Vose v. Commissioner , 14 T.C. 113 ( 1950 )

Estate of Julien W. Vose, Anna E. Vose, Leroy W. Vose and Donald W. Vose, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent

Vose v. Commissioner

Docket No. 10478

United States Tax Court

14 T.C. 113; 1950 U.S. Tax Ct. LEXIS 290;

January 30, 1950, Promulgated

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Decision will be entered under Rule 50.

Decedent in 1935 created an irrevocable trust, naming himself and two others as trustees. The trust instrument provided that income was payable to him for life, and gave him power, by deed or will, to appoint persons to receive income and principal after his death. It also provided for the execution and delivery by the trustees to the decedent at his request of so-called "certificates of indebtedness" payable to such persons as he should nominate. Certificates stated that trust was "indebted" to holder in specified sum to be paid out of corpus upon its termination with "interest" at rate of 6 per cent per annum, payable quarterly. Trust was to terminate upon the death of the survivor of decedent's children and grandchildren then living. Held, the value of the corpus of the trust at the date of death of decedent was includible in his gross estate under the provisions of section 811 (c), I. R. C., undiminished by the face value of so-called "certificates of indebtedness" issued prior to decedent's death.

J. N. Welch, Esq., Anthony Brayton, Esq., Edward J. Keelan, Jr., Esq., and Samuel S. Dennis, 3d, Esq., for the petitioners.

Paul P. Lipton, Esq., for the respondent.

Harron, Judge.

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HARRON

Respondent determined a deficiency in estate tax in the amount of $ 43,164.66. The deficiency is the result of two adjustments made by respondent in the value of decedent's gross estate as reported in the estate tax return, one of which is not contested. The sole question is, Did the respondent err in his determination that the value of the trust corpus at the date of decedent's death may not be reduced by the face amount of "certificates of indebtedness" issued, in arriving at the value of the trust corpus to be included in decedent's gross estate?

The record in this proceeding consists of testimony, stipulations of certain facts, and exhibits.

FINDINGS OF FACT.

The agreed facts which have been stipulated are found as facts.

Petitioners are the duly appointed and acting executors of the last will and testament of Julien W. Vose, who was a resident of Edgartown, Massachusetts, when he died on August 3, 1943, at the age of 82. They filed an estate tax return with the collector of internal revenue for the district of Massachusetts.

For many years prior to 1935 the decedent had made substantial gifts to his wife, his children, and his grandchildren. In that year he consulted with his attorney with the objective of entering into some arrangement which would permit him to avoid income tax on amounts donated to members of his family in 1935 and subsequent years. At the suggestion of his attorney he created a trust on December 24, 1935, to which he transferred a parcel of real estate consisting of land and a factory in Boston, Massachusetts, which at that time was rented for $ 25,000 per annum and was his principal income-producing asset. The decedent, Leroy W. Vose, and Frank S. Lovewell were named as cotrustees in the trust instrument, which provided, among other things, that the trust was to be known as the Vose Family Trust; that it was to be for the sole use and benefit of decedent during his lifetime and from and after his death for the use of such persons as he by deed or will appointed; that the trustees pay the net income to the decedent during his lifetime and after his death to such persons as he appointed by deed or will; and that the trust was to terminate upon the death of the last born child of decedent or the survivor of his grandchildren living at the date of the creation of the trust, whichever event occurred later. The trust instrument further provided as follows:

XIV. In addition to all other obligations hereunder, the Trustees shall from time to time upon the request of Julien W. Vose, execute and deliver to him certificates of indebtedness in the form hereto annexed and marked "A" in such amounts as he shall from time to time request and payable to such persons as he shall nominate, but not, in any event, in an aggregate sum of more than Three Hundred Thousand ($ 300,000.00) Dollars and not during the calendar year 1935 in an amount in excess of One Hundred Thousand ($ 100,000.00) Dollars nor in any calendar year thereafter in an amount in excess of Fifty Thousand ($ 50,000.00) Dollars.

The form annexed to the trust agreement reads as follows:

No.

This Is To Certify that The Vose Family Trust is indebted to

In the sum of Dollars

1.00 [sic]

To be paid out of the corpus of the trust upon its termination with interest at the rate of six per cent per annum payable quarter annually. All obligations hereunder are payable only out of the corpus of the trust. This certificate is personal to the Payee named herein and may not be transferred or assigned without the consent in writing of the Trustees of the Vose Family Trust endorsed hereon.

