Katz v. Commissioner , 46 B.T.A. 187 ( 1942 )

MEYER KATZ AND HELEN KATZ, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

MEYER KATZ, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Katz v. Commissioner

Docket Nos. 104007, 105511.

United States Board of Tax Appeals

46 B.T.A. 187; 1942 BTA LEXIS 894;

January 27, 1942, Promulgated

---

Held, that the income of three trusts as to which the petitioner was the grantor and trustee is not taxable to him under section 22(a), section 166, or section 167, of the Revenue Acts of 1936 and 1938.

Max Swiren, Esq., for the petitioners.

Gerald W. Brooks, Esq., for the respondent.

---

TYSON

These consolidated proceedings involve income tax deficiencies in the amounts of $6,609.73 and $13,193.48 for the calendar years 1937 and 1938, respectively.

In these proceedings error is assigned in the respondent's inclusion in the gross income of petitioner Meyer Katz the amounts of $24,890 for 1937 and $28,835 for 1938, representing income from three trusts created in 1937 by Meyer Katz for the benefit of his three children, which inclusion is based on respondent's determination that Meyer Katz remained, in substance, the owner of the corpus of such trusts and that the income therefrom is taxable to him under section 22(a) of the Revenue Acts of 1934 and 1938 or, in the alternative, under section 166 of those acts.

FINDINGS OF FACT.

For the year 1937 petitioners Meyer and Helen Katz filed a joint Federal income tax return with the collector of internal revenue for the first district of Illinois. For the year 1938 petitioner Meyer Katz filed a separate individual return with the same collector.

The petitioners are husband and wife, residing at 2136 West Pratt Boulevard, Chicago, Illinois. They have three children: Stanley Michael Katz, who reached his majority at 21 years of age on October 20, 1938; Bernice Lois Katz, who reached her majority at 18 years of age on August 24, 1937; and Harry Katz, who was born October 11, 1932, and was a minor throughout both of the years 1937 and 1938. None of those children was a married person during the taxable years in question.

Prior to and during 1937 and 1938 Meyer Katz, hereinafter sometimes referred to as petitioner, was president of the Rival Packing Co., an Illinois corporation which since 1932 has been profitably engaged in the business of manufacturing a dog food which is sold throughout the United States. The company's capital stock, par value $100 per share, was increased to 750 shares through stock dividends issued in the amounts of 150 shares in December 1933 and 550 shares in June 1935. During 1936 the company paid cash dividends in the amount of $105,000. In 1937, at the time of the creation of the trusts involved herein, petitioner was a minority stockholder owning 187 1/2 shares of that company's outstanding 750 shares of stock, and the remaining 562 1/2 shares were closely held by four other individuals. In 1937 petitioner entered into a contract with the Rival Packing Co. whereby he was employed as president of that company for a term of years on the basis of a fixed salary plus a percentage of the company's profits, which amounted to a total compensation of $48,793.94 for 1937 and $65,101.07 for 1938.

On April 5, 1937, by four written declarations of trust, petitioner Meyer Katz established a separate trust for his wife and each of his three children, with himself as trustee. The original corpus of each trust consisted solely of shares of stock of the Rival Packing Co. and the 187 1/2 shares of that company's stock owned by the petitioner at that time were transferred on the company's books to his name as trustee, in the respective amounts of 56 1/2 shares for his wife Helen, 56 shares for his son Michael, 37 1/2 shares for his daughter Bernice, and 37 1/2 shares for his son Harry. The trust for the benefit of petitioner's wife is not involved in this proceeding.

The petitioner's purpose in establishing the trust for each of his three children was to set apart an asset which he felt would create "independence and a source of income for them for later years, and through their life." Petitioner was aware of the fact that the creation of the trusts would decrease his tax liability, but his dominant motive was to provide for his children. He felt that his individual interest in the Rival Packing Co. was protected by his contract of employment, without any necessity of being a stockholder in that company.

The provisions of the declaration of trust for each of the three children are identical, except for the name of the child specifically designated as the primary beneficiary and the number of shares of stock transferred to each trust, and what we hereinafter state with reference to the Stanley Michael Katz trust applies to all three trusts.

Petitioner Meyer Katz, grantor of the Stanley Michael Katz trust, was also named the initial trustee thereof and, so far as the record shows, remained so throughout the taxable years. As trustee he was given full power and authority to manage and control the corpus of the trust estate and also any accumulated income therefrom in such manner as he deemed advisable and as though he were the owner thereof, including the power to invest, reinvest, sell, mortgage, and pledge such property without regard to the normal restrictions on investment of trust funds, and also the right to vote all shares of stock held by the trust. He was authorized to evaluate all distributions and to make the same in kind or in cash. It was provided that the trustee and any successor trustee should not be liable for any loss or damage incurred by the trust estate, except as caused by willful default or misconduct, and, further, that when petitioner ceased to be trustee, Harry I. Hoffman should become trustee, or, if he was unable to act, then the person appointed by petitioner's wife, or, if she was not living, the person appointed by the majority of petitioner's children.

