Staley v. Commissioner

ESTATE OF A. E. STALEY, SR., A. E. STALEY, JR., EXECUTOR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Staley v. Commissioner

Docket No. 103754.

United States Board of Tax Appeals

47 B.T.A. 260; 1942 BTA LEXIS 713;

July 2, 1942, Promulgated

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Decedent desired to make gifts of stock to his five children but did not have sufficient funds to pay the estimated gift taxes payable on the contemplated gifts. In order to obtain such funds and still place the stocks in trust he transferred the stocks in trust "in consideration" of the trustee's payment to him of $30,000 from the income of each of the trusts, an aggregate of $150,000. The sum of $150,000 was paid decedent by the trustee in the taxable year. Held, that the $150,000 is taxable as income to decedent.

Charles C. LeForgee, Esq., for the petitioner.

Franklin F. Korell, Esq., and David Altman, Esq., for the respondent.

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ARUNDELL

The Commissioner determined a deficiency in the income tax of decedent for the year 1935 in the sum of $79,300.99. The sole issue before the Board is whether or not the sum of $150,000 of the income of trusts established by decedent for his children is includible in decedent's income for the taxable year.

Many of the facts were stipulated. We set forth only those of the stipulated facts material to disposition of the issue before us.

FINDINGS OF FACT.

Petitioner is the executor of the estate of A. E. Staley, Sr., hereinafter referred to as decedent. Decedent's income tax return for the taxable year was filed with the collector of internal revenue for the district of Florida.

Prior to March 1932 decedent was president of the A. E. Staley Manufacturing Co., hereinafter referred to as the corporation, and after that date he became and remained chairman of the board of directors of the corporation until his death. In the year 1934 decedent was the father of five children, Ione Tressler Dunlap, Augustus E. Staley, Jr., Ruth Richardson Hunt, Mary Louise Annan, and Andrew Rollin Staley, all of whom were living and over 27 years of age. Decedent at that time was the owner of approximately 36,000 of the outstanding 42,000 shares of the common stock of the corporation and of a substantial number of shares of the preferred stock of the corporation.

Decedent determined to make a gift of 6,000 shares of common stock and 2,000 shares of preferred stock of the corporation in trust for the benefit of each of his children. It was ascertained that the transfer of the proposed gifts in trust would entail a gift tax aggregating approximately $150,000 more than the amount of cash which decedent had available for payment of such tax. Decedent there upon decided to transfer the stock in trust in such a way as to enable him to raise the $150,000 necessary for payment of the gift tax.

Under date of October 18, 1934, decedent executed five trust instruments, each naming the Safe Deposit & Trust Co. of Baltimore, trustee, A. E. Staley, Jr., cotrustee, and one of decedent's children life beneficiary. Upon execution of the trust instruments decedent delivered to the trustee, as the corpus of each trust, certificates representing 6,000 shares of common stock and 2,000 shares of preferred stock of the corporation. At the date of these transfers the common stock had a value of $42.50 a share and the preferred stock had a value of $85 per share.

The five trust instruments were identical except as to the named beneficiary. Each of the trust instruments contained, among others, the following provisions:

THIS TRUST AGREEMENT made this 18th day of October, 1934, by and between AUGUSTUS E. STALEY, hereinafter called Donor, Party of the First Part, and the SAFE DEPOSIT AND TRUST COMPANY OF BALTIMORE, (a Maryland corporation), hereinafter called Trustee, and AUGUSTUS E. STALEY, JR., of Decatur, Illinois, hereinafter called Co-Trustee, the Parties of the Second Part.

WITNESSETH:

THAT, WHEREAS, the Donor has assigned, transferred and delivered to the Trustee the property described in the schedule hereto attached and made a part hereof and entitled, "SCHEDULE OF THE PROPERTY OF THE AUGUSTUS E. STALEY TRUST," (hereinafter called Trust Estate), in Trust, however, for the uses and purposes in this instrument set forth and stated.

NOW, THEREFORE, for and in consideration of the sum of Thirty Thousand Dollars ($30,000.00) to be paid to the Donor, as provided in ARTICLE THIRD, and certain other good and valuable considerations paid by the parties hereto each to the other, receipt of which is by them now severally acknowledged, and in further consideration of the covenants in this instrument to be by said parties respectively kept and performed, it is hereby agreed:

* * *

ARTICLE THIRD: Out of the income derived and received by my said Trustee from the Trust Estate, the Trustee shall:

(a) Upon the written approval of the Co-Trustee, pay all taxes, costs and expenses necessary for the preservation and maintenance of said Trust Estate.