[Ruled for signatures.]

The limitation of $ 300,000 on the amount of "certificates of indebtedness" that could be issued was on the assumption that, based on an estimated income of $ 30,000 from the trust, the "interest" charges would amount to $ 18,000 on $ 300,000 of certificates at 6 per cent, leaving the decedent $ 12,000 for his own use.

On December 25, 1935, one day after the Vose Family Trust was created, Julien Vose requested the trustees to issue, and the trustees issued, 10 of the so-called "certificates of indebtedness," in the form above set forth, to 10 persons named by Julien Vose, all of whom were members of his family -- his wife, his children, and his grandchildren. The face amount of the certificates aggregated $ 100,000. Julien Vose delivered a certificate to each of the 10 persons named therein.

On March 16, 1936, the decedent filed a gift tax return for the year 1935 in which he reported gifts of the 10 certificates. Although the face amount of the certificates was $ 100,000, the total value which was reported for gift tax was $ 60,000. The following explanation of the gifts was set forth in the gift tax return:

All of these gifts were certificates of indebtedness of the Vose Family Trust. I have been contributing to the support of each of the persons named above for some years and I am taking this method of fixing the amount of my contribution in the future.

Also, on March 16, 1936, each donee filed a donee's information return of gift, reporting receipt of gifts of the certificates.

In 1936 Julien Vose caused the trustees to issue five more certificates in the total face amount to five of the persons to whom certificates had been given in 1935. The face amount of the five additional certificates aggregated $ 25,000.

In 1937 Julien Vose caused the trustees to issue five more certificates to five persons, four of whom had received certificates in 1935, and one of whom received, for the first time, a certificate in 1937. The latter was a great granddaughter. The aggregate face amount of these certificates was $ 25,000.

In 1938 the decedent caused the trustees to issue two more certificates, of an aggregate face amount of $ 10,000, to two of the persons who had received certificates in 1935.

In 1939 no certificates were issued.

In 1940 the decedent gave one new certificate in the face amount of $ 5,000 to his son, Leroy Vose, who had received certificates in the earlier years.

In 1941 the decedent gave five new certificates, in the aggregate face amount of $ 25,000, to five persons, four of whom had received certificates in earlier years, and one of whom, a granddaughter-in-law, received a certificate for the first time in 1941.

In 1942 the decedent gave two new certificates, aggregating $ 10,000 face amount, to two persons who had received certificates in earlier years.

The decedent did not file any gift tax returns for the years 1936, 1937, 1938, 1940, 1941, and 1942; and the donees did not file any donee's information returns.

From the date of the creation of the trust in 1935 up until the time of death, the decedent caused the trustees of the trust to issue 30 certificates, having an aggregate face amount of $ 200,000, to 12 members of his family, and the decedent gave the certificates to the persons named therein. None of the persons named in all of the "certificates of indebtedness" ever advanced any money, or property, or loan to the trust. The trust was not indebted to any of the persons who received "certificates of indebtedness." The annual payments to be made to certificate holders out of the annual trust income by the trustees did not represent "interest." The so-called "certificates of indebtedness" were not evidence of any debt of the trust to the holders thereof, but they were merely a device by which the decedent, the grantor of the trust, during his lifetime could name the beneficiaries of the corpus and income of the trust, and add to the number of beneficiaries, or increase the interest of any person already, thereby, designated as a beneficiary.

At the end of 1942, after the decedent had caused 30 certificates of the face amount of $ 200,000 to be issued, the decedent could have caused additional certificates to be issued in the aggregate amount of an additional $ 100,000 face amount to any person he desired to designate.

The following schedule shows the 12 persons to whom certificates were issued and delivered during the years 1935 to 1942, inclusive, the relationship of the donee to the decedent, and the total face amount of certificates issued to each of the 12 persons:

