Harter v. Commissioner , 3 T.C. 1151 ( 1944 )

Estate of Rose M. Harter, Deceased, the First-Central Trust Company, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent

Harter v. Commissioner

Docket No. 1167

United States Tax Court

3 T.C. 1151; 1944 U.S. Tax Ct. LEXIS 80;

July 26, 1944, Promulgated

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Decision will be entered under Rule 50.

In reporting the value of decedent's estate for estate tax purposes, petitioner included the net value of the property in an inter vivos revocable trust created by decedent. In computing this net value petitioner reduced the gross value of the trust property by the amount of certain unpaid notes, together with interest thereon, and certain expenses and court allowances in connection with an independent noncollusive proceeding brought by the trustee before a Court of Common Pleas of Ohio for the purpose, exclusively, of construing the trust so as to obtain an authoritative determination of its legal rights and duties and of the respective interests of the several beneficiaries under the trust. The court there held that certain of the unpaid notes constituted valid primary "obligations" of and payable out of the "corpus" of the trust estate as of decedent's death, but that the other notes did not, and allowed certain expenses. Respondent disallowed the deduction of all these items on the ground that certain of the notes were not supported by "an adequate and full consideration in money or money's worth," as required by section 812 (b) (3), I. R. C., the remainder of the notes did not evidence primary liabilities of decedent's estate, and the expenses and court allowances deducted were liabilities only of the trust estate. Held:

(1) The deductibility of claims against the trust estate does not require the presence of "an adequate and full consideration in money or money's worth," as provided by section 812 (b) (3), I. R. C., since the requirements of that section apply only to "claims against the estate."

(2) This Court is bound by the decree of the Court of Common Pleas of Ohio in its determination as to which of the unpaid notes evidenced legal and primary obligations of the trust estate as of the date of decedent's death. Freuler v. Helvering, 291 U.S. 35">291 U.S. 35; Blair v. Commissioner, 300 U.S. 5">300 U.S. 5.

(3) In computing the net value of the trust for present purposes the gross value of the trust estate is not to be reduced by expenses allowed by the court in the court proceeding in Ohio, because the obligation to pay them arose after the date of decedent's death. Estate of Frederic E. Baldwin, 44 B. T. A. 900.

Edwin W. Brouse, Esq., for the petitioner.

W. W. Kerr, Esq., for the respondent.

Leech, Judge. Murdock, J., concurs only in the result.

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LEECH

This proceeding seeks redetermination of a deficiency in estate taxes in the sum of $ 16,945.87, determined January 6, 1943. The contested issues relate to (a) the disallowance by respondent, as claims against the estate, of certain promissory notes executed by decedent in favor of her children and certain promissory notes upon which the decedent was comaker or endorser and (b) the disallowance of deductions alleged to be executor's commissions, attorneys' fees, debts, and miscellaneous administration expenses.

The proceeding was submitted upon oral testimony and exhibits. Petitioner concedes the correctness of respondent's determination in increasing certain valuations and disallowing certain claims and deductions. Effect will be given to these concessions in the computation under Rule 50.

FINDINGS OF FACT.

The petitioner is the executor of the estate of Rose M. Harter, who died February 26, 1940. The estate tax return was filed with the collector of internal revenue for the eighteenth district of Ohio at Cleveland, Ohio. The decedent was the widow of Otto N. Harter, who died intestate on the fifth day of May 1924. In addition to his widow, Rose M. Harter, he was survived by five children, two of whom were minors at the time of his death.

Shortly after the death of Otto N. Harter a conference was had among Rose M. Harter and her children respecting action to be taken in connection with the estate of her husband, which amounted to approximately $ 250,000 and in which the children owned more than a two-thirds interest. All of the parties in interest agreed that action be taken to conserve the estate and avoid the loss incident to sale and distribution of the assets. It was finally decided that the children should convey to their mother title to their respective interests in the property, both real and personal, and that she, in turn, would reconvey these interests, together with her own and certain other property belonging to her, to a trust, the income from which was to be enjoyed by her during her life and the corpus to be divided upon her death into five portions, each to be held upon separate trust in favor of her five children, respectively.

