 (a) (5) is to provide that in the case of property transferred in trust to pay the income for life to or upon the order or direction of the grantor the basis of the property in the hands of the persons entitled to it under the terms of the trust instrument after the grantor’s death shall be its fair market value at the time of his death, provided the grantor has reserved the right to revoke the trust.

Under the terms of the trust instrument involved in the case before us, the grantor, Sumner Moore Kirby, received a iarge portion of the income for life and had at all times during his life the power by amendment of the trust instrument to order and direct the disposition of the remainder of the income. Furthermore, Kirby as grantor reserved at all times prior to his death the right to revoke the trust and in the instrument of revocation to direct the disposition to be made of the trust funds or of the portion thereof affected by the revocation.

It is true that by the amendment to the trust instrument executed on December 14, 1934, Kirby added to Article Eighth, which gave him the power of revocation, a proviso to the effect that the power of revocation should not be exercised so as to increase his interest or that of his estate in the income from the trust funds or to revest in him or his estate title to any part of the principal thereof. But it is perfectly clear that under Article Eighth of the trust instrument as thus limited by the amendment Kirby retained at all times full power to revoke the trust as such in toto and by the instrument of revocation to direct the payment of the trust funds to anyone other than himself or his estate. This was sufficient to satisfy the statutory test. Porter v. Commissioner, 1933, 288 U. S. 436, 443.

The distinction to be made is between the power to revoke a trust created by a deed of grant and convert it into an outright gift, on the one hand, and the power wholly to revoke the original grant and revest the corpus in the grantor, on the other. It is the latter right which the proviso that Kirby added to Article Eighth of the trust instrument barred him from exercising, while it is only the former much more limited right which section 113 (a) (5) stipulates must be reserved by the grantor in order that the trust assets may take the stepped-up basis at his death for which that subsection provides. In the case before us, at any time prior to Kirby’s death he could have revoked the trust and directed the trustee to pay over the property comprising the trust fund as an outright gift to his daughters or to anyone else except himself. If be had done this the trust would have been completely revoked and wiped out of existence, and the proviso added by the amendment of December 14,1934, would have been in no way violated.

In reaching the conclusion that section 113 (a) (5) is applicable for determining the basis of the Fremkir Corporation stock upon its exchange by the trustee, we have not overlooked the fact that the exercise of Kirby’s power to revoke the trust was subject to the written consent of his father or the legal representative of the latter. However, since the father had no adverse interest in the disposition of any part of the principal or income of the trust the law will presume that he and his personal representative would be amenable to the wishes of his son, the grantor, as to any changes which the latter might desire to make in the disposition of the fund and that Kirby accordingly had in fact the effective power of revocation. Loeb v. Commissioner, 2 Cir. 1940, 113 F. 2d 664, 667; cert. denied 311 U. S. 710. Enquiring a disinterested person to join in the exercise of a power of alteration or revocation does not in fact deprive the grantor of practical control, as has long been recognized by Congress. See e. g., Internal Kevenue Code of 1939, sections 166 and 167. Indeed in the case of this very trust the annual income was taxed to the grantor, in part at least, upon this theory. We think that the recognition of this fact of life, which Congress made explicit in sections 166 and 167 of the Internal Eevenue Code of 1939, and which the Commissioner thus applied in taxing to the grantor the ordinary income of the trust, must be regarded as implicit in the analogous provisions of section 113 (a) (6) of the Code and must be followed in applying that subsection to the facts of this case.

Since the fair market value of the Fremkir stock on the date of Kirby’s death was much in excess of the value of the F. W. Woolworth stock subsequently received by the trustee in exchange for it, no taxable gain was realized by the trust upon that exchange in 1948 and there was accordingly no income tax liability by the trust for that year.

The plaintiffs are entitled to recover, and judgment will be entered in the amount of $1,718,504.43, with interest on $429,626.11 thereof from March 15, 1949, on $429,626.11 thereof from June 14, 1949, on $429,626.11 thereof from September 15, 1949, and on $429,626.10 thereof from December 16,1949, as provided by law.

It is so ordered.

Madden, Judge; Whitaker, Judge; Littleton, Judge; and Jones, Chief Judge, concur.