The declaration of trust specified that all liquidating cash dividends, all stock dividends, and all stock subscription rights upon shares of stock held by the trust should be treated not as income, but as capital, and become part of the corpus of the trust estate.

Paragraph 8 of the declaration of trust provided that after payment of taxes, expenses, etc., the entire net income derived from the trust estate should be distributed at such regular intervals as the trustee might deem proper:

(a) To petitioner's son Stanley during the latter's lifetime;

(b) In the event Stanley should die before termination of the trust, then to his lawful issue living at the time of his death, per stirpes; and

(c) In the event Stanley should die without surviving issue before the termination of the trust, then in equal shares to petitioner's wife Helen and petitioner's children surviving Stanley, and to the surviving issue of any of petitioner's children who predeceased Stanley, per stirpes; provided, however, that the trustee, in his discretion, might withhold and accumulate any net income payable to the foregoing beneficiaries and/or apply any or all of such income for the benefit of such beneficiaries.

Paragraph 9 of the declaration of trust provided that all withheld net income should be accumulated and set apart in a separate account designated "Accumulated Net Income Account" and be held, invested, reinvested, and distributed pursuant to the terms of the trust, to the beneficiary from whom withheld, or in event of his or her death, to the beneficiaries taking through or under him or her during the continuance of the trust or upon distribution of the entire trust estate at its termination.

Paragraph 10 of the declaration of trust provided that the trust might be terminated at any time by delivery to the trustee of a written instrument directing such termination, executed:

(a) Jointly by petitioner and his wife, until petitioner's son Stanley reached 21 years of age; or

(b) Jointly by petitioner and his son Stanley after the latter reached the age of 21 or after the death of petitioner's wife Helen, whichever should first occur.

Paragraph 10 further provided that immediately upon termination of the trust by either of methods (a) or (b) above mentioned the trustee is directed to:

(c) Distribute the accumulated net income in the same manner as the trust estate would have been distributed, under paragraph 11 of the trust instrument, upon the death of petitioner Meyer Katz; and

(d) Transfer, pay over and deliver to the petitioner Meyer Katz the entire trust estate, except the accumulated net income and income derived therefrom.

Paragraph 11 of the declaration of trust provided that after petitioner's death unless the trust had previously terminated in accordance with paragraph 10, the entire trust estate including accumulated net income should be distributed in the following manner and upon the occurrence of the following contingencies:

(a) To petitioner's son Stanley when he reached the age of 25 years;

(b) In the event Stanley predeceased petitioner leaving lawful issue living at the time of petitioner's death, then to such issue, per stirpes;

(c) In the event Stanley predeceased petitioner without such issue, then (1) if petitioner's wife Helen survived him, in equal shares to that wife and petitioner's surviving children and the living issue of those of petitioner's children who were not then surviving, per stirpes; or (2) if petitioner's wife predeceased him, in equal shares to his surviving children and the issue, living at the time of petitioner's death, of such children as may have died prior to petitioner's death, per stirpes;

(d) In the event all of petitioner's children predeceased him, without issue surviving the petitioner, then to his wife Helen, if she survived him, but if not, then to petitioner's heirs at law according to the laws of descent and distribution of Illinois;

(e) In the event that at the time of distribution of the trust any beneficiary should not have reached 25 years of age, his or her distributive share should be retained in trust by the trustee until he or she reached 25 years of age, for the benefit of such beneficiary and his or her heirs at law; and

(f) In the event the trust should terminate 21 years after the death of the survivor of petitioner Meyer Katz, his wife Helen, and his children, Stanley, Bernice, and Harry Katz, the entire trust estate, including the accumulated net income, should be immediately distributed to the beneficiaries then entitled thereto under the provisions of paragraph 11 of the trust instrument.

The declaration of trust further provided that the provisions therein for petitioner's wife and for his children and their issue should be for their sole and separate use, free from all statutory or marital rights of any of their husbands or wives, and that they should have no right to anticipate or alienate the trust estate or the accumulated net income and income therefrom, and the same should not be subject to attachment or execution by any of their creditors.