(b) Out of the income of said Trust Estate to annually pay to the Trustee two percent (2%) for the services by it rendered as such Trustee, and annually pay two percent (2%) of the income of said Trust Estate to the Co-Trustee so long as said Co-Trustee shall so act as Co-Trustee.

* * *

(c) After the Trustee has made the payments in (a) and (b) of this ARTICLE THIRD hereof mentioned, the Trustee shall out of the income by it received up to and including March 15, 1935, pay to the Donor the entire income by it received out of said Trust Estate, in satisfaction of the consideration of Thirty Thousand Dollars ($30,000.00) as hereinbefore provided, but in no event shall such payment to the Donor exceed the sum of Thirty Thousand Dollars ($30,000.00).

After March 15, 1935, the said Trustee shall distribute the income from said Trust Estate in the following manner:

(1) After the payment of (a) and (b) aforesaid, it shall pay to * * * [the named beneficiary] out of the income of said Trust Estate the sum of Five Thousand Dollars ($5,000.00) per annum, accounting from March 15, 1935, all payments of said Five Thousand Dollars ($5,000.00) shall be paid in such installments as the Trustee shall deem practicable, and all sums annually received as income by said Trustee in excess of said annual payments of Five Thousand Dollars ($5,000.00) per annum, shall be by said Trustee annually paid to the Donor until the total sum of said Thirty Thousand Dollars ($30,000.00) has been paid to the said Donor.

Each of the trust instruments further provided for the accumulation of a fund of $25,000, after the $30,000 had been paid to decedent and $5,000 had been paid to the beneficiary or beneficiaries. Thereafter the trustee was to retain 20 percent of the income of each trust until an additional $25,000 had been accumulated in each trust, after which the trustee should pay the balance of the net income to the beneficiaries. In the event that the net income of any trust should fall below $5,000 during any year, the trustee was directed to invade the $50,000 accumulated fund to the extent of the deficiency.

Each of the trusts is irrevocable and is to terminate upon the expiration of 20 years after the death of the named beneficiary or upon the expbiration of 40 years after the date of execution of the trust instrument. But if the expiration of the 40-year period occurs after the death of the named beneficiary, then the trust is to terminate upon the date of the periods mentioned nearest in time after the death of the named bendficiary. Each trust is to terminate, in any event, within 20 years of the death of the named beneficiary.

Each trust instrument provided that upon termination the trustee should pay the entire trust estate with all accumulations therein to the child of the named bendficiary surviving at the date of distribution, or to the descendants then surviving of any deceased child of the beneficiary, or, if no children of the named beneficiary or descendants of such children should then be living, then in equal shares to the decedent's other surviving children or their descendants per stirpes.

Each trust instrument contained a "Schedule of Duties, Rights and Powers of the Trustee and Co-Trustee" providing that the trustee should not sell, transfer, mortgage, or pledge securities forming the corpus of the trust except upon written approval of decedent. This schedule also provided that upon the sale of stocks the proceeds might be invested by the trustee but only upon the approval of decedent. The schedule of duties of the trustee and co-trustee provided that during decedent's life decedent or his nominee might vote the stocks held in trust.

This schedule further provided:

(1) If any estate, inheritance or succession taxes, duties or transfer charges are assessed in connection with any annuity or gift under this agreement they shall be paid out of the income of the estate, and if said income is not sufficent to meet such charge, then the Trustee, upon written approval of the Co-Trustee, is authorized to pay the same out of the corpus of the Trust Estate.

(m) In case the Trustee shall be compelled at any time during the existence of this Trust or after its termination ot pay any tax or any penalty with respect to any succession or transfer here affected or directed, or because of the property held under this agreement or income arising therefrom, the said Trustee shall be entitled to sell such of the Trust Estate as may be necessary to pay said tax or penalty, such sale to be approved by Donor, if living, and if dead, then by the Co-Trustee, if he be then serving.

Decedent retained the right in the case of each trust to substitute another trustee, upon written notice to the trustee.

In January 1935 the trustee received five checks of $7,000 each from the corporation in payment of a dividend on preferred stock of the corporation held in trust. After deducting its commission and certain minor expenses from these dividend checks, the trustee sent its check to decedent in the sum of $33,600 in partial satisfaction of the aggregate of $150,000 to be paid under the provisions of article third of the five trust instruments.

In February 1935 the corporation declared a dividend on common stock and the trustee received an aggregate of $150,000 in dividends on this stock held in the five trusts. From this dividend payment, totaling $150,000, the trustee paid decedent the balance of the $150,000 payable under the provisions of article third of the five trusts, by check dated March 4, 1935, in the amount of $116,400.