FINDINGS OE EAOT

The court, having considered the facts as stipulated by the parties, and the briefs and argument of counsel, makes findings of fact as follows:

1. On March 15, 1949, the Bankers Trust Company, trustee, filed a Federal fiduciary income tax return for the Sumner Moore Kirby Trust for the calendar year 1948, reporting thereon a tax liability of $1,718,504.43 which was paid to the collector of Internal Revenue for the Second District of New York, as follows:

March 15, 1949_ $429, 626.11

June 14,1949_ 429, 626.11

September 15, 1949_ 429,626.11

December 16, 1949_ 429,626.10

Total_$1,718,504.43

After an examination of the records of the trust, the Commissioner of Internal Revenue accepted, without correction, the aforesaid return as filed.

2. On March 11, 1952, the Bankers Trust Company, trustee for the Sumner Moore Kirby Trust, filed a claim for refund for the year 1948 in the amount of $1,718,504.43.

3. On March 14,1952, Gloria Kirby Conahay filed a claim for refund for the year 1948 in the amount of $571,403.29 of the income taxes paid by the Sumner Moore Kirby Trust for the year 1948.

4. On March 11, 1952, Charles C. Austin, as general guardian of the estate of Helene Louise Kirby, filed a claim for refund for the year 1948 in the amount of $576,403.29 of the income taxes paid by the Sumner Moore Kirby Trust for the year 1948.

5. Statutory notice of the disallowance of the three aforesaid claims for refund in accordance with provisions of section 3772 (a) (2) of the Internal Bevenue Code of 1939 have not been issued by the Commissioner of Internal Bevenue but more than six months had elapsed from the various filing dates of the refund claims when plaintiffs instituted this suit.

6. Under date of September 15, 1931, Sumner Moore Kirby created a trust with the Bankers Trust Company as trustee. Thereafter under dates of April 28, 1932, and December 14, 1934, certain amendments were made in the trust instrument by Sumner Moore Kirby.

Article Eighth of the trust instrument provided as follows:

Eighth: Notwithstanding anything to the contrary herein contained, the Donor may, from time to time, during the continuance of the trust, by instrument in writing executed and acknowledged in the manner required for a deed of real property so as to enable it to be recorded in the State of New York and delivered to the Trustee, with the written consent of the Donor’s father, Fred M. KIBBY, his executors, administrators or legal representatives, modify or alter in any manner, or revoke m whole or in part, this Indenture and the trusts then existing, and the estates and interests in property hereby created, and in case of such revocation said instrument shall direct the disposition to be made of the trust fund, or of the portion thereof affected by such revocation, and the Trustee shall make, execute and deliver such instruments, if any, and make such conveyances and transfers of property as may be necessary or proper in order to carry the same into effect, and no one shall have any right, interest or estate under this Indenture except subject to such proper modification, alteration or revocation thereof.

The amendment of December 14,1934, inter alia, added to Article Eighth the following provision:

Provided, However, that this power of modification, alteration or revocation shall not be exercised so as to operate in any manner to increase the interest of the Donor or his estate in the income from the trust funds or to revest in the Donor or his estate title to any part of the principal of the trust funds or accumulated income thereon.

7. When Sumner Moore Kirby died on April 7, 1945, he was survived by his divorced wife, Doris Kirby (now Doris Barbour). He was also survived by bis daughter, Gloria Kirby (now Gloria Kirby Conahay), and Helene Louise Kirby, a second daughter and step-sister of Gloria Kirby Conahay.

8. Gloria Kirby Conahay has received distribution of one-third of the principal of the Sumner Moore Kirby Trust as provided in said trust instrument. She has also received distribution of all income which was accumulated for her benefit prior to her attaining 21 years of age.

9. Distribution of one-third of the principal of the Sumner Moore Kirby Trust has been made to Helene Louise Kirby by payment of such sums to the general guardian of her estate, Charles C. Austin, one of the plaintiffs herein.

10. The remaining one-third of the principal of the Sumner Moore Kirby Trust is now being held by Bankers Trust Company as trustee of the continuing trust for the benefit of Doris Barbour and Gloria Kirby Conahay.

11. The corpus of the Sumner Moore Kirby Trust consisted of 30,000 shares of stock of the Fremkir Corporation. There was included in the gross estate of the grantor, decedent Sumner Moore Kirby, on account of said stock, $5,986,239.50, in determining the Federal estate tax paid on November 1, 1948, by the Bankers Trust Company, trustee and transferee, of $3,088,780.47. Subsequently, evidence was furnished showing the payment of inheritance and estate taxes by the estate to the states of Pennsylvania and New York, on December 6,1949, in the total amount of $509,148.74. Pursuant to an agreement as to final determination of the estate tax liability, which was approved by the Acting Secretary of the Treasury on March 21,1949, $509,148.74 of the estate tax paid on November 1, 1948, was refunded to the estate of Sumner Moore Kirby.