In accordance with this understanding, the children of Rose M. Harter on or about July 14, 1928, when the youngest of the children became of age, joined in an application to the proper Probate Court for the distribution to Rose M. Harter of the personal property of the estate, in order that the administration of the estate might be closed. All five of the children also executed quitclaim deeds to their mother of their interest in the real estate possessed by their father at the time of his death and joined in the transfer to her of the personal property left by him. Rose M. Harter, in turn, executed an indenture of trust conveying this and substantially all her other property to the Depositors Savings & Trust Co.

The provisions of that indenture of trust directed the trustee to realize $ 10,000 from the trust property and pay it in equal shares forthwith to the five children and to realize an equal sum and set it aside under separate trust, the income from which was payable to a sister of Rose M. Harter during the life of that sister, the remainder over to the High Street Church of Christ, Akron, Ohio. The income from the corpus of the principal trust was to be paid into the account of Rose M. Harter during her life and upon her death the corpus of the trust was to be divided into five portions, each to be held under separate trust for one of the five children, each to enjoy the income from his or her trust for life, with a right of disposition of the remainder interest by will, in the absence of which it was to pass to his or her heirs under the intestate laws of the State of Ohio. The trustee was given authority to invade the corpus in each of these five trusts in case of necessity for assistance to the beneficiary. By the trust indenture Rose M. Harter reserved to herself the right of revocation or amendment of the trust, in whole or in part, during her lifetime. Coincident with the creation of the trust, Rose M. Harter executed a will providing that such individual estate as she might leave at the time of her death be transferred to the trustee of the trust referred to and be added to the corpus then to be divided and set apart in the five separate trusts.

Subsequent to the creation of the above mentioned trust by the decedent, Rose M. Harter, she conferred with her children in 1936, 1938, and 1939 and advised them that she was then directing the trustee to make certain equalized distributions from the trust corpus to them, but, in view of the fact that it was desired to avoid sale of securities in the trust, she was executing a demand note covering all or a part of some of the distributions to them, and requested each child receiving such a note to withhold demand for its payment by the trustee until such time as the trustee could pay the amount of the distribution without sacrifice of the trust estate, unless there should be necessity for the holder of the note to have the money. In each instance she then notified the trustee that she was making "gifts" to the children from the trust estate, asking the trustee to prepare the demand notes for her signature, advising it that the children would not present the notes for collection until such time as their payment would not embarrass the trust estate, and directing that payments on account of the notes were to be made from the trust corpus. Thus in 1936 she directed the trustee to distribute $ 5,000 from the corpus of the trust to each of the children; in 1938, $ 4,840 to each, and in 1939, $ 4,000 to each. At the death of the decedent, of the 1936 distributions two of the children had each received the full amount of $ 5,000; one had been paid in part and held a note of $ 616.01 for the balance; another child had been partially paid and held a note for $ 1,500 for the balance; and the fifth child had received payment of his $ 5,000 in full by credit in that amount upon his note evidencing a loan to him by the trust.

At the death of the decedent, of the 1938 distributions three of the children held unpaid notes, each in the full amount of the $ 4,840 then ordered distributed; another child held an unpaid note of $ 4,340, having received a payment of $ 500 on account from the trust; and the fifth child had received payment of his distribution in full by a credit on his note covering a loan to him by the trust.

Of the 1939 distributions, unpaid notes were held at the date of decedent's death by each of four of her children in the full amount of $ 4,000 each, the amount ordered in that distribution, while the fifth child had received his distribution in full by a credit on his note covering a loan by the trust.

All payments to the children on account of these distributions, and the loans or advancements from the trust against which part of the distributions were credited, were charged against and paid out of the corpus of the trust estate by the trustee in accordance with the directions of the decedent.