CERTIFICATES OF THE VOSE FAMILY TRUST
		Face amount	Number of
Year of	Donee	of certificates	certificates
gift
1935	Anna Vose, wife	$ 30,000	1
1936		5,000	1
1937		5,000	1
1938		5,000	1
1941		5,000	1
1942		5,000	1
	Total	55,000	6
1935	Elsie B. Lovewell, daughter	15,000	1
1938		5,000	1
1941		5,000	1
	Total	25,000	3
1935	Leroy W. Vose, son	5,000	1
1936		5,000	1
1937		5,000	1
1940		5,000	1
	Total	20,000	4
1935	Edna B. Weston, daughter	5,000	1
1936		5,000	1
1937		5,000	1
	Total	15,000	3
1935	Donald Vose, grandson	15,000	1
1935	John S. Lovewell, grandson	10,000	1
1936		5,000	1
	Total	15,000	2
1935	Julien Weston, grandson	5,000	1
1935	Virginia Weston Beese, granddaughter	5,000	1
1935	Marjorie B. White, granddaughter	5,000	1
1935	Donna W. Vose, great granddaughter	5,000	1
1936		5,000	1
1937		5,000	1
1941		5,000	1
	Total	20,000	4
1937	Dennise Vose, great granddaughter	5,000	1
1941		5,000	1
1942		5,000	1
	Total	15,000	3
1942	Drucilla B. Vose, granddaughter-in-law	5,000	1
	Grand total, 12 donees	200,000	30

After the creation of the Vose Family Trust the trustees executed a certificate designating decedent as treasurer of the trust and authorizing him to deposit funds of the trust in a checking account in a national bank or trust company, subject to withdrawal by his check. On January 7, 1936, the decedent opened an account in the First National Bank of Boston in his name by the deposit of a check for the monthly rental due from the tenant of the real estate conveyed to the trust. After January 7, 1936, decedent deposited in the bank account rental checks sufficient to provide funds for the payment of all "interest" obligations created by the execution of the "certificates of indebtedness" of the trust. Commencing April 1, 1936, and quarterly thereafter until his death, checks drawn on the bank account were issued by decedent to the persons named as payees in the so-called "certificates of indebtedness" in amounts equivalent to 6 per cent annually on the face amount of the certificates previously delivered to the named payees. The checks so issued were cashed by the respective payees. That portion of the rentals not distributed to the payees was used by decedent for his own personal purposes.

For the period prior to the death of Julien W. Vose, all records of rents received or disbursements made were kept by him. These records consisted of the bank statements and check stubs for the account of the First National Bank and a few isolated memoranda. Prior to his death the decedent managed the real estate which was the corpus of the trust.

Fiduciary income tax returns filed for the Vose Family Trust show that the following distributions were made by it to the decedent and to the holders of the so-called "certificates of indebtedness":

		Certificate
Year	Decedent	holders
1936	$ 18,051.16	$ 7,500
1937	19,551.16	9,000
1938	19,251.16	9,300
1939	18,951.16	9,600
1940	18,841.56	9,900
1941	15,547.10	12,900
1942	9,221.81	13,500
1943	5,338.78	13,500

In the fiduciary returns the trustees reported the distributions to the certificate holders as "interest" paid.

Decedent executed his last will and testament on May 7, 1937. He bequeathed the residue of his property, including the property in respect of which he had a power of appointment, to Anna E. Vose, his wife; Leroy W. Vose, his son; and Donald W. Vose, his grandson, in trust to pay the income to his wife for life with discretion to accumulate income after her death or to distribute it in equal shares to Edna W. Weston and her issue; Leroy W. Vose and his issue; Elsie W. Lovewell, a daughter, and her issue; and Donald W. Vose, his grandson, and his issue.

The will provided that when the survivor of the decedent's children and grandchildren living at his death should die or the youngest of his grandchildren should reach the age of 21, whichever should be later, the principal of the trust fund should be divided among his grandchildren and their issue per stirpes, the issue of Donald W. Vose to be considered grandchildren. The will stated that decedent made no direct testamentary provision for his grandchildren except Donald W. Vose, because he had already provided for them by transfer to them of "certificates of indebtedness" of the Vose Family Trust.

Decedent was in good health when he established the Vose Family Trust and thereafter until in 1943, when he fell and suffered a broken neck, which led to his death. The transfer made by him to the trust in December, 1935, was not made in contemplation of death.

