DocketNumber: Docket No. 7331-79
Citation Numbers: 76 T.C. 1040, 1981 U.S. Tax Ct. LEXIS 109
Judges: Fay
Filed Date: 6/22/1981
Status: Precedential
Modified Date: 1/13/2023
Petitioner-husband was grantor of a trust from which he received unsecured loans. The loans were not repaid by the beginning of 1974 or by the beginning of 1975.
*1040 Respondent determined deficiencies of $ 7,225 and $ 6,732 in petitioners' Federal income taxes for 1974 and 1975, respectively. The only issue for decision is what part of a trust created by petitioner-husband is to be treated as being owned by him during 1974 and 1975 under
FINDINGS OF FACT
Some of the facts have been stipulated and are found accordingly.
Petitioners Larry W. Benson and June E. Benson, husband and wife, were residents of Peoria, Ill., when they filed their petition in this case.
After earning a degree in marketing at Wartburg College, petitioner Larry Benson began working for Maytag. While in Peoria, Ill., *110 on a special project, he became interested in opening his own business in the Peoria area. Petitioners opened a home appliance center in Peoria in January 1966. Petitioners have been very successful; they currently own and operate two retail appliance centers and three laundromats. However, it is the first home appliance center which is important to this case, and that is the one to which we will refer.
Petitioners initially operated their business on rented premises. *1041 In 1968 and 1969, they acquired two contiguous tracts of land in Peoria County for about $ 28,000. Subsequently, they erected a building and other improvements on the land at a cost of $ 120,624. The real estate as thus improved shall hereinafter be referred to as the "property." In March 1970, petitioners moved their appliance business from the rented premises to the "property."
On January 1, 1972, petitioners leased the "property" to Benson's Maytag, Inc., petitioner Larry Benson's wholly owned corporation. The lease, which runs until June 30, 1982, calls for a monthly rent of $ 1,700.
On March 31, 1972, petitioners, by quitclaim deeds, transferred the "property" to the "L. William Benson Short Term Irrevocable *111 Trust," a trust created by petitioner Larry Benson on the same date. 2 Petitioner June Benson was named trustee of the trust. The trust is to terminate 10 years and 10 days after the last contribution to it is made. All net trust income is to be paid annually to petitioners' four children or for their benefit with all capital gains and losses being allocated to principal. 3*112 When the trust terminates, all accrued but undistributed net income will be distributed to the children or to the children's appointees, while the trust principal will revert to petitioner Larry Benson. 4
Petitioner June Benson, as trustee, has the power to invest, sell, or exchange trust property and the power to borrow money pledging trust property as security. Additionally she may as trustee, "loan trust property to any person with provision for reasonable interest and security."
Evidently the only asset ever transferred to the trust was the "property" which housed the home appliance center. Therefore, *1042 the rents paid by Benson's Maytag, Inc., were the trust's only source of income. 5*113 When the "property" was transferred to the trust, its fair market value was $ 200,000. Its fair market value was approximately $ 295,000 on January 1, 1974, and approximately $ 325,000 on January 1, 1975.
Petitioner June Benson, as trustee, made several loans to petitioner Larry Benson. Each of those loans was unsecured, bore interest of 8 percent, and was represented by a promissory demand note. 6 The loans were as follows:
Date of loan | Amount |
May 1, 1973 | $ 17,215 |
Sept. 1, 1974 | 5,000 |
Sept. 1, 1974 | 1,500 |
Nov. 1, 1974 | 24,000 |
No payments on the loans were made before January 1, 1976. The loans, including accrued interest, were paid in full on December 30, 1977. The total principal and interest amounts outstanding at the beginning of the taxable years involved herein were as follows:
Principal | Interest | Total | |
Jan. 1, 1974 | $ 17,215 | 916.87 | $ 18,131.87 |
Jan. 1, 1975 | 47,715 | 2,782.06 | 50,497.06 |
The trust reported the following income and deductions on its returns for 1973, 1974, and 1975:
Income | Taxes | Depreciation | Distributions | |
1973 | 7*114 $ 22,150 | ($ 5,097) | ($ 3,016) | $ 14,037 |
1974 | 20,400 | (3,619) | 16,781 | |
1975 | 20,400 | (3,724) | 16,676 |
Thus, the trust reported zero taxable income for each of those 3 years.
*1043 Although distribution deductions were taken, the beneficiary children received no money or property from the trust. 8 All net trust receipts until November 1, 1974, were loaned to petitioner Larry Benson.
In his statutory notice of deficiency, respondent determined that petitioner Larry Benson should be treated as owning the entire trust during 1974 and 1975. Thus, per
OPINION
The only issue for decision is what part of a trust created by petitioner-husband is to be treated as being owned by him during 1974 and 1975 as a result of loans made by the trust to him. Petitioner-husband, a trust grantor, borrowed *115 trust funds without security and did not repay the loans before the beginning of 1974 or before the beginning of 1975, the taxable years involved herein. Thus, under
Petitioners contend that "portion" refers to the part of the trust borrowed in comparison to the entire trust. Accordingly, they maintain that the part of the trust income taxable to them is an amount which bears the same ratio to the trust's entire income as the amount of loans, including interest, outstanding at the beginning of the taxable year bears to the fair market value of the trust at the beginning of the taxable year. Respondent argues that "portion" *116 means the entire trust whenever a grantor has the power to borrow all corpus or income and any trust *1044 property is borrowed. Alternatively, respondent contends that "portion" is a fraction arrived at by dividing the amount borrowed, including interest, by the trust's income for the year calculated without the sections 651 and 661 distribution deductions. 11*117 We do not adopt respondent's analysis but sustain his determination in this case for the reasons below.
