DocketNumber： Docket Nos. 76550, 76551, 79756, 79757
Citation Numbers： 38 T.C. 392, 1962 U.S. Tax Ct. LEXIS 120
Judges： Forrester
Filed Date： 6/25/1962
Status： Precedential
Modified Date： 10/19/2024
Trust-petitioner is a trust created under the residuary clause of the will of Lambert Tree, who died in 1910. Under said clause stated percentages of "net income" are to be retained in the trust in an Improvement Fund. Apart from this retention, the "net income" is payable to individual husband-petitioner (Ronald) for life (after a small annuity to a third party). The trust is to terminate on Ronald's death. At termination one-half of the trust estate (at its then size) goes to a charitable organization contributions to which are deductible under
1. Prior litigation between this trust and respondent involving the tax year 1925 is not binding upon us here under the doctrine of collateral estoppel because this proceeding (involving different taxable years, 1951-1954) involves a question not previously litigated.
2. In applying the stated percentages to "net income" to determine the amount to be retained for the Improvement Fund, income *121 of the trust (after expenses) need not be further reduced by depreciation under the trust instrument and applicable State law.
3. In apportioning the depreciation deduction under
The trust is a resident of the United States. Two of Ronald's three living children are currently residents of the United Kingdom and not engaged in trade or business in the United States.
4. Trust-petitioner is not entitled to the benefits of article XIV of the tax convention between United States and United Kingdom which exempts capital gains earned in the United States by residents of the United Kingdom not engaged in trade or business in the United States.
*393 Respondent has determined the following deficiencies in income tax:
| Docket | Taxpayer | Year | Deficiency |
| No. | |||
| 1951 | $ 1,064.43 | ||
| 76550 | Lambert Tree Trust Estate | 1952 | 6,126.07 |
| 1953 | 8,847.63 | ||
| 1951 | 56,062.56 | ||
| 76551 | Ronald L. and Mary E. Tree | 1952 | 87,088.90 |
| 1953 | 39,672.60 | ||
| 79756 | Lambert Tree Trust Estate | 1954 | 53,685.21 |
| 79757 | Ronald L. and Mary E. Tree | 1954 | 93,925.55 |
The *122 issues remaining for our determination are: (1) Whether a prior adjudication by the Court of Claims relative to the proper depreciation deduction by the trust-petitioner is operative to bar respondent from litigation here under the doctrine of collateral estoppel; if not, whether the trustee set aside too much "income" for charity by failing to deduct depreciation in determining the amount *394 to be set aside; (2) the proper allocation of the allowable depreciation deduction between the trust and the income beneficiaries; (3) whether the trust-petitioner, as to that portion of its capital gains set aside for noncharitable remaindermen, is entitled to have such capital gains exempt from taxation under the tax convention between the United States and the United Kingdom to the extent that the currently indicated remaindermen are now residents of the United Kingdom and not now engaged in trade or business in the United States.
FINDINGS OF FACT.
Some of the facts have been stipulated and are so found.
Lambert Tree died October 9, 1910, a resident of Chicago, Illinois. Under his duly probated will the following pertinent provisions were made:
* * * *
To pay to my said son Arthur for his use and benefit the net income of said trust estate (subject to the reservation hereinafter in this Will mentioned) until my said grand-son Arthur Ronald shall arrive at the age of thirty (30) years, and if that event happens and the said Arthur Ronald is at the time a man of temperate habits and good moral character, then and thereafter to pay to him, the said Arthur Ronald, one-quarter of the net income of said trust estate, and to my son Arthur the remaining three-quarters of the net income of the said trust estate, for and during the term of his natural life.
Upon the death of my son Arthur the net income derived from said trust estate hall be paid to the said *125 Ronald and any other child or children born in lawful *395 wedlock of my said son, Arthur, and the survivors of them, from time to time, during the continuance of the trust, in equal shares; provided, however, that in the event of the death of any of my said son's children, born in lawful wedlock as aforesaid, during the continuance of the trust hereby created, leaving issue surviving, such issue shall receive the same share of the income of said trust estate which such deceased child would have been entitled to receive if living; and provided, further, that while any beneficiary entitled to share in said income shall be under the age of thirty (30) years the said trustees shall, out of his or her share of said net income, make a suitable allowance for the support, maintenance and education of such beneficiary, taking into consideration his or her rank and condition in life; and the residue of his or her share of said net income shall be retained and kept invested by said trustees until such beneficiary shall arrive at the age of thirty (30) years, at which age any accumulation of his or her share of said net income shall be paid over and delivered to such beneficiary.