The fair market value of the real estate comprising the corpus of the Vose Family Trust was $ 250,000 on the date of decedent's death and there was an outstanding mortgage thereon of $ 30,000. In the estate tax return decedent's executors reported gross estate of $ 45,406.52. Included in the gross estate at a value of $ 25,000

In determining the deficiency the respondent eliminated the above described item of $ 25,000 and determined that the net value of the corpus of the trust to be included in the gross estate was $ 220,000, i. e., $ 250,000, the value of the real estate and building, less the outstanding mortgage of $ 30,000. In the statement attached to the notice of deficiency in estate tax the respondent gave the following explanation of his determination:

The net value of the trust is undiminished by certificates of indebtedness issued by the trustee between 12-25-1935 and 1-1-1942 at decedent's direction, outstanding in the aggregate amount of $ 200,000.00 at decedent's death, because such certificates were given without any consideration and are unenforceable. These certificates of indebtedness did not constitute a completed gift by the decedent to the donees, who are members of decedent's immediate family, when given to them. In the alternative, if these certificates of indebtedness were completed gifts at the time that they were delivered to the members of decedent's family, then they were transfers made by decedent in contemplation of death, and intended to take effect in possession or enjoyment at or after decedent's death, and includible in decedent's gross estate under Section 811 (c) of the Internal Revenue Code.

OPINION.

The petitioners concede that the net value of the corpus of the Vose Family Trust at the time of decedent's death is includible in his gross estate under the provisions of section 811 (c), Internal Revenue Code,

The Vose Family Trust had its inception in the desire of decedent to avoid income tax on amounts he distributed annually among members of his family. The attorney who prepared the trust instrument testified that it was one of several plans prepared by him for setting up decedent's property in such a manner as to reduce his income tax and allocate certain portions of it to the persons who were the recipients of his bounty. The attorney was a lecturer on trusts at the Northern University Law School and had had over 25 years' experience with trusts and the liability of trusts.

We think it is obvious that the draftsman of the trust in question could have accomplished the objective sought by the decedent by having him make an irrevocable transfer of the income-producing property to a trust created by him, and providing in the trust instrument that certain portions of the income from the trust corpus should be paid to members of decedent's family and the remainder to the decedent. We are convinced from an examination of the trust instrument that he did not adopt this simple procedure because he thought he could best serve his client by devising some plan which in his opinion would result not only in tax savings to decedent during his lifetime, but also to his estate after his death. While recognizing that taxpayers have the legal right to decrease the amount of what otherwise would be their taxes by means which the law permits, this and other courts have ofttimes stated that transactions entered into for the purpose of avoiding taxes must be scrutinized with particular care.

The avoidance-of-tax feature of the trust instrument executed by the decedent in December, 1935, is contained in the last paragraph, wherein it is provided that, in addition to all other obligations, the trustees shall from time to time upon the request of the decedent, execute and deliver to him "certificates of indebtedness" in the form thereto annexed in such amounts as he shall from time to time request and payable to such persons as he shall nominate, but not, in any event, in an aggregate sum of more than $ 300,000. Each certificate stated that the Vose Family Trust "is indebted to" the person designated therein in a specified amount "to be paid out of the corpus of the trust upon its termination," with "interest" at the rate of 6 per cent per annum payable quarter annually.

In Commissioner v. Estate of Church, 335 U.S. 632">335 U.S. 632, and Estate of Spiegel v. Commissioner, 335 U.S. 701">335 U.S. 701, the Supreme Court of the United States stated that the taxability of a trust corpus under the provisions of section 811 (c) of the Internal Revenue Code "depends upon the nature and operative effect of the trust transfer" and that in applying this section courts must look "to substance not to form." And in Goldstone v. United States, 325 U.S. 687">325 U.S. 687, the same Court said, with reference to this section, that it "sweeps into the gross estate all property the ultimate possession or enjoyment of which is held in suspense until the moment of the decedent's death or thereafter.

* * * Testamentary disposition of an inter vivos nature cannot escape the force of this section by hiding behind legal niceties contained in devices and forms created by conveyancers."

The petitioners' contention that the value of the trust corpus should be reduced by the face amount of the "certificates of indebtedness" in determining the net value to be used for estate tax purposes is bottomed on the premise that they evidenced a valid, legal, and enforceable indebtedness due from the trust to the holders of the certificates at the time of decedent's death. If this were true, they would be entitled to prevail. Estate of Rose M. Harter, 3 T. C. 1151, 1158. But the fact that the certificates were labeled "certificates of indebtedness" is not conclusive of their true character. See John Wanamaker Philadelphia v. Commissioner, 139 Fed. (2d) 644, 646; United States v. Title Guarantee & Trust Co., 133 Fed. (2d) 990; and Brown Rogers-Dixon Co. v. Commissioner, 122 Fed. (2d) 347, and the provision therein that the trust "is indebted to" the person designated does not necessarily create a debt. The sole asset of the trust during the years 1936 to 1943, inclusive, was the land and building transferred to it by the decedent and its income during those years was derived from the rental of this property. No moneys, or anything else, were loaned or transferred to the trust by the certificate holders. If they made no loans or transfers, how did an "indebtedness" arise? The obvious answer is that there was no real "indebtedness" and no real debt owed by the trust to the persons who were named in the certificates, either at the time the decedent caused them to be issued, or at any time thereafter, or at the time of decedent's death. Drury v. Hartigan (Mass.), 43 N. E. (2d) 660. Never having had the use of any money loaned by the certificate holders, the trust never owed them any "interest" as such. The provision for "interest at six per cent" was inserted for the obvious purpose of providing a means of measuring the amount of income which would be paid annually to certificate holders, i. e., 6 per cent of the face amount of each certificate.