On July 10, 1940, almost immediately subsequent to the death of decedent and prior to the setting up of the five separate trusts as directed in the trust executed by decedent, the trustee of the principal trust instituted a proceeding in the Court of Common Pleas of Summit County, Ohio, asking a declaratory judgment. This proceeding was not collusive. It was brought without any tax motive and for the sole purpose of determining the proper interests of the several beneficiaries which should be included in those separate trusts. All of the persons interested in the principal trust as well as the five separate trusts, including the several minor children of decedent's children, were named as defendants. The petition instituting the proceeding set out the facts surrounding the execution of the demand promissory notes of decedent outstanding at the time of her death. No answers were filed by the defendants, who were sui juris. But the minors, who were defendants, through their guardian ad litem denied the allegations in the petition in so far as prejudicial to them. There were insufficient funds in decedent's estate to meet these notes, but the trust corpus was more than sufficient to meet them. In this proceeding the court entered its decision decreeing that the several unpaid notes held by the children at the time of decedent's death were a primary liability of and an encumbrance upon the principal trust estate. The court also decided that certain notes, together with accrued interest thereon as of the date of decedent's death, aggregating, in all, $ 17,603.25, held by the First-Central Trust Co., and upon which decedent was either a comaker or endorser, with her son, Fred S. Harter, and upon which the trust company held as collateral certain securities of the trust, pledged to it for this purpose by the trustee upon the written direction of the decedent, were the obligations of decedent's son, Fred S. Harter, whose duty it was to discharge and save harmless the trust estate from payment thereof. But, it was adjudged that, if not so discharged, then such notes were an encumbrance upon the trust fund to be set up in the individual trust for the benefit of Fred S. Harter. The decree also fixed and directed the trustee to pay certain fees in connection with the setting up of the five trusts for the children, and the fees and court costs incident to the declaratory judgment proceeding. These fees were $ 3,000 to the trustee, $ 1,650 to the attorneys, $ 125 to the guardian ad litem, and court costs of $ 54.89, all of which were paid by the trustee out of the corpus of the principal trust estate.

Subsequent to decedent's death there were paid from the corpus of the separate trust set up for the benefit of Fred S. Harter the notes upon which decedent was comaker or endorser with that son and held by the First-Central Trust Co. and against which at decedent's direction securities of the trust estate had been pledged by the trustee as collateral. The amount thus paid was charged by the trustee against Fred S. Harter individually and at the date of the hearing of this proceeding was being repaid by the latter to the trustee by the application of the income of such separate trust to that purpose, which income would otherwise have been distributed to Fred S. Harter.

Among the assets forming a part of the corpus of the principal trust was certain real estate known as 1004 Emma Avenue, Akron, Ohio. This property was sold by the trustee of the trust estate subsequent to the death of the decedent. Between the date of such death and the sale of the property, the trustee expended on this property, by way of maintenance, repairs, taxes, and expenses of sale, the sum of $ 748.29.

In the estate tax return filed by the estate of the decedent, Rose M. Harter, there was claimed as miscellaneous administration expenses $ 115 as paid to appraisers. The respondent disallowed $ 100 of this amount on the ground that it was paid for appraising the assets of the trust estate and not the decedent's estate. The petitioner now admits that only $ 55 was actually paid to the appraisers, but contests the disallowance of $ 40 of this sum. In the estate tax return the alleged net value of the corpus of the above mentioned revocable principal trust was included in the value of the decedent's estate for estate tax purposes. This net value was there set out as $ 191,083.62 as of the date of decedent's death and $ 183,949.38 as of the option date. ¹

In arriving at both of these amounts reflecting alleged net value of the trust estate, the unpaid notes, executed by the decedent in favor of her children, together with accrued interest thereon as of the date of her death, were deducted from the value of the corpus as liabilities of the trust. Similarly, there was deducted the amount of the notes held by the First-Central Trust Co., together with accrued interest thereon to the date of decedent's death, upon which decedent was comaker or endorser with her son, Fred S. Harter, and against which that trust company held as collateral certain securities of the trust estate pledged to it for this purpose by the trustee at the direction of the decedent. There were likewise deducted amounts either owing or paid by the trust as trustee's or attorneys' fees. The individual amounts and the total of these deductions follows:

Liabilities of Trust
Bessie Harter Plumb	Notes and interest		$ 9,703.57
Flora Harter Alexander	Notes and interest		10,672.57
Harry Harter	Notes and interest		9,031.01
Bert Harter	Notes and interest		8,513.35
Total			37,920.50
First-Central Trust Co.	Notes and interest		17,603.25
First-Central Trust Co.	Trustee's fee	$ 3,000.00
Attorneys' fee in trust		2,025.00
			5,025.00
Total liabilities of trust			60,548.75

The trustee's fee of $ 3,000, above set out, was the fee payable to the trustee of the trust created by decedent, upon its division and transfer of its assets to the five separate trusts in favor of each of the children. Of the attorneys' fees of $ 2,025, all but $ 250 covered services to the trust estate rendered subsequent to decedent's death in connection with setting up these five trusts and bringing and conducting the proceeding in court for the declaratory judgment.

In determining the contested deficiency the respondent treated all these deductions, aggregating $ 60,548.75, as having been claimed as liabilities of the decedent's estate. He disallowed all the claims based on the promissory demand notes of decedent to her children, outstanding at her death, on the ground that, under section 812 (b) (3) of the Internal Revenue Code, ² they were not deductible because they had not been incurred for money or money's worth. The deduction premised upon the note evidencing the loan by the First-Central Trust Co. to Fred S. Harter, decedent's son, and jointly executed or endorsed by her as well as secured by collateral of the trust estate pledged at decedent's direction, was disallowed on the ground that it constituted only a secondary and not a primary indebtedness of decedent's estate. The commissions of the trustee and $ 1,775 of the fees of the attorneys, paid by the trust estate for services thereto and listed in the above deductions, were disallowed on the ground that they were liabilities of the trust estate and therefore not deductible as liabilities of the decedent's estate. The remaining $ 250 of the total of $ 2,025 in attorneys' fees was allowed by respondent as a claim against decedent's estate.

OPINION.

In determining the deficiency respondent has treated the items in controversy as if petitioner were claiming them as deductions representing claims against the estate of the decedent allowable under section 812 (b) (3), of the Internal Revenue Code, supra. He disallowed those evidenced by unpaid notes held by decedent's children by applying the limitation of that section to claims "for an adequate and full consideration in money or money's worth." The others he disallowed upon the ground that they represent not claims against decedent's estate, but against the trust estate.

Had petitioner asked credit for these items as claims against decedent's estate, it may well be that respondent's disallowance would have been proper upon those grounds. Guaranty Trust Co. of New York v. Commissioner, 98 Fed. (2d) 62. It appears, however, that petitioner does not seek to deduct them as claims against the decedent's estate. Rather it asks that they be reflected as indebtedness of the trust estate in computing the net value thereof for inclusion in the total upon which the estate tax due from decedent's estate is to be computed.

Petitioner does not question the fact that the net value of the trust estate, as of decedent's death, is to be included in the total upon which the estate tax is to be computed. That value is the real issue here and is a question of fact. That value is the gross fair market value of the trust corpus as of decedent's death, less the amount of legal encumbrances against it as of that date. Commissioner v. Procter, 142 Fed. (2d) 824, affirming this Court on that point.

In determining the question of value the indebtedness to be offset against gross value need merely be legal and enforceable. The limitation of section 812 (b) (3), supra, has no application, since that limitation applies only to "claims against the estate" of the decedent. The trust estate, even though its net value is to be included in computing the estate tax due, is separate and distinct from the decedent's estate and the individuality of the indebtedness of each must be recognized. Estate of Frederic E. Baldwin, 44 B. T. A. 900. In fact, respondent has recognized this principle in disallowing certain of the items contested here as claims against the trust estate and consequently not deductible from the decedent's estate.