The trust hereby *126 created shall continue until the death of my son Arthur and of the children of my said son Arthur born in lawful wedlock: provided, however, that in any event the trust hereby created shall cease and determine at the expiration of twenty-one (21) [changed to twenty (20) years by codicil] years after the death of the last survivor of my said son and his children born in lawful wedlock prior to my decease.
Upon the termination of the trust hereby created one-half of the trust estate then remaining in the hands of my said trustees shall go to and be distributed between the lawful issue of my said son Arthur, per stirpes, in the same shares and interests in which they would inherit property owned by him if he had died intestate under the laws of the State of Illinois: and in the event that no lawful issue of my said son Arthur, born in lawful wedlock, shall then survive, then one equal half of the said trust estate shall go to my heirs at law. The other equal one-half of said trust estate I give and bequeath to St. Luke's Hospital of the City of Chicago, in the State of Illinois, * * *.
* * * *
The disposition above provided of the principal and income of said trust estate is subject always *127 to the provision hereinbefore made that all the annuitants hereinbefore provided for shall in any event be first paid out of the income of the said trust estate, and a sufficient amount of the said trust estate shall be retained by said trustees to discharge and pay the said annuities so long as said annuitants, or either of them, shall survive.
Neither my said son Arthur, nor either of his children, or any of their issue, shall have power to anticipate, assign, transfer or otherwise dispose of the whole or any part of the income payable to him or them, or either of them, under the terms and provisions of this article of my will, it being my intention hereby to provide for the comfortable support and maintenance of my said son and his children, and their issue, during the life of the trust hereby created, in the manner and to the extent hereinbefore provided, and which shall not be liable to be diverted from the purposes aforesaid, either by the act of the parties or by process of law.
The petitioners in Docket Nos. 76550 and 79756 are the duly appointed successor trustees under the above testamentary trust. The trust office of these fiduciaries is in Chicago. The individual trustee, Ronald L. Tree (hereinafter referred to as Ronald), was Arthur M. Tree's only child and Lambert's only grandchild and is the same person as the one designated Arthur Ronald under paragraph 20 of the above will. Ronald was born in 1897. During the years in issue he was receiving all the income distributions of the trust (apart from the specific annuities under paragraph 14).
The trust corpus consisted almost exclusively *130 of investments in income-producing property, mostly real estate located in the United States and securities of corporations domiciled in the United States. The trust did not operate any of its properties as part of a going business.
The trust and Ronald (jointly with his wife) filed fiduciary and individual income tax returns, respectively, with the district director of internal revenue at Chicago, Illinois, for the years 1951-1954, inclusive.
During the years 1951-1954 the trust received the following amounts of income (after expenses) prior to the inclusion of capital gains, the deductions for depreciation, the deduction for amounts permanently set aside for St. Luke's Hospital, and the deduction for amounts distributable to Isabel and Ronald:
| Income (includes | |
| Year | tax-exempt interest) |
| 1951 | $ 282,162.52 |
| 1952 | 275,537.27 |
| 1953 | 334,607.52 |
| 1954 | 148,077.48 |
*397 In ascertaining the portions of these amounts to be retained pursuant to paragraph 21 of Lambert's will, the trust based its computation on the theory that these figures were "net income" as that term was used in paragraph 21 of the will and did not further reduce these figures by depreciation *131 on trust property.
The Improvement Fund provided under paragraph 21 of the will was funded by the purchase of bonds which were retained in amounts always greater in value than the credit balance in the fund.
The capital gains earned by the trust were at all times retained by said trust and treated as accretions to trust corpus under the settled practice of trust officers in Illinois. The income beneficiaries of the trust acquiesced in such treatment.
At all times material herein Ronald was a subject of the United Kingdom of Great Britain and Northern Ireland and an alien resident of the United States. Ronald was alive during all the years in issue and has had three children, all born in lawful wedlock and all still living. His two sons are residents and citizens of Great Britain and have never been engaged in trade or business in the United States. We assume, from petitioners' arguments, that the third child, a daughter, was not a resident of Great Britain.
OPINION.