The provision for the issuance and delivery of the "certificates of indebtedness" was merely a device adopted by decedent's attorney to give the appearance of a debtor-creditor relationship when it did not in fact exist. Disregarding form and giving effect to substance, it constituted a retention by decedent of the right to designate those members of his family whom he desired to receive income of the trust and the amounts each was to receive. It was a right to designate beneficiaries of the trust and not creditors. The fact that it was clothed in the garb of an evidence of indebtedness is immaterial. Decedent exercised this right on 30 different occasions from the time the trust was created in 1935 until his death in 1943 to either create beneficial interests or add to interests theretofore created. At the time of his death he had the unexercised right to issue certificates in the aggregate amount of $ 100,000 and thus alter the beneficial interests theretofore created by him or create new interests. Any residue of income or corpus of the trust not disposed of through the issuance and delivery of the certificates passed under a power of appointment by will reserved in the trust deed and exercised by decedent in his will. His death, therefore, fixed and determined the proportionate interests of all beneficiaries in the trust income and corpus. Cf. Commissioner v. Chase National Bank, 82 Fed. (2d) 157; certiorari denied, 299 U.S. 552">299 U.S. 552.

As we view the provision for the issuance and delivery of the "certificates of indebtedness," and the certificates themselves, they merely furnish another reason for the inclusion of the value of the corpus of the trust, without reduction, in the gross estate of the decedent under the provisions of section 811 (c). Petitioners, in conceding that the value of the corpus of the trust is includible under subsection (1) of section 811 (c) because of the reservation of the right to income for life, apparently overlook that it is also includible under subsection (2) because of the reservation of the right, by deed or will or through the medium of the so-called "certificates of indebtedness," to designate the persons whom he desired to possess or enjoy the trust property and income. The latter right, standing alone, would be sufficient to require the inclusion of the value of the trust corpus in the decedent's gross estate. Where such a right is retained in connection with a transfer in trust, section 811 (c) provides that "the value of the gross estate of the decedent shall be determined by including the value at the time of his death * * * to the extent of any interest therein of which the decedent * * * has at any time made a transfer, by trust or otherwise * * *." In other words, the value to be included in the gross estate is the value at date of death of the property transferred to the trust. Milliken v. United States, 283 U.S. 15">283 U.S. 15, 22; Helvering v. Hallock, 309 U.S. 106">309 U.S. 106, 111; In re Kroger's Estate, 145 Fed. (2d) 901, 907. That value is $ 220,000 ($ 250,000 the fair market value of the transferred property at date of death, less the outstanding mortgage of $ 30,000), as respondent determined. Cf. Fidelity-Philadelphia Trust Co. v. Rothensies, 324 U.S. 108">324 U.S. 108. Accordingly, the respondent's determination is sustained.

The respondent, in determining the deficiency, did not allow any credit for state inheritance and succession taxes paid. Petitioners claim a credit of at least $ 2,037.16. This matter was left open for the parties to agree upon under Rule 50, and for that reason,

Decision will be entered under Rule 50.

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Footnotes

• 1. The amount was apparently erroneously determined by subtracting the amount of an outstanding mortgage of $ 30,000 plus the face amount ($ 200,000) of certain so-called "certificates of indebtedness" from the fair market value ($ 250,000) of the corpus of the trust created by the decedent during his lifetime, which would leave a net figure of $ 20,000 rather than $ 25,000.↩

• 2. SEC. 811. GROSS ESTATE.

  The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property * * *

  * * * *

  (c) Transfers in Contemplation of, or Taking Effect at Death. -- To the extent of any interest therein of which the decedent * * * has at any time made a transfer, by trust or otherwise, under which he has retained for his life or for any period which does not in fact end before his death (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.↩