Wilson v. Commissioner ( 1940 )

JOHN P. WILSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Wilson v. Commissioner

Docket No. 93140.

United States Board of Tax Appeals

42 B.T.A. 1260; 1940 BTA LEXIS 877;

November 22, 1940, Promulgated

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Held:

(1) The ordinary income of two trusts was currently distributable and distributed to named beneficiaries other than grantor. The capital gains of the trust were accumulated and added to corpus for distribution as such at termination of the trusts. The trusts were not revocable. Neither the ordinary income nor the capital gains thereof were taxable to grantor under section 166 of the Revenue Act of 1934.

(2) One of the trusts involved was for a two-year period and terminated by its terms in the taxable year. Capital gains were realized in the taxable year, added to corpus, and as such paid to grantor in such year. The capital gains are taxable as income to grantor under section 167 of the Revenue Act of 1934.

(3) On the facts of the second trust involved, grantor retained a mere possibility of reverter of corpus. The accumulated capital gains are not taxable to grantor.

C. F. Selfridge, Esq., for the petitioner.

D. A. Taylor, Esq., and David Altman, Esq., for the respondent.

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HILL

This proceeding involves deficiencies in income tax of petitioner for the calendar years 1934 and 1935. For 1934 respondent determined a deficiency of $1,562.57, based upon the inclusion of additional income of $2,849.72 representing the entire net income of a trust created by petitioner in December 1933 for the benefit of his son. For 1935 respondent determined a deficiency of $11,156.24 based upon the inclusion of additional income of $35,986.20, of which $28,876.10 represented the net ordinary income and capital gain of the 1933 trust and $7,110.10 represented the net ordinary income and capital gain of a trust created by petitioner in June 1935 for the benefit of his daughter.

FINDINGS OF FACT.

Petitioner, John P. Wilson, an individual, resides at 1516 North State Street, Chicago, Illinois.

Prior to December 1930 the petitioner had given to his son, John P. Wilson, Jr., an allowance of $300 per month. On December 29, 1930, petitioner created a trust for a period of three years, under which the son was to receive $300 per month. The corpus of the trust consisted of 150 bonds of $1,000 face value each of the American Tar Products Co. On the same day that the trust expired and the corpus reverted to the petitioner, December 21, 1933, petitioner executed a new trust indenture providing for a short term trust to continue for not more than two years. The corpus of this trust consisted of the same bonds that comprised the corpus of the prior trust. The same three trustees were named again. They were to hold the corpus, collect the income, and, after paying expenses, distribute ordinary income to the son. The capital gains were to be accumulated. This trust was to continue for a period of two years, ending December 21, 1935, or on the death of the petitioner in the event petitioner died prior to December 21, 1935. Article second (4) empowered the trustees to receive all proceeds which might be paid upon the sale of the trust assets:

* * * or which may be otherwise paid out of capital or on account of the principal of any bond, stock or other security * * * provided that any and all moneys, stock dividends or other securities received under this paragraph shall constitute and be a part of the principal of the trust estate.

Article fourth of the trust provided as follows:

Distribution of the Principal of the Trust Estate

The trust hereby created shall terminate on December 21st, A.D. 1935, or on the death of said grantor, JOHN P. WILSON , if he shall die prior to said date, and upon the termination of said trust the entire net income then remaining in the hands of said Trustees shall be paid over to said JOHN P. WILSON, JR., and the entire principal of said trust estate shall then vest in and be transferred and delivered to said Grantor if he shall then be living, absolutely as his own property free from said trust, and in case he shall not then be living said entire trust estate shall vest in and be transferred and delivered to the executors of his estate and shall be administered by them in the same manner as if said Grantor had died owning the same.

The trusts for three and two years, respectively, were created for such periods because petitioner did not wish to set up any trust of a permanent character for his son until the latter had demonstrated to his father's satisfaction that the income would not impair his ambition or usefulness in his work.

By an indenture dated November 29, 1935, petitioner created a third trust for the benefit of his son, John. The principal of that trust was about the same as in the 1933 trust. The 1935 trust provides that the son shall have the entire net income so long as he and his father both live. The trust is to terminate at the expiration of ten years from the death of the last survivor of Alice B. Wilson (wife of petitioner), John P. Wilson, Jr., and Cynthia Compton. No part of this trust is involved in the issues in the present proceeding.

By indenture dated June 25, 1935, the petitioner created a trust for the benefit of his daughter, Cynthia Wilson, and Beverly Compton, whom she married on July 6, 1935. Under this trust the net income was to be paid to the beneficiaries during their lifetimes in such shares as the trustees should determine; provided, however, that the beneficiaries could designate in writing the shares in which the net income was to be paid to them. Shortly after the creation of the trust, Cynthia Wilson issued written instructions to the trustees to pay the entire net income to her husband. The corpus of the trust consisted of $500 cash and 46 bonds of the American Tar Products Co., dated July 1, 1930, having a face value of $1,000 each. Article second (4) of the trust indenture empowered the trustees to receive all proceeds which might be paid upon a sale of the trust assets:

* * * or which may be otherwise paid out of capital or on account of the principal of any bond, stock or other security, * * * provided that any and all moneys, stock dividends or other securities received under this paragraph shall constitute and be a part of the principal of the trust estate.