Petitioner Meyer Katz established and maintained in his name as trustee a separate bank account for each trust for the benefit of his children and all checks drawn on each of those accounts were signed by him as trustee, together with a designation of the name of the trust. Those bank accounts were kept completely separate from petitioner's personal account. The petitioner, as trustee, maintained separate books of accounts for each trust for the children, respectively, showing the income and the disposition thereof for each trust. During 1937 and 1938 the net income of each of those trusts, prior to any distributions, was as follows:

	1937	1938
Stanley Michael Katz trust	$10,640	$14,837.08
Bernice Lois Katz trust	7,125	9,937.50
Harry Katz trust	7,125	9,937.50

The entire net income of each of those trusts for 1937 was accumulated and was invested in United States bonds registered in the name of Meyer Katz as trustee, together with a designation of the name of the trust. Of the net income of each of those trusts for 1938, distributions were made to the respective beneficiaries in the amounts of $7,500 to Stanley and $5,500 each to Bernice and Harry, and the remainder of the income of each trust was accumulated and invested in bonds registered in petitioner's name as trustee for the respective trusts. The $7,500 distributed to Stanley was invested by him in a first mortgage which is still held. The record does not disclose what use Bernice and Harry made of the funds distributed to each of them.

For each of the years 1937 and 1938 the petitioner, as trustee, filed a separate fiduciary income tax return reporting the income and tax liability of each trust for the benefit of his three children, respectively. The income of those trusts was not included in the income of petitioner Meyer Katz as reported by him for 1937 and 1938. In determining the deficiencies in controversy the respondent has included in the income of Meyer Katz the amount of $24,890 for 1937, representing the total of the net income during that year of the trusts for the three children, and the amount of $28,835 for 1938, representing all of the net income during that year of the trusts for the benefit of Bernice and Harry and that portion of the net income received by the trust for the benefit of Stanley during the period from January to October 20, 1938, on which latter date he became 21 years of age.

Neither of the three trusts here in question was created as a mere form for the purpose of tax avoidance, but was a genuine, valid, subsisting trust created by petitioner Meyer Katz for the benefit of the specifically named child, with specifically designated contingent beneficiaries other than the petitioner himself. The accumulated net income of the trust was definitively and permanently disposed of by the provisions of the trust instrument, with no possibility of it ever being distributed to petitioner even if the trust were terminated by revocation during petitioner's lifetime. The only power of revoking the trust, which would result in a revesting of the corpus, or any part thereof, in petitioner Meyer Katz, was not vested in him alone, but was vested in him jointly with designated persons, each of whom had a substantial adverse interest in the corpus as well as the income of the trust; that is to say, jointly with petitioner's wife until the child named as the primary beneficiary reached the age of 21 and thereafter, or upon the wife's death prior thereto, jointly with the primary beneficiary.

OPINION.

TYSON: The pleadings raise two issues involving the questions of whether the income of the three trusts for the benefit of petitioner's children is taxable to petitioner (1) under the broad provisions of section 22(a) of the Revenue Acts of 1936 and 1938, ¹ because, in substance, he retained ownership of the trust property, or, (2) under the specific provisions of section 166 of those acts ² because he reserved a power of revocation of the trusts.

Under , the applicability of section 22(a), supra, depends upon whether, after creating the trusts the petitioner, grantor, retained such incidents and attributes of ownership that he continued to possess the economic enjoyment of the property or the fruits of such property placed in trust. In that case the trust was for a short term and upon its termination the corpus was, under the specific terms of the trust, to revert to the grantor, who was the trustee and had broad powers over the control and management of the trust property in that short interim. The rationale of that case has been discussed and applied or not applied in numerous subsequent cases, a great many of which have been reviewed in the recent case of . It will serve no useful purpose in this opinion to again review those cases.

In the instant case, except for possible revocation by petitioner jointly with persons having substantial adverse interests hereinafter discussed, the trusts were to continue for an indefinite period, but at least until after the death of the grantor, petitioner; during the tenure of the trusts he had no dominion and control over the corpus and income therefrom except in the exercise of his duties as trustee and he could not receive individually any of the benefits of either the corpus or the income; and upon termination of the trusts after the grantor's death both the corpus and any accumulated income was to be distributed to or held in trust for the benefit of specifically designated primary beneficiaries or specifically designated contingent beneficiaries, the latter including the surviving issue of the primary beneficiaries or the surviving sisters and brothers and mother of the primary beneficiaries, and, lastly, the petitioner's (grantor's) heirs at law upon the remote contingency that the grantor's wife and all of his children, without leaving issue, predecease him. Here the corpus and income of the trusts were definitively and permanently disposed of by the terms of the trust instruments with no reversion to the grantor, petitioner, and with no power in him to make testamentary disposition thereof. We hold that the income of the trusts in question during 1937 and 1938 is not taxable to petitioner under section 22(a), supra. ;; ; ; affirmed per curiam, ; , and authorities relied upon in those cases.