On or about March 15, 1936, the trustee filed a fiduciary return of income for the year 1935 in behalf of each of the trusts, reporting therein retained income taxable to the trusts, which included the amounts paid to decedent under the provisions of article third of the trust instruments.

Decedent did not report as gross income in his 1934 or 1935 Federal income tax return the $150,000 paid him in 1935 by the trustee in accordance with the provisions of article third of the trust instruments.

On March 16, 1935, decedent filed a gift tax return for the year 1934 and reported therein the five gifts in trust made in 1934 for the benefit of his children. He excluded from the reported value of the gifts in trust the $150,000 payable to him under article third of each of the trusts. The Commissioner determined a deficiency in decedent's gift tax liability, which decedent petitioned this Board to redetermine. On May 3, 1940, the Board rendered its decision to the effect that there was a deficiency in the gift tax liability of decedent in the amount of $55,700. In determining the amount of the deficiency of decedent's gift tax liability the Board found that the sum of $150,000 representing the aggregate amount of the five $30,000 payments under article third of the trusts was properly excluded from computation of the value of the properties which decedent transferred to the trustee and cotrustee of the five trusts on October 18, 1934.

OPINION.

ARUNDELL: The single question raised in this proceeding is whether the $150,000 paid to decedent out of the income of the five trusts created by him for the benefit of his five children is to be taxed as ordinary income or is to be treated as a return of capital. The provision in the trust instruments for this payment was inserted, according to the testimony, to provide money to assist decedent in the payment of a very large gift tax on the transfers in trust.

Petitioner argues that each trust instrument has a provision requiring the payment to decedent of a consideration of $30,000 and that as the payment was made pursuant to this provision, it follows that the sum received was not income but must be regarded as "consideration." But this is an over-simplification. It does not follow that all money received in consideration for the transfer of property, whether in trust or otherwise, is a return of capital. The record in this case is completely barren of any testimony disclosing the basis of the shares of stock in the A. E. Staley Manufacturing Co. which were transferred to the several trusts. The necessity for this proof was repeatedly pointed out to counsel for the petitioner, both at the outset of the hearing and during the course of the trial of the case. Thus, if we accept the approach of petitioner that the $150,000 was paid decedent in consideration for making the transfer, there is a complete failure of proof in establishing how much, if any, of this sum represented a return of capital to him. Nor do we think there is any merit in petitioner's argument, suggested for the first time in his reply brief, that, assuming the full $150,000 to be profit on the transfers in trust, this profit was realized in 1934, when the trusts were created, and not in 1935, when the money was paid over. The stated consideration was to be paid solely out of income if, as, and when received by the trusts and not otherwise. The decedent did not treat the transaction as a sale of securities in the making of his 1934 income tax return and in fact made no mention of having sold any shares to the several trusts. The income tax law and regulations have always required an identification of the shares sold, a statement of their cost or other basis, the time of their acquisition, and the length of their holding. Regulations 86, art. 22(a)-8; ; . The testimony in this proceeding is that the decedent rejected the idea of a sale of these shares to the several trusts but adopted instead the plan already described.

At one point in the presentation of this case petitioner's counsel seemed to advance the argument that the $150,000 was consideration for the execution of the trusts as distinct from a payment for the shares transferred. If this were true, the $150,000 would necessarily be taxed to decedent in full, since there clearly was no cost or other basis shown for the execution of the trusts.

While in our opinion the record would not support a decision in petitioner's favor even on his own hypothesis, we are not disposed, however, to rest our decision on a failure of proof on the part of petitioner.

The treatment of the money received by decedent as a return of capital from the sale of securities seems to us entirely artificial. Petitioner was making a gift of property to his children. He was not selling them shares of stock. One does not sell over $2,000,000 worth of shares for $150,000. It is equally artificial to treat the transactions as in part a sale and in part a gift. The property transferred was for shares of stock and if it had been decedent's intention to sell some of those shares he could have easily designated the ones he intended to sell as distinct from those that he was giving away. Since there was no bona fide sale of stock, the case of , relied upon by petitioner, is clearly distinguishable. The simple fact is that decedent was providing a means of securing $150,000 from the first income of the trusts, and this income he received. The fact that payment of the $150,000 was to be made out of income is indicative of decedent's retention of a right to income in that amount. See . Whether we say decedent made himself a preferred beneficiary of the trusts to the extent provided, , or that he reserved $150,000 of the income of the trusts when he made the gifts, , is of no particular importance in determining the fundamental question of whether or not the sum received was taxable income. Nothing more nor less than gifts of the shares was involved and the $150,000 was received by decedent as income rather than return of capital.

Decision will be entered for the respondent.