(5) The decision of said Trustees as to the source from which any and all cash received by them on account or by reason of their holding any stocks or securities hereunder, that is, as to whether such cash is paid from principal or income, shall be final and binding on all parties for all purposes.

Article fourth provided as follows:

Distribution of the Principal of the Trust Estate

The trust hereby created shall terminate on the death of said CYNTHIA WILSON, unless she shall die leaving issue surviving her, in which case the trust hereby created shall continue in force and terminate when her youngest child surviving from time to time attains the age of twenty (20) years or dies prior to attaining said age; provided, however, that the trust hereby created shall in any and the latest event terminate upon the death of said Grantor, JOHN P. WILSON, and upon the termination of said trust, under any of the conditions above named, the entire principal of said trust estate, together with all accrued and unpaid income thereon, shall then vest in and be transferred and delivered to said Grantor if he shall then be living, absolutely as his own property free from said trust, and in case he shall not then be living said entire trust estate, together with all accrued but unpaid income thereon, shall revert to his estate and be transferred and delivered to the executors of his estate and shall pass under his will and be administered by his executors in the same manner as if said Grantor had died owning the same.

Petitioner's daughter was in a financially independent position to marry because petitioner's father in his lifetime had given her stocks which would produce an income of something better than $5,000 a year, which petitioner thought was adequate to take care of a young married couple "just starting out." The reason petitioner created this trust, which was expected to produce about $1,200 to $1,500 a year, was because his daughter's husband was a young doctor who had no established practice yet and petitioner was opposed to having the wife hold all the money in the family.

Cynthia Wilson Compton had two children at the time this proceeding was heard - Beverly, Jr., three, and Cynthia, one.

During the year 1934 the entire net income of the trust created December 21, 1933, amounted to $2,849.72, which was paid during 1934 to John P. Wilson, Jr. The net income of this trust for 1935 was $28,876.10, consisting of dividend income of $1,000, interest income of $11,937.50, and capital gains of $16,095.31 (after the application of the 40 percent holding period percentage) from the sale of the 150 bonds constituting the trust corpus. The trustees distributed in 1935 to John P. Wilson, Jr., $12,780.79, but retained the capital gains of $16,095.31, which they reported as income of the trust on a Form 1040 income tax return for 1935, and paid a tax thereon. Upon termination of this trust on December 21, 1935, in accordance with the terms of the trust indenture, the corpus thereof was returned to the petitioner, together with the $40,238.27 capital gains representing the capital gains (prior to the application of the 40 percent holding period percentage, which reduced this amount to $16,095.31).

The net income of the trust created June 25, 1935, for the calendar year 1935 amounted to $7,110.10, including $4,935.89 (after the application of the holding period percentage of 40 percent) from the sale of the 46 bonds constituting the trust corpus. The trustees distributed the ordinary income to Beverly Compton and retained the capital gains of $4,935.89, which they reported as income of the trust on a Form 1040 income tax return.

The American Tar Products Co. bonds which constituted the entire principal of both trusts, with the exception of $500 cash to each, were delivered to and received by the trustees of the respective trusts when the trusts were created and were held by the trustees until their sale in October 1935. The trustees kept the bonds in a custodian's account in their names at the First National Bank. Separate bank accounts and complete books of account were kept by the trustees.

In 1935 the trustees considered selling the bonds and sought petitioner's advice in the matter. The sale was agreed upon and the proceeds were reinvested in other securities, issued in the names of the trustees and kept in separate safe deposit boxes.

In his individual income tax returns for 1934 and 1935 the petitioner did not report or include either the ordinary income or capital gains of the two trusts.

Upon audit of these returns, the Commissioner determined that the income of these two trusts, both ordinary and capital, was taxable to the petitioner, as grantor thereof.

OPINION.

HILL: Since this proceeding was submitted to the Board, the Supreme Court has rendered two decisions construing section 166 of the Revenue Act of 1934, upon which respondent rests, in part, his argument in this case - Helvering v. Clifford,309 U.S. 331">309 U.S. 331, and Helvering v. Wood,309 U.S. 344">309 U.S. 344. The distinction between a reversion, with which we are faced in the instant case, and a power to revest or revoke is clearly set forth in the Wood case, supra:

* * * generally speaking, the power to revest or to revoke an existing estate is discretionary with the donor; a reversion is the residue left in the grantor on determination of a particular estate. * * * Congress seems to have drawn Sec. 166 with that distinction in mind, for mere reversions are not specifically mentioned. * * * And where Congress has drawn a distinction, however nice, it is not proper for us to obliterate it. * * *

The interest of this petitioner in the 1933 trust was clearly a reversion. He reserved no power to revoke the trust set up for his son, and the trust was certain to terminate in two years. In the case of the trust for his daughter and her husband the facts are different; but the ultimate vesting of the trust estate, either in the petitioner or in his estate is no less certain to occur than in the case of the 1933 trust, nor did petitioner have the power either to change the conditions set forth in the instrument or to revoke the trust.