Respondent's position on this issue is not altogether clear, but, as we perceive it, his argument is that the trust retained too much in the Improvement Fund created under paragraph 21 *132 of Lambert's will. He maintains that by applying the requisite percentages to "net income"
When the Commissioner of Internal Revenue originally determined the plaintiffs' tax liability for the year 1925, he made an error in allowing a deduction of only $ 6,562 on the interest of the St. Luke's Hospital in the fund of $ 44,219.10, set up pursuant to the terms of the will of the testator as a building fund and as a protection against the impairment of the corpus of the trust estate. As the will provided that one-half of the trust corpus was to be distributed to St. Luke's Hospital at the termination of *134 the trust, the sum of $ 22,109.55, set aside to preserve that property, was properly deductible as a gift to an organization operated exclusively for religious, charitable, scientific, literary, or educational purposes. The defendant agrees that this amount is correct but sets up as an
We do not feel that it is necessary to enter into a discussion of this offset as presented by the defendant. The section allowing the charitable deduction * * * provides that the deduction shall be allowed "without limitation." If an adjustment is to be made which affects that allowance, it must be clearly shown that it does not do violence to that section which allows the deduction without limitation. Suffice it to say the Commissioner never made any determination on this point and it was first made in the trial of the case. *135 The evidence produced is not sufficient to bear the burden which the defendant has of sustaining its contention by the preponderance of the evidence.
[Emphasis supplied.]
The defendant's (Commissioner's) claimed offset was thus denied.
The doctrine of res judicata is based upon "considerations of economy of judicial time and public policy favoring the establishment of certainty in legal relations."
The language quoted from the Court of Claims opinion in the earlier litigation suggests, as respondent here strenuously urges, that the issue there litigated was the proper amount of the depreciation deduction by the trust.
This difference in approach urged to support the Government's position is enough to compel the conclusion that respondent is not here attempting to litigate the identical issue on which he was unsuccessful in the Court of Claims.
In addition,
We thus hold, from all of the above, that respondent has not previously litigated the issue as to the proper amount of the charitable deduction and thus is not here barred by collateral estoppel.
B. "Net Income" Under Trust Instrument.
We thus proceed to decide on its merits the question whether the retention by the trust for the Improvement Fund was excessive and thereby caused the trust to deduct too large an amount on account of the one-half of this fund which was permanently set aside for charitable purposes. The solution to this question turns upon the *401 meaning of the term "net income" as used in Lambert's will directing the retention of this fund by the trust.
Whether or not the settlor intended the trustee to set aside a reserve for depreciation before distributing income to beneficiaries (for purposes of this discussion we may treat the fund as a beneficiary receiving portions of income) must be determined from the intention of the settlor as expressed in the governing instrument. In the absence of any direct expressions by the settlor such intention must, of course, be gleaned from a study of the instrument as *142 a whole with careful consideration of the purpose it sought to achieve. The accepted rule in Illinois seems to be that where neither the State law nor the settlor has required otherwise, the trustee is to pay the "net income" beneficiary his share of net income
In
Much difficulty could have been avoided if the trust agreement had been so worded as to specify what was meant and intended by the words "net income," * * *. In the absence of express directions to the trustee contained in the trust agreement, where the corpus of the trust is composed of real estate, the term "net income" ordinarily means all of the income remaining from rents, issues and profits, after deducting all the ordinary expenses incurred in connection with the trust estate, or with its administration and management, including annual taxes assessed against the estate, premiums on insurance taken upon the trust property, interest on mortgages, ordinary repairs, *143 water rents, costs of power, light, fuel and janitorial services, the trustee's regular compensation for operating the premises, and other necessary annual expenses of a like nature. All other expenses, including improvements to the real estate, the cost of maintaining, defending or protecting the title to the trust property, principal payments upon mortgages and encumbrances covering the property, are properly charged to principal rather than to income. Cases from other jurisdictions in general accord with this definition of "net income" are
See also
Beyond these rules, we have here independent evidence of the settlor's intention in the very provision creating the Improvement Fund. The express purpose of this fund was to provide a means for financing improvements of the trust real estate and could well have been considered as a substitute for accumulations of depreciation by the trustees. The last portion of paragraph 21 of Lambert's will wherein he permits a reduction in the annual retention for the Improvement Fund if net income falls below $ 60,000 in any year also strongly suggests a primary intent to benefit the life tenant. We thus conclude that the retentions in the Improvement Fund were proper and that all amounts permanently set *145 aside for charity were in pursuance of the trust instrument.