That the unpaid notes held by decedent's children evidenced valid, legal, and enforceable claims against the trust estate as of decedent's death can not, we think, be questioned. Even respondent does not do so. Shortly after the death of the decedent and before the pending controversy arose, the bank, trustee under her trust, brought a proceeding before the Court of Common Pleas of Summit County, Ohio, for the purpose of construing the trust so as to obtain an authoritative determination of its legal rights and duties and the respective rights and interests of the several beneficiaries thereunder. This proceeding was not collusive. It was adverse. It had no tax motive. The court formally decided and decreed that these unpaid notes to her children, at the decedent's death, were "obligations" of or "encumbrances" upon the "corpus" of the trust estate and payable therefrom -- before the five individual trust funds were set up pursuant to the trust instrument. The court apparently reached this conclusion upon the ground that the decedent, by her instructions to the trustee and her directions as to the payment of the notes, had modified the trust agreement pro tanto under the power specifically reserved in the instrument. We think we are bound by that judgment. Blair v. Commissioner, 300 U.S. 5">300 U.S. 5; Freuler v. Helvering, 291 U.S. 35">291 U.S. 35; St. Louis Union Trust Co. v. United States, 143 Fed. (2d) 842; Estate of Sallie Houston Henry, 47 B. T. A. 843.

It necessarily follows that the amount of such notes, together with interest thereon to the date of decedent's death, was properly to be reflected by deduction from the gross value of the trust corpus in computing its net value as of that date.

The notes, together with the accrued interest thereon to the date of decedent's death, aggregating $ 17,603.25, held by the First-Central Trust Co., occupy a radically different status, however. These were the primary obligations of Fred S. Harter, decedent's son, and evidenced loans to him from that bank. The trust estate was only secondarily liable, as a guarantor, for the payment of these loans in the amount of its security pledged therefor. After paying the notes from the corpus of the separate trust set up for the benefit of Fred S. Harter, the trustee had and exercised the right of recoupment of that payment from the latter. There is thus no basis for the deduction of this item in determining the net value of the original trust estate of which the separate trust for Fred S. Harter was a part. The corpus was not diminished by this expenditure since, coincident therewith, a collectible claim arose in favor of the trust and in the amount of the payment made. This was the judgment of the state court in the above mentioned proceeding. For the same reasons and upon the same authorities appearing above, that judgment concludes us here.

The trustee's commissions in the sum of $ 3,000 and the attorneys' fees in the amount of $ 1,775 are likewise not deductible in computing the net value of the trust estate as of the date of the death of the decedent since the liabilities for those commissions and fees did not exist at the date of decedent's death. These commissions are not of the character of those involved and allowed as deductions in determining the net value of the trust estate in Estate of Frederic E. Baldwin, supra. In that case the trust terminated upon the death of the decedent. The commissions allowed were those in a fixed percentage of the value of the trust property, which were stipulated to be due and payable in that amount upon termination of the trust. Accordingly those commissions were held to be accruable as a liability of the trust estate upon decedent's death. Here the trust created by the decedent did not terminate upon her death. The trustee continued to hold the trust corpus and was merely required at the death of decedent to divide it into five equal portions to be thereafter held upon five separate trusts. The fees of $ 3,000, allowed here by the court to the trustee, appear to be not a percentage commission for receiving and paying out, but commissions in a lump sum for the additional service rendered by the trustee in bringing the proceeding for a declaratory judgment, in segregating the property into five equal portions, and in paying off indebtedness under the direction of the court's decree, all of which services were performed and the liability to pay for the same arose, after decedent's death.

The contested deduction of the $ 40 alleged to have been paid by petitioner as the cost of the appraisal of the principal trust property after the death of the decedent; the item of $ 748.29, expended by the trust after decedent's death, for taxes, maintenance, repairs, and in connection with the sale of property belonging to the trust estate; and the costs and fees paid by the trustee in connection with the declaratory judgment proceeding, are not deductible for the same reason.

Decision will be entered under Rule 50.

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Footnotes

• 1. Revenue Act of 1926, sec. 302 (j), as added by the Revenue Act of 1935, sec. 202.↩

• 2. SEC. 812. NET ESTATE.

  For the purpose of the tax the value of the net estate shall be determined, in the case of a citizen or resident of the United States by deducting from the value of the gross estate --

  (b) Expenses, Losses, Indebtedness, and Taxes. -- Such amounts

  (3) for claims against the estate,

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  The deduction herein allowed in the case of claims against the estate, unpaid mortgages, or any indebtedness shall, when founded upon a promise or agreement be limited to the extent that they were contracted bona fide and for an adequate and full consideration in money or money's worth. [Italics supplied.]

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