Both of the trusts clearly fall within that class of trusts which the Supreme Court in the Wood case, supra, specifically excluded from the scope of section 166. They are not revocable trusts.

In the brief of counsel for respondent the income of the two trusts is sought to be attributed to petitioner on the theory that the direction of investments and sales and the accumulation of capital income is tantamount to control over the income. Clearly this view is erroneous. Cf. Christopher L. Ward,40 B.T.A. 225">40 B.T.A. 225, where, as here, the corpus was actually conveyed to the trustees who collected and distributed the income to the beneficiaries in accordance with the trust agreements. The advice given by petitioner for sales and investments could not nullify a trust otherwise valid.

Respondent, however, has a further alternative contention, i.e., that the capital gains of the two trusts for the year 1935 are taxable to the petitioner as grantor under section 167 of the Revenue Act of 1934.^{section 167. Everett D. Graff,40 B.T.A. 920">40 B.T.A. 920, and Commissioner v. Morris, 90 Fed.(2d) 962. In the Morris case the court said, at page 964, in upholding a decision of this Board:}

As to its decision regarding the capital gains which has to be added to the principal, regardless of any exercise of discretion by the trustees, for disposal when the trusts terminated, we think the Board was right. It held that as to such income from capital gains absolutely distributable as principal at the termination of the trust section 167 of the 1928 Act did not apply. * * * There is, indeed, no plausible reason apparent why, when income which may be accumulated for eventual distribution to the grantor is taxed to him, he should not also be taxed on income which must be accumulated for that purpose. In the Revenue Act of 1932 (Section 167 (26 U.S.C.A. Sec. 167 and note)), the tax was so extended * * * Nor does the fact that in the Revenue Act of 1932 Congress changed the law to cover such instances as this indicate more than that the amendment was for the purpose of filling a gap in the previous law. * * * [Italics ours.]

And at page 924 of the Graff case, supra, the Board said:

* * * But section 167, in its present form, operates as effectively upon accumulated trust income where it "is * * * held * * * for future distribution to the grantor" as it does where that future distribution may be contingent upon the exercise of a nonadverse discretion. * * *

In the instant case the income from capital gains of the 1933 trust was paid to petitioner in 1935 as a part of the reverted trust corpus. Furthermore, there is no dispute as to the amount of that income. Clearly, therefore, the petitioner is taxable thereon pursuant to section 167.

As to the 1935 trust for the daughter, the situation is materially different. The corpus, including any and all capital gains which the trustees must accumulate, must at some future date vest either in the petitioner or his estate. It will vest in the petitioner himself only if (1) Cynthia Wilson Compton dies without issue during the lifetime of the petitioner, or, (2) her youngest surviving child attains the age of 20 or dies prior thereto during the lifetime of petitioner. And it will vest in petitioner's estate upon (3) the death of petitioner at any time.

There is not only no reasonable certainty that the corpus will ever vest in the petitioner, but, on the contrary, it would seem that such vesting is not reasonably probable. The future life expectancy of the daughter is now greater than that of the petitioner. And, even should she predecease him, he would not become entitled to the corpus until her youngest surviving child reached the age of 20 or died prior thereto. In view of these contingencies, it can not be said that the petitioner has any more than a mere possibility of reverter in the corpus. This Board and the courts have now definitely established that the grantor of a trust is not subject to tax upon accumulated income if his only interest is a mere possibility of reverter. William E. Boeing,37 B.T.A. 178">37 B.T.A. 178; J. S. Pyeatt,39 B.T.A. 774">39 B.T.A. 774; Genevieve F. Moore,39 B.T.A. 808">39 B.T.A. 808; Christopher L. Ward, supra.It is our conclusion that such interest as petitioner retained in the property of the 1935 trust was not of sufficient substance to justify a reasonable expectation that he will ever benefit by the accumulations of the income thereof.

As already pointed out, however, the corpus must vest in petitioner's estate, if not in petitioner himself. Because of this fact, counsel for respondent concludes that the situation falls within the scope of section 167, a conclusion with which we do not agree. The wording of that section is "for future distribution to the grantor." Nowhere is there any mention of "or his estate", the additional scope which counsel for respondent would impute to the section.

Accordingly, we hold in favor of the respondent as to the taxability to petitioner of the accumulated capital gains of the 1933 trust, and in favor of the petitioner on all issues concerning the 1935 trust for the daughter.

Decision will be entered under Rule 50.

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Footnotes

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

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

  (1) is, * * * held or accumulated for future distribution to the grantor, or

  * * *

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