Moreover, respondent's position is highly illogical when we consider the language of the instrument itself in specifying the charity's remainder interest in the trust (par. 20). Upon termination of the trust, said instrument gives one-half of the total trust corpus (at its then size) to the charity. This clearly included all accretions to corpus, whether funded or not. Manifestly, "net income" distributable to Ronald must be measured by the same standard as is "net income" retained in the Improvement Fund. Thus, if respondent were correct and we were to hold that too much was retained in the Improvement Fund, we would simply hold that the trust was to retain an amount of income (equal to the total depreciation) in its
*403
The question here is the proper method of allocating the total allowable depreciation deduction between the trust and the beneficiaries thereof. The rule prior to the Revenue Act of 1928 had been that the trust, being the entity with
Respondent has recognized that the trust instrument contained no provision respecting the apportionment of depreciation; accordingly,
The effect of plaintiff's contention would be to give him the benefit of depreciation on that part of the property in which he had neither a legal nor an equitable interest. *149 If such position is correct, the settlor of a trust might convey 95 percent of the income to charities and 5 percent to an individual and such an individual, by deducting depreciation on the entire property, might escape taxes altogether. To justify such an inequitable conclusion would require a very clear mandate of the statute. Of course, if the statute shows that as the manifest intention of the Congress we have no choice but to apply it, regardless of the result.
Do the provisions of the statute when read together show this to be the intent of the Congress? We think not.
*404 The court then further observed (p. 815):
It is the effect of plaintiff's position that the term "income beneficiaries" as here used
If there had been a provision in the trust instrument that *150 the trustee should set up a reserve for depreciation and distribute the net balance, then charitable beneficiaries would have borne their part of the depreciation and the plaintiff would have received only that part of the depreciation which was allocable to his interest. Since the instrument did not provide for such a reserve, the charitable organizations bore the loss that was occasioned by depreciation in the form of subsequently reduced income. It seems very clear from this provision that plaintiff was entitled only to the depreciation allocable to his interest, and not to his interest plus a corresponding part of the depreciation attributable to the interest of the charitable beneficiaries.
In the
The *151 trust-petitioner seeks to avoid the imposition of any Federal income tax upon two-thirds of the one-half portion of its capital gains which it retained for noncharitable beneficiaries. It relies upon the provisions of article XIV of the income tax convention between the United States and the United Kingdom of Great Britain and Northern Ireland (signed Apr. 16, 1945),
In apparent support of its proposition, petitioner relies upon
The Government's contention that the trust is a *153 separate taxable entity under domestic law and hence not a resident of the United Kingdom, is rather finely drawn and entirely overlooks the evident purpose of the Treaty. The phrase "A resident of the United Kingdom" found in Article XIV, and defined in Article II(1)(g), n5 does not refer to concepts of tax entities under American domestic tax law. The relevant concept is the economics burden upon the individual taxpayer, n6 and the chief purpose of the Treaty is relief from the economic burden of double taxation. * * * [Footnotes omitted.]
Regrettably, the court failed to identify the character (as to certainty of enjoyment) of the remainders there owned by the British residents. It can perhaps be inferred from this failure that the court felt the nature of such remainders to be immaterial and that the
Here, it is clear from the provisions of Lambert's will (par. 20) that the trust will terminate upon Ronald's death since Ronald was Arthur's *406 only child and Arthur was already dead. The indicated remaindermen are the children of Ronald, they being the only issue of Arthur. But which, if any, of Ronald's children (or their heirs) will then take is still a matter of conjecture. Upon Ronald's death, the *155 remaindermen can take only if (a) they are then surviving, or (b) they leave issue who survive Ronald. See Ill. Ann. Stat. ch. 3,
Petitioner devotes considerable time on brief to arguing that remainders here are "vested subject to open" or "vested subject to defeasance" rather than "contingent." We believe otherwise, and in any event the tax consequences here turn not upon such distinctions but rather upon the nature of such interests, whatever label they bear. See
We thus decide this issue for respondent.
Other issues have been settled by stipulation.