The petitioner, grantor, as to each trust, did not retain in himself alone a power of revocation, but only jointly with his wife Helen, until the child named as beneficiary reached the age of 21, and thereafter or, upon the wife's death prior thereto, jointly with the beneficiary. In our opinion, the primary beneficiary's vested interest in the trust estate constituted a "substantial adverse interest" within the meaning of section 166, supra. The petitioner's wife Helen was a living, definitely ascertained person who had the fixed right, in the event the primary beneficiary predeceased her without leaving issue, to have a substantial share of the trust income that might be currently distributed and of the entire trust estate, including accumulated income, distributed to her. Also, in our opinion, such contingent interest of the wife was a "substantial adverse interest" to the grantor, petitioner, within the meaning of section 166, supra. ; ; ; ; . We hold that the income of the trusts involved herein is not taxable to petitioner under section 166, supra.

The case of , cited by respondent, in which the court concluded that the grantors of the trusts there involved were taxable on the income therefrom under both section 22(a) and section 166 of the Revenue Act of 1934, is distinguishable on its facts from those in the instant proceedings. While in that case the court, in applying those sections and in connection with the grantors' reserved rights to revoke the trusts in conjunction with any other beneficiary, appears to have considered that, in connection with all the other facts therein, the interests of beneficiaries, who were members of the grantors' family, were not such substantial adverse interests as would bring the grantors within the protective provisions of section 166, yet the other factors of broad powers of control of the trust estates reposed in the grantors by the trust instruments would of themselves seem to have been sufficient to justify the holding in that case - among such other factors, the vital one being that grantor might, under the express terms of the trust instruments, at any time solely in his own discretion have paid the whole of the corpus to himself for his support, comfort, or maintenance. There the right of the grantor to exercise such discretion was, for all practical purposes, equivalent to a power to revoke the trust and revest the corpus in himself without the consent of anyone else and thus the facts in that case brought it squarely within the operation of section 166, or, alternately, under section 22(a) as was held by the court, independently of any consideration of the substantial adverse interest there involved.

The case of Altmaier v. Commissioner, 116, Fed.(2d) 162, also cited by respondent, in which the court concluded that the grantor of the trust involved was taxable on the income therefrom under the provisions of section 167 of the Revenue Act of 1932, is also distinguishable on its facts from those in the instant proceedings. In that case the court said:

* * * Here the trust instrument specifically directs that (1) the net income of the estate shall be accumulated, invested and added to the principal while the settlor lives or until his wife dies, should she predecease him, (2) in which latter event, he shall receive the entire net income for the rest of his life, or in the alternative (3) may sweep clean the entire original and accumulated trust estate by the exercise of his reserved power to terminate and take all.

That reserved power of which the court spoke was in the grantor alone. The court held that "Under the arrangements of the trust agreement, the income of the trust 'may be * * * accumulated for future distribution to the grantor.'" and was therefore taxable to him on the grounds that if under any circumstances or contingencies any part of the accumulated income might inure to the benefit of the grantor such income was taxable to him. In that case further facts were that during the life time of the grantor and his wife the power to alter, amend, revoke, and terminate the trust was vested in them jointly. While the court said that in the circumstances the wife was not, in its judgment, a person having "a substantial adverse interest" within the meaning of the statute and proceeded to discuss the concept of family solidarity, yet the court's decision rested on the possibility of the grantor acquiring the accumulated income as bringing that case squarely within section 167.

In the Cox and Altmaier cases the facts other than and independent of those with reference to the adverse interests there considered, clearly showed that the income of the trusts involved was taxable to the grantors under section 166 in the Cox case and under section 167 in the Altmaier case. The expressions in those cases to the effect that under the circumstances therein a member of an intimate family group had no substantial interest in the trusts adverse to the grantor within the meaning of sections 166 and 167 does not, in our opinion, establish a general principle to that effect which would be controlling here and warrant a holding in the instant case that petitioner's wife had no "substantial adverse interest" merely because she was the grantor's wife.

While no issue has been raised by the pleadings as to the taxability of petitioner under section 167 of the Revenue Acts of 1936 and 1938, ³ we deem it proper to consider that question. See Though certain capital gains, if realized, were not distributable to the beneficiaries of the trusts, but were to be added to corpus, such gains, as a part of corpus, could never be distributed to the petitioner, grantor, except through his exercise of the power of revocation jointly with persons having substantial adverse interests as above stated. As to the net income of the trust which could be currently distributed to or accumulated for the benefit of the primary beneficiaries and/or the contingent beneficiaries, such income could never be distributed to the grantor, petitioner, even in the event of a revocation of the trust. It is clear that section 167, supra, has no application to the instant case.

The respondent erred in including in petitioner's income any portion of the income of the three trusts in question for the years 1937 and 1938.

Decision will be entered under Rule 50.

---

Footnotes

• 1. SEC. 22. GROSS INCOME.

  (a) GENERAL DEFINITION. - "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * * ↩

• 2. SEC. 166. REVOCABLE TRUSTS.

  Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested -

  (1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or

  (2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom,

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

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

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

  (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor; or

  (2) may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; or

  * * *

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