At the outset, we note that while "portion" is used throughout the Code sections comprising the grantor trust rules, its meaning varies from section to section and from case to case.
In determining what "portion" of a trust should be treated as being owned by its grantor, most of the grantor trust rules focus on powers set forth in the trust instrument *119 which evidence a grantor's dominion and control over trust property without regard to whether or not those powers are ever exercised. 13 In most cases, it is fairly simple to tell over what part of a trust a power extends; therefore, the meaning of "portion" is easily decided. For example, if a grantor has the power to distribute the entire trust to his spouse, the entire trust is treated as his even if only part of the trust is actually so distributed. See sec. 677(a)(1). On the other hand, if a grantor has the power to distribute only current income to his spouse, he is treated as owning only the current income interest in the trust. In the latter case, "portion" means only the current income interest, because that is the only trust segment over which the grantor has any power.
In order fully to understand the implications of grantor borrowing,
As *122 previously noted,
Likewise, we reject petitioners' contention that "portion" refers to the amount borrowed in comparison to the entire trust. Petitioner would have us calculate a fraction arrived at by dividing the amount borrowed by the trust corpus, and treat that fraction as the trust "portion" owned by the grantor. If such were the case, a trust grantor could borrow the entire trust income derived from the entire trust corpus but only be treated as owning a fraction of the trust, even though his borrowing evidences dominion and control over the entire trust. We find such a result patently unreasonable and unsupported by the statutory language or any other authority. 18*125
On the other hand, we need not address respondent's contention that "portion" means the entire trust whenever a grantor has the power to borrow all corpus or income and any trust property is borrowed. See
Petitioners in this case have made no showing that less than all the trust should be treated as being owned by petitioner-husband. 20 As previously *127 noted, he borrowed all the trust income which was in respect of all the trust corpus. His borrowings undoubtedly indicate significant dominion and control over the entire trust. Accordingly, we conclude that petitioner-husband is treated as owning the entire trust during 1974 and 1975.
To reflect the foregoing,
1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as amended.↩
2. At the time the "property" was transferred to the trust, it was subject to a mortgage executed by petitioners on Sept. 30, 1971. Petitioners remained personally liable and continued to make the mortgage payments after the transfer.↩
3. When the trust was created, all petitioners' children were minors, each being under 8 years of age. Thus, according to the trust terms, the children were considered "incapacitated." Their status as such gave the trustee, petitioner June Benson, the right to distribute the income either to the children, to their parents (petitioners), to their custodian, guardian, or conservator, or to anyone with whom the children resided. The trust expressly absolves the actual recipient of the distribution from responsibility for its expenditure.
4. Since the trust requires annual distribution of all net income, the only accrued income should be year-of-termination income not yet distributed to the children at the time the trust terminates.↩
5. Certain facts in this case indicate that the trust might have had additional assets and income. See note 7
6. The notes were executed by L. William Benson (petitioner Larry Benson) d. b. a. Benson's Leasing.↩
7. The record does not show how the trust had $ 22,150 of income in 1973 which is $ 1,750 more than the $ 20,400 which should have resulted from 12 monthly rental payments from Benson's Maytag, Inc.
8. The trust filed its tax returns as a simple trust each year. See sec. 651(a)(1).↩
9. Although the trust did not claim any depreciation deductions in 1974 or 1975, respondent has allowed petitioners those deductions.↩
10.
The [trust] grantor shall be treated as the owner of any
* * * *
(3) Borrowing of the trust funds. -- The grantor has directly or indirectly borrowed the corpus or income and has not completely repaid the loan, including any interest, before the beginning of the taxable year. * * *
[Emphasis added.]↩
11. Respondent also contends that the trust is a "sham" for tax purposes.
"No items of a trust shall be included in computing the taxable income and credits of the grantor or of any other person solely on the grounds of his dominion and control under section 61 * * * or any other provision of this title, except as specified in this subpart."
Thus, income of a trust is not attributed to the trust grantor because of the grantor's dominion and control over the trust unless one of the specific grantor trust rules, see secs. 673-677, or assignment of income principles applies. See
12. The regulations recognize six possible meanings of "portion": the entire trust; the trust accounting income; the trust corpus; a fraction or dollar amount of trust accounting income; a fraction or dollar amount of corpus; or specific trust property. See
13. See, e.g., secs. 674; 675(1), (2), and (4); 676; 677(a).↩
14. See also sec. 677(b), which applies when trust income is actually used, pursuant to a discretionary power, to support or maintain a beneficiary, other than the grantor's spouse, whom the grantor is legally obligated to support or maintain. That section clearly limits taxation of the grantor to income actually so applied.↩
15. Of course, if the tainted lending power extends only to a "portion" of the trust, that is, if the grantor could only lend himself corpus, then only that "portion" should be attributed to the grantor. Cf.
16. By referring to a friendly trustee, we mean one who is a related or subordinate party subservient to the grantor. See
17. In
It might seem that
18. Petitioners mistakenly rely on
19. Such a case would arise if, for example, a trust grantor transferred two separate income-producing stocks to a trust, but only borrowed the income derived from one of those stocks. Respondent would argue that the grantor's borrowing represents not only the grantor's control of the property he has in hand but is indicative of his ability to control all the trust property on similar terms. Just as the mere existence of a power to revoke evidences substantial dominion and control, see
20. Petitioners contend that the burden of proof rests with respondent because respondent took alternative, inconsistent positions in his notice of deficiency. That contention is meritless. See