1. Proceedings of the following petitioners are consolidated herewith: Ronald L. and Mary E. Tree, Docket Nos. 76551 and 79757; and Lambert Tree Trust Estate, Continental Illinois National Bank and Trust Company of Chicago and Ronald Lambert Tree, Cotrustees, Docket No. 79756.↩
2. Arthur M. Tree, Lambert's son and Ronald's father, had apparently died prior to 1951 38 T.C.↩
3. The amounts of said depreciation are no longer in dispute.
4. Unless otherwise noted, all Code references are to the Internal Revenue Code of 1954.
(c) Deduction for Amounts Paid or Permanently Set Aside for a Charitable Purpose. -- In the case of an estate or trust * * * there shall be allowed as a deduction in computing its taxable income * * * any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid or permanently set aside for a purpose specified in
5. The tax year there involved was 1925 and the law in effect for that year did not permit (or require, as the case may be) the depreciation deduction to be allocated between the income beneficiaries and the trust. Rather, the trust was the only taxpayer entitled to any part of the depreciation deduction.
6. This can never be entirely free from doubt, for the water is here muddied by the circumstance that in its concluding paragraph disposing of the defendant's (Government's) arguments the court said it was rejecting "an adjustment * * * which affects
7. Under the law in effect since the Revenue Act of 1928 (see footnote 5) the difference is, of course, academic. Respondent's earlier position (denying part of the depreciation deduction) would still not prejudice the allocation between Ronald and the trust under current law. Thus, Ronald would benefit from the depreciation deduction against the amount received (undiminished by depreciation). If respondent were successful in his position as to the meaning of "net income," Ronald would be taxed upon a share already diminished by depreciation but would get no further depreciation deduction under 167(g). Likewise, the tax consequences would be the same to the trust under either view. In one case it would only get an aliquot portion of the depreciation deduction but would get a larger distribution deduction. In the other (where "net income" is construed to mean
8.
(g) Life Tenants and Beneficiaries of Trusts and Estates. -- * * * In the case of property held in trust, the allowable deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or, in the absence of such provisions, on the basis of the trust income allocable to each. * * *
(e) Deduction for Depreciation and Depletion. -- An estate or trust shall be allowed the deduction for depreciation and depletion only to the extent not allowable to beneficiaries under
9. This observation is justified because respondent appears to make no argument concerning the distribution deduction of the trust and we thus need consider only the question of the proper charitable deduction. Logically, the distribution deduction should also be affected, since respondent's position on paragraph 21 of the will necessarily implies that the distribution of "net income" to Ronald was too high, and that accordingly his income under 661(a) should be reduced. See
10. Article XIV provides (
"A resident of the United Kingdom not engaged in trade or business in the United States shall be exempt from United States tax on gains from the sale or exchange of capital assets."↩
11. Respondent does not challenge petitioners' proposition that under Illinois law the Federal income tax upon capital gains is (absent a provision to the contrary in the trust instrument) chargeable to corpus.
12. This decision seems squarely opposed to the recent decision of the Second Circuit in
Commissioner v. Sunnen , 68 S. Ct. 715 ( 1948 )
Continental Illinois Nat. Bank & Trust Co. v. United States , 18 F. Supp. 229 ( 1937 )
Scott v. United States , 78 F. Supp. 811 ( 1948 )
In re the Estate of Edgar , 282 N.Y.S. 795 ( 1935 )
In re the Accounting of Herz , 163 N.Y.S.2d 349 ( 1957 )
Freuler v. Helvering , 54 S. Ct. 308 ( 1934 )
BW Jones Trust v. Commissioner of Internal Revenue , 132 F.2d 914 ( 1943 )
Grey v. Commissioner of Internal Revenue , 118 F.2d 153 ( 1941 )
American Trust Company v. Smyth , 141 F. Supp. 414 ( 1956 )
United States Trust Co. v. Jones , 414 Ill. 265 ( 1953 )
Tait v. Western Maryland Railway Co. , 53 S. Ct. 706 ( 1933 )
Fairmont Aluminum Company v. Commissioner of Internal ... , 222 F.2d 622 ( 1955 )
Mercantile Trust & Savings Bank v. Rogers , 5 Ill. App. 2d 162 ( 1955 )
Baltzell v. Mitchell , 3 F.2d 428 ( 1925 )
American Trust Company, a Corporation v. James G. Smyth, ... , 247 F.2d 149 ( 1957 )