12. Under the provisions of the Sumner Moore Kirby Trust Indenture the entire income of the trust was taxable to Sumner Moore Kirby during his lifetime and the Federal income tax due and payable thereon was assessed and paid to the United States accordingly.

13. Prior to his death, the decedent Sumner Moore Kirby had executed two wills, one a holographic French will dated June 13, 1941, dealing with his real and personal property physically located in Europe at the time of his death, and another American will dated June 30,1941, dealing with all his property other than that located in Europe.

14. The aforesaid American will of Sumner Moore Kirby, dated June 30, 1941, was duly admitted to probate by the Surrogate’s Court of the County of New York on April 1, 1946, and on April 2, 1946, Letters Testamentary on said American will of Sumner Moore Kirby were duly granted by said court to John Dube, one of the executors named therein, the other executor named therein not having qualified.

15. By letter dated November 26, 1948, there was forwarded to John Dube, executor of the estate of Sumner Moore Kirby, a copy of the report of the revenue agent, dated November 23, 1948, which disclosed the assets and deductions of the estate and the tax liability determined thereon.

16. Pursuant to petition for instructions filed by the executor of the decedent’s estate on January 10,1950, the Surrogate’s Court of New York County ordered and decreed that all estate taxes should be charged to the residuary estate of the decedent.

17. The assets of the decedent’s estate, exclusive of the trust, amounted to less than the claims of the creditors of the said estate. A compromise agreement was entered into among various creditors and legatees of the estate of Sumner Moore Kirby, deceased, in settlement of their claims. A decree, based upon this compromise agreement, was entered in the Surrogate’s Court of New York County on June 1, 1955.

18. Fremkir Corporation was a personal holding company, its shares being wholly owned by the Kirby family, of which Mr. Allan P. Kirby was the principal stockholder and controlling head in 1948.

19. Prior to the death of Sumner Moore Kirby, the basis for determining gain on the 30,000 shares of Fremkir Corporation’s stock in the hands of the trustee of the Sumner Moore Kirby Trust was $635,066.73. The decedent acquired the stock by gift from his father in 1923 when the corporation was organized.

20. The fair market value of the Fremkir Corporation stock held by the trust on April 7,1945, the day of Sumner Moore Kirby’s death, was $8,228,403.76.

The fair market value of the 173,500 shares of common stock of F. W. Woolworth Company received by the Sumner Moore Kirby Trust from the Fremkir Corporation in the cancellation and redemption of the 30,000 shares of the latter corporation’s own stock on September 10, 1948, was $7,493,031.25. This latter figure was determined by taking the mean of the high and low quoted market price of the F. W. Woolworth Company stock on September 10, 1948, and reducing it on account of blockage to a net price of $43.1875 per share.

21. The estate tax liability of Sumner Moore Kirby, deceased, was made the subject of a closing agreement and for estate tax purposes the 30,000 shares of Fremkir Corporation stock was included in the gross estate of the decedent.

22. Before the Sumner Moore Kirby Trust surrendered the 30,000 shares of the Fremkir Corporation stock in exchange for the 173,500 shares of F. W. Woolworth Company stock, owned by the former corporation, on September 10,1948, the Commissioner of Internal Kevenue issued rulings stating that such exchange would not result in recognizable gain or loss to the Fremkir Corporation nor gift tax liability to the corporation, its stockholders or beneficiaries of the stockholders.

23. The Fremkir Corporation being a family personal holding corporation, its stock was not listed on any stock exchange and was not outstanding in the hands of the public. The trustee persuaded the said Allan P. Kirby (the decedent’s brother) to cause the Fremkir Corporation to accept in exchange 30,000 shares of Fremkir stock for 173,500 shares of F. W. Woolworth stock as stated in the preceding paragraph.

CONCLUSION OE LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that the plaintiffs are entitled to recover, and it is therefore adjudged and ordered that they recover of and from the United States the sum of one million, seven hundred eighteen thousand, five hundred four dollars and forty-three cents ($1,718,504.43), with interest on $429,626.11 thereof from March 15, 1949, on $429,626.11 thereof from June 14, 1949, on $429,626.11 thereof from September 15, 1949, and on $429,626.10 thereof from December 16, 1949, as provided by law.